** **

**UNITED STATESSECURITIES AND EXCHANGE COMMISSION**

**Washington,D.C. 20549**

**FORM 10-Q**

**xQUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THESECURITIES EXCHANGE ACT OF 1934**

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

**OR**

**oTRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THESECURITIES EXCHANGE ACT OF 1934**

**Forthe transition 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   o NO

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   x NO

The number of outstanding shares of Common Stock of Fidelity D & DBancorp, Inc. at October 31, 2006, the latest practicable date, was 2,053,205shares.

 

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**FIDELITYD & D BANCORP, INC.**

Form 10-QSeptember 30, 2006

Index
| **Part I. Financial Information**          | ** **                                                                                                              |
|--------------------------------------------|-------------------------------------------------------------------------------------------------------------------------|
| ** **                                 | ** **                                                                                                              | ** ** |
| Item 1.                                    | Financial  Statements:                                                                                                  |   |
|                                       | Consolidated Balance Sheets as of  September 30, 2006  and December 31, 2005                                            |   |
|                                       | Consolidated Statements of  Income for the three  and nine months ended September 30, 2006 and 2005                     |   |
|                                       | Consolidated Statements of  Changes in Shareholders’ Equity  for the nine months ended September 30, 2006 and 2005 |   |
|                                       | Consolidated Statements of  Cash Flows for the nine months  ended September 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

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**PART I –Financial Information**

**Item 1:Financial Statements**

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

Consolidated Balance Sheets

As of September30, 2006 and December 31, 2005
| ** **                                                                                                                                | ** ** | **September 30, 2006** | ** **  | **December 31, 2005** | ** ** |
|-------------------------------------------------------------------------------------------------------------------------------------------|------------|----------------------------------|-------------|---------------------------------|------------|
| ** **                                                                                                                                | ** ** | **(unaudited)**                  | ** **  | **(audited)**                   | ** ** |
| **ASSETS**                                                                                                                                |       |                             |        |                            |       |
| Cash and due from banks                                                                                                                   |       | $                                | 10,276,404  |                            | $          | 12,525,723 |   |
| Interest-bearing  deposits with financial institutions                                                                                    |       | 123,375                          |        | 68,817                          |       |
| Federal funds sold                                                                                                                        |       | 10,433,000                       |        | —                          |       |
| Total cash and  cash equivalents                                                                                                          |       | 20,832,779                       |        | 12,594,540                      |       |
| Available-for-sale  securities                                                                                                            |       | 100,019,927                      |        | 95,681,654                      |       |
| Held-to-maturity  securities                                                                                                              |       | 1,720,419                        |        | 1,996,919                       |       |
| Federal Home Loan Bank  Stock                                                                                                             |       | 3,259,400                        |        | 4,628,200                       |       |
| Loans and leases, net  (allowance for loan losses of $5,843,538 in 2006; $5,984,649 in 2005)                                              |       | 409,650,864                      |        | 403,144,095                     |       |
| Loans available-for-sale  (fair value $427,684 in 2006; $434,272 in 2005)                                                                 |       | 421,189                          |        | 428,584                         |       |
| Bank premises and  equipment, net                                                                                                         |       | 11,296,696                       |        | 11,683,148                      |       |
| Cash surrender value of  bank owned life insurance                                                                                        |       | 8,105,171                        |        | 7,891,898                       |       |
| Other assets                                                                                                                              |       | 4,642,016                        |        | 4,033,132                       |       |
| Accrued interest  receivable                                                                                                              |       | 2,760,173                        |        | 1,959,826                       |       |
| Foreclosed assets held  for sale                                                                                                          |       | 131,849                          |        | 18,702                          |       |
| **Total  assets**                                                                                                                         |       | $                                | 562,840,483 |                            | $          | 544,060,698 |   |
| **LIABILITIES**                                                                                                                           |       |                             |        |                            |       |
| Deposits:                                                                                                                                 |       |                             |        |                            |       |
| Non-interest-bearing                                                                                                                      |       | $                                | 71,548,817  |                            | $          | 70,361,086 |   |
| Certificates of  deposit of $100,000 or more                                                                                              |       | 62,241,944                       |        | 76,257,553                      |       |
| Other  interest-bearing deposits                                                                                                          |       | 285,939,026                      |        | 232,880,001                     |       |
| Total deposits                                                                                                                            |       | 419,729,787                      |        | 379,498,640                     |       |
|                                                                                                                                      |       |                             |        |                            |       |
| Accrued interest  payable and other liabilities                                                                                           |       | 3,730,970                        |        | 3,238,844                       |       |
| Short-term borrowings                                                                                                                     |       | 22,826,739                       |        | 28,772,997                      |       |
| Long-term debt                                                                                                                            |       | 65,590,062                       |        | 83,704,188                      |       |
| **Total  liabilities**                                                                                                                    |       | 511,877,558                      |        | 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  2,053,205 shares in 2006; 2,039,639 shares in 2005 |       | 18,560,899                       |        | 10,594,901                      |       |
| Retained earnings                                                                                                                         |       | 33,544,484                       |        | 39,363,461                      |       |
| Accumulated other  comprehensive loss                                                                                                     |       | (1,142,458                       | )           | (1,112,333                      | )          |
| **Total  shareholders’ equity**                                                                                                      |       | 50,962,925                       |        | 48,846,029                      |       |
| **Total liabilities and  shareholders’ equity**                                                                                      |       | $                                | 562,840,483 |                            | $          | 544,060,698 |   |

 

See Notes to ConsolidatedFinancial Statements

3

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

Consolidated Statements ofIncome

(unaudited)
| ** **                                                | ** ** | **Three Months Ended** | ** ** | **Nine Months Ended**  | ** ** |
|-----------------------------------------------------------|------------|----------------------------------|------------|----------------------------------|------------|
| ** **                                                | ** ** | **September 30, 2006** | ** ** | **September 30, 2005** | ** ** | **September 30, 2006** | ** ** | **September 30, 2005** | ** ** |
| **Interest  income:**                                     |       |                             |       |                             |       |   |   |   |   |
| Interest and fees on loans and leases:                    |       |                             |       |                             |       |   |   |   |   |
| Taxable                                                   |       | $                                | 7,122,621  |                             | $          | 6,019,084 |   | $ | 20,500,909 |   | $ | 17,454,699 |   |
| Nontaxable                                                |       | 104,193                          |       | 120,630                          |       | 357,813 |   | 335,159 |   |
| Interest-bearing deposits with financial  institutions    |       | 2,045                            |       | 3,263                            |       | 6,821 |   | 12,234 |   |
| Investment securities:                                    |       |                             |       |                             |       |   |   |   |   |
| U.S. Government agency and corporations                   |       | 918,070                          |       | 861,777                          |       | 2,789,335 |   | 2,693,019 |   |
| States and political subdivisions (nontaxable)            |       | 149,611                          |       | 156,931                          |       | 440,929 |   | 397,491 |   |
| Other securities                                          |       | 239,280                          |       | 162,285                          |       | 668,492 |   | 461,043 |   |
| Federal funds sold                                        |       | 58,746                           |       | —                           |       | 94,872 |   | 47,427 |   |
| **Total interest income**                                 |       | 8,594,566                        |       | 7,323,970                        |       | 24,859,171 |   | 21,401,072 |   |
| **Interest  expense:**                                    |       |                             |       |                             |       |   |   |   |   |
| Certificates of deposit of $100,000 or more               |       | 692,888                          |       | 722,680                          |       | 2,029,353 |   | 2,096,344 |   |
| Other deposits                                            |       | 2,439,514                        |       | 1,023,540                        |       | 6,250,072 |   | 2,881,871 |   |
| Securities sold under repurchase agreements               |       | 177,668                          |       | 148,677                          |       | 476,543 |   | 486,794 |   |
| Other short-term borrowings and long-term debt            |       | 962,182                          |       | 1,061,871                        |       | 3,271,395 |   | 2,966,014 |   |
| Other                                                     |       | 8,817                            |       | 4,946                            |       | 22,578 |   | 13,840 |   |
| **Total interest expense**                                |       | 4,281,069                        |       | 2,961,714                        |       | 12,049,941 |   | 8,444,863 |   |
| **Net interest income**                                   |       | 4,313,497                        |       | 4,362,256                        |       | 12,809,230 |   | 12,956,209 |   |
| Provision for  loan losses                                |       | 75,000                           |       | 300,000                          |       | 325,000 |   | 680,000 |   |
| **Net interest income, after provision for loan  losses** |       | 4,238,497                        |       | 4,062,256                        |       | 12,484,230 |   | 12,276,209 |   |
| **Other  income:**                                        |       |                             |       |                             |       |   |   |   |   |
| Service charges on deposit accounts                       |       | 698,839                          |       | 689,435                          |       | 1,965,620 |   | 1,961,966 |   |
| Gain (loss) on:                                           |       |                             |       |                             |       |   |   |   |   |
| Investment securities                                     |       | —                           |       | —                           |       | (166 | ) | 2,643 |   |
| Loans                                                     |       | 20,707                           |       | 8,468                            |       | 62,550 |   | 1,011 |   |
| Leased assets                                             |       | —                           |       | 22,626                           |       | 15,154 |   | (11,328 | ) |
| Disposal of premises and equpment                         |       | (16,334                          | )          | —                           |       | (14,774 | ) | (589 | ) |
| Foreclosed assets held for sale                           |       | (4,416                           | )          | 41,472                           |       | (3,795 | ) | 33,861 |   |
| Write-down lease residual                                 |       | —                           |       | —                           |       | — |   | (220,000 | ) |
| Fees and other service charges                            |       | 437,479                          |       | 466,186                          |       | 1,324,463 |   | 1,334,154 |   |
| **Total other income**                                    |       | 1,136,275                        |       | 1,228,187                        |       | 3,349,052 |   | 3,101,718 |   |
| **Other  expenses:**                                      |       |                             |       |                             |       |   |   |   |   |
| Salaries and employee benefits                            |       | 2,078,715                        |       | 1,755,611                        |       | 6,059,586 |   | 5,251,730 |   |
| Premises and equipment                                    |       | 810,235                          |       | 750,266                          |       | 2,434,645 |   | 2,221,742 |   |
| Advertising                                               |       | 164,855                          |       | 127,709                          |       | 453,132 |   | 407,517 |   |
| Professional fees and services                            |       | 287,989                          |       | 290,619                          |       | 909,163 |   | 1,086,537 |   |
| Other                                                     |       | 653,970                          |       | 666,582                          |       | 2,010,137 |   | 1,800,848 |   |
| **Total other expenses**                                  |       | 3,995,764                        |       | 3,590,787                        |       | 11,866,663 |   | 10,768,374 |   |
| **Income  before provision for income taxes**             |       | 1,379,008                        |       | 1,699,656                        |       | 3,966,619 |   | 4,609,553 |   |
| Provision for  income taxes                               |       | 349,032                          |       | 405,311                          |       | 966,392 |   | 1,160,011 |   |
| **Net income**                                            |       | $                                | 1,029,976  |                             | $          | 1,294,345 |   | $ | 3,000,227 |   | $ | 3,449,542 |   |
| Per share data:                                           |       |                             |       |                             |       |   |   |   |   |
| Net income - basic                                        |       | $                                | 0.51       |                             | $          | 0.64 |   | $ | 1.47 |   | $ | 1.70 |   |
| Net income - diluted                                      |       | $                                | 0.51       |                             | $          | 0.64 |   | $ | 1.47 |   | $ | 1.70 |   |
| Dividends                                                 |       | $                                | 0.22       |                             | $          | 0.20 |   | $ | 0.66 |   | $ | 0.60 |   |

 

SeeNotes to Consolidated Financial Statements

4

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

Consolidated Statements ofChanges in Shareholders’ Equity

For the Nine Months EndedSeptember 30, 2006 and 2005
| ** **                                                                                                                             | ** ** | ** **             | ** ** | ** **   | ** ** | ** **        | ** ** | **Accumulated other** | ** ** | ** ** | ** ** |
|----------------------------------------------------------------------------------------------------------------------------------------|------------|------------------------|------------|--------------|------------|-------------------|------------|----------------------------|------------|------------|------------|
| ** **                                                                                                                             | ** ** | **Capital stock** | ** ** | **Retained** | ** ** | **comprehensive** | ** ** | ** **                 | ** ** |
| ** **                                                                                                                             | ** ** | **Shares ***      | ** ** | **Amount**   | ** ** | **earnings**      | ** ** | **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                                                                                                                             |       |                   |       |         |       | 3,449,542         |       |                       |       | 3,449,542  |       |
| Change in net unrealized holding gains (losses) on  available-for-sale securities, net of reclassification adjustment and tax  effects |       |                   |       |         |       |              |       | (611,071                   | )          | (611,071   | )          |
| Comprehensive income                                                                                                                   |       |                   |       |         |       |              |       |                       |       | 2,838,471  |       |
| Issuance of common stock through Employee Stock  Purchase Plan                                                                         |       | 1,134                  |       | 31,671       |       |              |       |                       |       | 31,671     |       |
| Dividends reinvested through Dividend Reinvestment  Plan                                                                               |       | 11,463                 |       | 367,367      |       |              |       |                       |       | 367,367    |       |
| Cash dividend  declared                                                                                                                |       |                   |       |         |       | (1,217,039        | )          |                       |       | (1,217,039 | )          |
| Balance,  September 30, 2005 (unaudited)                                                                                               |       | 2,036,126              |       | $            | 10,471,172 |              | $          | 38,628,530                 |       | $          | (712,472   | ) | $ | 48,387,230 |   |

 

----

* The number ofshares has been adjusted to reflect the retroactive effect of a 10% stockdividend 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                                                                                                                             |       |              |       |         |       | 3,000,227         |       |                  |       | 3,000,227  |       |
| Change in net unrealized holding gains (losses) on  available-for-sale securities, net of reclassification adjustment and tax  effects |       |              |       |         |       |              |       | (30,125               | )          | (30,125    | )          |
| Comprehensive income                                                                                                                   |       |              |       |         |       |              |       |                  |       | 2,970,102  |       |
| Issuance of common stock through Employee Stock  Purchase Plan                                                                         |       | 1,571             |       | 48,151       |       |              |       |                  |       | 48,151     |       |
| Dividends reinvested through Dividend Reinvestment  Plan                                                                               |       | 12,023            |       | 427,003      |       |              |       |                  |       | 427,003    |       |
| Stock-based  compensation expense                                                                                                      |       |              |       | 28,744       |       |              |       |                  |       | 28,744     |       |
| Cash dividend  declared                                                                                                                |       |              |       |         |       | (1,349,656        | )          |                  |       | (1,349,656 | )          |
| Stock dividend  declared                                                                                                               |       | 185,394           |       | 7,462,100    |       | (7,462,100        | )          |                  |       | —     |       |
| Cash paid for  fractional shares on stock dividend                                                                                     |       |              |       |         |       | (7,448            | )          |                  |       | (7,448     | )          |
| Balance, September 30,  2006 (unaudited)                                                                                               |       | 2,053,205         |       | $            | 18,560,899 |              | $          | 33,544,484            |       | $          | (1,142,458 | ) | $ | 50,962,925 |   |

 

SeeNotes to Consolidated Financial Statements

5

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

Consolidated Statements ofCash Flows

(unaudited)
| ** **                                                                         | ** ** | **Nine Months Ended**  | ** ** |
|------------------------------------------------------------------------------------|------------|----------------------------------|------------|
| ** **                                                                         | ** ** | **September 30, 2006** | ** ** | **September 30, 2005** | ** ** |
| **Cash flows from operating  activities:**                                         |       |                             |       |   |   |
| Net income                                                                         |       | $                                | 3,000,227  |   | $ | 3,449,542 |   |
| Adjustments to  reconcile net income to net cash provided by operating activities: |       |                             |       |   |   |
| Depreciation                                                                       |       | 893,134                          |       | 880,897 |   |
| Amortization of  securities (net of accretion)                                     |       | 58,190                           |       | 180,449 |   |
| Provision for  loan losses                                                         |       | 325,000                          |       | 680,000 |   |
| Deferred income  tax benefit                                                       |       | (27,073                          | )          | (184,956 | ) |
| Stock-based  compensation expense                                                  |       | 28,744                           |       | — |   |
| Amortization of  investment in limited partnership                                 |       | 67,500                           |       | 67,500 |   |
| Proceeds from  sale of loans available-for-sale                                    |       | 8,081,253                        |       | 1,561,456 |   |
| Originations of  loans available for sale                                          |       | (8,011,308                       | )          | (1,681,523 | ) |
| Write-down of  foreclosed assets held for sale                                     |       | —                           |       | 50,451 |   |
| Write-down lease  residual                                                         |       | —                           |       | 220,000 |   |
| Increase in cash  surrender value of life insurance                                |       | (213,273                         | )          | (202,807 | ) |
| Loss (gain) on  sale of investment securities                                      |       | 166                              |       | (2,643 | ) |
| Gain on sale of  loans                                                             |       | (62,550                          | )          | (1,011 | ) |
| Loss (gain) on  sale of foreclosed assets held-for-sale                            |       | 3,795                            |       | (33,861 | ) |
| Loss on sale of  leased assets                                                     |       | —                           |       | 11,328 |   |
| Loss on disposal  of premises and equipment                                        |       | 14,774                           |       | 589 |   |
| Amortization of  loan servicing rights                                             |       | 54,537                           |       | 71,871 |   |
| Change in:                                                                         |       |                             |       |   |   |
| Accrued interest  receivable                                                       |       | (800,347                         | )          | (236,854 | ) |
| Other assets                                                                       |       | (688,329                         | )          | (928,862 | ) |
| Accrued interest  payable and other liabilities                                    |       | 493,341                          |       | 221,490 |   |
| Net cash  provided by operating activities                                         |       | 3,217,781                        |       | 4,123,056 |   |
| **Cash flows from investing  activities:**                                         |       |                             |       |   |   |
| Held-to-maturity  securities:                                                      |       |                             |       |   |   |
| Proceeds from  maturities, calls and principal pay-downs                           |       | 274,397                          |       | 827,760 |   |
| Available-for-sale  securities:                                                    |       |                             |       |   |   |
| Proceeds from  sales                                                               |       | 1,537,338                        |       | 19,282,027 |   |
| Proceeds from  maturities, calls and principal pay-downs                           |       | 16,798,981                       |       | 11,934,551 |   |
| Purchases                                                                          |       | (22,776,489                      | )          | (24,207,222 | ) |
| Net decrease in  FHLB stock                                                        |       | 1,368,800                        |       | 158,900 |   |
| Net increase in  loans and leases                                                  |       | (7,005,816                       | )          | (8,088,646 | ) |
| Proceeds from  sale of leased assets                                               |       | —                           |       | 766,598 |   |
| Acquisition of  bank premises and equipment                                        |       | (521,456                         | )          | (389,504 | ) |
| Proceeds from  sale of foreclosed assets held-for-sale                             |       | 55,890                           |       | 444,814 |   |
| Net cash (used  in) provided by investing activities                               |       | (10,268,355                      | )          | 729,278 |   |
| **Cash flows from financing  activities:**                                         |       |                             |       |   |   |
| Net increase in  non-interest-bearing deposits                                     |       | 1,187,731                        |       | 4,974,049 |   |
| Net decrease in  certificates of deposit of $100,000 or more                       |       | (14,015,609                      | )          | (7,092,475 | ) |
| Net increase in  other interest-bearing deposits                                   |       | 53,059,025                       |       | 5,919,354 |   |
| Net decrease in  short-term borrowings                                             |       | (5,946,258                       | )          | (6,507,235 | ) |
| Proceeds from  long-term borrowings                                                |       | 16,000,000                       |       | — |   |
| Repayment of  long-term debt                                                       |       | (34,114,126                      | )          | (582,602 | ) |
| Dividends paid,  net of dividend reinvestment                                      |       | (922,653                         | )          | (849,672 | ) |
| 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                               |       | 15,288,813                       |       | (4,106,910 | ) |
| Net increase in cash  and cash equivalents                                         |       | 8,238,239                        |       | 745,424 |   |
| Cash and cash equivalents,  beginning                                              |       | 12,594,540                       |       | 10,216,394 |   |
| Cash and cash equivalents, ending                                                  |       | $                                | 20,832,779 |   | $ | 10,961,818 |   |

 

SeeNotes to Consolidated Financial Statements

6

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

**Notes to Consolidated Financial Statements**

**(unaudited)**

**1.             Nature of operations and criticalaccounting policies**

# **Nature ofoperations**

# The FidelityDeposit and Discount Bank (the Bank) is a commercial bank chartered in theCommonwealth of Pennsylvania and a wholly-owned subsidiary of Fidelity D &D Bancorp, Inc. (the Company or collectively, the Company).  Having commenced operations in 1903, the 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.

# **Principlesof consolidation**

# The accompanyingunaudited consolidated financial statements of the Company and the Bank havebeen prepared in accordance with accounting principles generally accepted inthe United States of America (GAAP) for interim financial information and withthe instructions to this Form 10-Q and Rule 10-01 of Regulation S-X.  Accordingly, they do not include all of theinformation and footnote disclosures required by GAAP for complete financialstatements.  In the opinion ofManagement, all normal recurring adjustments necessary for a fair presentationof the financial condition and results of operations for the periods have beenincluded.  All significant inter-companybalances and transactions have been eliminated in consolidation.  Prior period amounts are reclassified whennecessary to conform to the current period’s presentation.

# During the fourthquarter of 2005, the Company changed its classification, within theconsolidated statements of cash flows, of the activity associated with loansavailable-for-sale from investing activities to operating activities.  Accordingly, the cash flows for the ninemonths ended September 30, 2005 have been reclassified to conform to thecurrent year’s presentation.  The effect ofthe change decreased operating cash flows by $120,000 and increased investingcash flows by $120,000.  The Companybelieves the change in classification of loans available-for-sale is preferablebecause it better reflects the primary business purpose of these transactionsand complies with the requirements of SFAS 102, *Statement of Cash Flows—Exemption of Certain Enterprises andClassification of Cash Flows from Certain Securities Acquired for Resale.*

# OnJanuary 17, 2006, the Board of Directors declared a 10% stockdividend.  The new common shares weredistributed on February 15, 2006 to shareholders of record at the close ofbusiness on January 30, 2006.  Allcommon stock and per-share data, presented in the prior period, has beenadjusted to reflect the retroactive effect of the 10% stock dividend.

The preparation of financial statements in conformitywith GAAP requires Management to make estimates and assumptions that affect thereported amounts of assets and liabilities and disclosure of contingent assetsand liabilities at the date of the financial statements and the reported amountsof revenues and expenses during the reported periods.  Actual results could differ from thoseestimates.  For additional informationand disclosures required under GAAP, refer to the Company’s Annual Report onForm 10-K for the year ended December 31, 2005.

Management is responsible for the fairness, integrityand objectivity of the unaudited financial statements included in thisreport.  Management prepared theunaudited financial statements in accordance with GAAP.  In meeting its responsibility for thefinancial statements, Management depends on the Company’s accounting systemsand related internal controls.  Thesesystems and controls are designed to provide reasonable, but not absolute,assurance that the financial records accurately reflect the transactions of theCompany, the Company’s assets are safeguarded and that the financial statementspresent fairly the financial condition and results of operations of theCompany.

In the opinion of Management, the consolidated balancesheets as of September 30, 2006 and December 31, 2005 and the relatedconsolidated statements of income for the three- and nine-month periods endedSeptember 30, 2006 and 2005 and changes in shareholders’ equity and cash flowsfor the nine month periods ended September 30, 2006 and 2005 present fairly thefinancial condition and results of operations of the Company.  All material adjustments required for a fairpresentation have been made.  These adjustmentsare of a normal recurring nature.

As indicated in Note 3, “Stock Plans”, includedherein, the Company adopted Statement of Financial Accounting Standard 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 of application.  Other than the retroactive adjustment of 2005

7

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common stock and the related per-share data, as aresult of the 10% stock dividend noted above, there have been no otherretroactive adjustments during these periods. The results of operations for interim periods are not necessarilyindicative of the results of operations for the entire year.

This Quarterly Report on Form 10-Q should be read inconjunction with the Company’s audited financial statements for the year endedDecember 31, 2005 and the notes included therein, included within the Company’sAnnual Report filed on Form 10-K.

# **Criticalaccounting policies**

The presentation of financial statements in conformitywith GAAP requires Management to make estimates and assumptions that affectmany of the reported amounts and disclosures. Actual results could differ fromthese 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 ofSeptember 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 different assumptions,and could, therefore calculate a materially different allowance value.  While Management uses available informationto recognize losses on loans, changes in economic conditions may necessitaterevisions in the future.  In addition,various regulatory agencies, as an integral part of their examination process,periodically review the Company’s allowance. Such agencies may require the Company to recognize adjustments to theallowance based on their judgments of information available to them at the timeof their examination.

Another materialestimate is the calculation of fair values of the Company’s investmentsecurities.  The Company receivesestimated fair values of investment securities from an independent valuationservice.  In developing these fairvalues, the valuation service uses estimates of cash flows, based on historicalperformance of 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 or the Pennsylvania Housing FinanceAuthority.  To determine the fair valueof student loans, classified as AFS, the Bank uses the pricing obtained fromthe 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 as AFS, is obtained from anoutside pricing source.  The market towhich the Bank sells mortgage and other loans is restricted and price quotesfrom other sources are not typically obtained. As of September 30, 2006 and December 31, 2005, the AFS loan portfolioconsisted of residential mortgages and student loans.

**2.             Earnings per share**

Basic earnings pershare (EPS) is computed by dividing income available to common shareholders bythe weighted-average number of common stock outstanding for the period.  Diluted EPS is computed in the same manner asbasic EPS but reflects the potential dilution that could occur if stock optionsto issue additional common stock were exercised, which would then result inadditional stock outstanding to share in or dilute the earnings of theCompany.  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.

In the computationof diluted EPS, the Company uses the treasury stock method to determine thedilutive 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,* proceedsinclude: proceeds from the exercise of outstanding stock options; compensationcost for future service that the Company has not yet recognized; and any“windfall” tax benefits that would be credited directly to shareholders’ equitywhen the grant generates a tax deduction (or a reduction in proceeds if thereis a charge to equity).  For a furtherdiscussion on the Company’s stock option plans, see note 3, below.

The followingtable illustrates the data used in computing basic EPS and a reconciliation toderive at the components of diluted EPS for the periods indicated:

8

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| Nine months ended September 30,           | ** ** | **2006**   | ** ** | **2005**   | ** ** |
|---------------------------------------------------------------|------------|------------|------------|------------|------------|
| ** **                                                    | ** ** | ** ** | ** ** | ** ** | ** ** |
| Basic EPS:                                                    |       |       |       |       |       |
|                                                          |       |       |       |       |       |
| Net income available to common shareholders                   |       | $          | 3,000,227  |       | $          | 3,449,542 |   |
|                                                          |       |       |       |       |       |
| Weighted-average common shares outstanding                    |       | 2,045,872  |       | 2,029,271  |       |
|                                                          |       |       |       |       |       |
| Basic EPS                                                     |       | $          | 1.47       |       | $          | 1.70 |   |
|                                                          |       |       |       |       |       |
| Diluted EPS:                                                  |       |       |       |       |       |
|                                                          |       |       |       |       |       |
| Net income available to common shareholders                   |       | $          | 3,000,227  |       | $          | 3,449,542 |   |
|                                                          |       |       |       |       |       |
| Weighted-average common shares outstanding                    |       | 2,045,872  |       | 2,029,271  |       |
|                                                          |       |       |       |       |       |
| Dilutive potential common shares                              |       | 1,454      |       | 523        |       |
|                                                          |       |       |       |       |       |
| Weighted-average common shares and dilutive  potential shares |       | 2,047,326  |       | 2,029,794  |       |
|                                                          |       |       |       |       |       |
| Diluted EPS                                                   |       | $          | 1.47       |       | $          | 1.70 |   |

 

**3.             Stock plans**

In December 2004,the Financial Accounting Standard Board 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 (oroffering to issue) its shares, share options, or other equity instruments(except for those held by an ESOP) or by incurring liabilities (1) in amountsbased (even in part) on the price of the entity’s shares or other equityinstruments, or (2) that require (or may require) settlement by the issuance ofan entity’s shares 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 and permit the grant of share-basedcompensation awards to its directors, key officers and certain otheremployees.  The Company believes thatthese plans better align the interest of its directors, key officers andemployees with the interest of its shareholders.  The Company further believes that thegranting of share-based awards, under the provisions of the plans, is necessaryto retain the knowledge base, continuity and expertise of its directors, keyofficers 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 nine months of 2006 or for each of the years ended December 31, 2005,2004 and 2003 due to the directors’ voluntary election to forego theaward.  At September 30, 2006 andDecember 31, 2005, there were 14,850 unexercised stock options outstandingunder this plan.

The Company has alsoestablished the 2000 Stock Incentive Plan and has reserved 55,000 shares of itsun-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 stock options 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 September 30, 2006 and December 31, 2005, there were 5,830 and5,280, 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 September 30, 2006, December31, 2005 and December 31, 2004 and changes during the periods is presentedbelow:
|                                 | ** ** | ** **  | ** ** | ** **       | ** ** | **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, September 30, 2006 |       | 20,680      |       | $                | 32.64      |                | 4.5        |          | $          | 18,498 |   |
| Exercisable, September 30, 2006 |       | 20,680      |       | $                | 32.64      |                | 4.5        |          | $          | 18,498 |   |

 

----

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

No options havebeen granted under the 2000 Independent Directors Stock Option Plan since 2002and all options previously granted and outstanding are fully vested.  As of September 30, 2006, no options havebeen exercised 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.  Nooptions 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 ofSeptember 30, 2006, all options issued under the plan were fully vested andtherefore, there is no unrecognized compensation expense related to non-vestedshare-based compensation agreements under the plan as of that date.

10

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In addition to thetwo stock option plans above, the Company has established the 2002 EmployeeStock Purchase 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 September 30, 2006, 6,051shares have been issued under the plan. The ESPP is considered a compensatory plan and, as such, is required tocomply with the provisions of SFAS 123R. The Company recognizes compensation expense on its ESPP Plan on the datethe shares are purchased.  For the ninemonths ended September 30, 2006, compensation expense related to the ESPPapproximated $15,000 and is included as a component of salaries and employeebenefits in the consolidated income statement.

**4.             Bank Premises and Equipment**

During the second quarter of 2006, the Bank enteredinto a long-term facility lease agreement in concert with the construction andrelocation of one of its branch offices. Under the lease agreement, the Bank has committed to an initial 15-yearterm with options to renew for two consecutive periods of five years each.  Under this agreement, the Bank will recognizeapproximately $36,000 of rent expense in 2006 and a total of $1,384,000 throughthe expiration of the second renewal option on August 31, 2031.

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

The following is Management’s discussion and analysisof the significant changes in the consolidated financial condition of theCompany as of September 30, 2006 compared to December 31, 2005 and the resultsof operations for the three and nine months ended September 30, 2006 andSeptember 30, 2005.  Current performancemay not be indicative of future results. This discussion should be read in conjunction with the Company’s 2005Annual Report filed on Form 10-K.

**Forward looking statements**

This Interim Report on Form 10-Q contains a number offorward-looking statements within the meaning of Section 27A of the SecuritiesAct of 1933, as amended, or the Securities Act, and Section 21E of theSecurities Exchange Act of 1934, as amended, or the Exchange Act.  These statements may be identified by the useof the words “anticipate,” “believe,” “could,” “estimate,” “expect,” “intend,”“may,” “outlook,” “plan,” “potential,” “predict,” “project,” “should,” “will,”“would” and similar terms and phrases, including references toassumptions.  Forward looking statementsinclude risks and uncertainties.

Forward-looking statements are based on variousassumptions and analyses made by us in light of Management’s experience and itsperception of historical trends, current conditions and expected futuredevelopments, as well as other factors Management believes are appropriateunder the circumstances.  Thesestatements are not guarantees of future performance and are subject to risks,uncertainties and other factors (many of which are beyond our control) thatcould cause actual results to differ materially from future results expressedor implied by such forward-looking statements. 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;

11

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

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

·                  actsof war or terrorism; or

·                  naturaldisaster.

Management cautions readers not to place unduereliance on forward-looking statements, which reflect analyses only as of thedate of this document.  We have noobligation to update any forward-looking statements to reflect events orcircumstances after the date of this document. Readers should review the risk factors described in other documents thatwe file or furnish, from time to time, with the Securities and ExchangeCommission, including Annual Reports to Shareholders, Annual Reports filed onForm 10-K and other current reports filed or furnished on Form 8-K.

**General**

The Company’s principal revenues are derived frominterest, dividends and fees earned on its interest-earning assets, which arecomprised of loans, securities and other short-term investments.  The Company’s principal expenses consist ofinterest paid on its interest-bearing liabilities, which are comprised ofdeposits, short-and long-term borrowings and operating and generalexpenses.  The Company’s profitabilitydepends primarily on its net interest income, which is the difference betweeninterest income generated from its interest-earning assets and the interestexpense incurred on its interest-bearing liabilities.  Net interest income is dependent upon the interest-ratespread, which is the difference between the average yield earned oninterest-earning assets and the average rate paid on interest-bearingliabilities.  When interest-earningassets approximate or exceed interest-bearing liabilities, any positive ratespread will generate net interest income. The interest rate spread is significantly impacted by changes ininterest rates and market yield curves and their related impact on cash flowsfrom loans, investments, customer deposit flows and loan demand.  The interest rate spread is further influencedby the composition and characteristics of interest-earning assets andinterest-bearing liabilities and by the competition in our marketplace.  Additionally, the interest rate spread andthe changes in the interest rate spread, from period-to-period, is affected bydifferences in the maturity and re-pricing characteristics of the assetscompared to the maturity and re-pricing characteristics of the liabilities thatfund them.

In addition to net interest income, profitability isaffected by the level of its non-interest income and expenses, provision forloan losses and provision for income taxes. Non-interest income consists mostly of service charges on the Bank’sloan and deposit products, trust and asset management service fees, increasesin the cash surrender value of the bank owned life insurance (BOLI), net gainsor losses from sales of leases, securities, loans AFS, sales of other realestate (ORE) properties and disposal of other bank owned assets.  Non-interest expense consists of compensationand related employee benefit expenses, occupancy, equipment, data processing,advertising, marketing, professional fees, insurance and other operatingoverhead.

The Company’s profitability is significantly affectedby general economic and competitive conditions, changes in market interestrates, government policies and actions of regulatory authorities.  The Company’s loan portfolio is comprisedprincipally of commercial and commercial real estate loans.  The properties underlying the Company’smortgages 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.

**COMPARISON OF RESULTS OF OPERATIONS**

**THREE ANDNINE MONTHS ENDED SEPTEMBER 30, 2006 AND SEPTEMBER 30, 2005**

**Overview**

Net income for the third quarter of 2006 was$1,030,000, a decrease of $264,000 from the $1,294,000 recorded in the samequarter in 2005.  Diluted earnings pershare was $0.51 and $0.64 for each of the respective periods.  For the nine months ended September 30, 2006,net income was $3,000,000, or $1.47 per diluted share, compared to $3,450,000,or $1.70 per diluted share for the nine months ended September 30, 2005.  The decline in net income in the thirdquarter was primarily the result of lower non-interest income and increasedoperating expenses.  The decline in netincome for the nine month comparison was due mostly to increased operatingexpenses.  During both periods, theprovision for loan losses decreased $225,000 and $355,000, respectively.

12

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The decline in net income was the primary cause of thedecline in return on average assets (ROA) and return on average shareholders’equity (ROE) to 0.72% and 8.18%, respectively, for the three months endedSeptember 30, 2006, compared to 0.96% and 10.62, respectively, for the sameperiod in 2005.  For the nine monthsended September 30, 2006 ROA and ROE were 0.71% and 8.12% compared to 0.86% and9.73% for the nine months ended September 30, 2005.

During the third quarterof 2006, the Bank refinanced a portion of its long-term debt that was designedto reduce interest expense and thereby improve net interest income. For afurther discussion on this transaction see the *Borrowings*sectionunder *Comparison of Financial Condition,*below.

*Netinterest income and interest sensitive assets / liabilities*

Net interest income decreased $49,000 to $4,313,000for the third quarter of 2006, from $4,362,000 recorded in the same period of2005.  The decrease was principally dueto the effect rising interest rates had on the rates paid on averageinterest-bearing liabilities compared to interest-earning assets.  Rates paid increased 99 basis points, to3.83%, for the three months ended September 30, 2006 compared to 2.84% for thesame 2005 period.  In addition to theincrease in rates paid, there was an increase in the average interest-bearingliabilities of $29,350,000 for the comparable periods.  The Bank has continued to deploy variousmarketing and rate enhancing techniques to enhance core deposit growth.  From these efforts, average core deposits,which exclude time deposits of greater than $100,000, increased approximately$74,800,000 compared to the quarter ended September 30, 2005.  As a result, interest expense on depositsincreased $1,319,000, or 45%, during the third quarter of 2006 compared to thethird quarter of 2005.  Though rates paidon borrowings increased 62 basis points, the related interest expense declined$67,000 due to a decline in the average balance in the 2006 quarter compared tothe 2005 quarter.

Interest income increased $1,271,000, or 17%,partially offsetting the increase in interest expense during the third quarterof 2006 compared to the third quarter of 2005. This improvement was primarily due to a 59 basis point increase in thebook yield earned on its average interest-earning assets which also experiencedgrowth during the third quarter of 2006 compared to the third quarter of2005.  The quarter-to-quarter improvementin yield was due to higher market interest rates and was further bolstered byour progress in shifting non-performing loans to performing status.  The loan portfolio grew by $29,427,000 on averageand yielded 57 basis points more during the current year quarter than in thesame quarter of 2005.

During the third quarterof 2006, the Bank’s tax-equivalent margin and spread decreased 26 and 41 basispoints, respectively, compared to the third quarter of 2005.  The decline in margin and spread is frominterest costs outpacing the yield earned on higher balances ofinterest-earning assets.

Similar to the third quarter comparisons, the Bank’stax-equivalent margin and spread decreased 22 and 38 basis points,respectively, during the nine months ended September 30, 2006 compared to thesame 2005 period.  For the nine monthsended September 30, 2006, net interest income declined $147,000 to $12,809,000from $12,956,000 recorded in the comparable 2005 period.  The decrease was due to a combination of anet increase in average interest-bearing liabilities of $28,129,000 and to amore significant degree, an increase in the average rate paid of 92 basispoints.  As a result, total interestexpense increased $3,605,000, or 43%, for the nine months ended September 30,2006 compared to the same period ended in 2005.

Interest income increased $3,458,000, or 16%, for thefirst nine months of 2006 compared to the first nine months of 2005.  The dominant factor leading to theimprovement was an increase in the book yield on average-earning assets of 53basis points in addition to a $30,758,000 increase in average interest-earningassets.  The increased interest rateenvironment as well as the aforementioned reduction of non-performing loans,during the third quarter of 2006, helped improve the yield on the Bank’sportfolios of interest-earning assets.

The increasing interest rate environment, that hasdominated the economy for more than two years, and the more recent invertedtreasury yield curve, continues to pressure the Bank’s net interest incomeperformance.  However, our successfuldeposit gathering strategies, debt restructure and improved credit quality ofthe Bank’s earning assets will help position the Bank’s to optimize netinterest income during this challenging rate environment and should be furtherenhanced when the shape of the yield curve returns to a more normal slope.

The following table sets forth, a comparison ofaverage balance sheet amounts and their corresponding fully tax-equivalent (FTE)interest income and expense and annualized tax-equivalent yield and cost forthe periods indicated (dollars in thousands):

13

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|                                                | ** ** | **Three months ended** | ** ** | **Nine months ended** | ** ** |
|------------------------------------------------|------------|----------------------------------|------------|---------------------------------|------------|
| ** **                                     | ** ** | **September 30,**           | ** ** | **September 30,**          | ** ** |
| ** **                                     | ** ** | **2006**                         | ** ** | **2005**                        | ** ** | **2006** | ** ** | **2005** | ** ** |
| Average  interest-earning assets:              |       |                             |       |                            |       |   |   |   |   |
| Loans and leases                               |       | $                                | 420,256    |                            | $          | 390,829 |   | $ | 418,354 |   | $ | 387,754 |   |
| Investments                                    |       | 112,107                          |       | 113,632                         |       | 116,262 |   | 115,842 |   |
| Federal funds  sold                            |       | 4,414                            |       | —                          |       | 2,618 |   | 2,451 |   |
| Interest-bearing  deposits                     |       | 181                              |       | 400                             |       | 221 |   | 650 |   |
| Total                                          |       | $                                | 536,958    |                            | $          | 504,861 |   | $ | 537,455 |   | $ | 506,697 |   |
|                                           |       |                             |       |                            |       |   |   |   |   |
| Average  interest-bearing liabilities:         |       |                             |       |                            |       |   |   |   |   |
| Other  interest-bearing deposits               |       | $                                | 197,727    |                            | $          | 128,830 |   | $ | 185,014 |   | $ | 124,853 |   |
| Certificates of  deposit                       |       | 151,387                          |       | 170,893                         |       | 154,008 |   | 176,644 |   |
| Borrowed funds                                 |       | 70,175                           |       | 84,309                          |       | 82,339 |   | 78,909 |   |
| Repurchase  agreements                         |       | 23,779                           |       | 29,686                          |       | 24,203 |   | 37,029 |   |
| Total                                          |       | $                                | 443,068    |                            | $          | 413,718 |   | $ | 445,564 |   | $ | 417,435 |   |
|                                           |       |                             |       |                            |       |   |   |   |   |
| Interest income  (FTE):                        |       |                             |       |                            |       |   |   |   |   |
| Loans and leases                               |       | $                                | 7,281      |                            | $          | 6,202 |   | $ | 21,043 |   | $ | 17,963 |   |
| Investments                                    |       | 1,393                            |       | 1,270                           |       | 4,154 |   | 3,773 |   |
| Federal funds  sold                            |       | 59                               |       | —                          |       | 95 |   | 47 |   |
| Interest-bearing  deposits                     |       | 2                                |       | 3                               |       | 7 |   | 12 |   |
| Total                                          |       | $                                | 8,735      |                            | $          | 7,475 |   | $ | 25,299 |   | $ | 21,795 |   |
|                                           |       |                             |       |                            |       |   |   |   |   |
| Interest expense:                              |       |                             |       |                            |       |   |   |   |   |
| Other  interest-bearing deposits               |       | $                                | 1,572      |                            | $          | 419 |   | $ | 3,947 |   | $ | 1,006 |   |
| Certificates of  deposit                       |       | 1,560                            |       | 1,327                           |       | 4,332 |   | 3,972 |   |
| Borrowed funds                                 |       | 971                              |       | 1,067                           |       | 3,294 |   | 2,980 |   |
| Repurchase  agreements                         |       | 178                              |       | 149                             |       | 477 |   | 487 |   |
| Total                                          |       | $                                | 4,281      |                            | $          | 2,962 |   | $ | 12,050 |   | $ | 8,445 |   |
|                                           |       |                             |       |                            |       |   |   |   |   |
| Net interest  income (FTE)                     |       | $                                | 4,454      |                            | $          | 4,513 |   | $ | 13,249 |   | $ | 13,350 |   |
|                                           |       |                             |       |                            |       |   |   |   |   |
| Yield on average  interest-earning assets      |       |                             |       |                            |       |   |   |   |   |
| Loans and leases                               |       | 6.87                             | %          | 6.30                            | %          | 6.73 | % | 6.19 | % |
| Investments                                    |       | 4.93                             | %          | 4.43                            | %          | 4.78 | % | 4.35 | % |
| Federal funds  sold                            |       | 5.28                             | %          | —                          |       | 4.84 | % | 2.59 | % |
| Interest-bearing  deposits                     |       | 4.48                             | %          | 3.24                            | %          | 4.12 | % | 2.52 | % |
| Total                                          |       | 6.45                             | %          | 5.87                            | %          | 6.29 | % | 5.75 | % |
|                                           |       |                             |       |                            |       |   |   |   |   |
| Rates on average  interest-bearing liabilities |       |                             |       |                            |       |   |   |   |   |
| Other  interest-bearing deposits               |       | 3.16                             | %          | 1.29                            | %          | 2.85 | % | 1.08 | % |
| Certificates of  deposit                       |       | 4.09                             | %          | 3.08                            | %          | 3.76 | % | 3.01 | % |
| Borrowed funds                                 |       | 5.49                             | %          | 5.02                            | %          | 5.35 | % | 5.05 | % |
| Repurchase  agreements                         |       | 2.96                             | %          | 1.99                            | %          | 2.63 | % | 1.76 | % |
| Total                                          |       | 3.83                             | %          | 2.84                            | %          | 3.62 | % | 2.70 | % |
|                                           |       |                             |       |                            |       |   |   |   |   |
| Net interest  spread                           |       | 2.62                             | %          | 3.03                            | %          | 2.67 | % | 3.05 | % |
| Net interest  margin                           |       | 3.29                             | %          | 3.55                            | %          | 3.30 | % | 3.52 | % |
|                                           |       |                             |       |                            |       |   |   |   |   |
| Yield on average  interest-earning assets      |       | 6.45                             | %          | 5.87                            | %          | 6.29 | % | 5.75 | % |
| Rate on average  interest-bearing liabilities  |       | 3.83                             | %          | 2.84                            | %          | 3.62 | % | 2.70 | % |
| Net interest  spread                           |       | 2.62                             | %          | 3.03                            | %          | 2.67 | % | 3.05 | % |
| Net interest margin                            |       | 3.29                             | %          | 3.55                            | %          | 3.30 | % | 3.52 | % |

 

Inthe table above, interest income was adjusted to a tax-equivalent basis torecognize the income from the various tax-exempt assets as if the interest wasfully taxable.  This treatment allows auniform comparison among the yields on interest-earning assets.  The calculations were computed on a fullytax-equivalent basis using the corporate federal tax rate of 34%.  Net interest spread represents the differencebetween the yield on interest-earning assets and the rate on interest-bearingliabilities.  Net interest marginrepresents the ratio of net interest income to total average interest-earningassets.

14

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*Provision for 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 theBank’s loan and lease portfolio.  Loansand leases determined to be uncollectible are charged-off against the allowancefor loan 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. TheBank’s Special 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 $75,000, for the three months ended September 30,2006, compared to $300,000 for the three months ended September 30, 2005.  The decrease in the provision for loan lossesthis quarter was driven by the reduced levels of criticized and non-performingloans.  The balance of non-performingloans declined year-to-year by $4,910,000 to $5,079,000 at September 30, 2006compared to $9,989,000 at September 30, 2005. The non-accrual component of non-performing loans showed a $5,253,000decline in the same period as the Bank continues to make progress in movingnon-performing loans to performing status.

For the nine months endedSeptember 30, 2006, the provision for loan losses was $325,000, compared to$680,000 for the nine months ended September 30, 2005.  As a result, after taking into accountcharge-offs and recoveries during the period, the allowance was $5,844,000 atSeptember 30, 2006 compared to $6,035,000 at September 30, 2005.  The decrease in the provision for loan losses was driven by thesubstantial decrease in the non-performing loans mentioned above.  Our Special Assets Department continues tomake progress and carry out exit strategies and/or resolution plans for each ofthe non-performing loans.

 *Other income*

Total other(non-interest) income declined $92,000 for the three months ended September 30,2006 compared to the three months ended September 30, 2005.  The 2005 quarter consisted of net gains fromthe sales of foreclosed assets that included insurance proceeds from a claimfor damages on one of the properties, compared to net losses in 2006.  The Bank’s automobile lease finance businessconcluded in 2005 and during the quarter ended September 30, 2005, the Bankrecognized $23,000 of net gains from sales of previously leased vehicles whichdid not recur in the third quarter of 2006. Further, during the 2006 quarter, the Bank recognized a $16,000 lossfrom the disposal of obsolete premises and equipment.

For the nine months endedSeptember 30, 2006, other income increased $247,000, or 8%, compared to thenine months ended September 30, 2005. During 2005, the Bank recognized an estimated impairment charge of$220,000 in anticipation of projected realized losses from the future sales ofits leased vehicles.  Because the Bank’sautomobile lease finance business concluded in 2005, similar impairment chargesfrom this activity will not recur. During the nine months ended September 30, 2006, the Bank recognized$15,000 of residual insurance claims from previously leased vehicles, comparedto a net loss from their sales of $11,000 for the same 2005 period.  Finally, the Bank sold more loans into thesecondary market resulting in gains of $63,000 in the first nine months of2006.

*Other operating expenses*

For the quarter endedSeptember 30, 2006, other (non-interest) expenses increased $405,000, or 11%,compared to the same 2005 quarter. Salary and employee benefits increased $323,000, or 18%, due to anincrease in the number of full-time

15

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equivalent employees andmerit pay increases.  The increase inpremises and equipment was due to more lease expense on long-term facilityrental agreements and increases in equipment repair and maintenance andproperty insurance.  The $37,000 increasein advertising was caused by increased media advertising and direct mailingmarketing techniques.

For the nine months endedSeptember 30, 2006, other expenses increased $1,098,000 compared to the same2005 period. Salary and employee benefits increased $808,000, or 15%, due topay increases, increased number of full-time equivalent employees, one-timevoluntary separation benefit payments and stock-based compensation expense (seefootnote 3, Stock Plans, of the consolidated financial statements, includedherein for a discussion on the Company’s adoption of SFAS 123R).  The $213,000 increase in premises andequipment was caused by the aforementioned increase in lease expense andincreased equipment repair and additional core processing maintenancecosts.  The decrease in professionalservice fees was caused mostly by non-recurring expenses associated with the2005 Bank-wide participation in management skills development and salestraining programs as well as a decrease in outside consulting fees forSarbanes-Oxley compliance documentation procedures.  Increased traditional and alternative mediaadvertising caused advertising expense to increase 11% during the first ninemonths of 2006 compared to the same period in 2005.  The net increase in the other component ofoperating expenses included higher spending for supplies, telephone, outsidedata processing services, ATM related expenses, charitable contributions,directors’ fees, employee travel, dues and subscriptions partially offset bylower spending for ORE and settlement expense.

*Income tax provision*

Compared to 2005,income before provision for income taxes for the third quarter and first ninemonths of 2006 decreased $56,000 and $194,000, respectively resulting in lowerincome tax provisions in the comparable periods.  The effective federal income tax rate was25.3% and 24.4% for the three and nine months ended September 30, 2006,compared to 23.8% and 25.2% for each of the respective 2005 periods.  The effective tax rate variances areattributable to a combination of relative levels of pre-tax earnings and theamount of tax-free interest income from municipal securities, tax-free loansand tax-free earnings from the BOLI.

**COMPARISONOF FINANCIAL CONDITION ATSEPTEMBER 30, 2006 AND DECEMBER 31, 2005**

*Overview*

Consolidated assetsincreased $18,780,000, or 3%, during the nine months ended September 30, 2006to $562,840,000.  The net asset increaseresulted from an 11% increase in total deposits of $40,231,000 partially offsetby a net decrease in combined short- and long-term borrowings of$24,060,000.  Total investments, netloans and federal funds sold increased $4,062,000, $6,499,000 and $10,400,000,respectively, since December 31, 2005.

*Investment securities*

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 anadjustment to stockholders’ equity, net of tax, which is presented under thecaption “Accumulated other comprehensive income (loss).”  Securities designated as HTM are carried atamortized cost.

At September 30, 2006,the carrying value of investment securities totaled $101,740,000, or 18% oftotal assets compared to $97,679,000 or 18%, as of December 31, 2005.  At September 30, 2006, approximately 37% ofthe carrying value of the investment portfolio was comprised of mortgage-backedsecurities that amortize and provide monthly cash flow.  Also, at September 30, 2006, agency andmunicipal bonds comprised 38% and 10%, respectively, of the investmentportfolio.

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 $1,720,000 and $100,020,000, respectively.  At September 30, 2006, the AFS debtsecurities were recorded with a net unrealized loss in the amount of $1,912,000and equity securities were recorded with an unrealized gain of $181,000:

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                       |       | $             | 1,720      |                      | $          | 28                        |       | $         | —     |   | $ | 1,748 |   |
|                                             |       |          |       |                      |       |                      |       |      |       |
| Available-for-sale  securities:                  |       |          |       |                      |       |                      |       |      |       |
| U.S. government agencies and corporations        |       | $             | 39,956     |                      | $          | —                    |       | $         | 867        |   | $ | 39,089 |   |
| Obligations of states and municipal subdivisions |       | 14,604        |       | 154                       |       | 2                         |       | 14,756    |       |
| Corporate bonds                                  |       | 10,008        |       | 48                        |       | —                    |       | 10,056    |       |
| Mortgage-backed securities                       |       | 36,904        |       | —                    |       | 1,245                     |       | 35,659    |       |
|                                             |       |          |       |                      |       |                      |       |      |       |
| Total debt securities                            |       | 101,472       |       | 202                       |       | 2,114                     |       | 99,560    |       |
|                                             |       |          |       |                      |       |                      |       |      |       |
| Equity securities                                |       | 279           |       | 181                       |       | —                    |       | 460       |       |
|                                             |       |          |       |                      |       |                      |       |      |       |
| Total  available-for-sale                        |       | $             | 101,751    |                      | $          | 383                       |       | $         | 2,114      |   | $ | 100,020 |   |

 

The amortized cost and fair value of debt securitiesat September 30, 2006 by contractual maturity are as follows (dollars inthousands):

|                                           | ** ** | **Amortized** | ** ** | **Market** | ** ** |
|-------------------------------------------|------------|---------------|------------|------------|------------|
| ** **                                | ** ** | **cost**      | ** ** | **value**  | ** ** |
| Held-to-maturity  securities:             |       |          |       |       |       |
| Mortgage-backed securities                |       | $             | 1,720      |       | $          | 1,748 |   |
|                                      |       |          |       |       |       |
| Available-for-sale  securities:           |       |          |       |       |       |
| Debt securities:                          |       |          |       |       |       |
| One year or less                          |       | $             | 3,995      |       | $          | 3,967 |   |
| One through five years                    |       | 10,994        |       | 10,818     |       |
| Five through ten years                    |       | 22,402        |       | 21,876     |       |
| Over ten years                            |       | 27,177        |       | 27,240     |       |
| Subtotal                                  |       | 64,568        |       | 63,901     |       |
|                                      |       |          |       |       |       |
| Mortgage-backed securities                |       | 36,904        |       | 35,659     |       |
|                                      |       |          |       |       |       |
| Total  available-for-sale debt securities |       | $             | 101,472    |       | $          | 99,560 |   |

 

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 September 30, 2006,the AFS debt securities portfolio was carried at a net unrealized loss of$1,912,000 compared to a

17

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net unrealized loss of$1,859,000 at December 31, 2005. Compared to the end of the second quarter of 2006, the net unrealizedloss approximated $3,735,000, or an improvement of $1,823,000 during the 2006third quarter.  A large portion of theunrealized losses was for a continuous period of more than 12 months.  Management believes that the cause of theseunrealized losses is directly related to changes in market interest rates.  In general, as interest rates rise, the fairvalue of fixed rate securities will decrease; as interest rates fall, theirfair values will increase.  During thecurrent rising rate interest rate cycle, that largely began in 2004, the Bankhas experienced a steady decline in the value of its investment portfolio.  As of September 30, 2006, however, most allof the deterioration of the AFS debt portfolio is from investments that areguaranteed by the U.S. government or one of its agencies.  In analyzing an issuer’s financial condition,Management considers whether the securities are issued by the U.S. government,its agencies or other governments, whether downgrades by bond rating agencieshave occurred and, if necessary, reviews of the issuer’s financial condition.  Because the decline in market values isattributable to changes in interest rates and not credit quality, and theCompany has the ability and intent to hold those securities until recovery offair value, which may be maturity, Management views these unrealized losses tobe 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 loans are written down by the difference with a corresponding chargeto current earnings.  Subsequentappreciation, if any, is credited to current earnings but only to the extent ofprevious write-downs.

At September 30, 2006,loans AFS amounted to $421,000 with a corresponding fair value of $428,000,compared to $429,000 and $434,000, respectively, at December 31, 2005.  For the third quarter of 2006, residentialmortgage and student loans with principal balances of $3,131,000 were sold intothe secondary market with combined net gains of approximately $21,000recognized.

*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 origination of fixed-rate residential mortgageand consumer loans.  The broad spectrumof products provides diversification which helps manage, to an extent, interestrate risk and credit concentration risk. Credit risk is further managed through underwriting policies andprocedures and loan monitoring practices. Interest rate risk is managed using various asset/liability modelingtechniques and analyses.  The interestrates on most commercial loans are adjustable with reset intervals of fiveyears 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$415,494,000 at September 30, 2006 increased from $409,129,000 at December 31,2005.  Residential real estate loangrowth as well as that of consumer and home equity loans remained reasonablystrong due to the continued market demand for residential and consumer loanoriginations and successful sales campaigns. The decrease in commercial and commercial real estate lending isprincipally due to normal run off together with several payoffs.

18

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The composition ofthe loan portfolio at September 30, 2006 and December 31, 2005, is summarizedas follows:
|                                        | ** ** | **September 30, 2006** | ** **  | **December 31, 2005** | ** ** |
|----------------------------------------|------------|----------------------------------|-------------|---------------------------------|------------|
| ** **                             | ** ** | **Amount**                       | ** **  | **%**                           | ** ** | **Amount** | ** ** | **%** | ** ** |
| Commercial and  commercial real estate |       | $                                | 212,146,977 |                            | 51.1       |   | $ | 216,288,597 |   | 52.9 |   |
| Residential real  estate               |       | 113,273,908                      |        | 27.3                            |       | 103,920,613 |   | 25.4 |   |
| Consumer and  home equity              |       | 76,507,776                       |        | 18.4                            |       | 74,070,328 |   | 18.1 |   |
| Real estate  construction              |       | 12,961,746                       |        | 3.1                             |       | 14,198,858 |   | 3.4 |   |
| Direct financing  leases               |       | 603,995                          |        | 0.1                             |       | 650,348 |   | 0.2 |   |
| Gross loans                            |       | 415,494,402                      |        | 100.0                           |       | 409,128,744 |   | 100.0 |   |
| Allowance for loan losses              |       | (5,843,538                       | )           |                            |       | (5,984,649 | ) |   |   |
| Net loans                              |       | $                                | 409,650,864 |                            |       |   | $ | 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 (theallowance), on a quarterly basis.  Theallowance reflects Management’s best estimate of the amount of credit losses inthe loan portfolio.  Management’sjudgment is based on the evaluation of individual loans, past experience, theassessment of current economic conditions and other relevant factors includingthe amounts and timing of cash flows expected to be received on impairedloans.  Those estimates may besusceptible to significant change.  Theprovision for loan losses represents the amount necessary to maintain anappropriate allowance.  Loan losses arecharged directly 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 loss percentages(three-year average) to pools to determine the allowance allocation; 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 thenine months ended September 30, 2006 were $466,000, compared to $633,000 forthe same period in 2005.  Net charge-offsof commercial loans were $289,000 for the nine months ended September 30, 2006compared to $588,000 in the nine months of 2005.  Gross commercial charge-offs were $591,000less for the nine months ended September 30, 2006 compared to the nine monthsended September 30, 2005.  The September30, 2005 amount included one large commercial charge-off in the amount of$318,000 taken in the second quarter of 2005. Real estate mortgage net charge-offs were $65,000 in the first ninemonths of 2006 as opposed to $11,000 in the first nine months of 2005.  Consumer loan net charge-offs were $112,000in the first nine months ended September 30, 2006 as compared to $34,000 forthe same nine months of 2005.  There wereno lease financing charge-offs during the nine months ended September 30, 2006and lease recoveries posted were nominal.

19

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Management believes thatthe current balance in the allowance for loans losses of $5,844,000 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.  Potentialproblem loans are those where there is known information that leads Managementto believe repayment of principal and/or interest is in jeopardy and the loansare neither on non-accrual status nor past due 90 days or more.  However, there could be instances whichbecome identified over the year that may require additional charge-offs and/orincreases to the allowance.  The ratio ofallowance for loan losses to total loans was 1.41% at September 30, 2006 comparedto 1.46% at December 31, 2005 and 1.52% at September 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** | ** ** |
|----------------------------------|------------|-------------------------------------------|-------------|-------------------------------------------|------------|-------------------------------------------|------------|
| ** **                       | ** ** | **nine months ended**           | ** **  | **year ended**                       | ** ** | **nine months ended**           | ** ** |
| ** **                       | ** ** | **September 30, 2006**          | ** **  | **December 31, 2005**           | ** ** | **September 30, 2005**          | ** ** |
|                             |       |                                      |        |                                      |       |                                      |       |
| Balance at  beginning of period  |       | $                                         | 5,984,649   |                                      | $          | 5,987,798                                 |       | $ | 5,987,798 |   |
|                             |       |                                      |        |                                      |       |                                      |       |
| Provision  charged to operations |       | 325,000                                   |        | 830,000                                   |       | 680,000                                   |       |
|                             |       |                                      |        |                                      |       |                                      |       |
| Charge-offs:                     |       |                                      |        |                                      |       |                                      |       |
| Commercial                       |       | 350,203                                   |        | 1,076,721                                 |       | 940,911                                   |       |
| Real estate                      |       | 65,759                                    |        | 20,875                                    |       | 20,875                                    |       |
| Consumer                         |       | 226,812                                   |        | 287,676                                   |       | 183,659                                   |       |
| Lease financing                  |       | —                                    |        | 8,373                                     |       | —                                    |       |
| Total                            |       | 642,774                                   |        | 1,393,645                                 |       | 1,145,445                                 |       |
|                             |       |                                      |        |                                      |       |                                      |       |
| Recoveries:                      |       |                                      |        |                                      |       |                                      |       |
| Commercial                       |       | 60,732                                    |        | 395,162                                   |       | 352,413                                   |       |
| Real estate                      |       | 502                                       |        | 10,677                                    |       | 9,698                                     |       |
| Consumer                         |       | 115,229                                   |        | 154,557                                   |       | 150,085                                   |       |
| Lease financing                  |       | 200                                       |        | 100                                       |       | —                                    |       |
| Total                            |       | 176,663                                   |        | 560,496                                   |       | 512,196                                   |       |
|                             |       |                                      |        |                                      |       |                                      |       |
| Net charge-offs                  |       | 466,111                                   |        | 833,149                                   |       | 633,249                                   |       |
|                             |       |                                      |        |                                      |       |                                      |       |
| Balance at end  of period        |       | $                                         | 5,843,538   |                                      | $          | 5,984,649                                 |       | $ | 6,034,549 |   |
|                             |       |                                      |        |                                      |       |                                      |       |
| Total loans, end of  period      |       | $                                         | 415,494,402 |                                      | $          | 409,128,744                               |       | $ | 397,070,309 |   |

 

20

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| ** **                                                                | ** ** | **As of and for the** | ** ** | **As of and for the** | ** ** | **As of and for the** | ** ** |
|---------------------------------------------------------------------------|------------|-------------------------------------------|------------|-------------------------------------------|------------|-------------------------------------------|------------|
| ** **                                                                | ** ** | **nine months ended**           | ** ** | **year ended**                       | ** ** | **nine months ended**           | ** ** |
| ** **                                                                | ** ** | **September 30, 2006**          | ** ** | **December 31, 2005**           | ** ** | **September 30, 2005**          | ** ** |
| Net charge-offs to:                                                       |       |                                      |       |                                      |       |                                      |       |
| Loans, end of  period                                                     |       | 0.11                                      | %          | 0.20                                      | %          | 0.16                                      | %          |
| Allowance for  loan losses                                                |       | 7.98                                      | %          | 13.92                                     | %          | 10.49                                     | %          |
| Provision for  loan losses                                                |       | 1.43                                      | x          | 1.00                                      | x          | 0.93                                      | x          |
|                                                                      |       |                                      |       |                                      |       |                                      |       |
| Allowance for loan  losses to:                                            |       |                                      |       |                                      |       |                                      |       |
| Total loans                                                               |       | 1.41                                      | %          | 1.46                                      | %          | 1.52                                      | %          |
| Non-accrual  loans                                                        |       | 1.43                                      | x          | 0.63                                      | x          | 0.65                                      | x          |
| Non-performing  loans                                                     |       | 1.15                                      | x          | 0.62                                      | x          | 0.60                                      | x          |
| Net charge-offs                                                           |       | 12.54                                     | x          | 7.18                                      | x          | 9.53                                      | x          |
|                                                                      |       |                                      |       |                                      |       |                                      |       |
| Loans 30-89 days past  due and still accruing                             |       | $                                         | 2,525,382  |                                      | $          | 1,608,970                                 |       | $ | 2,396,798 |   |
| Loans 90 days past due  and accruing                                      |       | $                                         | 997,148    |                                      | $          | 196,928                                   |       | $ | 654,084 |   |
| Non-accrual loans                                                         |       | $                                         | 4,082,222  |                                      | $          | 9,452,788                                 |       | $ | 9,335,011 |   |
| Allowance for loan losses to loans 90 days or more past due and  accruing |       | 5.86                                      | x          | 30.39                                     | x          | 9.23                                      | 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 September 30, 2006, non-performingassets represented 0.93% of total assets compared to 1.78% at December 31, 2005and 1.87% at September 30, 2005.

Thenon-accrual loans declined by $5,371,000 during the first nine months of 2006to $4,082,000.  There were additions tothe non-accrual loans totaling $1,491,000 during the first nine months of2006.  These additions were offset bypayoffs or pay downs of $2,130,000, $4,035,000 of loans returned to accruing status,charge offs of $522,000 and $175,000 of loans that were transferred to otherreal estate owned.

AtSeptember 30, 2006 the 90-day past due loans were $997,000, compared to$197,000 at December 31, 2005 and $654,000 at September 30, 2005.  This increase was primarily due to $962,000that had been over 90 days delinquent at the current quarter-end.  However, payment was made subsequent toquarter-end to bring the amount contractually current.

Otherreal estate owned at September 30, 2006 consisted of four residentialproperties that were foreclosed upon and transferred from loans.   The total of these four properties was$132,000 at period end September 30, 2006. Two of the properties are listed for sale with a realtor, and the othertwo properties are under contracts for sale. There were no repossessed assets at September 30, 2006.

Non-performingloans were $5,079,000 at September 30, 2006, a decline of $4,570,000 fromyear-end 2005, as well as a decline of $4,910,000 compared to September 30,2005.  Although the decline occurredsubstantially in the commercial loans, reductions occurred in the real estateand consumer portfolios as well.  Theratio of non-performing loans to net loans declined by 115 basis points to1.24%, during the nine month period ended September 30, 2006.  At September 30, 2005, the ratio ofnon-performing loans to net loans was 2.55%. The ratio of non-performing assets to total assets decreased to 0.93% atSeptember 30, 2006, down from 1.78% at year-end 2005 and down from 1.87% September30, 2005.  This decline is mainly theresult of the reduced levels of non-accrual loans.

21

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The following table setsforth non-performing assets data as of the period indicated:
|                                                                                    | ** ** | **September 30, 2006** | ** **  | **December 31, 2005** | ** ** | **September 30, 2005** | ** ** |
|------------------------------------------------------------------------------------|------------|----------------------------------|-------------|---------------------------------|------------|----------------------------------|------------|
|                                                                               |       |                             |        |                            |       |                             |       |
| Loans past due  90 days or more and accruing                                       |       | $                                | 997,148     |                            | $          | 196,928                          |       | $ | 654,084 |   |
| Non-accrual  loans                                                                 |       | 4,082,222                        |        | 9,452,788                       |       | 9,335,011                        |       |
| Total non-performing loans                                                         |       | 5,079,370                        |        | 9,649,716                       |       | 9,989,095                        |       |
|                                                                               |       |                             |        |                            |       |                             |       |
| Other real  estate owned                                                           |       | 131,849                          |        | —                          |       | 77,750                           |       |
| Repossessed  assets                                                                |       | —                           |        | 18,702                          |       | 25,632                           |       |
| Total non-performing assets                                                        |       | $                                | 5,211,219   |                            | $          | 9,668,418                        |       | $ | 10,092,477 |   |
|                                                                               |       |                             |        |                            |       |                             |       |
| Net loans  including AFS                                                           |       | $                                | 410,072,053 |                            | $          | 403,572,679                      |       | $ | 391,035,760 |   |
| Total assets                                                                       |       | $                                | 562,840,483 |                            | $          | 544,060,698                      |       | $ | 538,434,511 |   |
| Non-accrual  loans to net loans                                                    |       | 1.00                             | %           | 2.34                            | %          | 2.39                             | %          |
| Non-performing  assets to net loans, foreclosed real estate and repossessed assets |       | 1.27                             | %           | 2.40                            | %          | 2.58                             | %          |
| Non-performing  assets to total assets                                             |       | 0.93                             | %           | 1.78                            | %          | 1.87                             | %          |
| Non-performing loans to  net loans                                                 |       | 1.24                             | %           | 2.39                            | %          | 2.55                             | %          |

 

*Accrued interest receivable andother assets*

The increase in accruedinterest receivable of $800,000 or 41%, from December 31, 2005 to September 30,2006 was principally due to higher average balances of interest-earning assets.  The increase in other assets of $609,000, or15%, for the same period, was due mostly to capitalized construction costs forthe Bank’s branch expansion projects.

*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.  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.

Compared to December 31,2005, total deposits increased $40,231,000, or 11%, during the nine monthsended September 30, 2006.  The increasein total deposits was primarily due to a $24,462,000, or 49%, increase in NOWaccounts, much of which stems from our continued positive relationship with ourpublic funds sector customers.  The$20,139,000, or 39%, increase in money market accounts was due to success inthe implementation of deposit-gathering strategies in conjunction withincreased short-term promotional interest rates and transfers from lessattractive time deposits.  Though theBank has introduced some promotional strategies for shorter-term time deposits,Management did not aggressively pursue time deposits; rather, most of theefforts were targeted to attracting transactional, no-term core deposits suchas NOW and money market accounts.  Thoughnon-interest bearing deposits increased modestly compared to December 31, 2005,the Bank continues to experience growth from its personal relationshipcustomers.  Prospectively, Management willcontinue to develop strategies and implement campaigns to attract thisall-important customer base in order to grow this cost-lowering funding source.

22

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The following tablerepresents the major components of deposits as of September 30, 2006 andDecember 31, 2005:
|                                              | ** ** | **September 30, 2006** | ** **  | **December 31, 2005** | ** ** |
|----------------------------------------------|------------|----------------------------------|-------------|---------------------------------|------------|
| ** **                                   | ** ** | **Amount**                       | ** **  | **%**                           | ** ** | **Amount** | ** ** | **%** | ** ** |
| Money market                                 |       | $                                | 71,722,007  |                            | 17.1       |   | $ | 51,583,473 |   | 13.6 |   |
| NOW                                          |       | 74,510,049                       |        | 17.8                            |       | 50,048,331 |   | 13.2 |   |
| Savings and club                             |       | 50,479,486                       |        | 12.0                            |       | 46,434,150 |   | 12.3 |   |
| Certificates of  deposit less than $100,000  |       | 89,227,484                       |        | 21.3                            |       | 84,814,047 |   | 22.3 |   |
| Certificates of  deposit of $100,000 or more |       | 62,241,944                       |        | 14.8                            |       | 76,257,553 |   | 20.1 |   |
| Total interest-bearing                       |       | 348,180,970                      |        | 83.0                            |       | 309,137,554 |   | 81.5 |   |
| Non-interest  bearing                        |       | 71,548,817                       |        | 17.0                            |       | 70,361,086 |   | 18.5 |   |
| Total deposits                               |       | $                                | 419,729,787 |                            | 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 $65,590,000 and $83,704,000 in long-term advancesfrom the FHLB at September 30, 2006 and December 31, 2005, respectively.  Also included in borrowings were REPOagreements of $21,811,000 and $26,913,000, as of the respective periods.  REPOs are non-insured interest-bearing liabilitiesthat have a security interest in qualified investment securities of theBank.  REPOs offered are eitherfixed-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 September 30, 2006, the Bank had nobalance in this account compared to $769,000 at December 31, 2005.

During the third quarter of2006, the Bank refinanced a portion of its long-term debt, with the FHLB, inorder to reduce interest expense.  Therepaid $16,000,000 of convertible select 6.22% advances scheduled to mature in2010.  Simultaneously, the Bank enteredinto a new FHLB $16,000,000 convertible select 5.26% advance with a scheduledmaturity in 2016.  The immediate effectof the 96 basis point decrease in rate was to reduce interest expense byapproximately $154,000 per annum.

Combined short- andlong-term borrowings amounted to $88,417,000 at September 30, 2006 compared to$112,477,000 at December 31, 2005, or a decrease of $24,060,000, or 21%.  The decrease was the result of increaseddeposit generation that was used to repay FHLB advances during the second andthird quarters 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 to maturity.  Interest rate risk management is an integralpart of the asset/liability management process. The Company has instituted certain procedures and policy guidelines tomanage the interest rate risk position. Those internal policies enable the Company to react to changes in marketrates to protect net interest income from significant fluctuations.  The primary objective in managing interestrate risk is to minimize the adverse impact of changes in interest rates on netinterest income along with creating an asset/liability structure that maximizesearnings.

23

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*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 to interestsensitive liabilities.  The process toreview interest rate risk is a regular part of managing the Company.  Consistent policies and practices ofmeasuring and reporting interest rate risk exposure, particularly regarding thetreatment of non-contractual assets and liabilities, are in effect.  In addition, there is an annual process toreview the interest rate risk policy with the Board of Directors which includeslimits on the impact to earnings from shifts in interest rates.

*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 rate relationships.

*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 September 30, 2006, theCompany maintained a negative one-year cumulative gap of $55,675,000 or -9.9%of total 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 interestrates.  Conversely, in a declininginterest rate environment, net interest income could be positively impactedbecause more liabilities 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 interestrates on a short-term basis and over the life of the asset.  In the event of a change in interest rates,prepayment and early withdrawal levels may deviate significantly from 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 followingtable illustrates the Company’s interest sensitivity gap position at September30, 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                     |       | $                 | 10,616     |               | $          | —             |       | $                | —     |       | $          | 10,217 |   | $ | 20,833 |   |
| Investment  securities (1)(2)                  |       | 15,725            |       | 9,232              |       | 23,581             |       | 56,462           |       | 105,000    |       |
| Loans (2)                                      |       | 104,945           |       | 63,841             |       | 101,043            |       | 140,243          |       | 410,072    |       |
| Fixed and other  assets                        |       | —            |       | 8,105              |       | —             |       | 18,830           |       | 26,935     |       |
| Total assets                                   |       | $                 | 131,286    |               | $          | 81,178             |       | $                | 124,624    |       | $          | 225,752 |   | $ | 562,840 |   |
| Total cumulative assets                        |       | $                 | 131,286    |               | $          | 212,464            |       | $                | 337,088    |       | $          | 562,840 |   |   |   |
|                                           |       |              |       |               |       |               |       |             |       |       |       |
| Non-interest  bearing transaction deposits (3) |       | $                 | —     |               | $          | 7,154              |       | $                | 19,675     |       | $          | 44,720 |   | $ | 71,549 |   |
| Interest-bearing  transaction deposits (3)     |       | 103,892           |       | —             |       | 37,335             |       | 55,485           |       | 196,712    |       |
| Time deposits                                  |       | 34,930            |       | 87,739             |       | 17,289             |       | 11,511           |       | 151,469    |       |
| Repurchase  agreements                         |       | 21,643            |       | 169                |       | —             |       | —           |       | 21,812     |       |
| Short-term  borrowings                         |       | 1,015             |       | —             |       | —             |       | —           |       | 1,015      |       |
| Long-term debt                                 |       | 5,825             |       | 5,772              |       | 993                |       | 53,000           |       | 65,590     |       |
| Other  liabilities                             |       | —            |       | —             |       | —             |       | 3,731            |       | 3,731      |       |
| Total liabilities                              |       | $                 | 167,305    |               | $          | 100,834            |       | $                | 75,292     |       | $          | 168,447 |   | $ | 511,878 |   |
| Total cumulative liabilities                   |       | $                 | 167,305    |               | $          | 268,139            |       | $                | 343,431    |       | $          | 511,878 |   |   |   |
|                                           |       |              |       |               |       |               |       |             |       |       |       |
| Interest  sensitivity gap                      |       | $                 | (36,019    | )                  | $          | (19,656            | )          | $                | 49,332     |       | $          | 57,305 |   |   |   |
|                                           |       |              |       |               |       |               |       |             |       |       |       |
| Cumulative gap                                 |       | $                 | (36,019    | )                  | $          | (55,675            | )          | $                | (6,343     | )          | $          | 50,962 |   |   |   |
|                                           |       |              |       |               |       |               |       |             |       |       |       |
| Cumulative gap to total  assets                |       | -6.40             | %          | -9.89              | %          | -1.13              | %          | 9.05             | %          |       |       |

 

----

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

(2)          Investments and loansare included in the earlier of the period in which interest rates were nextscheduled 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)          The Bank’s demand andsavings accounts are generally subject to immediate withdrawal.  However, Management considers a certain amountof such accounts to be core accounts having significantly longer effectivematurities based on the retention experiences of such deposits in changinginterest rate environments.  Theeffective maturities presented are the recommended maturity distribution limitsfor non-maturing deposits based on historical 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 simulationmeasures 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 September 30,2006 remained constant.  The impact ofthe rate movements was developed by simulating the effect of rates changingover a twelve-month period from the September 30, 2006 levels:
|                                                       | ** ** | **Rates +200** | ** ** | **Rates -200** | ** ** |
|-------------------------------------------------------|------------|---------------------|------------|---------------------|------------|
| Earnings at  risk:                                    |       |                |       |                |       |
| Percent change in:                                    |       |                |       |                |       |
| Net interest income                                   |       | (5.4                | )%         | 2.2                 | %          |
| Net income                                            |       | (16.6               | )          | 6.3                 |       |
|                                                  |       |                |       |                |       |
| Economic value  at risk:                              |       |                |       |                |       |
| Percent change in:                                    |       |                |       |                |       |
| Economic value of equity                              |       | (23.9               | )          | 5.4                 |       |
| Economic value  of equity as a percent of book assets |       | (2.6                | )          | 0.6                 |       |

 

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%.  AtSeptember 30, 2006, the Company’s risk-based capital ratio was 13.7%.

The table belowsummarizes estimated changes in net interest income over a twelve-month periodbeginning October 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                          |       | $                     | 17,073     |         | $          | (978         | )          | (5.4 | )% |
| +100 basis  points                          |       | 17,588                |       | (463         | )          | (2.6         | )          |
| Flat rate                                   |       | 18,051                |       | —       |       | —       |       |
| -100 basis  points                          |       | 18,442                |       | 391          |       | 2.2          |       |
| -200 basis points                           |       | 18,443                |       | 392          |       | 2.2          |       |
|                                             |            |                       |            |              |            |              |            |  |  |

 

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 rateenvironments.  Savings accounts,including passbook, statement savings, money market and interest checkingaccounts do not have a stated maturity or re-pricing term and can be withdrawnor re-priced at any time.  This mayimpact the margin if more expensive alternative sources of deposits arerequired to fund loans or deposit run-off. Management projects the re-pricing characteristics of these accountsbased on historical performance and assumptions that it believes reflect theirrate sensitivity.  The consulting modelreinvests all maturities, repayments and prepayments for each type of asset orliability into the same product for a new like-term at current rates providedmy Management.  As a result, the mix ofinterest-earning assets and interest bearing-liabilities is held constant.

*Derivative FinancialInstruments. *As partof the Bank’s overall interest rate risk management strategy, the Company hasadopted a policy whereby the Bank may periodically use derivative instrumentsto minimize significant fluctuations in earnings caused by interest ratevolatility.  This interest rate riskmanagement strategy entails the use of interest rate floors, caps andswaps.  In October 2006, the Bank enteredinto an interest rate floor derivative agreement on $20,000,000 notional valueof its prime-based loan portfolio.  Thepurpose of the hedge is to help protect the Bank’s interest income in the eventinterest rates decline below a pre-determined contractual interest rate.  The strategy is reflected in the scenariosfor earnings and economic value at risk and the net interest income in the twoimmediately preceding tables.

26

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*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 repurchase agreements,available fed fund lines and other borrowed funds from correspondent banks andissuance of capital stock.  Althoughregularly scheduled investment and loan payments are dependable sources ofdaily funds, the sales of both loans and investments AFS, deposit activity, andinvestment and loan prepayments are significantly influenced by generaleconomic conditions and the level of interest rates.

As of September 30, 2006, the Company maintained $12,833,000 in cashand cash equivalents, $100,020,000 of investments AFS and $421,000 of loansAFS.  In addition, as of September 30,2006, the Company had approximately $130,788,000 available to borrow from theFHLB and $10,000,000 available from another correspondent Bank.  This combined total of $254,062,000represented 45% of total assets at September 30, 2006.  Management believes this level of liquidityto 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 which largelybegan in 2004.  The Company is subject tovarious regulatory capital requirements administered by the federal bankingagencies.  Failure to meet minimumcapital requirements can initiate certain mandatory and possible additionaldiscretionary actions by regulators that, if undertaken, could have a directmaterial effect on the Company’s financial statements.  Under capital adequacy guidelines and theregulatory framework for prompt corrective action, the Company must meetspecific capital guidelines that involve quantitative measures of the Company’sassets, liabilities and certain off-balance-sheet items as calculated underregulatory accounting practices.  TheCompany’s capital amounts and classification are also subject to qualitativejudgments by the regulators about components, risk-weightings and otherfactors.

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%, including TierI capital to total risk-weighted assets (Tier I Capital) of 4% and Tier Icapital to average total assets (Leverage Ratio) of at least 4%.

As of September 30, 2006,the Company met all capital adequacy requirements to which it was subject.  The following table depicts the capitalamounts and ratios of the Company and the Bank as of September 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              |       | $          | 57,382,652 |       | 13.74      | %          |       | 3                     | $          | 33,406,107 |       |       | 3     | 8.00       | %          | 3                     |       | N/A        |       |       | 3     | N/A |   |
| Bank                      |       | $          | 57,077,057 |       | 13.67      | %          |       | 3                     | $          | 33,400,372 |       |       | 3     | 8.00       | %          | 3                     |       | $          | 41,750,465 |       |       | 3 | 10.00 | % |
| Tier I capital            |       |       |       |       |       |       |       |                       |       |       |       |       |       |       |       |                       |       |       |       |       |       |
| (to risk-weighted assets) |       |       |       |       |       |       |       |                       |       |       |       |       |       |       |       |                       |       |       |       |       |       |
| Consolidated              |       | $          | 52,073,739 |       | 12.47      | %          |       | 3                     | $          | 16,703,053 |       |       | 3     | 4.00       | %          | 3                     |       | N/A        |       |       | 3     | N/A |   |
| Bank                      |       | $          | 51,843,829 |       | 12.42      | %          |       | 3                     | $          | 16,700,186 |       |       | 3     | 4.00       | %          | 3                     |       | $          | 25,050,279 |       |       | 3 | 6.00 | % |
| Tier I capital            |       |       |       |       |       |       |       |                       |       |       |       |       |       |       |       |                       |       |       |       |       |       |
| (to average assets)       |       |       |       |       |       |       |       |                       |       |       |       |       |       |       |       |                       |       |       |       |       |       |
| Consolidated              |       | $          | 52,073,739 |       | 9.21       | %          |       | 3                     | $          | 22,608,975 |       |       | 3     | 4.00       | %          | 3                     |       | N/A        |       |       | 3     | N/A |   |
| Bank                      |       | $          | 51,843,829 |       | 9.18       | %          |       | 3                     | $          | 22,593,881 |       |       | 3     | 4.00       | %          | 3                     |       | $          | 28,242,351 |       |       | 3 | 5.00 | % |

 

27

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**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 have materially affected, or are reasonably likely to materially affect, the Company’s internal control over financial reporting.

**PART II - Other Information**

**Item 1. Legal Proceedings**

The nature of the Company’s business generates some litigationinvolving matters arising in the ordinary course of business.  However, in the opinion of the Company, afterconsulting with legal counsel, no legal proceedings are pending, which, ifdetermined adversely to the Company or the Bank, would have a material effecton 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**

None

**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.

***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 

28

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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 by referenceto Exhibit 99.1 to Registrant’s Current Report on Form 8-K filed with the SECon 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, DanielSantaniello, Registrant and The Fidelity Deposit and Discount Bank, datedNovember 1, 2005.*** Incorporatedby reference to Exhibits 99.1and 99.2 to Registrant’s Current Report on Form8-K filed with the SEC on November 3, 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******                    Change ofControl Agreements with Daniel J. Santaniello, Salvatore R. DeFrancesco, JamesT. Gorman, Registrant and The Fidelity Deposit and Discount Bank, dated March21, 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.

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

***31.2******                              Rule13a-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.***

29

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

Pursuant to therequirements of the Securities Exchange Act of 1934, the registrant has dulycaused this report to be signed on its behalf by the undersigned thereunto dulyauthorized.
|                        |   | **FIDELITY D & D BANCORP, INC.**                     |
|------------------------|--------|----------------------------------------------------------|
|                   |   | ** **                                               |
|                   |   |                                                     |   |
| Date: November 7, 2006 |   | /s/ Steven C. Ackmann                                    |   |
|                   |   |  Steven C.  Ackmann,                                |
|                   |   |    President  and Chief Executive Officer |
|                   |   |                                                     |
|                   |   |                                                     |
| Date: November 7, 2006 |   | /s/ Salvatore R. DeFrancesco, Jr.                        |   |
|                   |   |  Salvatore  R. DeFrancesco, Jr.,                    |
|                   |   |    Treasurer  and Chief Financial Officer |

30

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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.                                         |       | *          |
| *** ***                                                                                                                                                                                                                                                                                                                                                                                            |       |       |
| ***11 Statement regarding  computation of earnings per share.*** Included herein.                                                                                                                                                                                                                                                                                                                       |       | 8          |
|                                                                                                                                                                                                                                                                                                                                                                                                    |       |       |
| ***31.1 Rule 13a-14(a)  Certification of Principal Executive Officer.***                                                                                                                                                                                                                                                                                                                                |       | 33         |
|                                                                                                                                                                                                                                                                                                                                                                                                    |       |       |
| ***31.2 Rule 13a-14(a)  Certification of Principal Financial Officer.***                                                                                                                                                                                                                                                                                                                                |       | 34         |

 

31

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| ***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.*** |   | 35     |
|---------------------------------------------------------------------------------------------------------------------------------------------------------------------|--------|--------|
|                                                                                                                                                                |   |   |
| ***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.*** |   | 36     |

 

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* Incorporated byReference

32

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