**UNITED STATES**

**SECURITIES AND EXCHANGECOMMISSION**

**Washington,D.C. 20549**

**FORM 10-Q**

**x****QUARTERLY REPORT PURSUANT TOSECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934**

**For thequarterly period ended June 30, 2006**

**OR**

**o****TRANSITION REPORT PURSUANT TOSECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934**

**For thetransition period from                            to                                            **

**Commissionfile number: 333-90273**

**FIDELITY D & D BANCORP, INC.**

 

| STATE OF INCORPORATION: |   | IRS EMPLOYER  IDENTIFICATION NO: |
|-------------------------|--------|----------------------------------|
| **PENNSYLVANIA**        |   | **23-3017653**                   |

 

Address of principalexecutive offices:

**BLAKELY & DRINKER ST.**

**DUNMORE,PENNSYLVANIA 18512**

TELEPHONE:

**570-342-8281**

Indicate by checkmark whether the registrant (1) has filed all reports required to be filed bySection 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding12 months (or for such shorter period that the registrant was required to filesuch reports), and (2) has been subjected to such filing requirements for thepast 90 days.

xYES    oNO

Indicate by checkmark whether the registrant is a large accelerated filer, an accelerated filer,or a non-accelerated filer.  Seedefinition of “accelerated filer and large accelerated filer” in Rule 12b-2 ofthe Exchange Act.  (Check one):

Large accelerated filer o          Acceleratedfiler o          Non-accelerated filer x

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

oYES    xNO

The number of outstandingshares of Common Stock of Fidelity D & D Bancorp, Inc. at July 31, 2006,the latest practicable date, was 2,048,820 shares.

 

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**FIDELITY D & D BANCORP, INC.**

Form 10-Q June 30,2006

Index
| **Part I. Financial  Information**   | ** ** | ** **                                                                                                        |
|--------------------------------------|------------|-------------------------------------------------------------------------------------------------------------------|
| ** **                           | ** ** | ** **                                                                                                        |
| Item 1.                              |       | Financial Statements:                                                                                             |   |   |
|                                 |       | Consolidated Balance  Sheets as of June 30, 2006 and December 31, 2005                                            |   |   |
|                                 |       | Consolidated  Statements of Income for the three and six months ended June 30, 2006 and  2005                     |   |   |
|                                 |       | Consolidated  Statements of Changes in Shareholders’ Equity for the six months ended June  30, 2006 and 2005 |   |   |
|                                 |       | Consolidated  Statements of Cash Flows for the six months ended June 30, 2006 and 2005                            |   |   |
|                                 |       | Notes to  Consolidated Financial Statements                                                                       |   |   |
|                                 |       |                                                                                                              |   |   |
| Item 2.                              |       | Management’s  Discussion and Analysis of Financial Condition and Results of Operations                       |   |   |
|                                 |       |                                                                                                              |   |   |
| Item 3.                              |       | Quantitative  and Qualitative Disclosure about Market Risk                                                        |   |   |
|                                 |       |                                                                                                              |   |   |
| Item 4.                              |       | Controls and  Procedures                                                                                          |   |   |
|                                 |       |                                                                                                              |   |   |
| **Part II. Other  Information** |       |                                                                                                              |
| ** **                           | ** ** | ** **                                                                                                        |   |   |
| Item 1.                              |       | Legal Proceedings                                                                                                 |   |   |
|                                 |       |                                                                                                              |   |   |
| Item  1A.                            |       | Risk Factors                                                                                                      |   |   |
|                                 |       |                                                                                                              |   |   |
| Item 2.                              |       | Unregistered  Sales of Equity Securities and Use of Proceeds                                                      |   |   |
|                                 |       |                                                                                                              |   |   |
| Item 3.                              |       | Defaults  Upon Senior Securities                                                                                  |   |   |
|                                 |       |                                                                                                              |   |   |
| Item 4.                              |       | Submission  of Matters to a Vote of Security Holders                                                              |   |   |
|                                 |       |                                                                                                              |   |   |
| Item 5.                              |       | Other Information                                                                                                 |   |   |
|                                 |       |                                                                                                              |   |   |
| Item  6.                             |       | Exhibits                                                                                                          |   |   |
|                                 |       |                                                                                                              |   |   |
| Signatures                           |       |                                                                                                              |   |   |
|                                 |       |                                                                                                              |   |   |
| Exhibit  index                       |       |                                                                                                              |   |   |

 

2

----

 

**PART I –Financial Information**

**Item 1: Financial Statements**

 

**FIDELITY D& D BANCORP, INC.**

ConsolidatedBalance Sheets

As of June 30, 2006 andDecember 31, 2005

 
| ** **                                                                                                                                | ** ** | **June 30, 2006** | ** **  | **December 31, 2005** | ** ** |
|-------------------------------------------------------------------------------------------------------------------------------------------|------------|-----------------------------|-------------|---------------------------------|------------|
| ** **                                                                                                                                | ** ** | **(unaudited)**             | ** **  | **(audited)**                   | ** ** |
| **ASSETS**                                                                                                                                | ** ** | ** **                  | ** **  | ** **                      | ** ** |
| Cash and due from banks                                                                                                                   |       | $                           | 11,960,057  |                            | $          | 12,525,723 |   |
| Interest-bearing  deposits with financial institutions                                                                                    |       | 161,540                     |        | 68,817                          |       |
| Total cash and  cash equivalents                                                                                                          |       | 12,121,597                  |        | 12,594,540                      |       |
| Available-for-sale  securities                                                                                                            |       | 111,762,272                 |        | 95,681,654                      |       |
| Held-to-maturity  securities                                                                                                              |       | 1,785,410                   |        | 1,996,919                       |       |
| Federal Home Loan Bank  Stock                                                                                                             |       | 4,558,400                   |        | 4,628,200                       |       |
| Loans and leases, net  (allowance for loan losses of $5,738,470 in 2006; $5,984,649 in 2005)                                              |       | 417,726,617                 |        | 403,144,095                     |       |
| Loans  available-for-sale (fair value $198,935 in 2006; $434,272 in 2005)                                                                 |       | 195,379                     |        | 428,584                         |       |
| Bank premises and  equipment, net                                                                                                         |       | 11,521,561                  |        | 11,683,148                      |       |
| Cash surrender value of  bank owned life insurance                                                                                        |       | 8,033,031                   |        | 7,891,898                       |       |
| Other assets                                                                                                                              |       | 4,779,122                   |        | 4,033,132                       |       |
| Accrued interest  receivable                                                                                                              |       | 2,591,737                   |        | 1,959,826                       |       |
| Foreclosed assets held  for sale                                                                                                          |       | 53,099                      |        | 18,702                          |       |
| **Total  assets**                                                                                                                         |       | $                           | 575,128,225 |                            | $          | 544,060,698 |   |
| **LIABILITIES**                                                                                                                           | ** ** | ** **                  | ** **  | ** **                      | ** ** |
| Deposits                                                                                                                                  |       |                        |        |                            |       |
| Non-interest-bearing                                                                                                                      |       | $                           | 70,560,800  |                            | $          | 70,361,086 |   |
| Certificates of  deposit of $100,000 or more                                                                                              |       | 63,488,886                  |        | 76,257,553                      |       |
| Other interest-bearing  deposits                                                                                                          |       | 288,805,669                 |        | 232,880,001                     |       |
| Total deposits                                                                                                                            |       | 422,855,355                 |        | 379,498,640                     |       |
|                                                                                                                                      |       |                        |        |                            |       |
| Accrued interest  payable and other liabilities                                                                                           |       | 3,253,894                   |        | 3,238,844                       |       |
| Short-term borrowings                                                                                                                     |       | 31,659,106                  |        | 28,772,997                      |       |
| Long-term debt                                                                                                                            |       | 68,324,751                  |        | 83,704,188                      |       |
| **Total  liabilities**                                                                                                                    |       | 526,093,106                 |        | 495,214,669                     |       |
|                                                                                                                                      |       |                        |        |                            |       |
| **COMMITMENTS AND CONTINGENCIES**                                                                                                         | ** ** | ** **                  | ** **  | ** **                      | ** ** |
| ** **                                                                                                                                | ** ** | ** **                  | ** **  | ** **                      | ** ** |
| **SHAREHOLDERS’ EQUITY**                                                                                                             | ** ** | ** **                  | ** **  | ** **                      | ** ** |
| Preferred stock  authorized 5,000,000 shares with no par value; none issued                                                               |       | —                      |        | —                          |       |
| Capital stock  authorized 10,000,000 shares with no par value; issued and outstanding  2,048,820 shares in 2006; 2,039,639 shares in 2005 |       | 18,417,715                  |        | 10,594,901                      |       |
| Retained earnings                                                                                                                         |       | 32,965,248                  |        | 39,363,461                      |       |
| Accumulated other  comprehensive loss                                                                                                     |       | (2,347,844                  | )           | (1,112,333                      | )          |
| **Total  shareholders’ equity**                                                                                                      |       | 49,035,119                  |        | 48,846,029                      |       |
| **Total liabilities and  shareholders’ equity**                                                                                      |       | $                           | 575,128,225 |                            | $          | 544,060,698 |   |

 

See Notes to Consolidated Financial Statements

3

----

 

**FIDELITY D& D BANCORP, INC.**

ConsolidatedStatements of Income

(unaudited)

 
| ** **                                                | ** ** | **Three Months Ended** | ** ** | **Six Months Ended** | ** ** |
|-----------------------------------------------------------|------------|----------------------------------|------------|--------------------------------|------------|
| ** **                                                | ** ** | **June 30, 2006**      | ** ** | **June 30, 2005**    | ** ** | **June 30, 2006** | ** ** | **June 30, 2005** | ** ** |
| **Interest  income**                                      | ** ** | ** **                       | ** ** | ** **                     | ** ** | ** ** | ** ** | ** ** | ** ** |
| Interest and fees on loans and leases:                    |       |                             |       |                           |       |   |   |   |   |
| Taxable                                                   |       | $                                | 6,879,670  |                           | $          | 5,752,647 |   | $ | 13,378,288 |   | $ | 11,435,615 |   |
| Nontaxable                                                |       | 121,462                          |       | 116,119                        |       | 253,620 |   | 214,529 |   |
| Interest-bearing deposits with financial  institutions    |       | 2,239                            |       | 6,283                          |       | 4,776 |   | 8,971 |   |
| Investment securities:                                    |       |                             |       |                           |       |   |   |   |   |
| U.S. Government agency and corporations                   |       | 986,083                          |       | 921,085                        |       | 1,871,265 |   | 1,831,242 |   |
| States and political subdivisions (nontaxable)            |       | 150,274                          |       | 128,105                        |       | 291,318 |   | 240,560 |   |
| Other securities                                          |       | 230,802                          |       | 171,943                        |       | 429,212 |   | 298,758 |   |
| Federal funds sold                                        |       | 638                              |       | 6,635                          |       | 36,126 |   | 47,427 |   |
| **Total interest income**                                 |       | 8,371,168                        |       | 7,102,817                      |       | 16,264,605 |   | 14,077,102 |   |
| ** **                                                |       |                             |       |                           |       |   |   |   |   |
| **Interest  expense**                                     | ** ** | ** **                       | ** ** | ** **                     | ** ** | ** ** | ** ** | ** ** | ** ** |
| Certificates of deposit of $100,000 or more               |       | 670,056                          |       | 697,641                        |       | 1,336,465 |   | 1,373,664 |   |
| Other deposits                                            |       | 2,080,061                        |       | 978,115                        |       | 3,810,558 |   | 1,858,331 |   |
| Securities sold under repurchase agreements               |       | 163,426                          |       | 141,308                        |       | 298,875 |   | 338,117 |   |
| Other short-term borrowings and long-term debt            |       | 1,183,850                        |       | 963,293                        |       | 2,309,213 |   | 1,904,143 |   |
| Other                                                     |       | 8,351                            |       | 4,311                          |       | 13,761 |   | 8,894 |   |
| **Total interest expense**                                |       | 4,105,744                        |       | 2,784,668                      |       | 7,768,872 |   | 5,483,149 |   |
| **Net interest income**                                   |       | 4,265,424                        |       | 4,318,149                      |       | 8,495,733 |   | 8,593,953 |   |
| Provision for  loan losses                                |       | 175,000                          |       | 300,000                        |       | 250,000 |   | 380,000 |   |
| **Net interest income, after provision for loan  losses** |       | 4,090,424                        |       | 4,018,149                      |       | 8,245,733 |   | 8,213,953 |   |
| ** **                                                |       |                             |       |                           |       |   |   |   |   |
| **Other  income:**                                        | ** ** | ** **                       | ** ** | ** **                     | ** ** | ** ** | ** ** | ** ** | ** ** |
| Service charges on deposit accounts                       |       | 635,054                          |       | 674,210                        |       | 1,266,781 |   | 1,272,531 |   |
| Gain (loss) on:                                           |       |                             |       |                           |       |   |   |   |   |
| Investment securities                                     |       | 2                                |       | 2,643                          |       | (166 | ) | 2,643 |   |
| Loans                                                     |       | 26,858                           |       | 3,985                          |       | 41,843 |   | (7,457 | ) |
| Leased assets                                             |       | 100                              |       | 919                            |       | 15,154 |   | (33,954 | ) |
| Foreclosed assets held for sale                           |       | 216                              |       | (8,016                         | )          | 621 |   | (7,611 | ) |
| Write-down lease residual                                 |       | —                           |       | —                         |       | — |   | (220,000 | ) |
| Fees and other service charges                            |       | 421,722                          |       | 452,766                        |       | 886,984 |   | 867,968 |   |
| **Total other income**                                    |       | 1,083,952                        |       | 1,126,507                      |       | 2,211,217 |   | 1,874,120 |   |
| ** **                                                |       |                             |       |                           |       |   |   |   |   |
| **Other  expenses:**                                      | ** ** | ** **                       | ** ** | ** **                     | ** ** | ** ** | ** ** | ** ** | ** ** |
| Salaries and employee benefits                            |       | 1,974,057                        |       | 1,753,198                      |       | 3,980,871 |   | 3,496,119 |   |
| Premises and equipment                                    |       | 823,559                          |       | 737,021                        |       | 1,624,410 |   | 1,471,476 |   |
| Advertising                                               |       | 159,904                          |       | 148,599                        |       | 288,277 |   | 279,808 |   |
| Professional fees and services                            |       | 338,685                          |       | 413,875                        |       | 621,174 |   | 795,918 |   |
| Other                                                     |       | 651,944                          |       | 559,571                        |       | 1,354,607 |   | 1,134,855 |   |
| **Total other expenses**                                  |       | 3,948,149                        |       | 3,612,264                      |       | 7,869,339 |   | 7,178,176 |   |
| **Income  before provision for income taxes**             |       | 1,226,227                        |       | 1,532,392                      |       | 2,587,611 |   | 2,909,897 |   |
| Provision for  income taxes                               |       | 287,607                          |       | 396,584                        |       | 617,360 |   | 754,700 |   |
| **Net income**                                            |       | $                                | 938,620    |                           | $          | 1,135,808 |   | $ | 1,970,251 |   | $ | 2,155,197 |   |
| Per share data:                                           |       |                             |       |                           |       |   |   |   |   |
| Net income - basic                                        |       | $                                | 0.45       |                           | $          | 0.56 |   | $ | 0.96 |   | $ | 1.06 |   |
| Net income - diluted                                      |       | $                                | 0.45       |                           | $          | 0.56 |   | $ | 0.96 |   | $ | 1.06 |   |
| Dividends                                                 |       | $                                | 0.22       |                           | $          | 0.20 |   | $ | 0.44 |   | $ | 0.40 |   |

 

See Notes to ConsolidatedFinancial Statements

4

----

 

**FIDELITY D& D BANCORP, INC.**

ConsolidatedStatements of Changes in Shareholders’ Equity

For the Six Months Ended June30, 2006 and 2005

 
| ** **                                                                                                                             | ** ** | ** **             | ** ** | ** **   | ** ** | ** **        | ** ** | **Accumulated other** | ** ** | ** ** | ** ** |
|----------------------------------------------------------------------------------------------------------------------------------------|------------|------------------------|------------|--------------|------------|-------------------|------------|----------------------------|------------|------------|------------|
| ** **                                                                                                                             | ** ** | **Capital stock** | ** ** | **Retained** | ** ** | **comprehensive** | ** ** | ** **                 | ** ** |
| ** **                                                                                                                             | ** ** | **Shares ***      | ** ** | **Amount**   | ** ** | **earnings**      | ** ** | **income (loss)**     | ** ** | **Total**  | ** ** |
| Balance, December  31, 2004 (audited)                                                                                                  |       | 2,023,529              |       | $            | 10,072,134 |              | $          | 36,396,027                 |       | $          | (101,401   | ) | $ | 46,366,760 |   |
| Total  comprehensive income:                                                                                                           |       |                   |       |         |       |              |       |                       |       |       |       |
| Net income                                                                                                                             |       |                   |       |         |       | 2,155,197         |       |                       |       | 2,155,197  |       |
| Change in net unrealized holding gains (losses) on  available-for-sale securities, net of reclassification adjustment and tax  effects |       |                   |       |         |       |              |       | 105,656                    |       | 105,656    |       |
| Comprehensive income                                                                                                                   |       |                   |       |         |       |              |       |                       |       | 2,260,853  |       |
| Issuance of  common stock through                                                                                                      |       |                   |       |         |       |              |       |                       |       |       |       |
| Employee Stock Purchase Plan                                                                                                           |       | 1,134                  |       | 31,671       |       |              |       |                       |       | 31,671     |       |
| Dividends  reinvested through Dividend                                                                                                 |       |                   |       |         |       |              |       |                       |       |       |       |
| Reinvestment Plan                                                                                                                      |       | 7,472                  |       | 240,352      |       |              |       |                       |       | 240,352    |       |
| Cash dividend  declared                                                                                                                |       |                   |       |         |       | (810,611          | )          |                       |       | (810,611   | )          |
| Balance, June 30, 2005  (unaudited)                                                                                                    |       | 2,032,135              |       | $            | 10,344,157 |              | $          | 37,740,613                 |       | $          | 4,255      |   | $ | 48,089,025 |   |

 

----

* The number of shares has been adjusted to reflect the retroactiveeffect of a 10% stock dividend paid on February 15, 2006.

 
| ** **                                                                                                                             | ** ** | ** **             | ** ** | ** **   | ** ** | ** **        | ** ** | **Accumulated other** | ** ** | ** ** | ** ** |
|----------------------------------------------------------------------------------------------------------------------------------------|------------|------------------------|------------|--------------|------------|-------------------|------------|----------------------------|------------|------------|------------|
| ** **                                                                                                                             | ** ** | **Capital stock** | ** ** | **Retained** | ** ** | **comprehensive** | ** ** | ** **                 | ** ** |
| ** **                                                                                                                             | ** ** | **Shares**             | ** ** | **Amount**   | ** ** | **earnings**      | ** ** | **(loss)**                 | ** ** | **Total**  | ** ** |
| Balance, December  31, 2005 (audited)                                                                                                  |       | 1,854,217              |       | $            | 10,594,901 |              | $          | 39,363,461                 |       | $          | (1,112,333 | ) | $ | 48,846,029 |   |
| Total  comprehensive income:                                                                                                           |       |                   |       |         |       |              |       |                       |       |       |       |
| Net income                                                                                                                             |       |                   |       |         |       | 1,970,251         |       |                       |       | 1,970,251  |       |
| Change in net unrealized holding gains (losses) on  available-for-sale securities, net of reclassification adjustment and tax  effects |       |                   |       |         |       |              |       | (1,235,511                 | )          | (1,235,511 | )          |
| Comprehensive income                                                                                                                   |       |                   |       |         |       |              |       |                       |       | 734,740    |       |
| Issuance of  common stock through                                                                                                      |       |                   |       |         |       |              |       |                       |       |       |       |
| Employee Stock  Purchase Plan                                                                                                          |       | 1,571                  |       | 48,151       |       |              |       |                       |       | 48,151     |       |
| Dividends  reinvested through Dividend                                                                                                 |       |                   |       |         |       |              |       |                       |       |       |       |
| Reinvestment Plan                                                                                                                      |       | 7,638                  |       | 283,819      |       |              |       |                       |       | 283,819    |       |
| Stock-based  compensation expense                                                                                                      |       |                   |       | 28,744       |       |              |       |                       |       | 28,744     |       |
| Cash dividend  declared                                                                                                                |       |                   |       |         |       | (898,916          | )          |                       |       | (898,916   | )          |
| Stock dividend  declared                                                                                                               |       | 185,394                |       | 7,462,100    |       | (7,462,100        | )          |                       |       | —     |       |
| Cash paid for  fractional shares on stock dividend                                                                                     |       |                   |       |         |       | (7,448            | )          |                       |       | (7,448     | )          |
| Balance, June 30, 2006  (unaudited)                                                                                                    |       | 2,048,820              |       | $            | 18,417,715 |              | $          | 32,965,248                 |       | $          | (2,347,844 | ) | $ | 49,035,119 |   |

 

See Notes to Consolidated Financial Statements

5

----

 

**FIDELITY D& D BANCORP, INC.**

ConsolidatedStatements of Cash Flows

(unaudited)

 
| ** **                                                                         | ** ** | **Six Months Ended** | ** ** |
|------------------------------------------------------------------------------------|------------|--------------------------------|------------|
| ** **                                                                         | ** ** | **June 30, 2006**    | ** ** | **June 30, 2005** | ** ** |
| **Cash  flows from operating activities:**                                         | ** ** | ** **                     | ** ** | ** ** | ** ** |
| Net income                                                                         |       | $                              | 1,970,251  |   | $ | 2,155,197 |   |
| Adjustments to reconcile net income to net cash  provided by operating activities: |       |                           |       |   |   |
| Depreciation                                                                       |       | 592,613                        |       | 562,985 |   |
| Amortization of securities (net of accretion)                                      |       | 40,334                         |       | 144,482 |   |
| Provision for loan losses                                                          |       | 250,000                        |       | 380,000 |   |
| Deferred income tax expense (benefit)                                              |       | 32,967                         |       | (85,283 | ) |
| Stock-based compensation expense                                                   |       | 28,744                         |       | — |   |
| Amortization of investment in limited partnership                                  |       | 45,000                         |       | 45,000 |   |
| Proceeds from sale of loans available-for-sale                                     |       | 4,905,215                      |       | 807,434 |   |
| Originations of loans available for sale                                           |       | (4,630,167                     | )          | (314,686 | ) |
| Write-down of foreclosed assets held for sale                                      |       | —                         |       | 36,293 |   |
| Write-down lease residual                                                          |       | —                         |       | 220,000 |   |
| Increase in cash surrender value of life insurance                                 |       | (141,133                       | )          | (128,725 | ) |
| Loss (gain) on sale of investment securities                                       |       | 166                            |       | (2,643 | ) |
| (Gain) loss on sale of loans                                                       |       | (41,843                        | )          | 7,457 |   |
| (Gain) loss on sale of foreclosed assets  held-for-sale                            |       | (621                           | )          | 7,611 |   |
| Loss on sale of leased assets                                                      |       | —                         |       | 33,954 |   |
| Amortization of loan servicing rights                                              |       | 36,557                         |       | 51,717 |   |
| Change in:                                                                         |       |                           |       |   |   |
| Accrued interest receivable                                                        |       | (631,911                       | )          | (340,036 | ) |
| Other assets                                                                       |       | (224,039                       | )          | (701,222 | ) |
| Accrued interest payable and other liabilities                                     |       | 15,860                         |       | 15,051 |   |
| Net cash provided by operating activities                                          |       | 2,247,993                      |       | 2,894,586 |   |
| **Cash  flows from investing activities:**                                         | ** ** | ** **                     | ** ** | ** ** | ** ** |
| Held-to-maturity securities:                                                       |       |                           |       |   |   |
| Proceeds from maturities, calls and principal  pay-downs                           |       | 210,027                        |       | 349,441 |   |
| Available-for-sale securities:                                                     |       |                           |       |   |   |
| Proceeds from sales                                                                |       | 1,537,337                      |       | 19,282,027 |   |
| Proceeds from maturities, calls and principal  pay-downs                           |       | 3,247,531                      |       | 7,170,330 |   |
| Purchases                                                                          |       | (22,776,490                    | )          | (21,773,663 | ) |
| Net decrease in FHLB stock                                                         |       | 69,800                         |       | 262,600 |   |
| Net increase in loans and leases                                                   |       | (14,906,819                    | )          | (2,264,772 | ) |
| Proceeds from sale of leased assets                                                |       | —                         |       | 407,660 |   |
| Acquisition of bank premises and equipment                                         |       | (431,026                       | )          | (166,784 | ) |
| Proceeds from sale of foreclosed assets  held-for-sale                             |       | 39,711                         |       | 104,526 |   |
| Net cash (used in) provided by investing activities                                |       | (33,009,929                    | )          | 3,371,365 |   |
| **Cash  flows from financing activities:**                                         | ** ** | ** **                     | ** ** | ** ** | ** ** |
| Net increase in non-interest-bearing deposits                                      |       | 199,714                        |       | 3,875,466 |   |
| Net decrease in certificates of deposit of $100,000  or more                       |       | (12,768,667                    | )          | (4,413,039 | ) |
| Net increase in other interest-bearing deposits                                    |       | 55,925,668                     |       | 4,100,563 |   |
| Net increase (decrease) in short-term borrowings                                   |       | 2,886,109                      |       | (8,267,042 | ) |
| Repayments of long-term debt                                                       |       | (15,379,437                    | )          | (386,955 | ) |
| Dividends paid, net of dividend reinvestment                                       |       | (615,097                       | )          | (570,259 | ) |
| Proceeds from employee stock purchase plan                                         |       | 48,151                         |       | 31,671 |   |
| Cash payments in lieu of fractional shares on stock  dividend                      |       | (7,448                         | )          | — |   |
| Net cash provided by (used in) financing activities                                |       | 30,288,993                     |       | (5,629,595 | ) |
| Net (decrease)  increase in cash and cash equivalents                              |       | (472,943                       | )          | 636,356 |   |
| Cash and cash  equivalents, beginning                                              |       | 12,594,540                     |       | 10,216,394 |   |
|                                                                               |       |                           |       |   |   |
| Cash and cash  equivalents, ending                                                 |       | $                              | 12,121,597 |   | $ | 10,852,750 |   |

 

See Notes to ConsolidatedFinancial Statements

6

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**FIDELITY D & D BANCORP, INC.**

**Notes toConsolidated Financial Statements**

**(unaudited)**

**1.             Nature of operations and critical accounting policies**

# **Nature of operations**

# The Bank is a commercial bank chartered in theCommonwealth of Pennsylvania and a wholly-owned subsidiary of the Company.  Having commenced operations in 1903, the Bankis committed to provide superior customer service, while offering a full rangeof banking products and financial and trust services, to both our consumer andcommercial customers from its main office located in Dunmore and other branchesthroughout Lackawanna and Luzerne counties.

# **Principles of consolidation**

# The accompanying unaudited consolidated financialstatements of Fidelity D & D Bancorp, Inc., and its wholly-ownedsubsidiary, The Fidelity Deposit and Discount Bank (the Bank or collectively,the Company) have been prepared in accordance with accounting principlesgenerally accepted in the United States of America (“GAAP”) for interimfinancial information and with the instructions to this Form 10-Q and Rule10-01 of Regulation S-X.  Accordingly,they do not include all of the information and footnote disclosures required byGAAP for complete financial statements. In the opinion of Management, all normal recurring adjustments necessaryfor a fair presentation of the financial condition and results of operationsfor the periods have been included.  Allsignificant inter-company balances and transactions have been eliminated inconsolidation.  Prior period amounts arereclassified when necessary to conform to the current period’s presentation.

# During the fourth quarter of 2005, the Company changedits classification, within the consolidated statements of cash flows, of theactivity associated with loans available-for-sale from investing activities tooperating activities.  Accordingly, thecash flows for the six months ended June 30, 2005 have been reclassified toconform to the current year’s quarter presentation.  The effect of the change increased operatingcash flows by $508,000 and decreased investing cash flows by $508,000.  The Company believes the change inclassification of loans available-for-sale is preferable because it betterreflects the primary business purpose of these transactions and complies withthe requirements of SFAS 102, *Statement ofCash Flows—Exemption of Certain Enterprises and Classification of Cash Flowsfrom Certain Securities Acquired for Resale.*  On January 17, 2006, the Board ofDirectors declared a 10% stock dividend. The new common shares were distributed on February 15, 2006 toshareholders of record at the close of business on January 30, 2006.  All common stock and per-share data,presented in the prior period, has been adjusted to reflect the retroactiveeffect of the 10% stock dividend.

The preparation offinancial statements in conformity with GAAP requires Management to makeestimates and assumptions that affect the reported amounts of assets andliabilities and disclosure of contingent assets and liabilities at the date ofthe financial statements and the reported amounts of revenues and expensesduring the reported periods.  Actualresults could differ from those estimates. For additional information and disclosures required under GAAP, refer tothe Company’s Annual Report on Form 10-K for the year ended December 31, 2005.

Management is responsiblefor the fairness, integrity and objectivity of the unaudited financialstatements included in this report. Management prepared the unaudited financial statements in accordancewith GAAP.  In meeting its responsibilityfor the financial statements, Management depends on the Company’s accountingsystems and related internal controls. These systems and controls are designed to provide reasonable, but notabsolute, assurance that the financial records accurately reflect thetransactions of the Company, the Company’s assets are safeguarded and thatfinancial statements present fairly the financial condition and results ofoperations of the Company.

In the opinion ofManagement, the consolidated balance sheets as of June 30, 2006 and December31, 2005 and the related consolidated statements of income for each of thethree- and six-month periods ended June 30, 2006 and June 30, 2005 and changesin shareholders’ equity and cash flows for each of the six month periods endedJune 30, 2006 and June 30, 2005 present fairly the financial condition andresults of operations of the Company. All material adjustments required for a fair presentation have beenmade.  These adjustments are of a normalrecurring nature.

As indicated in Note 3, “StockPlans”, included herein, the Company adopted Statement of Financial AccountingStandard 123R,*Share-Based Payment,* during the first quarter of 2006.  There have been no other materialchanges in accounting principles and practices or in the method ofapplication.  Other than the retroactiveadjustment of 2005 common stock and the related per-share data, as a result ofthe 10% stock dividend noted above, there have been no other

7

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retroactive adjustmentsduring these periods.  The results ofoperations for interim periods are not necessarily indicative of the results ofoperations for the entire year.

This Quarterly Report onForm 10-Q should be read in conjunction with the Company’s audited financialstatements for the year ended December 31, 2005 and the notes included therein,included within the Company’s Annual Report filed on Form 10-K.

# **Critical accounting policies**

The presentation offinancial statements in conformity with GAAP requires Management to makeestimates and assumptions that affect many of the reported amounts anddisclosures. Actual results could differ from these estimates.

A materialestimate that is particularly susceptible to significant change is thedetermination of the allowance for loan losses (the allowance).  Management believes that the allowance, as ofJune 30, 2006, is adequate and reasonable. Given the subjective nature of identifying and valuing loan losses, itis likely that well-informed individuals could make materially differentassumptions, and could, therefore calculate a materially different allowancevalue.  While Management uses availableinformation to recognize losses on loans, changes in economic conditions maynecessitate revisions in the future.  Inaddition, various regulatory agencies, as an integral part of their examinationprocess, periodically review the Company’s allowance.  Such agencies may require the Company torecognize adjustments to the allowance based on their judgments of informationavailable to them at the time of their examination.

Another material estimateis the calculation of fair values of the Company’s investment securities.  The Company receives estimated fair values ofinvestment securities from an independent valuation service.  In developing these fair values, thevaluation service uses estimates of cash flows, based on historical performanceof similar instruments in similar interest rate environments.  Based on experience, Management is aware thatestimated fair values of investment securities tend to vary among valuationservices.  Accordingly, when sellinginvestment securities, Management may obtain price quotes from more than onesource.  Available-for-sale (“AFS”)securities are carried at fair value on the consolidated balance sheet, withunrealized gains and losses, net of income tax, reported separately withinshareholders’ equity through accumulated other comprehensive income (loss).

The fair value ofresidential mortgage loans, classified as AFS, is obtained from the FederalNational Mortgage Association (“FNMA”) or the Pennsylvania Housing FinanceAuthority (“PHFA”).  To determine thefair value of student loans, classified as AFS, the Bank uses the pricingobtained from the most recent student loans sold from its AFS portfolio.  From time-to-time, the Bank may originateSmall Business Administration (“SBA”) loans AFS.  The fair value of SBA loans, classified asAFS, is obtained from an outside pricing source.  The market to which the Bank sells mortgageand other loans is restricted and price quotes from other sources are nottypically obtained.  As of June 30, 2006and December 31, 2005, the AFS loan portfolio consisted of residentialmortgages and student loans.

**2.             Earnings per share**

Basicearnings per share (EPS) is computed by dividing income available to commonshareholders by the weighted-average number of common stock outstanding for theperiod.  Diluted EPS is computed in thesame manner as basic EPS but reflects the potential dilution that could occurif stock options to issue additional common stock were exercised, which wouldthen result in additional stock outstanding to share or dilute the earnings ofthe Company.  The Company maintains twoshare-based compensation plans that may generate additional potential dilutivecommon shares. Generally, dilution would occur if Company-issued stock optionswere exercised and converted into common stock.

Inthe computation of diluted EPS, the Company uses the treasury stock method todetermine the dilutive effect of its granted but unexercised stock options.  Under this method, the assumed proceedsreceived from shares issued, in a hypothetical stock option exercise, areassumed to be used to purchase treasury stock. Pursuant to the guidance of Statement of Financial Accounting Standard (“SFAS”)No. 128, *Earning Per Share,* proceeds include:proceeds from the exercise of outstanding stock options; compensation cost forfuture service that the Company has not yet recognized; and any “windfall” taxbenefits that would be credited directly to shareholders’ equity when the grantgenerates a tax deduction (or a reduction in proceeds if there is a charge toequity).  For a further discussion on theCompany’s stock option plans, see note 3, below.

Thefollowing table illustrates the data used in computing basic EPS and areconciliation to derive at the components of diluted EPS for the periodsindicated:

8

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| Six months ended June 30,                 | ** ** | **2006**  | ** ** | **2005**  | ** ** |
|---------------------------------------------------------------|------------|-----------|------------|-----------|------------|
|                                                          |       |      |       |      |       |
| Basic EPS:                                                    |       |      |       |      |       |
| Net income  available to common shareholders                  |       | $         | 1,970,251  |      | $          | 2,155,197 |   |
|                                                          |       |      |       |      |       |
| Weighted-average  common shares outstanding                   |       | 2,043,865 |       | 2,027,353 |       |
| Basic EPS                                                     |       | $         | 0.96       |      | $          | 1.06 |   |
|                                                          |       |      |       |      |       |
| Diluted EPS:                                                  |       |      |       |      |       |
| Net income  available to common shareholders                  |       | $         | 1,970,251  |      | $          | 2,155,197 |   |
|                                                          |       |      |       |      |       |
| Weighted-average  common shares outstanding                   |       | 2,043,865 |       | 2,027,353 |       |
| Dilutive  potential common shares                             |       | 2,024     |       | 547       |       |
|                                                          |       |      |       |      |       |
| Weighted-average  common shares and dilutive potential shares |       | 2,045,889 |       | 2,027,900 |       |
| Diluted EPS                                                   |       | $         | 0.96       |      | $          | 1.06 |   |

 

**3.             Stock plans**

In December 2004,the Financial Accounting Standard Board, (the “FASB”) issued SFAS 123R*, Share-Based Payment,* which replaces SFAS 123, *Accounting for Stock-Based Compensation*,and supersedes Accounting Principles Bulletin Opinion 25, *Accounting for Stock Issued to Employees*.  SFAS 123R requires that the cost ofshare-based payment transactions (including those with employees andnon-employees) be recognized in the financial statements.  SFAS 123R applies to all share-based paymenttransactions in which an entity acquires goods or services by issuing (or offeringto issue) its shares, share options, or other equity instruments (except forthose held by an ESOP) or by incurring liabilities (1) in amounts based (evenin part) on the price of the entity’s shares or other equity instruments, or(2) that require (or may require) settlement by the issuance of an entity’sshares or other equity instruments.

On January 1,2006, the Company implemented the provisions SFAS 123R using the ModifiedProspective Application transition method (the “MPA”).  The MPA requires the Company to apply theprovisions of SFAS 123R to: (a) new awards granted after its adoption; (b) anyawards that were granted after the first fiscal year beginning after December15, 1994 that have not vested by the date the Company adopts SFAS 123R; and (c)any outstanding liability awards.  Underthe MPA, the Company is not required to adjust prior years’ financialstatements.  In addition, as of December31, 2005, all of the Bank’s stock option awards granted, prior to that date,were fully vested and therefore the Bank is not required to apply theprovisions of SFAS 123R to these previously granted share-based awards.  Therefore, the following discussion will bemost applicable to share-based awards issued during 2006.

The Company hastwo stock-based compensation plans (the “plans”).  The plans were shareholder-approved andpermit the grant of share-based compensation awards to its directors, keyofficers and certain other employees. The Company believes that these plans better align the interest of itsdirectors, key officers and employees with the interest of itsshareholders.  The Company furtherbelieves that the granting of share-based awards, under the provisions of theplans, is necessary to retain the knowledge base, continuity and expertise of itsdirectors, key officers and certain employees.

The Companyestablished the 2000 Independent Directors Stock Option Plan and has reserved55,000 shares of its un-issued capital stock for issuance under the plan.  Under the 2000 Independent Directors StockOption Plan, each outside director is awarded stock options to purchase 500shares of the Company’s common stock on the first business day of January, eachyear, at the fair market value on date of grant.  No stock options were awarded during thefirst half of 2006 or for each of the years ended December 31, 2005, 2004 and2003 due to the directors’ voluntary election to forego the award.  At June 30, 2006 and December 31, 2005, therewere 14,850 unexercised stock options outstanding under this plan.

The Company hasalso established the 2000 Stock Incentive Plan and has reserved 55,000 sharesof its un-issued capital stock for issuance under the plan.  Under the 2000 Stock Incentive Plan, keyofficers and certain other employees are eligible to be awarded qualified stockoptions to purchase the Company’s common stock at the fair market value on thedate of grant.  During the first quarterof 2006, 2,200 shares were issued under the 2000 Stock Incentive plan.  No stock options were awarded for each of theyears ended December 31, 2005, 2004 and 2003. As of June 30, 2006 and December 31, 2005, there were 5,830 and 5,280,respectively, unexercised stock options outstanding under this plan.

9

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Under both plans,options are granted with an exercise price equal to the market price of theCompany’s stock at the date of grant. The awards vest based on six months of continuous service from the dateof grant and have 10-year contractual terms. Generally, all shares that are granted become fully vested.

The Company doesnot have stock options that are traded on organized capital exchanges.  As such, the estimated fair value of optionsawarded under its plans is determined, on the date of grant, using theBlack-Scholes Option Pricing Valuation Model. For the options granted during the first quarter of 2006, the modelincorporated the assumptions noted in the following table:
| Expected volatility      |   | 16.00 | %           |
|--------------------------|--------|-------|-------------|
| Expected  dividend       |   | 2.41  | %           |
| Risk-free  interest rate |   | 4.35  | %           |
| Expected term            |   | 5.25  |  years |

 

The expectedvolatility was determined based on the daily five-year historical volatility ofthe Company’s stock.  Management believesthe five-year historical volatility measurement closely resembles thefluctuation of its stock under most economic conditions and cycles.  Because of the relatively short vestingperiod, the model assumes that all options granted will fully vest.  The risk-free rate is for the period withinthe expected term of the options based on the U.S. Treasury yield curve.  The Company used the simplified method todetermine the term in which options are expected to be outstanding.

A summary of thestatus of the Company’s stock option plans as of June 30, 2006, December 31,2005 and December 31, 2004 and changes during the periods is presented below:
| ** **                      | ** ** | ** **  | ** ** | ** **       | ** ** | **Weighted-**       | ** ** | ** **    | ** ** |
|---------------------------------|------------|-------------|------------|------------------|------------|---------------------|------------|---------------|------------|
| ** **                      | ** ** | ** **  | ** ** | **Weighted-**    | ** ** | **average**         | ** ** | ** **    | ** ** |
| ** **                      | ** ** | ** **  | ** ** | **average**      | ** ** | **remaining**       | ** ** | **Aggregate** | ** ** |
| ** **                      | ** ** | ** **  | ** ** | **exercise**     | ** ** | **contractual**     | ** ** | **intrinsic** | ** ** |
| ** **                      | ** ** | **Options** | ** ** | **price *** | ** ** | **term (yrs)** | ** ** | **value**     | ** ** |
|                            |       |        |       |             |       |                |       |          |       |
| Outstanding,  December 31, 2004 |       | 20,570      |       | $                | 32.29      |                | 5.7        |          |       |   |
| Granted                         |       | —      |       |             |       |                |       |          |       |
| Exercised                       |       | —      |       |             |       |                |       |          |       |
| Forfeited or  expired           |       | (440        | )          | 34.09            |       |                |       |          |       |
| Outstanding,  December 31, 2005 |       | 20,130      |       | 32.25            |       | 4.7                 |       |          |       |
| Granted                         |       | 2,200       |       | 36.59            |       |                |       |          |       |
| Exercised                       |       | —      |       |             |       |                |       |          |       |
| Forfeited or  expired           |       | (1,650      | )          | 33.07            |       |                |       |          |       |
| Outstanding,  June 30, 2006     |       | 20,680      |       | $                | 32.64      |                | 4.8        |          | $          | 52,212 |   |
| Exercisable, June 30,  2006     |       | 20,680      |       | $                | 32.64      |                | 4.8        |          | $          | 52,212 |   |

 

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* Includes options with exercise prices ranging from $28.18 to $36.59per share.

 

No options have beengranted under the 2000 Independent Directors Stock Option Plan since 2002 andall options previously granted and outstanding are fully vested.  As of June 30, 2006, no options have beenexercised under the provisions of this plan.

Under the 2000Stock Incentive Plan, the grant-date fair value of the options granted wasdetermined to be $6.21 per share. Approximately $13,700 of stock-based compensation expense was recordedduring the first half of 2006 and is included as a component of salaries andemployee benefits in the consolidated income statement.  Since the plan is a qualified option planunder the Internal Revenue Code, no tax benefit will be recorded until theshares are exercised by the recipients. No options were exercised during the periods presented.  Since the Company adopted SFAS 123R onJanuary 1, 2006, under the MPA, the comparable data for the previous periods isnot required to be reported.  As of June30, 2006, all options issued under the plan were fully vested and therefore,there is no unrecognized compensation expense related to non-vested share-basedcompensation agreements under the plan as of June 30, 2006.

10

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In addition to the twostock option plans above, the Company has established the 2002 Employee StockPurchase Plan (the “ESPP”) and has reserved 110,000 shares of its un-issuedcapital stock for issuance under the plan. The plan was designed to promote broad-based employee ownership of theCompany’s stock.  Under the 2002 ESPP,employees may have automatic payroll deductions to purchase the Company’scapital stock at a discounted price based on the fair market value of theCompany’s capital stock on either the commencement date or terminationdate.  At June 30, 2006, 6,051 shareshave been issued under the plan.  TheESPP is considered a compensatory plan and, as such, is required to comply withthe provisions of SFAS 123R.  The Companyrecognizes compensation expense on its ESPP Plan on the date the shares arepurchased.  For the six months ended June30, 2006, compensation expense related to the ESPP approximated $15,000 and isincluded as a component of salaries and employee benefits in the consolidatedincome statement.

**4.             Bank Premises and Equipment**

During the secondquarter of 2006, the Bank entered into a long-term facility lease agreement inconcert with the construction and relocation of one of its branch offices.  Under the lease agreement, the Bank hascommitted to an initial 15-year term with options to renew for two consecutiveperiods of five years each.  Under thisagreement, the Bank will recognize approximately $36,000 of rent expense in2006 and a total of $1,384,000 through the expiration of the second renewaloption on August 31, 2031.

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

The following isManagement’s discussion and analysis of the significant changes in theconsolidated financial condition of the Company as of June 30, 2006 compared toDecember 31, 2005 and the results of operations for the three and six monthsended June 30, 2006 and June 30, 2005. Current performance may not be indicative of future results.  This discussion should be read in conjunctionwith the Company’s 2005 Annual Report filed on Form 10-K.

**Forward looking statements**

This Interim Report onForm 10-Q contains a number of forward-looking statements within the meaning ofSection 27A of the Securities Act of 1933, as amended, or the Securities Act,and Section 21E of the Securities Exchange Act of 1934, as amended, or theExchange Act.  These statements may beidentified by the use of the words “anticipate,” “believe,” “could,” “estimate,”“expect,” “intend,” “may,” “outlook,” “plan,” “potential,” “predict,” “project,”“should,” “will,” “would” and similar terms and phrases, including referencesto assumptions.  Forward lookingstatements include risks and uncertainties.

Forward-lookingstatements are based on various assumptions and analyses made by us in light ofManagement’s experience and its perception of historical trends, currentconditions and expected future developments, as well as other factors Managementbelieves are appropriate under the circumstances.  These statements are not guarantees of futureperformance and are subject to risks, uncertainties and other factors (many ofwhich are beyond our control) that could cause actual results to differ materiallyfrom future results expressed or implied by such forward-lookingstatements.  These factors include,without limitation, the following:

·                  thetiming and occurrence or non-occurrence of events may be subject tocircumstances beyond our control;

·                  theremay be increases in competitive pressure among financial institutions or fromnon-financial institutions;

·                  changesin the interest rate environment may reduce interest margins;

·                  changesin deposit flows, loan demand or real estate values may adversely affect ourbusiness;

·                  changesin accounting principles, policies or guidelines may cause our financialcondition to be perceived differently;

·                  generaleconomic conditions, either nationally or locally in some or all areas in whichwe do business, or conditions in the securities markets or the banking industrymay be less favorable than we currently anticipate;

·                  legislativeor regulatory changes may adversely affect our business;

·                  technologicalchanges may be more rapid, difficult or expensive than we anticipate;

11

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·                  successor consummation of new business initiatives may be more difficult or expensivethan we anticipate;

·                  actsof war or terrorism; or

·                  naturaldisaster.

Management cautionsreaders not to place undue reliance on forward-looking statements, whichreflect analyses only as of the date of this document.  We have no obligation to update anyforward-looking statements to reflect events or circumstances after the date ofthis document.  Readers should review therisk factors described in other documents that we file or furnish, from time totime, with the Securities and Exchange Commission, including Annual Reports toShareholders, Annual Reports filed on Form 10-K and other current reports filedor furnished on Form 8-K.

**General**

The Company’s principalrevenues are derived from interest, dividends and fees earned on itsinterest-earning assets, which are comprised of loans, securities and othershort-term investments.  The Company’sprincipal expenses consist of interest paid on its interest-bearingliabilities, which are comprised of deposits, short-and long-term borrowingsand operating and general expenses.  TheCompany’s profitability depends primarily on its net interest income, which isthe difference between interest income generated from its interest-earningassets and the interest expense incurred on its interest-bearingliabilities.  Net interest income isdependent upon the interest-rate spread, which is the difference between theaverage yield earned on interest-earning assets and the average rate paid oninterest-bearing liabilities.  Wheninterest-earning assets approximate or exceed interest-bearing liabilities, anypositive rate spread will generate net interest income.  The interest rate spread is significantlyimpacted by changes in interest rates and market yield curves and their relatedimpact on cash flows from loans, investments, customer deposit flows and loandemand.  The interest rate spread isfurther influenced by the composition and characteristics of interest-earningassets and interest-bearing liabilities and by the competition in ourmarketplace.  Additionally, the interestrate spread and the changes in the interest rate spread, from period-to-period,is affected by differences in the maturity and re-pricing characteristics ofthe assets compared to the maturity and re-pricing characteristics of theliabilities that fund them.

In addition to netinterest income, profitability is affected by the level of its non-interestincome and expenses, provision for loan losses and provision for incometaxes.  Non-interest income consistsmostly of service charges on the Bank’s loan and deposit products, trust andasset management service fees, increases in the cash surrender value of thebank owned life insurance (“BOLI”), net gains or losses from sales of leases,securities and loans AFS and from the sale of other real estate (“ORE”)properties.  Non-interest expenseconsists of compensation and related employee benefit expenses, occupancy,equipment, data processing, advertising, marketing, professional fees,insurance and other operating overhead.

The Company’sprofitability is significantly affected by general economic and competitiveconditions, changes in market interest rates, government policies and actionsof regulatory authorities.  The Company’sloan portfolio is comprised principally of commercial and commercial realestate loans.  The properties underlyingthe Company’s mortgages are concentrated in Northeastern Pennsylvania.  Credit risk, which represents the possibilityof the Company not recovering amounts due from its borrowers, is significantlyrelated to local economic conditions in the areas the properties are located aswell as the Company’s underwriting standards. Economic conditions affect the market value of the underlying collateralas well as the levels of adequate cash flow and revenue generation fromincome-producing commercial and multi-family properties.

**COMPARISONOF RESULTS OF OPERATIONS**

**THREE AND SIX MONTHS ENDED JUNE 30, 2006 AND JUNE30, 2005**

**Overview**

Net income for the secondquarter of 2006 was $939,000, a decrease of $197,000 or 17%, from the$1,136,000 recorded in the same quarter in 2005.  Diluted earnings per share was $0.45 and$0.56 for each of the respective periods. For the six months ended June 30, 2006, net income was $1,970,000, or$0.96 per diluted share, compared to $2,155,000, or $1.06 per diluted share forthe six months ended June 30, 2005.  Thedecline in net income in the second quarter was the result of a decrease in netinterest and other non-interest income and increased operating expenses.  The decline in net income for the six monthcomparison was due mostly to a decrease in net interest income and an increasein operating expenses.  During bothperiods, the provision for loan losses decreased $125,000 and $130,000,respectively.

12

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The decline in net incomewas the primary cause of the decline in return on average assets (“ROA”) andreturn on average shareholders’ equity (“ROE”) to 0.66% and 7.66%,respectively, for the three months ended June 30, 2006, compared to 0.86% and9.65, respectively, for the same period in 2005.  For the six months ended June 30, 2006 ROAand ROE were 0.70% and 8.08% compared to 0.81% and 9.26% for the six months endedJune 30, 2005.

*Netinterest income and interest sensitive assets / liabilities*

Net interest incomedecreased $53,000, or 1%, to $4,265,000 for the second quarter of 2006, from$4,318,000 recorded in the same period of 2005. The decrease was principally due to the effect rising interest rates hadon the rates paid on average interest-bearing liabilities compared to theeffect rising interest rates had on our interest-earning assets.  Rates paid increased 95 basis points, to3.65%, for the three months ended June 30, 2006 compared to 2.70% for the same2005 period.  In addition to the increasein rates paid, there was an increase in the average interest-bearingliabilities of $37,510,000 for the comparable periods.  To maintain its pursuit to attract and retaincore deposits, the Bank has continued to deploy various marketing and rateenhancing techniques.  From theseefforts, average core deposits, which excludes time deposits of greater than$100,000, increased approximately $54,744,000 compared to the quarter endedJune 30, 2005.  As a result, interestexpense on deposits increased $1,074,000, or 64%, during the second quarter of2006 compared to the second quarter of 2005. Interest expense on borrowings increased $247,000, or 22%, duepredominantly to an increase in the average balance in the 2006 quartercompared to the 2005 quarter.  Averagebalances of non-interest bearing deposits (“DDAs”) increased from year-endDecember 31, 2005 levels.  DDAs are animportant funding source as they help reduce the cost of money that is used tofund interest-earning assets.  Managementhas committed to continue the campaign to attract and retain thesecore-deposits and will further implement deposit-gathering strategiesthroughout 2006.

Interest income increased$1,268,000, or 18%, partially offsetting the increase in interest expenseduring the second quarter of 2006 compared to the second quarter of 2005.  This improvement was primarily due to a 53basis point increase in the yield earned on its average interest-earning assetswhich also experienced growth during the second quarter of 2006 compared to thesecond quarter of 2005.  During thisperiod, the loan portfolio grew by $33,815,000 on average and yielded 59 basispoints more during the current year quarter than in the same quarter of2005.  The increase in the loan portfoliowas from the successful implementation of various sales campaigns and programstargeted at mortgage and home equity lending products and increased productionin commercial lending.

During the second quarterof 2006, the Bank’s tax-equivalent margin and spread both decreased 28 and 42basis points, respectively, compared to the second quarter of 2005.  The decline in margin and spread is theresult of the rates paid on the Bank’s interest-bearing liabilities increasingat a faster pace than the increase in the yields earned on interest-earningassets.

Similar to the secondquarter comparisons, the Bank’s tax-equivalent margin and spread decreased 21and 35 basis points, respectively, during the first half of 2006 compared tothe first half of 2005.  For the firsthalf of 2006, net interest income declined $98,000, or 1%, to $8,496,000 from$8,594,000 recorded in the first half of 2005. The decrease was due to a combination of a net increase in averageinterest-bearing liabilities of $27,520,000 and to a more significant degree,an increase in the average rate paid of 87 basis points.  As a result, total interest expense increased$2,286,000, or 42%, for the six months ended June 30, 2006 compared to the sixmonths ended June 30, 2005.

Interest income increased$2,188,000, or 16%, for the first six months of 2006 compared to the sameperiod in 2005.  The dominate factorleading to the improvement was an increase in the book yield on average-earningassets of 51 basis points with a $30,089,000 increase in averageinterest-earning assets.

The increasing interestrate environment, that has been prevalent for approximately two years, and themore recent increases in short-term levels compounded with a flat-to-invertedmarket interest rate yield curve, has pressured the Bank’s net interestincome.  However, our successful depositgathering strategies will help position the Bank’s ability to optimize netinterest income during this challenging rate environment and should be evenfurther enhanced when the shape of the yield curve returns to a more normalslope.

The following table setsforth, a comparison of average balance sheet amounts and their correspondingtax-equivalent interest income and expense and annualized tax-equivalent yieldand cost for the periods indicated (dollars in thousands):

13

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|                                                | ** ** | **Three months ended** | ** ** | **Six months ended** | ** ** |
|------------------------------------------------|------------|----------------------------------|------------|--------------------------------|------------|
| ** **                                     | ** ** | **June 30,**                | ** ** | **June 30,**              | ** ** |
| ** **                                     | ** ** | **2006**                         | ** ** | **2005**                       | ** ** | **2006** | ** ** | **2005** | ** ** |
| Average  interest-earning assets:              |       |                             |       |                           |       |   |   |   |   |
| Loans and leases                               |       | $                                | 420,394    |                           | $          | 386,579 |   | $ | 417,403 |   | $ | 386,216 |   |
| Investments                                    |       | 122,582                          |       | 115,472                        |       | 118,340 |   | 116,946 |   |
| Federal funds  sold                            |       | 56                               |       | 985                            |       | 1,720 |   | 3,677 |   |
| Interest-bearing  deposits                     |       | 203                              |       | 909                            |       | 241 |   | 776 |   |
| Total                                          |       | $                                | 543,235    |                           | $          | 503,945 |   | $ | 537,704 |   | $ | 507,615 |   |
|                                           |       |                             |       |                           |       |   |   |   |   |
| Average  interest-bearing liabilities:         |       |                             |       |                           |       |   |   |   |   |
| Other  interest-bearing deposits               |       | $                                | 184,461    |                           | $          | 129,018 |   | $ | 178,658 |   | $ | 122,863 |   |
| Certificates of  deposit                       |       | 153,192                          |       | 176,134                        |       | 155,319 |   | 179,520 |   |
| Borrowed funds                                 |       | 89,684                           |       | 76,117                         |       | 88,421 |   | 76,208 |   |
| Repurchase  agreements                         |       | 24,042                           |       | 32,600                         |       | 24,414 |   | 40,701 |   |
| Total                                          |       | $                                | 451,379    |                           | $          | 413,869 |   | $ | 446,812 |   | $ | 419,292 |   |
|                                           |       |                             |       |                           |       |   |   |   |   |
| Interest income:                               |       |                             |       |                           |       |   |   |   |   |
| Loans and leases                               |       | $                                | 7,064      |                           | $          | 5,929 |   | $ | 13,763 |   | $ | 11,761 |   |
| Investments                                    |       | 1,454                            |       | 1,292                          |       | 2,760 |   | 2,503 |   |
| Federal funds  sold                            |       | 1                                |       | 7                              |       | 36 |   | 47 |   |
| Interest-bearing  deposits                     |       | 2                                |       | 6                              |       | 5 |   | 9 |   |
| Total                                          |       | $                                | 8,521      |                           | $          | 7,234 |   | $ | 16,564 |   | $ | 14,320 |   |
|                                           |       |                             |       |                           |       |   |   |   |   |
| Interest  expense:                             |       |                             |       |                           |       |   |   |   |   |
| Other  interest-bearing deposits               |       | $                                | 1,324      |                           | $          | 355 |   | $ | 2,374 |   | $ | 587 |   |
| Certificates of  deposit                       |       | 1,426                            |       | 1,321                          |       | 2,773 |   | 2,645 |   |
| Borrowed funds                                 |       | 1,193                            |       | 968                            |       | 2,323 |   | 1,913 |   |
| Repurchase  agreements                         |       | 163                              |       | 141                            |       | 299 |   | 338 |   |
| Total                                          |       | $                                | 4,106      |                           | $          | 2,785 |   | $ | 7,769 |   | $ | 5,483 |   |
|                                           |       |                             |       |                           |       |   |   |   |   |
| Net interest  income                           |       | $                                | 4,415      |                           | $          | 4,449 |   | $ | 8,795 |   | $ | 8,837 |   |
|                                           |       |                             |       |                           |       |   |   |   |   |
| Yield on average  interest-earning assets      |       |                             |       |                           |       |   |   |   |   |
| Loans and leases                               |       | 6.74                             | %          | 6.15                           | %          | 6.65 | % | 6.14 | % |
| Investments                                    |       | 4.76                             | %          | 4.49                           | %          | 4.70 | % | 4.32 | % |
| Federal funds  sold                            |       | 4.56                             | %          | 2.70                           | %          | 4.23 | % | 2.60 | % |
| Interest-bearing  deposits                     |       | 4.42                             | %          | 2.77                           | %          | 3.99 | % | 2.33 | % |
| Total                                          |       | 6.29                             | %          | 5.76                           | %          | 6.21 | % | 5.69 | % |
|                                           |       |                             |       |                           |       |   |   |   |   |
| Rates on average  interest-bearing liabilities |       |                             |       |                           |       |   |   |   |   |
| Other  interest-bearing deposits               |       | 2.88                             | %          | 1.10                           | %          | 2.68 | % | 0.96 | % |
| Certificates of  deposit                       |       | 3.73                             | %          | 3.01                           | %          | 3.60 | % | 2.97 | % |
| Borrowed funds                                 |       | 5.33                             | %          | 5.10                           | %          | 5.30 | % | 5.06 | % |
| Repurchase  agreements                         |       | 2.73                             | %          | 1.74                           | %          | 2.47 | % | 1.68 | % |
| Total                                          |       | 3.65                             | %          | 2.70                           | %          | 3.51 | % | 2.64 | % |
|                                           |       |                             |       |                           |       |   |   |   |   |
| Net interest  spread                           |       | 2.64                             | %          | 3.06                           | %          | 2.70 | % | 3.05 | % |
| Net interest margin                            |       | 3.26                             | %          | 3.54                           | %          | 3.30 | % | 3.51 | % |

 

In the table above, interest income was adjusted to a tax-equivalentbasis to recognize the income from the various tax-exempt assets as if theinterest was fully taxable.  Thistreatment allows a uniform comparison among the yields on interest-earningassets.  The calculations were computedon a fully tax-equivalent basis using the corporate federal tax rate of34%.  Net interest spread represents thedifference between the yield on interest-earning assets and the rate oninterest-bearing liabilities.  Netinterest margin represents the ratio of net interest income to total averageinterest-earning assets.

14

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*Provisionfor loan losses*

The provision for loanlosses represents the necessary amount to charge against current earnings, thepurpose of which is to increase the allowance for loan losses to a level thatrepresents Management’s best estimate of known and inherent losses in the Bank’sloan and lease portfolio.  Loans andleases determined to be uncollectible are charged-off against the allowance forloan losses.

The required amount ofthe provision for loan losses, based upon the adequate level of the allowancefor loan losses, is subject to ongoing analysis of the loan portfolio. The Bank’sSpecial Asset Committee meets periodically to review problem loans andleases.  The committee is comprised ofBank Management, including the chief risk officer, loan workout officers andcollection personnel.  The committeereports quarterly to the Credit Administration Committee of the Board ofDirectors.

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

·                  Specific loans that could have losspotential

·                  Levels of and trends in delinquenciesand non-accrual loans

·                  Levels of and trends in charge-offsand recoveries

·                  Trends in volume and terms of loans

·                  Changes in risk selection andunderwriting standards

·                  Changes in lending policies,procedures and practices

·                  Experience, ability and depth oflending management

·                  National and local economic trendsand conditions

·                  Changesin credit concentrations

Theprovision for loan losses was $175,000, for the three months ended June 30,2006, compared to $300,000 for the three months ended June 30, 2005.  The decrease in the provision for loan lossesresulted in part due to the reduced level of non-performing loans, which consistof loans past due 90 days or more and non-accrual loans.  The balance of non-performing loans declinedyear to year by $2,845,000 to $7,750,000 at June 30, 2006 compared to$10,595,000 at June 30, 2005.   The nonaccrual component of the non performing loans showed a $2,585,000 decline inthe same period.  During the same period,the 90 past due delinquent loans component declined as well to $277,000 at June30, 2006 compared to $538,000 the prior year. The efforts of our collections department staff have enabled us to keepdelinquencies at lower levels.

For the six months endedJune 30, 2006, the provision for loan losses was $250,000, compared to $380,000for the six months ended June 30, 2005. As a result, after taking into account charge-offs and recoveries duringthe period, the allowance was $5,738,000 at June 30, 2006 compared to$5,873,000 at June 30, 2005.  The decrease in the provision for loan losseswas driven by the substantial decrease in non-performing loans.   The decrease was mainly attributable to thecollection and pay-offs of non-performing loans.  Our Special Assets Department has developedand carried out exit strategies and/or resolution plans for each of thenon-performing loans which have resulted in the attainment of these reductions.

*Otherincome*

Total other(non-interest) income declined $43,000, or 4%, for the three months ended June30, 2006 compared to the same period in 2005. Fees and service charges on deposit related accounts and other fees andservice charges decreased $70,000 or 6%, due primarily to less ATM relatedcharges. Partially offsetting the various fees was an increase in gain on loanssold of $23,000, due to increased sales volume.

For the six months endedJune 30, 2006, other income increased $337,000, or 18%, compared to the sixmonths ended June 30, 2005.  During 2005,the Bank recognized an estimated impairment charge of $220,000 in anticipationof projected realized losses from the future sales of its leased vehicles.  The Bank’s automobile lease finance businessconcluded in 2005, and similar impairment charges from this activity will notrecur.  For the first six months of 2006,the Bank recognized $15,000 of gains from successful residual insurance claimson the automobile leasing business, which will curtail in 2006.  During the first half of 2005, sales ofleased vehicles yielded a net loss of $34,000. Finally, during the first half of 2006, the Bank sold more loans intothe secondary market resulting in gains of $42,000 compared to losses of $7,000in the first half of 2005.

15

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*Otheroperating expenses*

For the quarter endedJune 30, 2006, other (non-interest) expenses increased $336,000, or 9%,compared to the same 2005 quarter. Salary and employee benefits increased $221,000, or 12%, due to anincrease in the number of full-time equivalent employees and merit payincreases.  The increase in premises andequipment was caused by recognizing lease expense on long-term facility rentalagreements, equipment depreciation, repair and maintenance.  The $75,000, or 18%, decrease in professionalservice fees was due to the high-level management and sales training in 2005that did not recur in 2006.  The $92,000,or 17%, increase in the other component of operating expenses was caused byincreased expenses related to our loan collection efforts, ATM processing costsand telecommunication charges.

For the first six monthsof 2006, other expenses increased $691,000, or 10%, from the first half of2005.  Salary and employee benefitsincreased $485,000, or 14%, due to pay increases, increased number of full-timeequivalent employees, one-time voluntary separation benefit payments andstock-based compensation expense (see footnote 3, “Stock Plans”, of theconsolidated financial statements, included herein for a discussion on theCompany’s adoption of SFAS 123R).  Theincrease in premises and equipment was caused by the aforementioned increase inlease expense and increased equipment depreciation, repair and additional coreprocessing maintenance costs.  Thedecrease in professional service fees was caused mostly by non-recurringexpenses associated with the 2005 Bank-wide participation in management skillsdevelopment and sales training programs as well as a decrease in outsideconsulting fees for Sarbanes-Oxley compliance documentation procedures.

*Incometax provision*

Compared to 2005,income before provision for income taxes for the second quarter and first sixmonths of 2006 decreased $306,000 and $322,000, respectively.  The effective federal income tax rate was23.4% and 23.9% for the three and six months ended June 30, 2006, compared to25.9% for each of the respective 2005 periods. The effective tax rate decrease is attributable to lower pre-tax earningand an increase in tax-free interest income from municipal securities, tax-freeloans and tax-free earnings from the BOLI, collectively representing a largerportion of pre-tax earnings.

**COMPARISON OF FINANCIAL CONDITIONAT**

**JUNE 30, 2006 AND DECEMBER 31,2005**

 

*Overview*

Consolidated assetsincreased $31,068,000, or 6%, during the six months ended June 30, 2006 to$575,128,000.  The increase resulted froman increase in total deposits of $43,357,000, partially offset by a netdecrease in combined short-and long-term borrowings of $12,493,000.  Total investments and net loans increased$15,869,000 and $14,349,000, respectively, since December 31, 2005.

*Investmentsecurities*

At the time of purchase,the Bank classifies investment securities into one of three categories:trading, AFS or held-to- maturity (“HTM”). To date, Management has not purchased any securities for tradingpurposes.  Management classifies mostsecurities as AFS even though it has no immediate intent to sell them.  The AFS designation affords Management theflexibility to sell securities and adjust the balance sheet in response tocapital levels, liquidity needs, structuring strategies and/or changes inmarket conditions.  Securities AFS arecarried at net fair market value in the consolidated balance sheet with an adjustmentto stockholders’ equity, net of tax, which is presented under the caption “Accumulatedother comprehensive income (loss).” Securities designated as HTM are carried at amortized cost.

At June 30, 2006, thecarrying value of investment securities totaled $113,547,000, or 20%, of totalassets compared to $97,679,000 or 18%, as of December 31, 2005.  The increase in investments was due to thedeployment of deposit inflow, mostly into short-term U.S. government agencysecurities, to meet regulatory requirements. At June 30, 2006, approximately 34% of the carrying value of theinvestment portfolio was comprised of mortgage-backed securities that amortizeand provide monthly cash flow.  Also, atJune 30, 2006, agency and municipal bonds comprised 45% and 13%, respectively,of the investment portfolio.

As illustrated in thefollowing table of amortized cost and fair market value of investmentsecurities, the portfolio is comprised of HTM and AFS securities with carryingvalues of $1,785,000 and $111,762,000, respectively.  At June 30, 2006, the AFS debt securitieswere recorded with a net unrealized loss in the amount of $3,735,000 and equitysecurities were recorded with an unrealized gain of $176,000:

16

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| ** **                                        | ** ** | **Amortized** | ** ** | **Gross unrealized** | ** ** | **Gross unrealized** | ** ** | **Fair**  | ** ** |
|---------------------------------------------------|------------|---------------|------------|---------------------------|------------|---------------------------|------------|-----------|------------|
| **(dollars in thousands)**              | ** ** | **cost**      | ** ** | **gains**                 | ** ** | **losses**                | ** ** | **value** | ** ** |
|                                              |       |          |       |                      |       |                      |       |      |       |
| Held-to-maturity  securities:                     |       |          |       |                      |       |                      |       |      |       |
|                                              |       |          |       |                      |       |                      |       |      |       |
| Mortgage-backed  securities                       |       | $             | 1,785      |                      | $          | 9                         |       | $         | 4          |   | $ | 1,790 |   |
|                                              |       |          |       |                      |       |                      |       |      |       |
| Available-for-sale  securities:                   |       |          |       |                      |       |                      |       |      |       |
| U.S. government  agencies and corporations        |       | $             | 51,935     |                      | $          | —                    |       | $         | 1,423      |   | $ | 50,512 |   |
| Obligations of  states and municipal subdivisions |       | 14,620        |       | 5                         |       | 305                       |       | 14,320    |       |
| Corporate bonds                                   |       | 10,012        |       | 61                        |       | —                    |       | 10,073    |       |
| Mortgage-backed  securities                       |       | 38,475        |       | —                    |       | 2,073                     |       | 36,402    |       |
|                                              |       |          |       |                      |       |                      |       |      |       |
| Total debt  securities                            |       | 115,042       |       | 66                        |       | 3,801                     |       | 111,307   |       |
|                                              |       |          |       |                      |       |                      |       |      |       |
| Equity  securities                                |       | 279           |       | 176                       |       | —                    |       | 455       |       |
|                                              |       |          |       |                      |       |                      |       |      |       |
| Total  available-for-sale                         |       | $             | 115,321    |                      | $          | 242                       |       | $         | 3,801      |   | $ | 111,762 |   |

 

The amortized cost andfair value of debt securities at June 30, 2006 by contractual maturity are asfollows (dollars in thousands):

|                                           | ** ** | **Amortized** | ** ** | **Market** | ** ** |
|-------------------------------------------|------------|---------------|------------|------------|------------|
| ** **                                | ** ** | **cost**      | ** ** | **value**  | ** ** |
| Held-to-maturity  securities:             |       |          |       |       |       |
| Mortgage-backed  securities               |       | $             | 1,785      |       | $          | 1,790 |   |
|                                      |       |          |       |       |       |
| Available-for-sale securities:            |       |          |       |       |       |
| Debt securities:                          |       |          |       |       |       |
| One year or less                          |       | $             | 14,977     |       | $          | 14,958 |   |
| One through five  years                   |       | 11,993        |       | 11,650     |       |
| Five through ten  years                   |       | 22,101        |       | 21,250     |       |
| Over ten years                            |       | 27,496        |       | 27,047     |       |
| Subtotal                                  |       | 76,567        |       | 74,905     |       |
|                                      |       |          |       |       |       |
| Mortgage-backed  securities               |       | 38,475        |       | 36,402     |       |
|                                      |       |          |       |       |       |
| Total  available-for-sale debt securities |       | $             | 115,042    |       | $          | 111,307 |   |

 

Expected maturities willdiffer from contractual maturities because issuers and borrowers may have theright to call or repay obligations with or without call or prepaymentpenalty.  Federal agency and municipalsecurities are included based on their original stated maturity.  Mortgage-backed securities, which are basedon weighted-average lives and subject to monthly principal pay-downs, arelisted in total.

Management evaluatessecurities for other-than-temporary impairment on a quarterly basis or morefrequently when economic conditions or market conditions warrant suchevaluation.  Consideration is given to(1) the length of time and the extent to which the fair value has been lessthan cost, (2) the financial condition and near-term prospects of the issuer,and (3) the intent and ability of the Company to retain its investment in theissuer for a period of time sufficient to allow for any anticipated recovery infair value.

At June 30, 2006, the AFSdebt securities portfolio was carried at a net unrealized loss $3,735,000compared to $1,859,000 at December 31, 2005. A large portion of the unrealized losses were for a continuous period ofmore than 12 months.  Management believesthat the cause of these unrealized losses is directly related to changes inmarket interest rates.  In

17

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general, as interestrates rise, the fair value of fixed rate securities will decrease; as interestrates fall, their fair values will increase. During the current rising rate interest rate cycle that largely began in2004 the Bank has experienced a steady decline in the value of its investmentportfolio.  As of June 30, 2006, however,approximately $3.5 million, or 94%, of the deterioration of the AFS debtportfolio are from investments that are guaranteed by the U.S. government orone of its agencies.  In analyzing anissuer’s financial condition, Management considers whether the securities areissued by the U.S. government, its agencies or other governments, whetherdowngrades by bond rating agencies have occurred and, if necessary, reviews ofthe issuer’s financial condition. Because the decline in market values is attributable to changes ininterest rates and not credit quality, and the Company has the ability andintent to hold those securities until recovery of fair value, which may bematurity, Management views these unrealized losses to be temporary.

*Loans available - for- sale (“AFS”)*

Generally, uponorigination, certain residential mortgages, the guaranteed portions of SmallBusiness Administration loans and student loans are classified as AFS.  In the event of market rate increases,fixed-rate loans and loans not immediately scheduled to re-price would nolonger produce yields consistent with the current market.  In a declining interest rate environment, theBank would be exposed to prepayment risk and, as rates on adjustable rate loansdecrease, interest income would be negatively affected.  To better manage prepayment and interest raterisk, loans that meet these conditions may be considered for sale in thesecondary market.  Consideration is alsogiven to the Company’s current liquidity position and expected future liquidityneeds.  Loans AFS are carried at thelower of cost or estimated fair value. If the fair market values of these loans fall below their amortizedcost, the loan is written down by the difference with a corresponding charge tocurrent earnings.  Subsequentappreciation, if any, is credited to current earnings but only to the extent ofprevious write-downs.

At June 30, 2006, loansAFS amounted to $195,000 with a corresponding fair value of $199,000, comparedto $429,000 and $434,000, respectively, at December 31, 2005.  For the second quarter of 2006, residential mortgageand student loans with principal balances of $3,104,000 were sold into thesecondary market with combined net gains of approximately $27,000 recognized.

*Loans and leases*

The Bank originatescommercial and industrial (commercial) and commercial real estate loans,residential, consumer, home equity and construction loans.  The relative volume of originations isdependent upon customer demand, current interest rates and the perception andduration of future interest levels.  TheBank continues to focus its efforts on the expansion of variable-ratecommercial loan portfolios and fixed-rate residential mortgage and consumerloans.  The broad spectrum of productsprovides diversification which helps manage, to an extent, interest rate riskand credit concentration risk.  Creditrisk is further managed through underwriting policies and procedures and loanmonitoring practices.  Interest rate riskis managed using various asset/liability modeling techniques and analyses.  The interest rates on most commercial loansare adjustable with reset intervals of five years or less.

The majority of our loanportfolio is collateralized, at least in part, by real estate in the greaterLackawanna and Luzerne Counties of Pennsylvania.  Commercial lending activities generallyinvolve a greater degree of credit risk than residential lending because theytypically have larger balances and are more affected by adverse conditions inthe economy.  Because payments oncommercial loans depend upon the successful operation and management of theproperties and the businesses which operate from within them, repayment of suchloans may be affected by factors outside the borrower’s control.  Such factors may include adverse conditionsin the real estate market, the economy, the industry or changes in governmentregulations.  As such, commercial loansrequire more ongoing evaluation and monitoring which occurs with the Bank’scredit administration and outsourced loan review functions.

Gross loans, of$423,465,000 at June 30, 2006 increased from $409,129,000 at December 31,2005.  Residential real estate loangrowth was reasonably strong due to the continued market demand for residentialloan originations and successful sales campaigns.  The increase in commercial and commercialreal estate lending is principally due to experienced commercial lenders andthe creation of a business lending department as part of the commercial lendingteam.  The team’s continued focus is toprovide outstanding service and value-added proposals to the Bank’s customerbase.  The growth in consumer and homeequity loans stems from branch sales campaigns during the second quarter of2006.

Thecomposition of the loan portfolio at June 30, 2006 and December 31, 2005, issummarized as follows:

18

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|                                        | ** ** | **June 30, 2006** | ** **  | **December 31, 2005** | ** ** |
|----------------------------------------|------------|-----------------------------|-------------|---------------------------------|------------|
| ** **                             | ** ** | **Amount**                  | ** **  | **%**                           | ** ** | **Amount** | ** ** | **%** | ** ** |
| Commercial and  commercial real estate |       | $                           | 220,197,114 |                            | 52.0       |   | $ | 216,288,597 |   | 52.9 |   |
| Residential real estate                |       | 111,009,318                 |        | 26.2                            |       | 103,920,613 |   | 25.4 |   |
| Consumer and home equity               |       | 77,753,307                  |        | 18.4                            |       | 74,070,328 |   | 18.1 |   |
| Real estate construction               |       | 13,885,792                  |        | 3.3                             |       | 14,198,858 |   | 3.4 |   |
| Direct financing leases                |       | 619,556                     |        | 0.1                             |       | 650,348 |   | 0.2 |   |
| Gross loans                            |       | 423,465,087                 |        | 100.0                           |       | 409,128,744 |   | 100.0 |   |
| Allowance for  loan losses             |       | (5,738,470                  | )           |                            |       | (5,984,649 | ) |   |   |
| Net loans                              |       | $                           | 417,726,617 |                            |       |   | $ | 403,144,095 |   |   |   |

 

*Allowance for loan losses*

Management continuallyevaluates the credit quality of the Bank’s loan and lease portfolio andperforms a formal review of the adequacy of the allowance for loan losses (the “allowance”),on a quarterly basis.  The allowancereflects Management’s best estimate of the amount of credit losses in the loanportfolio.  Management’s judgment isbased on the evaluation of individual loans, past experience, the assessment ofcurrent economic conditions and other relevant factors including the amountsand timing of cash flows expected to be received on impaired loans.  Those estimates may be susceptible tosignificant change.  The provision forloan losses represents the amount necessary to maintain an appropriateallowance.  Loan losses are chargeddirectly against the allowance when loans are deemed to be uncollectible.  Recoveries from previously charged-off loansare added to the allowance when received.

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

·                  Identification of specific problemloans by loan category;

·                  Calculation of specific allowancesrequired based on collateral and objective and quantifiable evidence;

·                  Determination of homogenous pools byloan category and eliminating loans with specific allocations;

·                  Application of historical losspercentages (three-year average) to pools to determine the allowanceallocation; and

·                  Applicationof qualitative factor adjustment percentages to historical losses for trends orchanges in the loan portfolio.

Allocation of theallowance for different categories of loans is based on the methodology asexplained above.  A key element of themethodology to determine the allowance is the Company’s credit risk evaluationprocess, which includes credit risk grading of individual commercialloans.  Commercial loans are assignedcredit risk grades based on the Company’s assessment of conditions that affectthe borrower’s ability to meet its contractual obligations under the loanagreement.  That process includesreviewing borrowers’ current financial information, historical paymentexperience, credit documentation, public information and other informationspecific to each individual borrower. The changes in the allocations from period to period are based upon thecredit risk grading assigned from periodic reviews of the loan and leaseportfolios.

Net charge-offs for thesix months ended June 30, 2006 were $496,000, compared to $494,000 for the sameperiod in 2005.  Net charge-offs ofcommercial loans were $311,000 for the six months ended June 30, 2006 comparedto $426,000 in the six months of 2005. Gross commercial charge-offs were $378,000 less for the six months endedJune 30, 2006 compared to the six months ended June 30, 2005.  The June 30, 2005 amount included one largecommercial charge-off in the amount of $318,000 taken in the second quarter of2005. Recoveries on three commercial loans aggregating $259,000 in the firstquarter of 2005 helped reduce the net charge-offs for the six months ended June30, 2005.  Real estate mortgage netcharge-offs were $32,000 in the first half of 2006 as opposed to $21,000 in thefirst half of 2005.  Consumer loan netcharge-offs were $154,000 for the six months ended June 30, 2006 as compared to$47,000 for the same six months of 2005. There were no lease financing charge-offs during the six months endedJune 30, 2006 and recoveries posted were nominal.

Management believes thatthe current balance in the allowance for loans losses of $5,738,000 issufficient to withstand the identified potential credit quality issues that mayarise and are inherent to the portfolio. Currently, Management is unaware of any potential problem loans thathave not been reviewed.  Potential problemloans are those where there is known information that leads Management tobelieve repayment of principal and/or interest is in jeopardy and the loans areneither

19

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on non-accrual status norpast due 90 days or more.  However, therecould be instances which become identified over the year that may requireadditional charge-offs and/or increases to the allowance.  The ratio of allowance for loan losses tototal loans was 1.36% at June 30, 2006 compared 1.46% at December 31, 2005 and1.51% at June 30, 2005.

The following tables setforth the activity in the allowance for loan losses and certain key ratios forthe period indicated:
| ** **                       | ** ** | **As of and for the** | ** **  | **As of and for the** | ** ** | **As of and for the** | ** ** |
|----------------------------------|------------|-------------------------------------------|-------------|-------------------------------------------|------------|-------------------------------------------|------------|
| ** **                       | ** ** | **six months ended**            | ** **  | **year ended**                       | ** ** | **six months ended**            | ** ** |
| ** **                       | ** ** | **June 30, 2006**               | ** **  | **December 31, 2005**           | ** ** | **June 30, 2005**               | ** ** |
|                             |       |                                      |        |                                      |       |                                      |       |
| Balance at beginning of  period  |       | $                                         | 5,984,649   |                                      | $          | 5,987,798                                 |       | $ | 5,987,798 |   |
|                             |       |                                      |        |                                      |       |                                      |       |
| Provision charged to  operations |       | 250,000                                   |        | 830,000                                   |       | 380,000                                   |       |
|                             |       |                                      |        |                                      |       |                                      |       |
| Charge-offs:                     |       |                                      |        |                                      |       |                                      |       |
| Commercial                       |       | 350,133                                   |        | 1,076,721                                 |       | 728,516                                   |       |
| Real estate                      |       | 31,626                                    |        | 20,875                                    |       | 20,875                                    |       |
| Consumer                         |       | 195,636                                   |        | 287,676                                   |       | 108,302                                   |       |
| Lease financing                  |       | —                                    |        | 8,373                                     |       | —                                    |       |
| Total                            |       | 577,395                                   |        | 1,393,645                                 |       | 857,693                                   |       |
|                             |       |                                      |        |                                      |       |                                      |       |
| Recoveries:                      |       |                                      |        |                                      |       |                                      |       |
| Commercial                       |       | 39,197                                    |        | 395,162                                   |       | 302,204                                   |       |
| Real estate                      |       | 60                                        |        | 10,677                                    |       | 60                                        |       |
| Consumer                         |       | 41,759                                    |        | 154,557                                   |       | 61,009                                    |       |
| Lease financing                  |       | 200                                       |        | 100                                       |       | —                                    |       |
| Total                            |       | 81,216                                    |        | 560,496                                   |       | 363,273                                   |       |
|                             |       |                                      |        |                                      |       |                                      |       |
| Net charge-offs                  |       | 496,179                                   |        | 833,149                                   |       | 494,420                                   |       |
|                             |       |                                      |        |                                      |       |                                      |       |
| Balance at end of  period        |       | $                                         | 5,738,470   |                                      | $          | 5,984,649                                 |       | $ | 5,873,378 |   |
|                             |       |                                      |        |                                      |       |                                      |       |
| Total loans, end of  period      |       | $                                         | 423,465,087 |                                      | $          | 409,128,744                               |       | $ | 388,249,252 |   |

 

20

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| ** **                                                                | ** ** | **As of and for the** | ** ** | **As of and for the** | ** ** | **As of and for the** | ** ** |
|---------------------------------------------------------------------------|------------|-------------------------------------------|------------|-------------------------------------------|------------|-------------------------------------------|------------|
| ** **                                                                | ** ** | **six months ended**            | ** ** | **year ended**                       | ** ** | **six months ended**            | ** ** |
| ** **                                                                | ** ** | **June 30, 2006**               | ** ** | **December 31, 2005**           | ** ** | **June 30, 2005**               | ** ** |
| Net charge-offs to:                                                       |       |                                      |       |                                      |       |                                      |       |
| Loans, end of period                                                      |       | 0.12                                      | %          | 0.20                                      | %          | 0.13                                      | %          |
| Allowance for  loan losses                                                |       | 8.65                                      | %          | 13.92                                     | %          | 8.42                                      | %          |
| Provision for  loan losses                                                |       | 1.98                                      | x          | 1.00                                      | x          | 1.30                                      | x          |
|                                                                      |       |                                      |       |                                      |       |                                      |       |
| Allowance for loan  losses to:                                            |       |                                      |       |                                      |       |                                      |       |
| Total loans                                                               |       | 1.36                                      | %          | 1.46                                      | %          | 1.51                                      | %          |
| Non-accrual  loans                                                        |       | 0.77                                      | x          | 0.63                                      | x          | 0.58                                      | x          |
| Non-performing  loans                                                     |       | 0.74                                      | x          | 0.62                                      | x          | 0.55                                      | x          |
| Net charge-offs                                                           |       | 11.57                                     | x          | 7.18                                      | x          | 11.88                                     | x          |
|                                                                      |       |                                      |       |                                      |       |                                      |       |
| Loans 30-89 days past  due and still accruing                             |       | $                                         | 3,696,924  |                                      | $          | 1,608,970                                 |       | $ | 2,681,224 |   |
| Loans 90 days past due  and accruing                                      |       | $                                         | 277,250    |                                      | $          | 196,928                                   |       | $ | 537,588 |   |
| Non-accrual loans                                                         |       | $                                         | 7,472,830  |                                      | $          | 9,452,788                                 |       | $ | 10,057,877 |   |
| Allowance for loan losses to loans 90 days or more past due and  accruing |       | 20.70                                     | x          | 30.39                                     | x          | 10.93                                     | x          |

 

*Non-performing assets*

The Bank definesnon-performing assets as accruing loans past due 90 days or more, non-accrualloans, restructured loans, other real estate owned and repossessed assets.  As of June 30, 2006, non-performing assetsrepresented 1.36% of total assets compared to 1.78% at December 31, 2005 and2.07% at June 30, 2005.

Thenon-accrual loans declined by $1,980,000 during the first six months of 2006 to$7,473,000.  There were additions to thenon-accrual loans totaling $554,000 during the first six months of 2006.  These additions were offset by payoffs or paydowns of $1,955,000, charge offs of $486,000 and $93,000 of loans that weretransferred to other real estate owned. As of June 30, 2006, approximately one-half of the non-accrual loanbalances consisted of one single relationship.

Otherreal estate owned at June 30, 2006 consisted of two residential properties thatwere foreclosed upon and transferred from loans.   The total of these two properties was$53,000 at June 30, 2006.  One of theproperties has been listed for sale with a realtor.  The second property is under a contract forsale.  There were no repossessed assetsat June 30, 2006.

Non-performingloans declined $1,900,000 from year-end 2005, to $7,750,000 at June 30,2006.  Although the decline occurredmainly in the commercial loans, reductions occurred in the real estate andconsumer portfolios as well.  The ratioof non-performing loans to net loans declined by 54 basis points to 1.85%,during the six month period ended June 30, 2006.  At June 30, 2005, the ratio of non-performingloans to net loans was 2.77%, compared to 1.85% at June 30, 2006 or a decreaseof 92 basis points.  The ratio ofnon-performing assets to total assets decreased to 1.36% at June 30, 2006, downfrom 1.78% at year-end 2005.  This ismainly a result of the reduced levels of non-accrual loans, and also the increasein which occurred in total assets.

21

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

|                                                                                    | ** ** | **June 30, 2006** | ** **  | **December 31, 2005** | ** ** | **June 30, 2005** | ** ** |
|------------------------------------------------------------------------------------|------------|-----------------------------|-------------|---------------------------------|------------|-----------------------------|------------|
|                                                                               |       |                        |        |                            |       |                        |       |
| Loans past due 90 days  or more and accruing                                       |       | $                           | 277,250     |                            | $          | 196,928                     |       | $ | 537,588 |   |
| Non-accrual loans                                                                  |       | 7,472,830                   |        | 9,452,788                       |       | 10,057,877                  |       |
| Total  non-performing loans                                                        |       | 7,750,080                   |        | 9,649,716                       |       | 10,595,465                  |       |
|                                                                               |       |                        |        |                            |       |                        |       |
| Other real estate owned                                                            |       | 53,099                      |        | —                          |       | 351,550                     |       |
| Repossessed assets                                                                 |       | —                      |        | 18,702                          |       | 100,484                     |       |
| Total  non-performing assets                                                       |       | $                           | 7,803,179   |                            | $          | 9,668,418                   |       | $ | 11,047,499 |   |
|                                                                               |       |                        |        |                            |       |                        |       |
| Net loans including AFS                                                            |       | $                           | 417,921,996 |                            | $          | 403,572,679                 |       | $ | 382,375,874 |   |
| Total assets                                                                       |       | $                           | 575,128,225 |                            | $          | 544,060,698                 |       | $ | 533,320,637 |   |
| Non-accrual loans to  net loans                                                    |       | 1.79                        | %           | 2.34                            | %          | 2.63                        | %          |
| Non-performing assets  to net loans, foreclosed real estate and repossessed assets |       | 1.87                        | %           | 2.40                            | %          | 2.89                        | %          |
| Non-performing assets  to total assets                                             |       | 1.36                        | %           | 1.78                            | %          | 2.07                        | %          |
| Non-performing loans to net loans                                                  |       | 1.85                        | %           | 2.39                            | %          | 2.77                        | %          |

 

*Accrued interest receivable andother assets*

The increase in accruedinterest receivable of $632,000 or 32%, from December 31, 2005 to June 30, 2006was principally due to higher average balances of interest-earning assets.  The increase in other assets of $746,000, or18%, for the same period, was due to an increase in the deferred income taxasset caused by the decline in value in the securities AFS portfolio.

*Deposits*

The Bank is acommunity-based commercial financial institution and offers a variety ofdeposit accounts with a range of interest rates and terms.  Deposit products include non-interestbearing, savings, NOW, money market, and certificates of deposit accounts.  The flow of deposits is significantlyinfluenced by general economic conditions, changes in prevailing interestrates, pricing and competition.  Most ofthe Bank’s deposits are obtained from the communities surrounding its 12 branchoffices.  We attempt to attract andretain deposit customers via sales and marketing efforts with new products,quality service, competitive rates and maintaining long-standing customerrelationships.

Compared to December 31,2005, total deposits increased $43,357,000, or 11%, during the six months endedJune 30, 2006.  The increase in totaldeposits was primarily due to a $26,370,000, or 53%, increase in NOW accounts,much of which stems from our continued positive relationship with our publicsector customers.  The $22,538,000, or44%, increase in money market accounts was due to the successful implementationof deposit-gathering strategies in conjunction with increased short-termpromotional interest rates and transfers from less attractive timedeposits.  Though the Bank has introducedsome promotional strategies for shorter-term time deposits, Management did notaggressively pursue time deposits; rather, most of the efforts were targeted toattracting transactional, no-term core deposits such as NOW and money marketaccounts.  Though non-interest bearingdeposits were relatively flat compared to December 31, 2005, the Bank continuesto experience growth from its personal relationship customers.  Going forward, Management will continue todevelop strategies and implement campaigns to attract this all-importantcost-lowering funding source.

To determine depositproduct interest rates, the Bank considers local competition, market yields andthe rates charged for alternative sources of funding such as borrowings.  Although we continue to experience intensecompetition for deposits, we have not increased rates above market rates, as weonly consider cost effective strategies in all interest rate environments.

22

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The following tablerepresents the major components of deposits as of June 30, 2006 and December31, 2005:

|                                              | ** ** | **June 30, 2006** | ** **  | **December 31, 2005** | ** ** |
|----------------------------------------------|------------|-----------------------------|-------------|---------------------------------|------------|
| ** **                                   | ** ** | **Amount**                  | ** **  | **%**                           | ** ** | **Amount** | ** ** | **%** | ** ** |
| Money market                                 |       | $                           | 74,121,373  |                            | 17.5       |   | $ | 51,583,473 |   | 13.6 |   |
| NOW                                          |       | 76,417,961                  |        | 18.1                            |       | 50,048,331 |   | 13.2 |   |
| Savings and club                             |       | 49,897,684                  |        | 11.8                            |       | 46,434,150 |   | 12.3 |   |
| Certificates of  deposit less than $100,000  |       | 88,368,651                  |        | 20.9                            |       | 84,814,047 |   | 22.3 |   |
| Certificates of  deposit of $100,000 or more |       | 63,488,886                  |        | 15.0                            |       | 76,257,553 |   | 20.1 |   |
| Total interest-bearing                       |       | 352,294,555                 |        | 83.3                            |       | 309,137,554 |   | 81.5 |   |
| Non-interest  bearing                        |       | 70,560,800                  |        | 16.7                            |       | 70,361,086 |   | 18.5 |   |
| Total deposits                               |       | $                           | 422,855,355 |                            | 100.0      |   | $ | 379,498,640 |   | 100.0 |   |

 

*Borrowings*

Borrowings are used as acomplement to deposit generation as an alternative funding source whereby theBank will borrow under customer repurchase agreements (“REPOs”) in the localmarket and advances from the Federal Home Loan Bank of Pittsburgh (FHLB) forasset growth and liquidity needs. Borrowings included $68,325,000 and $83,704,000 in long-term advancesfrom the FHLB at June 30, 2006 and December 31, 2005, respectively.  Also included in borrowings were REPOagreements of $23,951,000 and $26,913,000, as of the respective periods.  REPOs are non-insured low-costinterest-bearing liabilities that have a security interest in qualifiedinvestment securities of the Bank.  REPOsoffered are either fixed-term or a daily-sweep product of the Bank.  The balance in customer REPOs can fluctuatedaily because the daily-sweep product is dependent on the level of availablefunds in depositor accounts.  Inaddition, short-term borrowings may include overnight balances which the Bankmay require from time-to-time to fund daily liquidity needs.  As of June 30, 2006, the balance in thisaccount was $7,683,000 compared to $769,000 at December 31, 2005.

Combined short- andlong-term borrowings amounted to $99,984,000 at June 30, 2006 compared to$112,477,000 at December 31, 2005, or a decrease of approximately $12,493,000,or 11%.  The decrease was the result ofincreased deposit generation that was used to repay FHLB advances during thesecond quarter of 2006.

**Item3.  Quantitative and QualitativeDisclosure About Market Risk**

*Management of interest rate riskand market risk analysis*

The Company is subject tothe interest rate risks inherent in our lending, investing and financingactivities.  Fluctuations of interestrates will impact interest income and interest expense along with affectingmarket values of all interest-earning assets and interest-bearing liabilities,except for those assets or liabilities with a short-term remaining tomaturity.  Interest rate risk managementis an integral part of the asset/liability management process.  The Company has instituted certain proceduresand policy guidelines to manage the interest rate risk position.  Those internal policies enable the Company toreact to changes in market rates to protect net interest income from significantfluctuations.  The primary objective inmanaging interest rate risk is to minimize the adverse impact of changes ininterest rates on net interest income along with creating an asset/liabilitystructure that maximizes earnings.

*Asset/Liability Management*.  One major objective of the Company whenmanaging the rate sensitivity of its assets and liabilities is to stabilize netinterest income.  The management of andauthority to assume interest rate risk is the responsibility of the Company’sAsset/Liability Committee (“ALCO”), which is comprised of Senior Management andmembers of the Board of Directors.  ALCOmeets quarterly to monitor the relationship of interest sensitive assets tointerest sensitive liabilities.  Theprocess to review interest rate risk is a regular part of managing theCompany.  Consistent policies andpractices of measuring and reporting interest rate risk exposure, particularlyregarding the treatment of non-contractual assets and liabilities, are ineffect.  In addition, there is an annualprocess to review the interest rate risk policy with the Board of Directorswhich includes limits on the impact to earnings from shifts in interest rates.

23

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*Interest Rate Risk Measurement.* Interest rate risk is monitored through theuse of three complementary measures: static gap analysis, earnings at risk simulation and economic value atrisk simulation.  While each of theinterest rate risk measurements has limitations, taken together they representa reasonably comprehensive view of the magnitude of interest rate risk in theCompany and the distribution of risk along the yield curve, the level of riskthrough time and the amount of exposure to changes in certain interest raterelationships.

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

To manage this interest rate sensitivity gap position,an asset/liability model called cumulative gap analysis is used to monitor thedifference in the volume of the Company’s interest sensitive assets andliabilities that mature or re-price within given periods.  A positive gap (asset sensitive) indicatesthat more assets re-price during a given period compared to liabilities, whilea negative gap (liability sensitive) has the opposite effect.  The Company employs computerized net interestincome simulation modeling to assist in quantifying interest rate riskexposure.  This process measures andquantifies the impact on net interest income through varying interest ratechanges and balance sheet compositions. The use of this model assists the ALCO to gauge the effects of theinterest rate changes on interest sensitive assets and liabilities in order todetermine what impact these rate changes will have upon the net interestspread.  At June 30, 2006, the Companymaintained a negative one-year cumulative gap of $104,665,000 or -18.2% oftotal assets.  The effect of thisnegative gap position provided a mismatch of assets and liabilities, which mayexpose the Bank to interest rate risk during a period of rising interest rates.  Conversely, in a declining interest rateenvironment, net interest income could be positively impacted because moreliabilities than assets will re-price downward during a one-year period.

Certain shortcomings are inherent in the methodof analysis discussed above and presented in the next table.  Although certain assets and liabilities mayhave similar maturities or periods of re-pricing, they may react in differentdegrees to changes in market interest rates. The interest rates on certain types of assets and liabilities mayfluctuate in advance of changes in market interest rates, while interest rateson other types of asset and liabilities may lag behind changes in marketinterest rates.  Certain assets, such asadjustable-rate mortgages, have features which restrict changes in interest rateson 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 thoseassumed in calculating the table.  Theability of many borrowers to service their adjustable-rate debt may decrease inthe event of an interest rate increase.

The following table illustrates the Company’s interest sensitivity gapposition at June 30, 2006 (dollars in thousands):

24

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|                                                | ** ** | **3 months** | ** ** | **3 through** | ** ** | **1 through** | ** ** | **Over**         | ** ** | ** ** | ** ** |
|------------------------------------------------|------------|-------------------|------------|--------------------|------------|--------------------|------------|------------------|------------|------------|------------|
| ** **                                     | ** ** | **or less**  | ** ** | **12 months** | ** ** | **3 years**   | ** ** | **3 years** | ** ** | **Total**  | ** ** |
| Cash and cash  equivalents                     |       | $                 | 192        |               | $          | —             |       | $                | —     |       | $          | 11,930 |   | $ | 12,122 |   |
| Investment  securities (1)(2)                  |       | 23,804            |       | 9,567              |       | 16,415             |       | 68,320           |       | 118,106    |       |
| Loans (2)                                      |       | 106,879           |       | 63,474             |       | 100,299            |       | 147,270          |       | 417,922    |       |
| Fixed and other  assets                        |       | —            |       | 8,033              |       | —             |       | 18,945           |       | 26,978     |       |
| Total assets                                   |       | $                 | 130,875    |               | $          | 81,074             |       | $                | 116,714    |       | $          | 246,465 |   | $ | 575,128 |   |
| Total cumulative assets                        |       | $                 | 130,875    |               | $          | 211,949            |       | $                | 328,663    |       | $          | 575,128 |   |   |   |
|                                           |       |              |       |               |       |               |       |             |       |       |       |
| Non-interest  bearing transaction deposits (3) |       | $                 | —     |               | $          | 7,056              |       | $                | 19,404     |       | $          | 44,101 |   | $ | 70,561 |   |
| Interest-bearing  transaction deposits (3)     |       | 93,984            |       | 53,511             |       | 43,119             |       | 9,822            |       | 200,436    |       |
| Time deposits                                  |       | 31,303            |       | 86,529             |       | 19,673             |       | 14,353           |       | 151,858    |       |
| Repurchase  agreements                         |       | 13,886            |       | 8,421              |       | 1,644              |       | —           |       | 23,951     |       |
| Short-term borrowings                          |       | 7,708             |       | —             |       | —             |       | —           |       | 7,708      |       |
| Long-term debt                                 |       | 7,746             |       | 6,470              |       | 1,109              |       | 53,000           |       | 68,325     |       |
| Other  liabilities                             |       | —            |       | —             |       | —             |       | 3,254            |       | 3,254      |       |
| Total liabilities                              |       | $                 | 154,627    |               | $          | 161,987            |       | $                | 84,949     |       | $          | 124,530 |   | $ | 526,093 |   |
| Total cumulative liabilities                   |       | $                 | 154,627    |               | $          | 316,614            |       | $                | 401,563    |       | $          | 526,093 |   |   |   |
|                                           |       |              |       |               |       |               |       |             |       |       |       |
| Interest  sensitivity gap                      |       | $                 | (23,752    | )                  | $          | (80,913            | )          | $                | 31,765     |       | $          | 121,935 |   |   |   |
|                                           |       |              |       |               |       |               |       |             |       |       |       |
| Cumulative gap                                 |       | $                 | (23,752    | )                  | $          | (104,665           | )          | $                | (72,900    | )          | $          | 49,035 |   |   |   |
|                                           |       |              |       |               |       |               |       |             |       |       |       |
| Cumulative gap to total  assets                |       | -4.13             | %          | -18.20             | %          | -12.68             | %          | 8.53             | %          |       |       |

 

----

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

(2)            Investmentsand loans are included in the earlier of the period in which interest rateswere next scheduled to adjust or the period in which they are due.  In addition, loans are included in theperiods in which they are scheduled to be repaid based on scheduledamortization.  For amortizing loans andmortgage-backed securities, annual prepayment rates are assumed reflectinghistorical experience as well as Management’s knowledge and experience of itsloan products.

(3)            TheBank’s demand and savings accounts are generally subject to immediatewithdrawal.  However, Managementconsiders a certain amount of such accounts to be core accounts havingsignificantly longer effective maturities based on the retention experiences ofsuch deposits in changing interest rate environments.  The effective maturities presented are therecommended maturity distribution limits for non-maturing deposits based onhistorical deposit studies.

*Earnings at Risk and Economic Value at RiskSimulations.* The Company recognizes that more sophisticatedtools exist for measuring the interest rate risk in the balance sheet beyondstatic re-pricing gap analysis.  Althoughit will continue to measure its re-pricing gap position, the Company utilizesadditional modeling for identifying and measuring the interest rate risk in theoverall balance sheet.  The ALCO isresponsible for focusing on earnings at risk and economic value at risk, andhow both relate to the risk-based capital position when analyzing the interestrate risk.

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

*Economic Value at Risk. *Earnings at risk simulationmeasure the short-term risk in the balance sheet.  Economic value (or portfolio equity) at riskmeasures the long-term risk by finding the net present value of the future cashflows from the Company’s existing assets and liabilities.  The ALCO examines this ratio quarterlyutilizing an increase and decrease of 200 basis points in interest ratessimulation model.  The ALCO recognizesthat, in some instances, this ratio may contradict the earnings at risk ratio.

25

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The following table illustrates the simulated impactof 200 basis points upward or downward movement in interest rates on netinterest income, net income and the change in economic value (portfolioequity).  This analysis assumed thatinterest-earning asset and interest-bearing liability levels at June 30, 2006remained constant.  The impact of therate movements was developed by simulating the effect of rates changing over atwelve-month period from the June 30, 2006 levels:
|                                                      | ** ** | **Rates +200** | ** ** | **Rates -200** | ** ** |
|------------------------------------------------------|------------|---------------------|------------|---------------------|------------|
| Earnings at  risk:                                   |       |                |       |                |       |
| Percent change in:                                   |       |                |       |                |       |
| Net interest income                                  |       | (3.2                | )%         | (2.0                | )%         |
| Net income                                           |       | (8.5                | )          | (6.3                | )          |
|                                                 |       |                |       |                |       |
| Economic value  at risk:                             |       |                |       |                |       |
| Percent change in:                                   |       |                |       |                |       |
| Economic value of equity                             |       | (33.0               | )          | 15.2                |       |
| Economic value  of equity asa percent of book assets |       | (3.2                | )          | 1.5                 |       |

 

Economic value has themost meaning when viewed within the context of risk-based capital.  Therefore, the economic value may normallychange beyond the Company’s policy guideline for a short period of time as longas the risk-based capital ratio (after adjusting for the excess equityexposure) is greater than 10%.  At June30, 2006, the Company’s risk-based capital ratio was 13.3%.

The table belowsummarizes estimated changes in net interest income over a twelve-month periodbeginning July 1, 2006, under alternate interest rate scenarios using theincome simulation model described above (dollars in thousands):
|                                             | ** ** | **Net interest** | ** ** | **Dollar**   | ** ** | **Percent**  | ** ** |
|---------------------------------------------|------------|-----------------------|------------|--------------|------------|--------------|------------|
| **Change in interest rates** | ** ** | **income**            | ** ** | **variance** | ** ** | **variance** | ** ** |
|                                        |       |                  |       |         |       |         |       |
| +200 basis  points                          |       | $                     | 17,437     |         | $          | (577         | )          | (3.2 | )% |
| +100 basis  points                          |       | 17,662                |       | (352         | )          | (2.0         | )          |
| Flat rate                                   |       | 18,014                |       | —       |       | —       |       |
| -100 basis  points                          |       | 18,113                |       | 99           |       | 0.5          |       |
| -200 basis points                           |       | 17,661                |       | (353         | )          | (2.0         | )          |
|                                             |            |                       |            |              |            |              |            |  |  |

 

Simulation models requireassumptions about certain categories of assets and liabilities.  The models schedule existing assets andliabilities by their contractual maturity, estimated likely call date orearliest re-pricing opportunity. Mortgage-backed securities and amortizing loans are scheduled based ontheir anticipated cash flow including estimated prepayments.  For investment securities, we use a thirdparty service to provide cash flow estimates in the various rate environments.  Savings accounts, including passbook,statement savings, money market and interest checking accounts do not have astated maturity or re-pricing term and can be withdrawn or re-price at anytime.  This may impact the margin if moreexpensive alternative sources of deposits are required to fund loans or depositrun-off.  Management projects there-pricing characteristics of these accounts based on historical performanceand assumptions that it believes reflect their rate sensitivity.  The consulting model reinvests allmaturities, repayments and prepayments for each type of asset or liability intothe same product for a new like-term at current rates provided myManagement.  As a result, the mix ofinterest-earning assets and interest bearing-liabilities is held constant.

*Liquidity*

Liquidity managementensures that adequate funds will be available to meet customers’ needs forborrowings, deposit withdrawals and maturities and normal operating expenses ofthe Bank.  Current sources of liquidityare cash and cash equivalents, asset maturities and pay downs within one year,loans and investments AFS, growth of core deposits, growth of repurchaseagreements, available fed fund lines and other borrowed funds fromcorrespondent banks and issuance of capital stock.  Although regularly scheduled investment andloan payments are dependable sources of daily funds, the sales of both loansand investments AFS, deposit activity, and investment and loan prepayments aresignificantly influenced by general economic conditions and the level ofinterest rates.

26

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As of June 30, 2006, the Companymaintained $12,122,000 in cash and cash equivalents and had $111,762,000 ininvestments AFS and $195,000 of loans AFS. In addition, as of June 30, 2006, the Company had approximately$60,447,000 available to borrow from the FHLB. This combined total of $184,526,000 represented 32% of total assets atJune 30, 2006.  Management believes thislevel of liquidity to be strong and adequate to support current operations.

*Capital*

Shareholders’ equityincreased from net income, stock issuance from the Company’s various sponsoredstock plans partially offset by an increase in the unrealized loss on AFSsecurities and the declaration of cash dividends.  The decline in the market value of securitiesAFS is due to the predominant increasing interest rate environment whichlargely began in 2004.  The Company issubject to various regulatory capital requirements administered by the federalbanking agencies. Failure to meet minimum capital requirements can initiatecertain mandatory and possible additional discretionary actions by regulatorsthat, if undertaken, could have a direct material effect on the Company’sfinancial statements. Under capital adequacy guidelines and the regulatoryframework for prompt corrective action, the Company must meet specific capitalguidelines that involve quantitative measures of the Company’s assets,liabilities and certain off-balance-sheet items as calculated under regulatoryaccounting practices.  The Company’scapital amounts and classification are also subject to qualitative judgments bythe regulators about components, risk-weightings and other factors.

Under theseguidelines, assets and certain off-balance sheet items are assigned to broadrisk categories, each with appropriate weights. The resulting capital ratios represent capital as a percentage of totalrisk-weighted assets and certain off-balance sheet items.  The guidelines require all banks and bankholding companies to maintain a minimum ratio of total risk-based capital tototal risk-weighted assets (“Total Risk Adjusted Capital”) of 8%, includingTier I capital to total risk-weighted assets (“Tier I Capital”) of 4% and TierI capital to average total assets (“Leverage Ratio”) of at least 4%.

As of June 30,2006, the Company meets all capital adequacy requirements to which it issubject.  The following table depicts thecapital amounts and ratios of the Company and the Bank as of June 30, 2006:

 
| ** **                | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** **                 | ** ** | ** ** | ** ** | **To be well**   | ** ** | ** ** | ** ** |
|---------------------------|------------|------------|------------|------------|------------|------------|----------------------------|------------|------------|------------|----------------------------|------------|------------|------------|
| ** **                | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** **                 | ** ** | ** ** | ** ** | **capitalized under** | ** ** | ** ** | ** ** |
| ** **                | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | **For capital**       | ** ** | ** ** | ** ** | **prompt corrective** | ** ** | ** ** | ** ** |
| ** **                | ** ** | **Actual** | ** ** | ** ** | ** ** | ** ** | **adequacy purposes** | ** ** | ** ** | ** ** | **action provisions** | ** ** | ** ** | ** ** |
| ** **                | ** ** | **Amount** | ** ** | **Ratio**  | ** ** | ** ** | **Amount**                 | ** ** | ** ** | **Ratio**  | ** **                 | **Amount** | ** ** | ** ** | **Ratio** | ** ** |
| Total capital             |       |       |       |       |       |       |                       |       |       |       |                       |       |       |       |   |   |
| (to risk-weighted assets) |       |       |       |       |       |       |                       |       |       |       |                       |       |       |       |   |   |
| Consolidated              |       | $          | 56,799,103 |       | 13.28      | %          | >                  | $          | 34,194,812 |       | >                  | 8.00       | %          | N/A        |   |   | N/A |   |
| Bank                      |       | $          | 56,467,176 |       | 13.21      | %          | >                  | $          | 34,188,984 |       | >                  | 8.00       | %          | $          | 42,736,230 |   | >  | 10.00 | % |
| Tier I capital            |       |       |       |       |       |       |                       |       |       |       |                       |       |       |       |   |   |
| (to risk-weighted assets) |       |       |       |       |       |       |                       |       |       |       |                       |       |       |       |   |   |
| Consolidated              |       | $          | 51,351,627 |       | 12.01      | %          | >                  | $          | 17,097,406 |       | >                  | 4.00       | %          | N/A        |   |   | N/A |   |
| Bank                      |       | $          | 51,114,336 |       | 11.96      | %          | >                  | $          | 17,094,492 |       | >                  | 4.00       | %          | $          | 25,641,738 |   | >  | 6.00 | % |
| Tier I capital            |       |       |       |       |       |       |                       |       |       |       |                       |       |       |       |   |   |
| (to average assets)       |       |       |       |       |       |       |                       |       |       |       |                       |       |       |       |   |   |
| Consolidated              |       | $          | 51,351,627 |       | 8.99       | %          | >                  | $          | 22,854,148 |       | >                  | 4.00       | %          | N/A        |   |   | N/A |   |
| Bank                      |       | $          | 51,114,336 |       | 8.95       | %          | >                  | $          | 22,839,964 |       | >                  | 4.00       | %          | $          | 28,549,955 |   | >  | 5.00 | % |

 

**Item4.  Controls and Procedures**

The Company maintains controls and procedures designed to ensure that information required to be disclosed in the reports that the Company files or submits under the Securities Exchange Act of 1934 is recorded, processed, summarized and reported within the time periods specified in the rules and forms of the Securities and Exchange Commission. Based upon their evaluation of those controls and procedures as of the end of the period covered by this report, the Chief Executive and Chief Financial Officers of the Company concluded that the Company’s disclosure controls and procedures were adequate.

The Company assesses the adequacy of its internal control over financial reporting quarterly and enhances its controls in response to internal control assessments and internal and external audit and regulatory recommendations.  Based on this assessment, the Company’s Management concluded that there have been no changes in the Company’s internal controls or in other factors that has materially affected, or are reasonably likely to materially affect, the Company’s internal control over financial reporting.

27

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**PART II - Other Information**

**Item 1. Legal Proceedings**

The nature of the Company’s businessgenerates some litigation involving matters arising in the ordinary course ofbusiness.  However, in the opinion of theCompany, after consulting with legal counsel, no legal proceedings are pending,which, if determined adversely to the Company or the Bank, would have amaterial effect on the Company’s undivided profits or financial condition.  No legal proceedings are pending other thanordinary routine litigation incidental to the business of the Company and theBank.  In addition, to Management’sknowledge, no governmental authorities have initiated or contemplated anymaterial legal actions against the Company or the Bank.

**Item 1A.  Risk Factors**

Management of the Companydoes not believe there have been any material changes in the risk factors thatwere disclosed in the Form 10-K filed with the Securities and ExchangeCommission on March 28, 2006.

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

 None

**Item 3.    Default Upon Senior Securities**

 None

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

At the annual meeting ofshareholders held on May 2, 2006, the judges of election made the reportconcerning the results of balloting. Holders of 1,667,306 shares of common stock, representing 81.5% of thetotal number of shares outstanding, were represented in person or by proxy atthe 2006 annual meeting of shareholders.

The following votes werecast:

Election of Class A Directors to serve for athree-year term:

 
| ** **          | ** ** | **For**   | ** ** | **Withhold authority** | ** ** | **Abstain** | ** ** |
|---------------------|------------|-----------|------------|-----------------------------|------------|-------------|------------|
| Paul. A Barrett     |       | 1,583,501 |       | 83,805                      |       | —      |       |
| John T. Cognetti    |       | 1,583,223 |       | 84,082                      |       | —      |       |
| Michael J. McDonald |       | 1,652,098 |       | 15,208                      |       | —      |       |

 

In addition to the aboveelected Class A Directors, at the conclusion of its annual meeting, the Company’sBoard of Directors consisted of: Brian J. Cali, Esq. and Patrick J. Dempsey, asClass C Directors whose term expires in 2007; and Samuel C. Cali, Mary E.McDonald and David L. Tressler, Sr. as Class B Directors whose term expires in2008.

Ratification ofindependent certified public accountants:
|                        | ** ** | **For**   | ** ** | **Against** | ** ** | **Abstain** | ** ** |
|------------------------|------------|-----------|------------|-------------|------------|-------------|------------|
| Parente  Randolph, LLC |       | 1,655,962 |       | 10,853      |       | 491         |       |

 

**Item 5.    Other Information**

 None

**Item6.    Exhibits**

***3(i)******                                   Amendedand Restated Articles of Incorporation of Registrant. ***Incorporated by reference to Exhibit3(i) to Registrant’s Registration Statement No. 333-90273 on Form S-4/A, filedwith the SEC on November 3, 1999 and as amended on April 6, 2000.

***3(ii)******                               Bylawsof Registrant. ***Incorporated byreference to Exhibit 3(ii) to Registrant’s Registration Statement No. 333-90273on Form S-4/A, filed with the SEC on November 3, 1999 and as amended on April6, 2000.

28

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***10.1******                              1998Independent Directors Stock Option Plan of The Fidelity Deposit and DiscountBank, as assumed by Registrant. ***Incorporatedby reference to Exhibit 10.1 to Registrant’s Registration Statement No.333-90273 on Form S-4/A, filed with the SEC on November 3, 1999 and as amendedon April 6, 2000.

***10.2******                              1998Stock Incentive Plan of The Fidelity Deposit and Discount Bank, as assumed byRegistrant.***Incorporated by reference to Exhibit 10.2 of Registrant’sRegistration Statement No. 333-90273 on Form S-4/A, filed with the SEC onNovember 3, 1999 and as amended on April 6, 2000.

***10.3******                              Formof Deferred Compensation Plan of The Fidelity Deposit and Discount Bank. ***Incorporated by reference to Exhibit10.3 to Registrant’s Registration Statement No.333-45668 on Form S-1/A, filedwith the SEC on September 12, 2000 and as amended on October 11, 2000.

***10.4******                              Registrant’s2000 Dividend Reinvestment Plan. ***Incorporatedby reference to Exhibit 4 to Registrant’s Registration Statement No. 333-45668on Form S-1/A, filed with the SEC on September 12, 2000 and as amended byPre-Effective Amendment No. 1 on October 11, 2000, by Post-Effective AmendmentNo. 1 on May 30, 2001 and by Post-Effective Amendment No 2 on July 7, 2005.

***10.5******                              Registrant’s2000 Independent Directors Stock Option Plan. ***Incorporated by reference to Exhibit 4.3 to Registrant’sRegistration Statement No. 333-64356 on Form S-8 filed with the SEC on July 2,2001.

***10.6******                              Registrant’s2000 Stock Incentive Plan***. Incorporated by reference to Exhibit 4.4 toRegistrant’s Registration Statement No. 333-64356 on Form S-8 filed with theSEC on July 2, 2001.

***10.7******                              Registrant’s2002 Employee Stock Purchase Plan. ***Incorporatedby reference to Exhibit 4.5 to Registrant’s Registration Statement No.333-113339 on Form S-8 filed with the SEC on March 5, 2004.

***10.8***                              ***Employment Agreement between Registrant, TheFidelity Deposit and Discount Bank and Steven C. Ackmann, dated June 21,2004. ***Incorporated byreference to Exhibit 99.1 to Registrant’s Current Report on Form 8-K filed withthe SEC on June 24, 2004.

***10.9******                              CompleteSettlement Agreement and General Release between Michael F. Marranca,Registrant and The Fidelity Deposit and Discount Bank, dated July30, 2004.*** Incorporated by reference to Exhibit 99.1 toRegistrant’s Current Report on Form 8-K filed with the SEC on August 10, 2004.

***10.10******                    Change ofControl and Severance Agreement between James T. Gorman, Registrant and TheFidelity Deposit and Discount Bank, dated September 19, 2005.*** Incorporated by reference to    Exhibit 99.1 to Registrant’s Current Reporton Form 8-K filed with the SEC on September 22, 2005.

***  10.11******                          Amendmentand Termination of the Deferred Compensation Agreement with Joseph J. Earyes,Daniel Santaniello, Registrant and The Fidelity Deposit and Discount Bank,dated November 1, 2005.*** Incorporated by reference to Exhibits 99.1and99.2 to Registrant’s Current Report on Form 8-K filed with the SEC on November3, 2005.

***  10.12******                       Amendmentto the Complete Settlement Agreement and General Release between Michael F.Marranca, Registrant and The Fidelity Deposit and Discount Bank, dated November4, 2005*. **Incorporated byreference to****Exhibit 99.1 to Registrant’sCurrent Report on Form 8-K filed with the SEC on November 9, 2005.

*** 10.13******                             Changeof Control Agreements with Daniel J. Santaniello, Salvatore R. DeFrancesco,James T. Gorman, Registrant and The Fidelity Deposit and Discount Bank, datedMarch 21, 2006.*** Incorporated byreference to Exhibit 99.1, 99.2 and 99.3, respectively, to Registrant’s CurrentReport on Form 8-K filed with the SEC on March 27, 2006.

*** 11******                                     Statementregarding computation of earnings per share. ***Included herein in Note 2 “Earnings per Share”, contained withinthe Notes to Consolidated Financial Statements, and incorporated herein byreference.

29

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***31.1******                              Rule13a-14(a) Certification of Principal Executive Officer, filed herewith.***

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

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

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

30

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**FIDELITY D & D BANCORP, INC.**

Pursuant to the requirements of the SecuritiesExchange Act of 1934, the registrant has duly caused this report to be signedon its behalf by the undersigned thereunto duly authorized.

 
|                       | **FIDELITY D & D  BANCORP, INC.**  |
|-----------------------|----------------------------------------|
|                  |                                   |
|                  |                                   |
| Date: August 8, 2006  | /s/ Steven C. Ackmann                  |   |
|                  | Steven C. Ackmann,                     |
|                  | President and Chief  Executive Officer |
|                  |                                   |
|                  |                                   |
| Date: August 8,  2006 | /s/ Salvatore R. DeFrancesco, Jr.      |   |
|                  | Salvatore R.  DeFrancesco, Jr.,        |
|                  | Treasurer and Chief  Financial Officer |
|                       |                                        |  |  |

 

31

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EXHIBIT INDEX
|                                                                                                                                                                                                                                                                                                                                                                                                          | ** ** | **Page** | ** ** |
|----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|------------|----------|------------|
| ***3(i)  Amended and Restated Articles of Incorporation of Registrant***.  Incorporated by reference to Exhibit 3(i) to Registrant’s Registration  Statement No. 333-90273 on Form S-4/A, filed with the SEC on November 3, 1999  and as amended on April 6, 2000.                                                                                                                                  |       | *        |       |
|                                                                                                                                                                                                                                                                                                                                                                                                     |       |     |       |
| ***3(ii)  Bylaws of Registrant.*** Incorporated by reference to  Exhibit 3 (ii) to Registrant’s Registration Statement  No. 333-90273 on Form S-4/A, filed with the SEC on November 3, 1999 and  as amended on April 6, 2000.                                                                                                                                                                  |       | *        |       |
|                                                                                                                                                                                                                                                                                                                                                                                                     |       |     |       |
| ***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/A, filed with the SEC on November 3, 1999 and as amended on April 6,  2000.                                                                            |       | *        |       |
|                                                                                                                                                                                                                                                                                                                                                                                                     |       |     |       |
| ***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/A, filed with the SEC on Nov. 3, 1999 and as amended on April 6, 2000.                                                                                                     |       | *        |       |
|                                                                                                                                                                                                                                                                                                                                                                                                     |       |     |       |
| ***10.3  Form of Deferred Compensation Plan of The Fidelity Deposit and Discount Bank.***Incorporated by reference to Exhibit 10.3 to  Registrant’s Registration Statement No. 333-45668 on Form S-1/A, filed with  the SEC on September 12, 2000 and as amended on October 11, 2000.                                                                                                               |       | *        |       |
|                                                                                                                                                                                                                                                                                                                                                                                                     |       |     |       |
| ***10.4  Registrant’s 2000 Dividend Reinvestment Plan.***  Incorporated by reference to Exhibit 4 to Registrant’s Registration Statement  No. 333-45668 on Form S-1/A, 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, 2001and by Post-Effective Amendment  No 2 on July 7, 2005. |       | *        |       |
|                                                                                                                                                                                                                                                                                                                                                                                                     |       |     |       |
| ***10.5  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.                                                                                                                                                                         |       | *        |       |
|                                                                                                                                                                                                                                                                                                                                                                                                     |       |     |       |
| ***10.6  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  Registrant’s 2002 Employee Stock Purchase Plan.***Incorporated  by reference to Exhibit 4.5 to Registrant’s Registration Statement No.  333-113339 on Form S-8 filed with the SEC on March 5, 2004.                                                                                                                                                                                   |       | *        |       |
|                                                                                                                                                                                                                                                                                                                                                                                                     |       |     |       |
| ***10.8  Employment Agreement between Fidelity D & D Bancorp, Inc., The Fidelity  Deposit and Discount Bank and Steven C. Ackmann, dated June 21, 2004.***Incorporated  by reference to Exhibit 99.1 to Registrant’s Current Report on Form 8-K filed  with the SEC on June 24, 2004.                                                                                                           |       | *        |       |
|                                                                                                                                                                                                                                                                                                                                                                                                     |       |     |       |
| ***10.9  Complete Settlement Agreement and General Release between Michael F.  Marranca, Registrant and The Fidelity Deposit and Discount Bank, dated July  30, 2004.***Incorporated by reference to Exhibit 99.1 to  Registrant’s Current Report on Form 8-K filed with the SEC on August 10,  2004.                                                                                               |       | *        |       |
|                                                                                                                                                                                                                                                                                                                                                                                                     |       |     |       |
| ***10.10  Change of Control and Severance Agreement between James T. Gorman, Registrant  and the Fidelity Deposit and Discount Bank, dated September 19, 2005.***Incorporated  by reference to Exhibit 99.1 to Registrant’s Current Report on Form 8-K filed  with the SEC on September 22, 2005.                                                                                                   |       | *        |       |
|                                                                                                                                                                                                                                                                                                                                                                                                     |       |     |       |
| ***10.11  Amendment and Termination of the Deferred Compensation Agreement with Joseph  J. Earyes, Daniel Santaniello, Registrant and The Fidelity Deposit and  Discount Bank, dated November 1, 2005.*** Incorporated by  reference to Exhibits 99.1 and 99.2 to Registrant’s Current Report on Form  8-K filed with the SEC on November 3, 2005.                                                  |       | *        |       |
|                                                                                                                                                                                                                                                                                                                                                                                                     |       |     |       |
| ***10.12  Amendment to the Complete Settlement Agreement and General Release between  Michael F. Marranca, Registrant and The Fidelity Deposit and Discount Bank,  dated November 4, 2005.*** Incorporated by reference to  Exhibit 99.1 to Registrant’s Current Report on Form 8-K filed with the SEC on  November 9, 2005.                                                                        |       | *        |       |
| *** ***                                                                                                                                                                                                                                                                                                                                                                                             |       |     |       |
| ***10.13  Change of Control Agreements with Daniel J. Santaniello, Salvatore R.  DeFrancesco, James T. Gorman, Registrant and The Fidelity Deposit and  Discount Bank, dated March 21, 2006.***Incorporated by  reference to Exhibit 99.1, 99.2 and 99.3, respectively, to Registrant’s  Current Report on Form 8-K filed with the SEC on March 27, 2006.                                           |       | *        |       |

 

32

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|                                                                                                                                                                     | ** ** | **Page** | ** ** |
|---------------------------------------------------------------------------------------------------------------------------------------------------------------------|------------|----------|------------|
| ***11  Statement regarding computation of earnings per share.***Included  herein.                                                                                   |       | 8        |       |
|                                                                                                                                                                |       |     |       |
| ***31.1  Rule 13a-14(a) Certification of Principal Executive Officer.***                                                                                            |       | 34       |       |
|                                                                                                                                                                |       |     |       |
| ***31.2  Rule 13a-14(a) Certification of Principal Financial Officer.***                                                                                            |       | 35       |       |
|                                                                                                                                                                |       |     |       |
| ***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.*** |       | 36       |       |
|                                                                                                                                                                |       |     |       |
| ***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.*** |       | 37       |       |

 

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* Incorporated byReference

33

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