**UNITEDSTATES**

**SECURITIESAND EXCHANGE COMMISSION**

**Washington,D.C. 20549**

 

**FORM 10-Q**

 

**QUARTERLYREPORT UNDER SECTION 13 OR 15(d) OF THE**

**SECURITIESEXCHANGE ACT OF 1934**

 

**FORQUARTER ENDED MARCH 31, 2005**

 

**COMMISSIONFILE NUMBER: 333-90273**

 

**FIDELITYD & D BANCORP, INC.**

 
| STATE OF  INCORPORATION:         |       | IRS EMPLOYER  IDENTIFICATION NO: |
|----------------------------------|------------|----------------------------------|
| **PENNSYLVANIA**                 | ** ** | **23-3017653**                   |
|                             |       |                             |
| PRINCIPAL  OFFICE:               |
| **BLAKELY  & DRINKER ST.**   |
| **DUNMORE,  PENNSYLVANIA 18512** |
|                             |
| TELEPHONE:                       |
| **570-342-8281**                 |

 

The Company (1) has filed all reports required to be filed by Section 13or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months(or for such shorter period that the Company was required to file suchreports), and (2) has been subject to such filing requirements for the past 90days.

 

**ý  **YES    o  NO

 

The Registrant is anaccelerated filer (as defined in Exchange Act Rule 12b-2)

 

**o  **YES    ý  NO

 

The number of outstandingshares of Common Stock of Fidelity D & D Bancorp, Inc. at April 29,2005, the latest practicable date, was 1,843,997 shares.

 

 

----

 

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

 

Form 10-Q March 31,2005

 

Index

 
| **Part I. Financial information**          |                                                                                                                      |
|--------------------------------------------|---------------------------------------------------------------------------------------------------------------------------|
|                                       |                                                                                                                      |
| Item 1. Financial  Statements (unaudited): |                                                                                                                      |
|                                       |                                                                                                                      |   |
|                                       | Consolidated Balance Sheets  as of March 31, 2005 and December 31, 2004                                         |   |
|                                       | Consolidated  Statements of Income for the three months ended March 31, 2005 and 2004                                |   |
|                                       | Consolidated  Statements of Changes in Shareholders’ Equity for the three months ended March 31,  2005 and 2004 |   |
|                                       | Consolidated  Statements of Cash Flows for the three months ended March 31, 2005 and  2004                           |   |
|                                       | 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  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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**FIDELITY D & D BANCORP, INC.**

ConsolidatedBalance Sheets

As of March 31, 2005 and December 31, 2004

 
| ** **                                                                                                                                   | ** ** | **March 31, 2005** | ** **  | **December 31, 2004** | ** ** |
|----------------------------------------------------------------------------------------------------------------------------------------------|------------|-------------------------|-------------|----------------------------|------------|
| ** **                                                                                                                                   | ** ** | **(unaudited)**         | ** **  | **(audited)**              | ** ** |
| **ASSETS**                                                                                                                                   |       |                    |        |                       |       |
| Cash  and due from banks                                                                                                                     |       | $                       | 11,188,920  |                       | $          | 9,013,060 |   |
| Interest-bearing  deposits with financial institutions                                                                                       |       | 1,555,390               |        | 1,203,334                  |       |
| Federal  funds sold                                                                                                                          |       | 9,010,000               |        | —                     |       |
| Total  cash and cash equivalents                                                                                                             |       | 21,754,310              |        | 10,216,394                 |       |
| Available-for-sale  securities                                                                                                               |       | 107,784,063             |        | 112,612,513                |       |
| Held-to-maturity  securities                                                                                                                 |       | 2,890,448               |        | 3,056,305                  |       |
| Federal  Home Loan Bank Stock                                                                                                                |       | 3,831,200               |        | 4,568,700                  |       |
| Loans  and leases, net (allowance for loan losses of   $6,000,956 in 2005 and $5,987,798 in 2004)                                            |       | 377,492,615             |        | 381,546,375                |       |
| Loans  available-for-sale (fair value $403,992 in 2005 and $582,141 in 2004)                                                                 |       | 399,992                 |        | 576,378                    |       |
| Bank  premises and equipment, net                                                                                                            |       | 10,955,283              |        | 11,163,292                 |       |
| Cash  surrender value of bank owned life insurance                                                                                           |       | 7,671,229               |        | 7,613,437                  |       |
| Other  assets                                                                                                                                |       | 4,794,769               |        | 3,385,790                  |       |
| Accrued  interest receivable                                                                                                                 |       | 2,078,349               |        | 1,722,850                  |       |
| Foreclosed  assets held for sale                                                                                                             |       | 207,271                 |        | 213,104                    |       |
| **Total assets**                                                                                                                             |       | $                       | 539,859,529 |                       | $          | 536,675,138 |   |
| **LIABILITIES**                                                                                                                              |       |                    |        |                       |       |
| Deposits                                                                                                                                     |       |                    |        |                       |       |
| Non-interest-bearing                                                                                                                         |       | $                       | 65,843,312  |                       | $          | 65,357,535 |   |
| Certificates  of deposit of $100,000 or more                                                                                                 |       | 92,501,794              |        | 93,986,033                 |       |
| Other  interest-bearing deposits                                                                                                             |       | 221,680,263             |        | 206,271,767                |       |
| Total  deposits                                                                                                                              |       | 380,025,369             |        | 365,615,335                |       |
| Accrued  interest payable and other liabilities                                                                                              |       | 3,610,398               |        | 3,039,809                  |       |
| Short-term  borrowings                                                                                                                       |       | 39,070,822              |        | 50,534,046                 |       |
| Long-term  debt                                                                                                                              |       | 70,926,430              |        | 71,119,188                 |       |
| **Total liabilities**                                                                                                                        |       | 493,633,019             |        | 490,308,378                |       |
| **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  1,843,997 shares in 2005 and 1,839,572 shares in 2004 |       | 10,224,377              |        | 10,072,134                 |       |
| Retained  earnings                                                                                                                           |       | 37,010,484              |        | 36,396,027                 |       |
| Accumulated  other comprehensive loss                                                                                                        |       | (1,008,351              | )           | (101,401                   | )          |
| **Total shareholders’ equity**                                                                                                          |       | 46,226,510              |        | 46,366,760                 |       |
| **Total liabilities and shareholders’ equity**                                                                                          |       | $                       | 539,859,529 |                       | $          | 536,675,138 |   |

 

3

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

Consolidated Statements of Income

(unaudited)

 
| ** **                                               | ** ** | **Three Months Ended**  | ** ** |
|----------------------------------------------------------|------------|-------------------------|------------|
| ** **                                               | ** ** | **March 31, 2005** | ** ** | **March 31, 2004** | ** ** |
| **Interest income**                                      |       |                    |       |   |   |
| Interest  and fees on loans:                             |       |                    |       |   |   |
| Taxable                                                  |       | $                       | 5,664,675  |   | $ | 5,412,352 |   |
| Nontaxable                                               |       | 98,410                  |       | 84,088 |   |
| Leases                                                   |       | 18,293                  |       | 49,420 |   |
| Interest-bearing  deposits with financial institutions   |       | 2,688                   |       | 1,115 |   |
| Investment  securities:                                  |       |                    |       |   |   |
| US  Government agencies                                  |       | 910,157                 |       | 1,218,595 |   |
| States  and political subdivisions (non-taxable)         |       | 112,455                 |       | 135,378 |   |
| Other  securities                                        |       | 126,815                 |       | 52,167 |   |
| Federal  funds sold                                      |       | 40,792                  |       | 10,210 |   |
| **Total interest income**                                |       | 6,974,285               |       | 6,963,325 |   |
| **Interest expense**                                     |       |                    |       |   |   |
| Certificates  of deposit of $100,000 or more             |       | 676,023                 |       | 890,671 |   |
| Other  deposits                                          |       | 880,216                 |       | 1,050,649 |   |
| Securities  sold under repurchase agreements             |       | 196,809                 |       | 102,861 |   |
| Other  short- and long-term borrowings and other         |       | 945,433                 |       | 986,199 |   |
| **Total interest expense**                               |       | 2,698,481               |       | 3,030,380 |   |
| **Net interest income**                                  |       | 4,275,804               |       | 3,932,945 |   |
| Provision  for loan losses                               |       | 80,000                  |       | 850,000 |   |
| **Net interest income, after provision for loan losses** |       | 4,195,804               |       | 3,082,945 |   |
| **Other income:**                                        |       |                    |       |   |   |
| Service  charges on deposit accounts                     |       | 598,321                 |       | 525,929 |   |
| Gain  (loss) on:                                         |       |                    |       |   |   |
| Investment  securities                                   |       | —                  |       | 9,497 |   |
| Loans                                                    |       | (11,442                 | )          | 23,611 |   |
| Leased  assets                                           |       | (34,873                 | )          | (93,266 | ) |
| Foreclosed  assets held-for-sale                         |       | 405                     |       | 2,726 |   |
| Write-down  lease residual                               |       | (220,000                | )          | — |   |
| Fees,  other service charges and other income            |       | 415,202                 |       | 477,920 |   |
| **Total other income**                                   |       | 747,613                 |       | 946,417 |   |
| **Other operating expenses:**                            |       |                    |       |   |   |
| Salaries  and employee benefits                          |       | 1,742,921               |       | 1,744,516 |   |
| Premises  and equipment                                  |       | 734,455                 |       | 719,411 |   |
| Advertising                                              |       | 131,209                 |       | 60,507 |   |
| Professional  fees and services                          |       | 382,043                 |       | 285,871 |   |
| Other                                                    |       | 575,284                 |       | 464,722 |   |
| **Total other operating expenses**                       |       | 3,565,912               |       | 3,275,027 |   |
| **Income before provision for income taxes**             |       | 1,377,505               |       | 754,335 |   |
| Provision  for income taxes                              |       | 358,116                 |       | 129,428 |   |
| **Net income**                                           |       | $                       | 1,019,389  |   | $ | 624,907 |   |
| Per  share data:                                         |       |                    |       |   |   |
| Net  income - basic                                      |       | $                       | 0.55       |   | $ | 0.34 |   |
| Net  income - diluted                                    |       | $                       | 0.55       |   | $ | 0.34 |   |
| Dividends                                                |       | $                       | 0.22       |   | $ | 0.22 |   |

 

4

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

ConsolidatedStatements of Changes in Shareholders’ Equity

Forthe Three Months Ended March 31, 2005 and 2004

 
| ** **                                                                                                                  | ** ** | ** **         | ** ** | ** **          | ** ** | ** **   | ** ** | ** **        | ** ** | ** **   | ** ** | **Accumulated  other** | ** ** | ** ** | ** ** |
|-----------------------------------------------------------------------------------------------------------------------------|------------|--------------------|------------|---------------------|------------|--------------|------------|-------------------|------------|--------------|------------|------------------------|------------|------------|------------|
| ** **                                                                                                                  | ** ** | **Capital  stock** | ** ** | **Treasury  stock** | ** ** | **Retained** | ** ** | **comprehensive** | ** ** | ** **   | ** ** |
| ** **                                                                                                                  | ** ** | **Shares**         | ** ** | **Amount**          | ** ** | **Shares**   | ** ** | **Amount**        | ** ** | **earnings** | ** ** | **income  (loss)**     | ** ** | **Total**  | ** ** |
| Balance,  December 31, 2003 (audited)                                                                                  |       | 1,828,270          |       | $                   | 9,698,879  |         | (5,227     | )                 | $          | (196,048     | )          | $                      | 34,641,976 |       | $          | (212,908 | ) | $ | 43,931,899 |   |
| Comprehensive  income:                                                                                                      |       |               |       |                |       |         |       |              |       |         |       |                   |       |       |       |
| Net  income                                                                                                                 |       |               |       |                |       |         |       |              |       | 624,907      |       |                   |       | 624,907    |       |
| Change  in net unrealized holding gains (losses) on available-for-sale securities,  net net of reclassification adjustments |       |               |       |                |       |         |       |              |       |         |       | 1,007,884              |       | 1,007,884  |       |
| Comprehensive  income                                                                                                       |       |               |       |                |       |         |       |              |       |         |       |                   |       | 1,632,791  |       |
| Reissued  treasury stock through Employee Stock Purchase Plan                                                               |       |               |       | (8,329              | )          | 1,635        |       | 61,370            |       |         |       |                   |       | 53,041     |       |
| Dividends  reinvested through Dividend Reinvestment Plan                                                                    |       |               |       | (633                | )          | 3,496        |       | 131,222           |       |         |       |                   |       | 130,589    |       |
| Fractional  shares repurchased                                                                                              |       | (4                 | )          | (110                | )          |         |       |              |       |         |       |                   |       | (110       | )          |
| Dividends  declared                                                                                                         |       |               |       |                |       |         |       |              |       | (401,429     | )          |                   |       | (401,429   | )          |
| Balance,  March 31, 2004 (unaudited)                                                                                   |       | 1,828,266          |       | $                   | 9,689,807  |         | (96        | )                 | $          | (3,456       | )          | $                      | 34,865,454 |       | $          | 794,976 |   | $ | 45,346,781 |   |
|                                                                                                                        |       |               |       |                |       |         |       |              |       |         |       |                   |       |       |       |
| Balance,  December 31, 2004 (audited)                                                                                  |       | 1,839,572          |       | $                   | 10,072,134 |         | —     |              | $          | —       |       | $                      | 36,396,027 |       | $          | (101,401 | ) | $ | 46,366,760 |   |
| Comprehensive  income:                                                                                                      |       |               |       |                |       |         |       |              |       |         |       |                   |       |       |       |
| Net  income                                                                                                                 |       |               |       |                |       |         |       |              |       | 1,019,389    |       |                   |       | 1,019,389  |       |
| Change  in net unrealized holding gains (losses) on available-for-sale securities,  net net of reclassification adjustments |       |               |       |                |       |         |       |              |       |         |       | (906,950               | )          | (906,950   | )          |
| Comprehensive  income                                                                                                       |       |               |       |                |       |         |       |              |       |         |       |                   |       | 112,439    |       |
| Stock  issued through Employee Stock Purchase Plan                                                                          |       | 1,031              |       | 31,671              |       |         |       |              |       |         |       |                   |       | 31,671     |       |
| Dividends  reinvested through Dividend Reinvestment Plan                                                                    |       | 3,394              |       | 120,572             |       |         |       |              |       |         |       |                   |       | 120,572    |       |
| Dividends  declared                                                                                                         |       |               |       |                |       |         |       |              |       | (404,932     | )          |                   |       | (404,932   | )          |
| Balance,  March 31, 2005 (unaudited)                                                                                   |       | 1,843,997          |       | $                   | 10,224,377 |         | —     |              | $          | —       |       | $                      | 37,010,484 |       | $          | (1,008,351 | ) | $ | 46,226,510 |   |

 

5

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

ConsolidatedStatements of Cash Flows

(unaudited)

 
| ** **                                                                         | ** ** | **Three Months Ended**  | ** ** |
|------------------------------------------------------------------------------------|------------|-------------------------|------------|
| ** **                                                                         | ** ** | **March 31, 2005** | ** ** | **March 31, 2004** | ** ** |
| **Cash flows from operating activities:**                                          |       |                    |       |   |   |
| Net  income                                                                        |       | $                       | 1,019,389  |   | $ | 624,907 |   |
| Adjustments  to reconcile net income to net cash provided by operating activities: |       |                    |       |   |   |
| Depreciation                                                                       |       | 285,546                 |       | 309,540 |   |
| Amortization  of securities (net of accretion)                                     |       | 108,079                 |       | 143,131 |   |
| Provision  for loan losses                                                         |       | 80,000                  |       | 850,000 |   |
| Deferred  income tax                                                               |       | (105,682                | )          | (10,258 | ) |
| Write-down  of foreclosed assets held-for-sale                                     |       | 28,603                  |       | 46,098 |   |
| Write-down  lease residual                                                         |       | 220,000                 |       | — |   |
| Increase  in cash surrender value of life insurance                                |       | (57,792                 | )          | (84,629 | ) |
| Gain  on sale of investment securities                                             |       | —                  |       | (9,497 | ) |
| Loss  (gain) on sale of loans                                                      |       | 11,442                  |       | (23,611 | ) |
| Gain  on sale of foreclosed assets held-for-sale                                   |       | (405                    | )          | (2,726 | ) |
| Loss  on sale of leased assets                                                     |       | 34,873                  |       | 93,266 |   |
| Loss  on disposal of equipment                                                     |       | —                  |       | 2,541 |   |
| Amortization  of loan servicing rights                                             |       | 27,952                  |       | 23,965 |   |
| Change  in:                                                                        |       |                    |       |   |   |
| Accured  interest receivable                                                       |       | (355,499                | )          | (344,806 | ) |
| Other  assets                                                                      |       | (436,972                | )          | (164,980 | ) |
| Accrued  interest payable and other liabilities                                    |       | 570,995                 |       | (310,809 | ) |
| Net  cash provided by operating activities                                         |       | 1,430,529               |       | 1,142,132 |   |
| **Cash flows from investing activities:**                                          |       |                    |       |   |   |
| Held-to-maturity  securities:                                                      |       |                    |       |   |   |
| Proceeds  from maturities, calls and paydowns                                      |       | 164,184                 |       | 382,321 |   |
| Available-for-sale  securities:                                                    |       |                    |       |   |   |
| Proceeds  from sales                                                               |       | —                  |       | 3,850,562 |   |
| Proceeds  from maturities, calls and paydowns                                      |       | 4,376,627               |       | 9,386,214 |   |
| Purchases                                                                          |       | (1,454,954              | )          | (6,035,552 | ) |
| Net  decrease FHLB stock                                                           |       | 737,500                 |       | 37,700 |   |
| Proceeds  from sale of loans available-for-sale                                    |       | 404,963                 |       | 1,671,411 |   |
| Net  decrease (increase) in loans and leases                                       |       | 3,238,754               |       | (2,018,977 | ) |
| Proceeds  from sale of leased assets                                               |       | 210,671                 |       | 274,616 |   |
| Acquisition  of bank premises and equipment                                        |       | (77,537                 | )          | (26,851 | ) |
| Proceeds  from sale of foreclosed assets held-for-sale                             |       | 5,817                   |       | 185,763 |   |
| Net  cash provided by investing activities                                         |       | 7,606,025               |       | 7,707,207 |   |
| **Cash flows from financing activities:**                                          |       |                    |       |   |   |
| Net  increase in noninterest-bearing deposits                                      |       | 485,776                 |       | 1,120,896 |   |
| Net  decrease in certificates of deposit of $100,000 or more                       |       | (1,484,239              | )          | (9,479,206 | ) |
| Net  increase (decrease) in other interest-bearing deposits                        |       | 15,408,496              |       | (10,448,071 | ) |
| Net  (decrease) increase in short-term borrowings                                  |       | (11,463,224             | )          | 3,352,356 |   |
| Net  decrease in long-term borrowings                                              |       | (192,758                | )          | (187,105 | ) |
| Dividends  paid, net of dividend reinvestment                                      |       | (284,360                | )          | (270,951 | ) |
| Proceeds  from employee stock purchase plan                                        |       | 31,671                  |       | 53,042 |   |
| Net  cash provided by (used in) financing activities                               |       | 2,501,362               |       | (15,859,039 | ) |
| Net  increase (decrease) in cash and cash equivalents                              |       | 11,537,916              |       | (7,009,700 | ) |
| Cash  and cash equivalents, beginning                                              |       | 10,216,394              |       | 19,231,601 |   |
| Cash  and cash equivalents, ending                                                 |       | $                       | 21,754,310 |   | $ | 12,221,901 |   |

 

6

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

 

**Notes toConsolidated Financial Statements**

**(unaudited)**

 

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

 

**Principles of consolidation**

 

The accompanyingunaudited consolidated financial statements of Fidelity D & D Bancorp,Inc., and its wholly owned subsidiary, The Fidelity Deposit and Discount Bank (theBank or collectively, the Company) have been prepared in accordance withaccounting principles generally accepted in the United States of America (GAAP)for interim financial information and with the instructions to this Form 10-Qand Rule 10-01 of Regulation S-X.  Accordingly,they do not include all of the information and footnote disclosures required byGAAP for complete financial statements.  Inthe opinion of management, all normal recurring adjustments necessary for afair presentation of the financial condition and results of operations for theperiods have been included.  Allsignificant inter-company balances and transactions have been eliminated inconsolidation.  Prior period amounts arereclassified when necessary to conform to the current period’s presentation.

 

The preparation offinancial statements in conformity with GAAP requires management to makeestimates and assumptions that affect the reported amounts of assets andliabilities and disclosure of contingent assets and liabilities at the date ofthe financial statements and the reported amounts of revenues and expensesduring the reported periods.  Actualresults could differ from those estimates.  For additional information and disclosuresrequired under GAAP, please refer to the Company’s Annual Report on Form 10-Kfor the year ended December 31, 2004.

 

**Nature of operations**

 

The Bank is a commercialbank chartered in the Commonwealth of Pennsylvania and a wholly ownedsubsidiary of the Company.  Havingcommenced operations in 1903, the Bank provides a full range of traditionalbanking services, trust services and alternative financial products from itsmain office located in Dunmore and other branches throughout Lackawanna andLuzerne counties.

 

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

 

In the opinion ofmanagement, the consolidated balance sheets as of March 31, 2005 and December 31,2004 and the related consolidated statements of income for each of the threemonth periods ended March 31, 2005 and March 31, 2004 and changes inshareholders’ equity and cash flows for each of the three month periods ended March 31,2005 and March 31, 2004 present fairly the financial condition and resultsof operations of the Company.  Allmaterial adjustments required for a fair presentation have been made.  These adjustments are of a normal recurringnature.  There have been no materialchanges in accounting principles, practices or in the method of application andthere have been no retroactive adjustments during these periods.  The results of operations for interim periodsare not necessarily indicative of the results of operations for the entireyear.

 

This Quarterly Report onForm 10-Q should be read in conjunction with the Company’s audited financialstatements for the year ended December 31, 2004 and the notes includedtherein, included within the Company’s Annual Report filed on Form 10-K.

 

7

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**Critical accounting policies**

 

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

 

A material estimate thatis particularly susceptible to significant change is the determination of theallowance for loan losses (the allowance). Management believes that the allowance, as of March 31, 2005, isadequate and reasonable.  Given thesubjective nature of identifying and valuing loan losses, it is likely thatwell-informed individuals could make materially different assumptions, andcould, 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 material estimateis the calculation of fair values of the Company’s investment securities.  The Company receives estimated fair values ofinvestment securities from an independent valuation service.  In developing these fair values, thevaluation service uses estimates of cash flows based on historical performanceof similar instruments in similar interest rate environments.  Based on experience, management is aware thatestimated fair values of investment securities tend to vary among valuationservices.  Accordingly, when sellinginvestment securities, management typically obtains price quotes from more thanone source.  The majority of the Company’sinvestment securities are classified as available-for-sale (AFS).  AFS securities are carried at fair market valueon the consolidated balance sheet, with unrealized gains and losses, net ofincome tax, reported as a separate component of shareholders’ equity in accumulatedother comprehensive income (loss).

 

The fair market value of residential mortgage loans, classified as AFS,is obtained from the Federal National Mortgage Association (Fannie Mae).  The fair value of Small BusinessAdministration (SBA) loans, classified as AFS, is obtained from an outsidepricing source.  To determine the fairmarket value of student loans, classified as AFS, the Bank uses the pricing obtainedfrom the most recent student loans sold from its AFS portfolio.  The market to which the Bank sells mortgageand other loans is restricted and price quotes from other sources are nottypically obtained.  As of March 31,2005 and December 31, 2004, the Company’s portfolio of loans AFS wascomprised of student loans.

 

8

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**2. Earnings per share**

 

Basic earnings per share (EPS) is computed using the weighted-averagenumber of shares of common stock outstanding. Diluted EPS is computed in the same manner as basic EPS but reflects thepotential dilution of common stock equivalents. Dilution would occur if Company-issued “in-the-money” stock options wereexercised and converted into common stock. Stock options are in-the-money if the market value of the underlyingstock is greater than the option’s exercise or strike price.  The Company uses the treasury stock method todetermine the dilutive effect of its unexercised stock options.  Under this method, the proceeds received fromshares issued in a hypothetical exercise of stock options are assumed to beused to purchase treasury stock.

 

The following data illustrates the amounts used in computing EPS andthe effects on income and the weighted-average number of shares of potentially dilutivecommon stock for the three months ended March 31, 2005 and 2004:

 
| ** **                                  | ** ** | ** **    | ** ** | **Weighted-average** | ** ** | ** ** | ** ** |
|---------------------------------------------|------------|---------------|------------|----------------------|------------|------------|------------|
| ** **                                  | ** ** | **Income**    | ** ** | **common shares**    | ** ** | ** ** | ** ** |
| ** **                                  | ** ** | **numerator** | ** ** | **denominator**      | ** ** | **EPS**    | ** ** |
| March 31,  2005                        |       |          |       |                 |       |       |       |
| Basic  EPS                                  |       | $             | 1,019,389  |                 | 1,841,295  |       | $          | 0.55 |   |
| Dilutive  effect of potential common stock: |       |          |       |                 |       |       |       |
| Stock  options:                             |       |          |       |                 |       |       |       |
| Exercise  of options outstanding            |       |          |       | 7,700                |       |       |       |
| Hypothetical  share repurchase at $35.75    |       |          |       | (7,173               | )          |       |       |
| Diluted  EPS                                |       | $             | 1,019,389  |                 | 1,841,822  |       | $          | 0.55 |   |
|                                        |       |          |       |                 |       |       |       |
| March 31,  2004                        |       |          |       |                 |       |       |       |
| Basic  EPS                                  |       | $             | 624,907    |                 | 1,824,766  |       | $          | 0.34 |   |
| Dilutive  effect of potential common stock: |       |          |       |                 |       |       |       |
| Stock  options:                             |       |          |       |                 |       |       |       |
| Exercise  of options outstanding            |       |          |       | 10,600               |       |       |       |
| Hypothetical  share repurchase at $36.00    |       |          |       | (9,758               | )          |       |       |
| Diluted  EPS                                |       | $             | 624,907    |                 | 1,825,608  |       | $          | 0.34 |   |

 

**3. Stock plans**

 

As permitted byAccounting Principles Board (APB) Opinion No. 25*, Accountingfor Stock Issued to Employees*, the Company uses the intrinsic valuemethod of accounting for its stock-based compensation plans.  Under the intrinsic value method,compensation cost is measured by the excess of the quoted market price of thestock, as of the grant date (or other measurement date) over the stock’s exerciseprice.  Since all options issued underthe Company’s stock-based compensation plans had an exercise price equal to thequoted market value of the underlying common stock on the date of grant, thestock is deemed to have no intrinsic value. Accordingly, no compensation cost is recorded.

 

The alternative fairvalue method of accounting for stock-based compensation provided under Statementof Financial Accounting Standards (SFAS) No. 123, *Accounting for Stock-Based Compensation*, requires the use ofoption valuation models, such as the Black-Scholes option pricing model.  The Black-Scholes option pricing model was notdeveloped for use in valuing stock options granted under employer stock optionplans.  Rather, the Black-Scholes option pricingmodel was developed for use in estimating the fair market value of short-termoptions traded in organized exchanges. Options traded in organized exchanges have no vesting restrictions andare fully transferable.  In addition,option valuation models require the input of highly subjective assumptionsincluding the expected or implied volatility of the options underlying stock.  Since the options granted under the Company’sstock option plans have characteristics significantly different from those of marketableoptions and because changes in the subjective input assumptions can materially impactthe estimated fair market value, in Management’s opinion, the existing valuationmodels do not necessarily provide a reliable single measure of the fair market valueof its employee stock options at the time of grant. In December 2004, theFASB issued SFAS 123(R) which replaces SFAS 123, *Accounting for Stock-Based*

 

9

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*Compensation*,and supersedes APB Opinion 25, *Accountingfor Stock Issued to Employees*. SFAS 123(R) requires that the cost of share-based payment transactions(including those with employees and non-employees) be recognized in thefinancial statements.  SFAS 123(R)applies to all share-based payment transactions in which an entity acquiresgoods or services by issuing (or offering to issue) its shares, share options,or other equity instruments (except for those held by an ESOP) or by incurringliabilities (1) in amounts based (even in part) on the price of the entity’sshares or other equity instruments, or (2) that require (or may require)settlement by the issuance of an entity’s shares or other equityinstruments.  Public entities such as theCompany are not required to apply SFAS 123(R) until the beginning of the firstinterim reporting period or fiscal year beginning after December 31, 2005.  The Company does not plan early implementationof the provisions of SFAS 123(R).

 

In 2004 and for the firstthree months of 2005, the Company did not grant stock options under any of itsstock plans.

 

**Item 2****:****                                  Management’sDiscussion and Analysis of Results of Operations and Financial Condition**

 

The following is Management’sdiscussion and analysis of the significant changes in the consolidated financialcondition of the Company as of March 31, 2005 compared to December 31,2004 and the results of operations for the three months ended March 31,2005 and March 31, 2004.  Currentperformance may not be indicative of future results. This discussion should beread in conjunction with the Company’s 2004 Annual Report filed on Form 10-K.

 

**Forward looking statements**

 

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

 

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

 

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

 

•                  there may beincreases in competitive pressure among financial institutions or fromnon-financial institutions;

 

•                  changes in theinterest rate environment may reduce interest margins;

 

•                  changes indeposit flows, loan demand or real estate values may adversely affect ourbusiness;

 

•                  changes inaccounting principles, policies or guidelines may cause our financial conditionto be perceived differently;

 

•                  general economicconditions, either nationally or locally in some or all areas in which we dobusiness, or conditions in the securities markets or the banking industry maybe less favorable than we currently anticipate;

 

•                  legislative orregulatory changes may adversely affect our business;

 

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

 

10

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•                  success orconsummation of new business initiatives may be more difficult or expensivethan we anticipate; or

 

•                  acts of war orterrorism.

 

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

 

**General**

 

The Company’s results ofoperations depend primarily on its net interest income.  Net interest income is the difference betweeninterest income and interest expense. Interest income is generated from yields on interest-earning assetswhich consist principally of loans and investment securities.  Interest expense is incurred from rates paidon interest-bearing liabilities which consist of deposits and borrowings.  Net interest income is determined by theCompany’s interest rate spread (i.e., the difference between the yields earnedon its interest-earning assets and the rates paid on its interest-bearingliabilities) and the relative amounts of interest-earning assets andinterest-bearing liabilities.  Theinterest rate spread is influenced by the overall interest rate environment,the composition and characteristics of interest-earning assets andinterest-bearing liabilities and by the competition in our marketplace.  The interest rate spread and the changes inthe interest rate spread, from period-to-period, is also influenced bydifferences in the maturity and re-pricing characteristics of assets comparedto the maturity and re-pricing characteristics of the liabilities that fundthem.

 

The Company’sprofitability is also affected by the level of its non-interest income andexpenses, provision for loan losses and provision for income taxes.  Non-interest income consists of servicecharges on the Bank’s loan and deposit products, trust and asset managementservice fees, net gains or losses from sales of leases, securities and loansAFS and increases in the cash surrender value of the bank owned lifeinsurance.  Non-interest expense consistsof compensation and related employee benefit expenses, occupancy, equipment,data processing, advertising, marketing, professional fees, insurance and otheroperating overhead.

 

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

 

**COMPARISONOF RESULTS OF OPERATIONS FOR THE THREE MONTHS ENDED**

**MARCH 31,2005 AND MARCH 31, 2004**

 

**Overview**

 

Net income for the first quarterof 2005 was $1,019,000, an increase of $394,000 or 63% from the $625,000recorded in the same quarter in 2004. Diluted earnings per share for the same period improved $0.21 from $0.34for the three months ended March 31, 2004 to $0.55 for the three monthsended March 31, 2005.

 

The quarter-to-quarter improvementin net income was primarily the results of an increase in net interest incomeand a decrease in the provision for loan losses.   Theseitems were partially offset by a decrease in non-interest income and increasesin non-interest expense and the provision for income taxes.

 

11

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Return on average assetsand return on average equity were 0.77% and 8.85%, respectively, for the three monthsended March 31, 2005 compared to 0.44% and 5.65%, respectively, for thesame period in 2004.  The improvement inthese ratios is principally due to the improved earnings.

 

*Net interest income*

 

Net interest income isthe Company’s primary source of earnings and is influenced primarily by theamount, distribution and re-pricing characteristics of its interest-earningassets and interest-bearing liabilities as well as the relative levels andmovements of interest rates.

 

Net interest income increased$343,000, or 9%, to $4,276,000 for the first quarter of 2005, from $3,933,000 recordedin the same period of 2004.  The increasewas attributable to a $32,595,000 decrease in the average interest-bearing liabilitiesin conjunction with a nine basis point decrease in the rates paid thereon.  The decrease in average interest-bearingliabilities was predominantly in the Bank’s time deposits or certificate of deposits(CD’s), which experienced a decline of $44,811,000.  In addition, the average rate paid the Bank’sCD’s declined 16 basis points in the first quarter of 2005 compared to the same2004 quarter.  The decline in the averagebalances of CD’s was prevalent in personal, business and public fundcertificates.  Management’s focus will beto continue to reduce high-costing CD’s, in favor of low-cost transaction andsavings accounts, and exit the competitive pricing pressure on these timedeposits until a more cost effective funding level is attained.  As of March 31, 2005, CD’s represented47% of total deposits, compared to 51% at December 31, 2004.

 

Partially offsetting thedecrease in CD’s, the Bank experienced an increase in the average balances of lower-costingtransaction and savings accounts and an increase in the average balances in repurchaseagreements (repos).  The growth in thetransaction and savings accounts was the caused by the success of the Bank’s marketingefforts in the promotion of our new savings products.  The increase in average balances of repos wasdue to temporary funds provided from the public sector.   As aresult of the combination of time deposit reductions, decreases in rates and increasesin the lower-costing deposit and repo balances, interest expense declined $332,000,or 11% during the first quarter of 2005, compared to the same 2004 quarter.

 

During the first quarterof 2005, interest income increased $11,000, despite a $28,353,000 decline inaverage interest-earning assets.  Theincrease was due to a 34 basis point increase in yield earned from the Bank’sinvestment securities and loans.  Theyield on the Bank’s loan portfolio increased 40 basis points during the firstquarter of 2005 due, in part, to the gradual increase in the national primerate, the bench mark rate to which floating rate loans re-price and also due tonew loan originations.  The investmentsecurities portfolios experienced a five basis point decline in yield in thefirst quarter of 2005 compared to the same quarter of 2004 but also experienced$23,426,000 decline in average balances for the respective period.  Funds received from securities that have beencalled, matured or paid-down, as in the case of mortgage-backed securities,were used to fund high-cost time deposit outflow.  Operating in a flattening yield curveenvironment with rising short-term rates will present certain challenges tomanage the investment securities portfolio in order to maintain acceptableyields.  As such, interest-earning assetsthat are benchmarked to prime should continue to bolster the performance of theloan portfolio; however the Bank will continue to scrutinize investmentsecurity purchases and use available cash flows to strategically run down highcosting time deposits and borrowings and will focus on growing its core depositbase.

 

During the first quarterof 2005, the Bank’s tax-equivalent margin and spread both increased 46 and 43 basispoints, respectively, compared to the first quarter of 2004.  The increase in margin and spread is theresult of the rates on the Bank’s interest-bearing liabilities, most notably ontime deposits, declining and the yield on interest-earning assets increasing.

 

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

 
| ** **                                    | ** ** | **Three months ended** | ** ** | **Year ended**        | ** ** |
|-----------------------------------------------|------------|------------------------|------------|-----------------------|------------|
| ** **                                    | ** ** | **March 31,**     | ** ** | **December 31,** | ** ** |
| ** **                                    | ** ** | **2005**               | ** ** | **2004**              | ** ** | **2004** | ** ** |
| Average  interest-earning assets:             |       |                   |       |                  |       |   |   |
| Loans  and leases                             |       | $                      | 385,854    |                  | $          | 392,668 |   | $ | 387,292 |   |
| Investments                                   |       | 118,421                |       | 141,846               |       | 132,130 |   |
| Federal  funds sold                           |       | 6,369                  |       | 4,407                 |       | 1,530 |   |
| Interest-bearing  deposits                    |       | 642                    |       | 718                   |       | 637 |   |
| Total                                         |       | $                      | 511,286    |                  | $          | 539,639 |   | $ | 521,589 |   |
|                                          |       |                   |       |                  |       |   |   |
| Average  interest-bearing liabilities:        |       |                   |       |                  |       |   |   |
| Other  interest-bearing deposits              |       | $                      | 116,709    |                  | $          | 111,598 |   | $ | 111,325 |   |
| Certificates  of deposit                      |       | 182,905                |       | 227,716               |       | 205,203 |   |
| Borrowed  funds                               |       | 76,300                 |       | 75,107                |       | 78,318 |   |
| Repurchase  agreements                        |       | 48,801                 |       | 42,889                |       | 41,695 |   |
| Total                                         |       | $                      | 424,715    |                  | $          | 457,310 |   | $ | 436,541 |   |
|                                          |       |                   |       |                  |       |   |   |
| Interest  income:                             |       |                   |       |                  |       |   |   |
| Loans  and leases                             |       | $                      | 5,832      |                  | $          | 5,588 |   | $ | 22,431 |   |
| Investments(1)                                |       | 1,211                  |       | 1,479                 |       | 5,385 |   |
| Federal  funds sold                           |       | 40                     |       | 10                    |       | 17 |   |
| Interest-bearing  deposits                    |       | 3                      |       | 1                     |       | 6 |   |
| Total                                         |       | $                      | 7,086      |                  | $          | 7,078 |   | $ | 27,839 |   |
|                                          |       |                   |       |                  |       |   |   |
| Interest  expense:                            |       |                   |       |                  |       |   |   |
| Other  interest-bearing deposits              |       | $                      | 232        |                  | $          | 184 |   | $ | 742 |   |
| Certificates  of deposit                      |       | 1,324                  |       | 1,757                 |       | 5,994 |   |
| Borrowed  funds                               |       | 945                    |       | 986                   |       | 3,980 |   |
| Repurchase  agreements                        |       | 197                    |       | 103                   |       | 464 |   |
| Total                                         |       | $                      | 2,698      |                  | $          | 3,030 |   | $ | 11,180 |   |
|                                          |       |                   |       |                  |       |   |   |
| Net  interest income                          |       | $                      | 4,388      |                  | $          | 4,048 |   | $ | 16,659 |   |
|                                          |       |                   |       |                  |       |   |   |
| Yield  on average interest-earning assets     |       | 5.62                   | %          | 5.28                  | %          | 5.34 | % |
| Rate  on average interest-bearing liabilities |       | 2.58                   | %          | 2.67                  | %          | 2.56 | % |
| Net  interest spread                          |       | 3.04                   | %          | 2.61                  | %          | 2.78 | % |
| Net  interest margin                          |       | 3.48                   | %          | 3.02                  | %          | 3.19 | % |

 

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 was fullytaxable.  This treatment allows a uniformcomparison 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.

 

----

(1)           The 2004 tax equivalent calculations wereadjusted to eliminate the effect attributable to the dividend from the FederalHome Loan Bank.

 

13

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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 the Bank’sloan portfolio.  Loans and leasesdetermined to be uncollectible are charged-off against the allowance for loanlosses.

 

The required amount ofthe provision for loan losses, based upon the adequate level of the allowancefor loan losses, is subject to ongoing analysis of the loan portfolio. The Bankmaintains a Special Asset Committee which meets periodically to review problemloans and leases. The committee is comprised of Bank management, including thecredit administration officer, loan workout officers and collection personnel.  The committee reports quarterly to the CreditAdministration Committee of the Board of Directors.

 

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

 

•                  Specificloans that could have loss potential

•                  Levelsof and trends in delinquencies and non-accrual loans

•                  Levelsof and trends in charge-offs and recoveries

•                  Trendsin volume and terms of loans

•                  Changesin risk selection and underwriting standards

•                  Changesin lending policies, procedures and practices

•                  Experience,ability and depth of lending personnel

•                  Nationaland local economic trends and conditions

•                  Changesin credit concentrations

 

The provision for loanlosses was $80,000, for the three months ended March 31, 2005, compared to$850,000 for the three months ended March 31, 2004.  The decrease in the provision for loan loseswas due to a decrease in non-performing loans, which consist of loans past due90 days or more and non-accrual loans. The balance of non-performing loans declined $729,000 to $9,733,000 at March 31,2005, compared to $10,462,000 at December 31, 2004.  Non-performing loans also decreased $2,945,000from $12,679,000 at March 31, 2004. The decrease was mainly attributable to the collection and pay-offs ofnon-accrual loans that produced significant recoveries.  The addition of an experienced Special AssetsOfficer during the third quarter of 2004 has enabled us to more aggressivelymanage and pursue the collection and resolution of non-accruing loans.

 

*Other income*

 

Other (non-interest)income consists of service charges or fees collected on the Bank’s variousdeposit and loan products, net mortgage servicing revenue, fees from trust,asset management and other financial services, the increase in cash surrendervalue of bank owned life insurance (BOLI), the net realized gains and lossesfrom the sales of investment securities, loans, leased assets and foreclosedassets held for sale and other various classifications of non-interest relatedincome.

 

Total other income decreased$199,000, or 21% for the three months ended March 31, 2005 compared to thesame period in 2004.  During the quarterthe Bank recognized an estimated impairment charge of $220,000 in anticipationof projected realized losses from the future sales of its leased vehicles.  The estimated losses are based on thehistorical performance of terminated leases that are typically sold below theirresidual value.  The balance of the Bank’sleased vehicles should mature or pay-off during 2005 and periodic adjustmentswill be made to this estimate, throughout 2005. The final determination will be dependent upon actual sales.  Service charges on deposit accounts grew by$72,000 or 14% due to the heightened effort to better manage the collection ofaccount maintenance and analysis fees charged to customer.  Fees, other service charges and othernon-interest related income decreased $63,000 or 13% principally from reducedbenefit crediting rates to the cash surrender value of BOLI during the firstquarter of 2005 compared to the same period of 2004.

 

14

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*Other operating expenses*

 

Other (non-interest) expensesincreased $291,000, or 9% for the three months ended March 31, 2005 comparedto the same period in 2004.  Professionalservice fees increased due to increased fees related to the Bank’s annualfinancial audit, internal audit, Sarbanes-Oxley compliance, the cost for the Bank-wideparticipation in management skills development and sales training programs andincreased FDIC assessments.  Advertisingexpenses for the first quarter of 2005 increased $71,000 or more than doubledfrom the same quarter of 2004.  The Bankcontinues to concentrate in its marketing endeavors and has begun its varioussales and spring campaigns with primary focus on home equity loan originationsand direct mail initiatives to garner new customer deposits in new deposit accountprograms.  Variances in other operatingexpenses, for the first quarter of 2005, included increases in ancillarytraining expense for the management skills training program, an increase in Pennsylvaniashares tax and an increase in collection expense.

 

*Income tax provision*

 

Income before provisionfor income taxes increased $623,000 for the first quarter of 2005 compared thefirst 2004 quarter.  The effectivefederal income tax rate was 26.0% and 17.2% for the respective quarters.  The effective tax rate increase is attributableto a decreased portion of combined tax-free interest income from municipalsecurities, tax-free loans and tax-free earnings from the BOLI, collectively representinga smaller portion of pre-tax earnings.

 

**COMPARISONOF FINANCIAL CONDITION AT**

**MARCH 31,2005 AND DECEMBER 31, 2004**

 

**Overview**

 

Consolidated assets increased$3,184,000 or 0.6%, during the three months ended March 31, 2005 to $539,860,000.  The asset increase resulted from an increase indeposits of $14,410,000, partially offset by a decrease in short-termborrowings of $11,463,000.  Cash and cashequivalents increased $11,538,000 while investments and loans decreased $4,994,000and $4,230,000, respectively, since December 31, 2004.   Shareholders’equity decreased $140,000 from $46,367,000 at December 31, 2004 to$46,227,000 at March 31, 2005.  The decreasein shareholders’ equity was primarily attributable to a $907,000 net unrealizedholding loss on AFS securities, recorded in other comprehensive income (loss), partiallyoffset by earnings net of dividends paid of $614,000 and an increase in commonstock of $152,000.  The decline ininvestments AFS is due to the recent and seemingly prevailing increasinginterest rate environment which began in the second half of 2004.  Generally, the value of stocks and bonds willmove in the opposite direction of interest rate movements.  Common stock grew from shares issued underthe employee stock purchase and dividend re-investment plans.

 

A comparison of selectedbalance sheet information as of March 31, 2005 and December 31, 2004follows:

 

*Investment securities*

 

The Bank’s investmentpolicy is designed to complement its lending activities, generate a favorablereturn without incurring undue interest rate and credit risk, manage interestrate sensitivity, provide monthly cash flow and manage liquidity at acceptablelevels.  In establishing investment strategies,the Bank considers its business and growth or restructuring plans, the economicenvironment, the interest rate sensitivity position, the types of securitiesheld, permissible purchases, credit quality, maturity and re-pricing terms,call or average-life intervals and investment concentrations.  The policy prescribes permissible investmentcategories that meet the policy standards and Management is responsible forstructuring and executing the specific investment purchases within these policyparameters.  Management buys and sellsinvestment securities from time-to-time depending on market conditions,business trends, liquidity needs, capital levels and structuringstrategies.  Investment securitypurchases provide a way to quickly invest excess liquidity in order to generateadditional earnings.  The Bank generallyearns a positive interest spread by assuming interest rate risk and usingdeposits and/or borrowings to purchase securities with longer maturities.

 

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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 March 31, 2005, thecarrying value of investment securities totaled $110,675,000 or 20.5% of totalassets compared to $115,669,000 or 21.6% as of December 31, 2004.  At March 31, 2005, approximately 54.6% ofthe investment portfolio was comprised of mortgage-backed securities thatamortize and provide monthly cash flow.  Atthe same time, agency and municipal bonds comprised 27.3% and 9.5%,respectively, of the investment portfolio. The portfolio is comprised of HTM and AFS securities with carryingvalues of $2,890,000 and $107,784,000, respectively.

 

At March 31, 2005, theAFS debt securities were recorded with a net unrealized loss in the amount of $1,703,000. Also at March 31, 2005, AFS equitysecurities were recorded at $454,000 including an unrealized gain of $175,000.

 

The amortized cost andfair value of investment securities HTM and AFS at March 31, 2005 consistedof the following (dollars in thousands):

 
| ** **                                        | ** ** | **Amortized  cost** | ** ** | **Gross unrealized  gains** | ** ** | **Gross unrealized  losses** | ** ** | **Fair  value** | ** ** |
|---------------------------------------------------|------------|---------------------|------------|-----------------------------|------------|------------------------------|------------|-----------------|------------|
|                                              |       |                |       |                        |       |                         |       |            |       |
| Held-to-maturity  securities:                     |       |                |       |                        |       |                         |       |            |       |
|                                              |       |                |       |                        |       |                         |       |            |       |
| Mortgage-backed  securities                       |       | $                   | 2,890      |                        | $          | 91                           |       | $               | —     |   | $ | 2,981 |   |
|                                              |       |                |       |                        |       |                         |       |            |       |
| Available-for-sale  securities:                   |       |                |       |                        |       |                         |       |            |       |
| U.S.  government agencies and corporations        |       | $                   | 31,029     |                        | $          | —                       |       | $               | 823        |   | $ | 30,206 |   |
| Obligations  of states and municipal subdivisions |       | 10,538              |       | 71                          |       | 63                           |       | 10,546          |       |
| Corporate  bonds                                  |       | 9,030               |       | 41                          |       | 9                            |       | 9,062           |       |
| Mortgage-backed  securities                       |       | 58,436              |       | 82                          |       | 1,002                        |       | 57,516          |       |
|                                              |       |                |       |                        |       |                         |       |            |       |
| Sub  total                                        |       | 109,033             |       | 194                         |       | 1,897                        |       | 107,330         |       |
|                                              |       |                |       |                        |       |                         |       |            |       |
| Equity  securities                                |       | 279                 |       | 175                         |       | —                       |       | 454             |       |
|                                              |       |                |       |                        |       |                         |       |            |       |
| Total  available-for-sale                         |       | $                   | 109,312    |                        | $          | 369                          |       | $               | 1,897      |   | $ | 107,784 |   |
|                                              |       |                |       |                        |       |                         |       |            |       |
| Total  securities                                 |       | $                   | 112,202    |                        | $          | 460                          |       | $               | 1,897      |   | $ | 110,765 |   |

 

16

----

 

The amortized cost and fair value of investments HTM andAFS by contractual maturity at March 31, 2005 are as follows (dollars inthousands):

 

| ** **                      | ** ** | **Amortized  cost** | ** ** | **Market  value** | ** ** |
|---------------------------------|------------|---------------------|------------|-------------------|------------|
| Held-to-maturity  securities:   |       |                |       |              |       |
| Mortgage-backed  securities     |       | $                   | 2,890      |              | $          | 2,981 |   |
|                            |       |                |       |              |       |
| Available-for-sale  securities: |       |                |       |              |       |
| Debt  securities:               |       |                |       |              |       |
| One  year or less               |       | $                   | —     |              | $          | — |   |
| One  through five years         |       | 5,430               |       | 5,319             |       |
| Five  through ten years         |       | 19,056              |       | 18,702            |       |
| Over  ten years                 |       | 26,111              |       | 25,793            |       |
| Total  debt securities          |       | 50,597              |       | 49,814            |       |
|                            |       |                |       |              |       |
| Mortgage-backed  securities     |       | 58,436              |       | 57,516            |       |
| Equity  securities              |       | 279                 |       | 454               |       |
|                            |       |                |       |              |       |
| Total  available-for-sale       |       | $                   | 109,312    |              | $          | 107,784 |   |
|                            |       |                |       |              |       |
| Total  securities               |       | $                   | 112,202    |              | $          | 110,765 |   |

 

Expected maturities will differ from contractualmaturities because issuers and borrowers may have the right to call or repayobligations with or without call or prepayment penalty.  Federal agency and municipal securities areincluded based upon their original stated maturity.  Mortgage-backed securities, which are basedon weighted-average lives and subject to monthly principal pay-downs, arelisted in total.  Equity securities,which have no stated maturity and are listed in total, include restrictedregulatory stock of the Federal Home Loan Bank which is carried at cost.

 

*Loans available - for- sale (AFS)*

 

Generally, upon origination,certain residential mortgages, the guaranteed portions of Small BusinessAdministration 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 no longerproduce 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 classified as AFS.  Consideration is also given to the Company’s currentliquidity position and expected future liquidity needs.  Loans AFS are carried at the lower of cost orestimated fair value.  If the fair marketvalues of these loans fall below their amortized cost, the loan is written downby the difference with a corresponding charge to current earnings.  Subsequent appreciation, if any, is creditedto current earnings but only to the extent of previous write-downs.

 

At March 31, 2005,loans AFS amounted to $400,000 with a corresponding fair value of $404,000,compared to $576,000 and $582,000, respectively, at December 31, 2004.  For the first quarter of 2005, student loanswith principal balances of $401,000 were sold into the secondary market withgains of approximately $4,010 being recognized. At March 31, 2005 and December 31, 2004, the entire balance ofloans AFS consisted of student loans.

 

17

----

 

*Loans and leases*

 

The Bank originatescommercial and commercial real estate loans, residential, consumer, home equityand construction loans.  The relativevolume of originations is dependent upon customer demand, current interest ratesand the perception and duration of future interest levels.  The Bank continues to focus its efforts onthe expansion of variable-rate portfolios of residential and consumer loans aswell as commercial loans and fixed-rate residential loans.  The broad spectrum of products providesdiversification which helps manage, to an extent, interest rate risk and creditconcentration risk.  Credit risk isfurther managed through underwriting policies and procedures and loanmonitoring practices.  Interest rate riskis managed using various asset/liability modeling techniques and analyses.  The interest rates on most commercial loansare adjustable with reset intervals of five years or less.  Whenever practical, the Bank originatesvariable-rate loans.

 

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 on loanssecured by commercial and commercial real estate often depend upon thesuccessful operation and management of the properties and the businesses whichoperate from within them, repayment of such loans may be affected by factorsoutside the borrower’s control.  Suchfactors may include adverse conditions in the real estate market, the economy,the industry or changes in government regulations.  As such, commercial loans require moreongoing evaluation and monitoring which occurs with the Bank’s creditadministration and outsourced loan review functions.

 

During the first quarterof 2005, the Bank established a reserve for estimated impairment from thefuture sales of its leased vehicles which was netted against the gross amountof direct finance leasing.  The estimatedimpairment is based on the historical sales performance of terminated leaseswhich are typically sold below their residual value.  The balance of the Bank’s leased vehicles shouldmature or payoff during 2005 and periodic adjustments will be made to thisreserve, during this timeframe.  Theamount of periodic adjustments will depend upon actual sales proceeds from theleased vehicles.  Currently, the Companydoes not anticipate re-entering the direct finance lease business when thecurrent agreements expire in 2005 or in the near-term.

 

Loans, net of unearnedincome of $383,494,000 at March 31, 2005 decreased from $387,534,000 at December 31,2004.  The decrease was predominantlyfrom the sold participation of a commercial loan during the quarter ended March 31,2005.  Advances in consumer and homeequity loans have improved by $1,663,000, since year-end 2004 on the successfulimplementation of the Bank’s home equity loan campaign.

 

The following table sets forth the composition of the loan portfolio atMarch 31, 2005 and December 31, 2004:

 
| ** **                             | ** ** | **March 31, 2005** | ** **  | **December 31, 2004** | ** ** |
|----------------------------------------|------------|-------------------------|-------------|----------------------------|------------|
| Commercial  and commercial real estate |       | $                       | 214,826,162 |                       | $          | 221,968,137 |   |
| Residential  real estate               |       | 93,042,493              |        | 91,294,401                 |       |
| Consumer  and home equity              |       | 63,150,516              |        | 61,487,608                 |       |
| Real  estate construction              |       | 10,876,343              |        | 10,620,472                 |       |
| Direct  financing leases               |       | 1,625,644               |        | 2,211,978                  |       |
| Gross  loans                           |       | 383,521,158             |        | 387,582,596                |       |
| Less:                                  |       |                    |        |                       |       |
| Unearned  discount                     |       | 27,587                  |        | 48,423                     |       |
| Allowance  for loan losses             |       | 6,000,956               |        | 5,987,798                  |       |
| Net  loans                             |       | $                       | 377,492,615 |                       | $          | 381,546,375 |   |
|                                   |       |                    |        |                       |       |
| Loans  available-for-sale              |       | $                       | 399,992     |                       | $          | 576,378 |   |
|                                   |       |                    |        |                       |       |
| Total  loans                           |       | $                       | 377,892,607 |                       | $          | 382,122,753 |   |

 

18

----

 

*Allowance for loan losses*

 

Management continuallyevaluates the credit quality of the Bank’s loan portfolio and performs a formalreview of the allowance for loan losses (the allowance) adequacy, on aquarterly basis.  The allowance reflectsmanagement’s best estimate of the amount of credit losses in the loanportfolio.  Management’s judgment isbased on the evaluation of individual loans, past experience, the assessment ofcurrent economic conditions and other relevant factors including the amountsand timing of cash flows expected to be received on impaired loans. Thoseestimates may be susceptible to significant change.  The provision for loan losses represents theamount necessary to maintain an appropriate allowance.  Loan losses are charged directly against theallowance when loans are deemed to be uncollectible.  Recoveries on 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:

 

•                  Identificationof specific problem loans by loan category by credit administration;

•                  Calculationof specific allowances required based on collateral and other persuasive evidence;

•                  Identificationof loans collateralized by cash and cash equivalents;

•                  Determinationof remaining homogenous pools by loan category and eliminating loanscollateralized by cash and cash equivalents and eliminating loans with specificallocations;

•                  Applicationof historical loss percentages (three-year average) to pools to determine theallowance 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 uponreviews of the loan and lease portfolios.

 

Net charge-offs for thethree months ended March 31, 2005 were $67,000, compared to $71,000, forthe same period in 2004.  Net charge-offsof commercial loans were $36,000 for the three months ended March 31, 2005compared to $32,000 in the first quarter of 2004.  Real estate mortgage net charge-offs declinedto $1,800 in the first quarter of 2005 compared to $33,000 in the first quarterof 2004.  Consumer loan net charge-offswere $29,000 for the quarter ended March 31, 2005 as opposed to a netrecovery of $12,000 in the first quarter of 2004.  There were no lease financing charge-offs inthe March 31, 2005 quarter.

 

Management believes thatthe current balance in the allowance for loans losses of $6,001,000 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 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 1.56% at March 31, 2005compared 1.54% at December 31, 2004 and 1.47% at March 31, 2004.

 

19

----

 

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**   | ** ** |
|----------------------------------|------------|-------------------------|-------------|----------------------------|------------|-------------------------|------------|
| ** **                       | ** ** | **three months ended**  | ** **  | **year ended**             | ** ** | **three months ended**  | ** ** |
| ** **                       | ** ** | **March 31, 2005** | ** **  | **December 31, 2004** | ** ** | **March 31, 2004** | ** ** |
|                             |       |                    |        |                       |       |                    |       |
| Balance  at beginning of period  |       | $                       | 5,987,798   |                       | $          | 4,996,966               |       | $ | 4,996,966 |   |
|                             |       |                    |        |                       |       |                    |       |
| Provision  charged to operations |       | 80,000                  |        | 2,150,000                  |       | 850,000                 |       |
|                             |       |                    |        |                       |       |                    |       |
| Charge-offs:                     |       |                    |        |                       |       |                    |       |
| Commercial                       |       | 322,425                 |        | 775,252                    |       | 151,762                 |       |
| Real  estate                     |       | 1,846                   |        | 266,324                    |       | 33,082                  |       |
| Consumer                         |       | 70,437                  |        | 480,462                    |       | 74,260                  |       |
| Lease  financing                 |       | —                  |        | 84,902                     |       | 37,651                  |       |
| Total                            |       | 394,708                 |        | 1,606,940                  |       | 296,755                 |       |
|                             |       |                    |        |                       |       |                    |       |
| Recoveries:                      |       |                    |        |                       |       |                    |       |
| Commercial                       |       | 286,133                 |        | 226,082                    |       | 119,719                 |       |
| Real  estate                     |       | 30                      |        | 20,039                     |       | —                  |       |
| Consumer                         |       | 41,703                  |        | 178,727                    |       | 86,621                  |       |
| Lease  financing                 |       | —                  |        | 22,924                     |       | 19,824                  |       |
| Total                            |       | 327,866                 |        | 447,772                    |       | 226,164                 |       |
|                             |       |                    |        |                       |       |                    |       |
| Net  charge-offs                 |       | 66,842                  |        | 1,159,168                  |       | 70,591                  |       |
|                             |       |                    |        |                       |       |                    |       |
| Balance  at end of period        |       | $                       | 6,000,956   |                       | $          | 5,987,798               |       | $ | 5,776,375 |   |
|                             |       |                    |        |                       |       |                    |       |
| Total  loans, end of period      |       | $                       | 383,893,563 |                       | $          | 388,110,551             |       | $ | 391,700,054 |   |

 
| ** **                                                                | ** ** | **As of and for the**   | ** ** | **As of and for the**      | ** ** | **As of and for the**   | ** ** |
|---------------------------------------------------------------------------|------------|-------------------------|------------|----------------------------|------------|-------------------------|------------|
| ** **                                                                | ** ** | **three months ended**  | ** ** | **year ended**             | ** ** | **three months ended**  | ** ** |
| ** **                                                                | ** ** | **March 31, 2005** | ** ** | **December 31, 2004** | ** ** | **March 31, 2004** | ** ** |
| Net  charge-offs to:                                                      |       |                    |       |                       |       |                    |       |
| Loans,  end of period                                                     |       | 0.02                    | %          | 0.30                       | %          | 0.02                    | %          |
| Allowance  for loan losses                                                |       | 1.11                    | %          | 19.36                      | %          | 1.22                    | %          |
| Provision  for loan losses                                                |       | 83.55                   | %          | 53.91                      | %          | 8.30                    | %          |
|                                                                      |       |                    |       |                       |       |                    |       |
| Allowance  for loan losses to:                                            |       |                    |       |                       |       |                    |       |
| Total  loans                                                              |       | 1.56                    | %          | 1.54                       | %          | 1.47                    | %          |
| Non-accrual  loans                                                        |       | 65.76                   | %          | 60.46                      | %          | 47.89                   | %          |
| Non-performing  loans                                                     |       | 61.65                   | %          | 57.24                      | %          | 45.56                   | %          |
| Net  charge-offs                                                          |       | 89.78                   | x          | 5.17                       | x          | 81.83                   | x          |
|                                                                      |       |                    |       |                       |       |                    |       |
| Loans  30-89 days past due and still accruing                             |       | $                       | 3,709,674  |                       | $          | 4,316,453               |       | $ | 3,874,870 |   |
| Loans  90 days past due and accruing                                      |       | $                       | 608,130    |                       | $          | 557,492                 |       | $ | 617,454 |   |
| Non-accrual  loans                                                        |       | $                       | 9,125,051  |                       | $          | 9,904,276               |       | $ | 12,061,062 |   |
| Allowance  for loan losses to loans 90 days or more past due and accruing |       | 9.87                    | x          | 10.75                      | x          | 9.35                    | x          |

 

20

----

 

*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 March 31, 2005, non-performingassets represented 1.84% of total assets compared to 1.99% at December 31,2004 and 2.32% at March 31, 2004.

 

The non-accrual loanbalance decreased by $779,000 during the first three months of 2005, and by$2,936,000 compared to a year ago.  Loansclassified as non-accrual of $1,179,000 were added during the first threemonths of 2005.  This increase was offsetby payoffs or pay downs of $1,203,000, charge offs of $322,000 and $433,000 ofloans that have migrated back to performing status.

 

Foreclosed assets heldfor sale includes other real estate owned (OREO) and repossessed assets.  OREO represents three properties that wereforeclosed upon and transferred from loans. Two of the properties are currently under contracts for sale and thethird is listed for sale with a realtor. Repossessed assets represent indirect auto loans that have becomedelinquent and the vehicles repossessed.

 

Non-performing loansdecreased $729,000 since December 31, 2004.  The decline was in all categories ofloans.  The ratio of non-performing loansto end of period total loans declined 16 basis points, during the three monthperiod ended March 31, 2005.  Forthe same period in 2004, the ratio of non-performing loans to total loans was3.29%, compared to 2.58% at March 31, 2005, or a decrease of 71 basispoints.  The ratio of non-performingassets to total assets decreased to 1.84%, at March 31, 2005, from 1.99%,at year end 2004.

 

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

 
| ** **                                                                         | ** ** | **March 31, 2005** | ** **  | **December 31, 2004** | ** ** | **March 31, 2004** | ** ** |
|------------------------------------------------------------------------------------|------------|-------------------------|-------------|----------------------------|------------|-------------------------|------------|
|                                                                               |       |                    |        |                       |       |                    |       |
| Loans  past due 90 days or more and accruing                                       |       | $                       | 608,130     |                       | $          | 557,492                 |       | $ | 617,454 |   |
| Non-accrual  loans                                                                 |       | 9,125,051               |        | 9,904,276                  |       | 12,061,061              |       |
| Total  non-performing loans                                                        |       | 9,733,181               |        | 10,461,768                 |       | 12,678,515              |       |
|                                                                               |       |                    |        |                       |       |                    |       |
| Restructured  loans                                                                |       | —                  |        | —                     |       | —                  |       |
| Other  real estate owned                                                           |       | 163,000                 |        | 163,000                    |       | 280,004                 |       |
| Repossessed  assets                                                                |       | 44,271                  |        | 50,104                     |       | 40,760                  |       |
| Total  non-performing assets                                                       |       | $                       | 9,940,452   |                       | $          | 10,674,872              |       | $ | 12,999,279 |   |
|                                                                               |       |                    |        |                       |       |                    |       |
| Net  loans including AFS                                                           |       | $                       | 377,892,607 |                       | $          | 382,122,753             |       | $ | 385,923,679 |   |
| Total  assets                                                                      |       | $                       | 539,859,529 |                       | $          | 536,675,138             |       | $ | 560,678,409 |   |
| Non-accrual  loans to net loans                                                    |       | 2.41                    | %           | 2.59                       | %          | 3.13                    | %          |
| Non-performing  assets to net loans, foreclosed real estate and repossessed assets |       | 2.63                    | %           | 2.79                       | %          | 3.37                    | %          |
| Non-performing  assets to total assets                                             |       | 1.84                    | %           | 1.99                       | %          | 2.32                    | %          |
| Non-performing  loans to net loans                                                 |       | 2.58                    | %           | 2.74                       | %          | 3.29                    | %          |

 

21

----

 

*Accrued interest receivable and otherassets*

 

The increase in accruedinterest receivable of $355,000 or 20.6% from December 31, 2004 to March 31,2005 was due to the timing of cash receipts on interest-earning assetbalances.   The increase in other assetsof $1,409,000 or 41.6%, for the same period, was due to an increase in thedeferred income tax asset caused by the decline in value in the securities AFSportfolio, and an increase in prepaid expenses and other current assetsincluding the receivable of a purchased investment security that did not settleuntil April.

 

*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 passbook andstatement savings accounts, NOW, money market, demand deposit and certificatesof deposit accounts.  The flow ofdeposits is significantly influenced by general economic conditions, changes inprevailing interest rates, pricing and competition.  Most of the Bank’s deposits are obtained fromthe communities surrounding its 12 branch offices.  We attempt to attract and retain depositcustomers via sales and marketing efforts with new products, quality service,competitive rates and long-standing customer relationships.

 

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 have experienced a continued intensecompetition for deposits, we have not increased rates significantly as we onlyconsider cost effective strategies in a relatively low, yet rising, interestrate environment.

 

22

----

 

The following tablerepresents the components of deposits as of March 31, 2005 and December 31,2004:

 
| ** **                                | ** ** | ** **              | ** **  | ** **                 | ** ** | **Dollar**  | ** ** | **Percent** | ** ** |
|-------------------------------------------|------------|-------------------------|-------------|----------------------------|------------|-------------|------------|-------------|------------|
| ** **                                | ** ** | **March 31, 2005** | ** **  | **December 31, 2004** | ** ** | **change**  | ** ** | **change**  | ** ** |
| **Non-interest-bearing  deposits**        |       |                    |        |                       |       |        |       |        |       |
| Personal                                  |       | $                       | 28,724,109  |                       | $          | 28,927,588  |       | $           | (203,479   | ) | -0.70 | % |
| Non-personal                              |       | 28,601,036              |        | 29,248,882                 |       | (647,846    | )          | -2.21       | %          |
| Public  fund                              |       | 3,284,691               |        | 2,479,373                  |       | 805,318     |       | 32.48       | %          |
| Bank  checks                              |       | 5,233,476               |        | 4,701,692                  |       | 531,784     |       | 11.31       | %          |
| Total                                     |       | $                       | 65,843,312  |                       | $          | 65,357,535  |       | $           | 485,777    |   | 0.74 | % |
| **Time  deposits of $100,000 or greater** |       |                    |        |                       |       |        |       |        |       |
| Personal                                  |       | $                       | 60,015,629  |                       | $          | 61,694,837  |       | $           | (1,679,208 | ) | -2.72 | % |
| Non-personal                              |       | 17,582,168              |        | 17,749,896                 |       | (167,728    | )          | -0.94       | %          |
| Public  fund                              |       | 9,400,570               |        | 9,023,956                  |       | 376,614     |       | 4.17        | %          |
| IRA’s                                |       | 5,503,427               |        | 5,517,344                  |       | (13,917     | )          | -0.25       | %          |
| Total                                     |       | $                       | 92,501,794  |                       | $          | 93,986,033  |       | $           | (1,484,239 | ) | -1.58 | % |
| **Other  interest-bearing deposits**      |       |                    |        |                       |       |        |       |        |       |
| Time  deposits less than $100,000:        |       |                    |        |                       |       |        |       |        |       |
| Personal                                  |       | $                       | 64,598,132  |                       | $          | 66,918,765  |       | $           | (2,320,633 | ) | -3.47 | % |
| Non-personal                              |       | 3,991,675               |        | 4,024,801                  |       | (33,126     | )          | -0.82       | %          |
| Public  fund                              |       | 709,364                 |        | 662,876                    |       | 46,488      |       | 7.01        | %          |
| IRA’s                                |       | 18,614,017              |        | 19,090,551                 |       | (476,534    | )          | -2.50       | %          |
| sub total                                 |       | 87,913,188              |        | 90,696,993                 |       | (2,783,805  | )          | -3.07       | %          |
| NOW  accounts                             |       | 57,290,291              |        | 41,421,525                 |       | 15,868,766  |       | 38.31       | %          |
| Money  market deposits                    |       | 25,669,423              |        | 27,606,102                 |       | (1,936,679  | )          | -7.02       | %          |
| Savings  and clubs                        |       | 50,807,361              |        | 46,547,147                 |       | 4,260,214   |       | 9.15        | %          |
| Total                                     |       | $                       | 221,680,263 |                       | $          | 206,271,767 |       | $           | 15,408,496 |   | 7.47 | % |
| **Total  deposits**                       |       |                    |        |                       |       |        |       |        |       |
| Noninterest-bearing  deposits             |       | $                       | 65,843,312  |                       | $          | 65,357,535  |       | $           | 485,777    |   | 0.74 | % |
| Interest-bearing  deposits                |       | 314,182,057             |        | 300,257,800                |       | 13,924,257  |       | 4.64        | %          |
| Total                                     |       | $                       | 380,025,369 |                       | $          | 365,615,335 |       | $           | 14,410,034 |   | 3.94 | % |
| **Public  funds**                         |       |                    |        |                       |       |        |       |        |       |
| Noninterest-bearing                       |       | $                       | 3,284,691   |                       | $          | 2,479,373   |       | $           | 805,318    |   | 32.48 | % |
| Certificates  of deposit                  |       | 10,109,934              |        | 9,686,832                  |       | 423,102     |       | 4.37        | %          |
| NOW  accounts                             |       | 25,360,327              |        | 8,406,827                  |       | 16,953,500  |       | 201.66      | %          |
| Money  market deposits                    |       | 1,500,834               |        | 4,710,720                  |       | (3,209,886  | )          | -68.14      | %          |
| Savings  and clubs                        |       | 1,194,365               |        | 1,266,834                  |       | (72,469     | )          | -5.72       | %          |
| Total                                     |       | $                       | 41,450,151  |                       | $          | 26,550,586  |       | $           | 14,899,565 |   | 56.12 | % |
|                                      |       |                    |        |                       |       |        |       |        |       |
| Total  assets                             |       | $                       | 539,859,529 |                       | $          | 536,675,138 |       |        |       |   |   |
| Total  deposits to total assets           |       | 70.39                   | %           | 68.13                      | %          |        |       |        |       |
| Public  funds to total deposits           |       | 10.91                   | %           | 7.26                       | %          |        |       |        |       |
| Public  funds to total assets             |       | 7.68                    | %           | 4.95                       | %          |        |       |        |       |

 

Total deposits increased $14,410,000or 3.9% during the three months ended March 31, 2005 to $380,025,000.  The increase in total deposits was primarilydue to a $15,869,000 increase in NOW accounts caused by the receipt of aseasonal increase from public fund deposits. In addition, savings accounts increased $4,260,000 or 9.2% due mostly tothe efforts of the marketing of our new savings products which began at the endof 2004.  Demand deposit accounts (DDA’s)increased $486,000 during the first three months of 2005.  Partially offsetting these increases was continuedtime deposit outflow which experienced a decline of $4,268,000 or 2.3% duringthe first 2005 quarter.

 

Total average interest-bearingdeposits decreased $16,900,000 or 5.3% from $316,528,000, at December 31,2004 to $299,614,000 at March 31, 2005. The average deposit decline included a reduction in total time depositsof

 

23

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$22,298,000.  Time deposits now represent approximately 47.5%of total deposits, down from 50.5% at December 31, 2004.  Management’s strategic objective is tocontinue to monitor but not actively participate in the current competitivepricing pressure and will allow high-cost time deposits to continue to run-offin favor of growing its lower costing transaction and savings accountprograms.  Through marketing efforts, theaverage balance of these transaction and savings accounts increased byapproximately $5.5 million during the first quarter of 2005.

 

Public funds continue tobe a relatively stable source of deposits and now represent $41,450,000 or 10.9%of total deposits at March 31, 2005, up from $26,551,000 or 7.3% at December 31,2004.  The Bank is able to maintain publicfunds due to long established relationships and competitive product pricing.  Public fund deposits are sensitive to theoperating demands and business cycles of the various public entities as well asthe forever-changing political landscape. Accordingly, the Bank couldexperience significant shifts and outflows of these balances throughout theyear.

 

*Borrowings*

 

Borrowings totaled $109,997,000at March 31, 2005 compared to $121,653,000 at December 31, 2004.

 

Borrowings are used as acomplement to deposit generation as an alternative funding source whereby the Bankwill borrow from the Federal Home Loan Bank (FHLB) for asset growth andliquidity needs.  Borrowings included $70,926,000and $71,119,000 in long-term advances from the FHLB at March 31, 2005 and December 31,2004, respectively.  Included inborrowings is short-term customer repurchase (repos) agreements of $37,982,000and $40,684,000, at March 31, 2005 and December 31, 2004,respectively.  Repos are non-insured low-costinterest-bearing liabilities that have a security interest in qualifiedinvestment securities of the Bank.  Reposoffered are either fixed-term or a daily-sweep product of the Bank.  The balance in customer repurchase agreementsfluctuates daily because the daily-sweep product is dependent on the level ofavailable funds in depositor accounts. In addition, short-term borrowings may include balances of Federal FundsPurchased which the Bank may require from time-to-time to fund overnightliquidity needs.  At December 31,2004, the balance in this account was $8,760,000.  The Bank did not have a balance of FederalFunds Purchased at March 31, 2005.

 

The combined short- andlong-term weighted-average interest rate on borrowings was 3.93% and 3.57% at March 31,2005 and December 31, 2004, respectively.

 

*Accrued interest payable andother liabilities*

 

Accrued interest payableand other liabilities increased $571,000 during the first three months of 2005.  Accrued interest payable increased $70,000while other liabilities and accrued expenses increased $501,000, the lattercaused primarily by a commitment to an investment security purchase transactionthat settled in April.

 

**Item 3****.****                                   Quantitativeand Qualitative Disclosure about Market Risk**

 

*Management of interest rate riskand market risk analysis*

 

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

 

*Asset/Liability Management*: One major objective of the Company whenmanaging the rate sensitivity of its assets and liabilities is to stabilize netinterest income.  The management of andauthority to assume interest rate risk is the responsibility of the Company’sAsset/Liability Committee (ALCO), which is comprised of senior management andBoard members.  ALCO meets quarterly tomonitor the ratio of interest sensitive assets to interest sensitiveliabilities.  The process to reviewinterest rate risk is a regular part of managing the Company.  Consistent policies and practices of

 

24

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measuring and reportinginterest rate risk exposure, particularly regarding the treatment ofnon-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 the use of three complementarymeasures:  static gap analysis, earningsat risk simulation and economic value at risk simulation.  While each of the interest rate riskmeasurements has limitations, taken together they represent a reasonablycomprehensive view of the magnitude of interest rate risk in the Company andthe distribution of risk along the yield curve, the level of risk through timeand the amount of exposure to changes in certain interest rate relationships.

 

*Static Gap:* Theratio between assets and liabilities re-pricing in specific time intervals isreferred to as an interest rate sensitivity gap.  Interest rate sensitivity gaps can be managedto take advantage of the slope of the yield curve as well as forecasted changesin the level of interest rate changes.

 

To manage this interestrate sensitivity position, an asset/liability model called ‘cumulative gapanalysis’ is used to monitor the difference in the volume of the Company’sinterest sensitive assets and liabilities that mature or re-price within givenperiods.  A positive gap (assetsensitive) indicates that more assets re-price during a given period comparedto liabilities, while a negative gap (liability sensitive) has the oppositeeffect.  The Company employs computerizednet interest income simulation modeling to assist in quantifying interest raterisk exposure.  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 March 31, 2005,the Company maintained a one-year cumulative positive gap of $41.7 million or 7.7%of total assets.  The effect of this positivegap position provided a mismatch of assets and liabilities, which may exposethe Bank to an increased interest rate risk position during a period of declininginterest rates.  Conversely, in an increasinginterest rate environment, net income could be positively affected because moreassets will re-price upward during a one-year period.

 

25

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The following tableillustrates the Company’s interest sensitivity gap position at March 31,2005 (dollars in thousands):

 
| ** **                                     | ** ** | **3 months** | ** ** | **3 through** | ** ** | **1 through** | ** ** | **Over**    | ** ** | ** ** | ** ** |
|------------------------------------------------|------------|--------------|------------|---------------|------------|---------------|------------|-------------|------------|------------|------------|
| ** **                                     | ** ** | **or less**  | ** ** | **12 months** | ** ** | **3 years**   | ** ** | **3 years** | ** ** | **Total**  | ** ** |
| Cash  and cash equivalents                     |       | $            | 10,595     |          | $          | —        |       | $           | —     |       | $          | 11,159 |   | $ | 21,754 |   |
| Investment  securities (1)(2)                  |       | 12,625       |       | 10,145        |       | 29,391        |       | 62,344      |       | 114,505    |       |
| Loans (2)                                      |       | 141,422      |       | 65,139        |       | 84,556        |       | 86,776      |       | 377,893    |       |
| Fixed  and other assets                        |       | —       |       | 7,671         |       | —        |       | 18,037      |       | 25,708     |       |
| Total  assets                                  |       | $            | 164,642    |          | $          | 82,955        |       | $           | 113,947    |       | $          | 178,316 |   | $ | 539,860 |   |
| Total  cumulative assets                       |       | $            | 164,642    |          | $          | 247,597       |       | $           | 361,544    |       | $          | 539,860 |   |   |   |
|                                           |       |         |       |          |       |          |       |        |       |       |       |
| Non-interest  bearing transaction deposits (3) |       | $            | —     |          | $          | 6,584         |       | $           | 18,106     |       | $          | 41,153 |   | $ | 65,843 |   |
| Interest-bearing  transaction deposits (3)     |       | 5,134        |       | 64,317        |       | 50,804        |       | 13,512      |       | 133,767    |       |
| Time  deposits                                 |       | 32,176       |       | 58,806        |       | 74,634        |       | 14,799      |       | 180,415    |       |
| Repurchase  agreements                         |       | 28,207       |       | 3,724         |       | 6,051         |       | —      |       | 37,982     |       |
| Short-term  borrowings                         |       | 1,089        |       | —        |       | —        |       | —      |       | 1,089      |       |
| Long-term  debt                                |       | 5,224        |       | 671           |       | 1,776         |       | 63,255      |       | 70,926     |       |
| Other  liabilities                             |       | —       |       | —        |       | —        |       | 3,611       |       | 3,611      |       |
| Total  liabilities                             |       | $            | 71,830     |          | $          | 134,102       |       | $           | 151,371    |       | $          | 136,330 |   | $ | 493,633 |   |
| Total  cumulative liabilities                  |       | $            | 71,830     |          | $          | 205,932       |       | $           | 357,303    |       | $          | 493,633 |   |   |   |
|                                           |       |         |       |          |       |          |       |        |       |       |       |
| Interest  sensitivity gap                      |       | $            | 92,812     |          | $          | (51,147       | )          | $           | (37,424    | )          | $          | 41,986 |   |   |   |
|                                           |       |         |       |          |       |          |       |        |       |       |       |
| Cumulative  gap                                |       | $            | 92,812     |          | $          | 41,665        |       | $           | 4,241      |       | $          | 46,227 |   |   |   |
|                                           |       |         |       |          |       |          |       |        |       |       |       |
| Cumulative  gap to total assets                |       | 17.19        | %          | 7.72          | %          | 0.79          | %          | 8.56        | %          |       |       |

 

----

(1)           Includesnet unrealized gains/losses on securities AFS.

 

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

 

(3)           TheBank’s demand and savings accounts are generally subject to immediate withdrawal.  However, management considers a certainamount of such accounts to be core accounts having significantly longereffective maturities based on the retention experiences of such deposits inchanging interest rate environments.  Theeffective maturities presented are the recommended maturity distribution limitsfor non-maturing deposits based on historical deposit studies.

 

Certainshortcomings are inherent in the method of analysis presented in the abovetable.  Although certain assets andliabilities may have similar maturities or periods of re-pricing, they mayreact in different degrees to changes in market interest rates.  The interest rates on certain types of assetsand liabilities may fluctuate in advance of changes in market interest rates,while interest rates on other types of assets and liabilities may lag behindchanges in market interest rates. Certain assets, such as adjustable-rate mortgages, have features whichrestrict changes in interest rates on a short-term basis and over the life of theloan.  In the event of a change ininterest rates, prepayment and early withdrawal levels may deviatesignificantly from those assumed in calculating the table.  The ability of many borrowers to servicetheir adjustable-rate debt may decrease in the event of an interest rateincrease.

 

*Earnings at Risk and EconomicValue at Risk Simulations:* The Company recognizes that moresophisticated tools exist for measuring the interest rate risk in the balancesheet beyond static re-pricing gap analysis. Although it will continue to measure its re-pricing gap position, theCompany utilizes additional modeling for identifying and measuring the interestrate risk in the overall balance sheet. The ALCO is responsible for focusing on “earnings at risk” and “economicvalue at risk”, and how both relate to the risk-based capital position whenanalyzing the interest rate risk.

 

26

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

 

*Economic Value at Risk:*Earnings at risk simulation measure the short-term risk in the balancesheet.  Economic value (or portfolioequity) at risk measures the long-term risk by finding the net present value ofthe future cash flows 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.

 

The following tableillustrates the simulated impact of 200 basis points upward or downwardmovement in interest rates on net interest income, net income and the change ineconomic value (portfolio equity).  Thisanalysis assumed that interest-earning asset and interest-bearing liabilitylevels at March 31, 2005 remained constant.  The impact of the rate movements wasdeveloped by simulating the effect of rates changing over a twelve-month periodfrom the March 31, 2005 levels:

 
| ** **                                            | ** ** | **Rates +200** | ** ** | **Rates -200** | ** ** |
|-------------------------------------------------------|------------|----------------|------------|----------------|------------|
|                                                  |       |           |       |           |       |
| Earnings  at risk:                                    |       |           |       |           |       |
| Percent  change in:                                   |       |           |       |           |       |
| Net  interest income                                  |       | 9.7            | %          | (19.7          | )%         |
| Net  income                                           |       | 25.6           |       | (51.0          | )          |
|                                                  |       |           |       |           |       |
| Economic  value at risk:                              |       |           |       |           |       |
| Percent  change in:                                   |       |           |       |           |       |
| Economic  value of equity                             |       | (12.4          | )          | (15.3          | )          |
| Economic  value of equity as a percent of book assets |       | (1.3           | )          | (1.6           | )          |

 

Economic value has themost meaning when viewed within the context of risk-based capital.  Therefore, the economic value may changebeyond the Company’s policy guideline for a short period of time as long as therisk-based capital ratio, after adjusting for the excess equity exposure, isgreater than 10%.  At March 31,2005, the Company’s risk-based capital ratio was 14.3%.

 

The table belowsummarizes estimated changes in net interest income over a twelve-month periodbeginning April 1, 2005, under alternate interest rate scenarios using theincome simulation model described above:

 
| ** **                    | ** ** | **Net interest**           | ** ** | **Dollar**   | ** ** | **Percent**  | ** ** |
|-------------------------------|------------|----------------------------|------------|--------------|------------|--------------|------------|
| **Change  in interest rates** | ** ** | **income**                 | ** ** | **variance** | ** ** | **variance** | ** ** |
| ** **                    | ** ** | **(dollars in thousands)** | ** ** | ** **   | ** ** |
| +200  basis points            |       | $                          | 20,718     |         | $          | 1,835        |       | 9.7 | % |
| +100  basis points            |       | 19,916                     |       | 1,033        |       | 5.5          |       |
|  Flat  rate              |       | 18,883                     |       | —       |       | —       |       |
| -100  basis points            |       | 17,440                     |       | (1,443       | )          | (7.6         | )          |
| -200  basis points            |       | 15,164                     |       | (3,719       | )          | (19.7        | )          |
|                               |            |                            |            |              |            |              |            |  |  |

 

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-price at any time.  This may impactthe margin if more expensive alternative sources of deposits are required tofund 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 then applies growth orrun-off estimates provided by Management. As a result, the mix of interest-earning assets and interestbearing-liabilities is not held constant.

 

27

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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,increase of other borrowed funds from correspondent banks and issuance ofcapital stock.  Although regularlyscheduled investment and loan payments are dependable sources of daily funds,the sale of loans and investment securities AFS, deposit activity, andinvestment and loan prepayments are significantly influenced by generaleconomic conditions and the level of interest rates.

 

At March 31, 2005, the Company maintained $21,754,000 in cash andcash equivalents.  The Company also had$111,615,000 in investments AFS and $400,000 of loans AFS.  This combined total of $133,769,000represented 25% of total assets at March 31, 2005.  In addition, at March 31, 2005, theCompany had approximately $95,315,000 available to borrow from the FHLB.  Management believes that the present level ofliquidity is remains strong and adequate for current operations.

 

*Capital*

 

The Company is subject tovarious regulatory capital requirements administered by the federal bankingagencies. Failure to meet minimum capital requirements can initiate certainmandatory and possible additional discretionary actions by regulators that, ifundertaken, could have a direct material effect on the Company’s financialstatements. Under capital adequacy guidelines and the regulatory framework forprompt corrective action, the Company must meet specific capital guidelinesthat involve quantitative measures of the Company’s assets, liabilities andcertain off-balance-sheet items as calculated under regulatory accountingpractices.  The Company’s capital amountsand classification are also subject to qualitative judgments by the regulatorsabout components, risk-weightings and other factors.

 

Capital is fundamental tosupport our continued growth. In addition, the Company and Bank are subject tovarious regulatory capital requirements. Regulatory capital is defined in termsof Tier II capital (shareholders’ equity plus the allowable portion of theminority interest in equity of subsidiaries, minus unrealized gains or plusunrealized losses on AFS, and minus certain intangible assets), Tier II capital(which includes the allowable portion of the allowance for loan losses,minority interest in equity of subsidiaries and subordinated debt), and totalcapital (Tier I plus Tier II). Risk-based capital ratios are expressed aspercentages of risk-weighted assets. Risk-weighted assets are determined by assigning various weights to allassets and off-balance sheet financial instruments, such as letters of credit andloan commitments, based on associated risk. Regulators have also adopted minimum Tier I leverage ratio standards,which measure the ratio of Tier I capital to total average quarterly assets.

 

Quantitative measures,established by regulation to ensure capital adequacy, require the Company tomaintain minimum amounts and ratios of total and Tier I capital torisk-weighted assets, and of Tier I capital to average assets.  Capital is evaluated in relation to totalassets and the risk associated with those assets.  As of March 31, 2005, the Company meetsall capital adequacy requirements to which it is subject.  The following table depicts the capitalamounts and ratios of the Company and the Bank as of March 31, 2005:

 

28

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| ** **                                 | ** ** | ** ** | ** ** | ** ** | ** ** | ** **            | ** ** | ** **                  | ** ** | **To be well capitalized** | ** ** |
|--------------------------------------------|------------|------------|------------|------------|------------|-----------------------|------------|-----------------------------|------------|----------------------------|------------|
| ** **                                 | ** ** | ** ** | ** ** | ** ** | ** ** | **For capital**       | ** ** | **under prompt corrective** | ** ** |
| ** **                                 | ** ** | **Actual** | ** ** | ** ** | ** ** | **adequacy purposes** | ** ** | **action provisions**       | ** ** |
| ** **                                 | ** ** | **Amount** | ** ** | **Ratio**  | ** ** | **Amount**            | ** ** | **Ratio**                   | ** ** | **Amount**                 | ** ** | **Ratio** | ** ** |
|                                       |       |       |       |       |       |                  |       |                        |       |                       |       |   |   |
| Total  capital  (to risk-weighted assets)  |       |       |       |       |       |                  |       |                        |       |                       |       |   |   |
| Consolidated                               |       | $          | 51,831,590 |       | 14.28      | %                     | $          | 29,030,241                  |       | 8.00                       | %          | N/A |   | N/A |   |
| Bank                                       |       | $          | 51,476,307 |       | 14.22      | %                     | $          | 28,959,513                  |       | 8.00                       | %          | $ | 36,199,392 |   | 10.00 | % |
| Tier  I capital  (to risk-weighted assets) |       |       |       |       |       |                  |       |                        |       |                       |       |   |   |
| Consolidated                               |       | $          | 47,198,650 |       | 13.01      | %                     | $          | 14,515,120                  |       | 4.00                       | %          | N/A |   | N/A |   |
| Bank                                       |       | $          | 46,926,004 |       | 12.96      | %                     | $          | 14,479,757                  |       | 4.00                       | %          | $ | 21,719,635 |   | 6.00 | % |
| Tier  I Capital  (to average assets)       |       |       |       |       |       |                  |       |                        |       |                       |       |   |   |
| Consolidated                               |       | $          | 47,198,650 |       | 8.74       | %                     | $          | 21,605,600                  |       | 4.00                       | %          | N/A |   | N/A |   |
| Bank                                       |       | $          | 46,926,004 |       | 8.70       | %                     | $          | 21,651,008                  |       | 4.00                       | %          | $ | 27,063,760 |   | 5.00 | % |

 

**Item 4****.****                                   Controlsand 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.

 

**PART II****. OtherInformation**

 

**Item 1.**                                   **Legal Proceedings**

 

The nature of the Company’sbusiness generates some litigation involving matters arising in the ordinarycourse of business.  However, in theopinion of the Company, after consulting with legal counsel, no legalproceedings are pending, which, if determined adversely to the Company or theBank, would have a material effect on the Company’s undivided profits orfinancial condition.  No legalproceedings are pending other than ordinary routine litigation incidental tothe business of the Company and the Bank. In addition, to Management’s knowledge, no governmental authorities haveinitiated or contemplated any material legal actions against the Company or theBank.

 

**Item 2.****                                   Unregistered Sales of Equity Securities andUse of Proceeds**

 

None

 

**Item 3.****                                   Default upon Senior Securities**

 

None

 

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

 

None

 

**Item 5.****                                   Other Information**

 

None

 

29

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**Item 6.****                                   Exhibits**

 
| **Exhibits** | ** **   | ** **                                                                                                                                                                                                                                                                                                                                               |
|--------------|--------------|----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
|         |         |                                                                                                                                                                                                                                                                                                                                                     |
| ***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, 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, 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, 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, filed with  the SEC on November 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, 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, filed with the SEC on September 12, 2000 and as amended by  Pre-Effective Amendment No. 1 on October 11, 2000 and by Post-Effective  Amendment No. 1 on May 30, 2001. |
|         |         |                                                                                                                                                                                                                                                                                                                                                     |
| ***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 Appendix A to Registrant’s Definitive Proxy Statement filed with  the SEC on March 28, 2002.                                                                                                                                                          |
|         |         |                                                                                                                                                                                                                                                                                                                                                     |
| ***10.***8   | *** *** | ***Employment  Agreement between Registrant, 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 July30, 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.                                                 |
| * *     | * *     | * *                                                                                                                                                                                                                                                                                                                                                 |
| ***11***     | *** *** | ***Statement  regarding computation of earnings per share.***Included  herein in Note 2 “Earnings per Share”, contained within the Notes to  Consolidated Financial Statements, and incorporated herein by reference.                                                                                                                          |

 

30

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| ***31.1*** | *** *** | ***Rule  13a-14(a) Certification of Principal Executive Officer, filed herewith.***                                                                                                       |
|------------|--------------|-------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
| * *   | * *     | * *                                                                                                                                                                                  |
| ***31.2*** | *** *** | ***Rule  13a-14(a) Certification of Principal Financial Officer, filed herewith.***                                                                                                       |
| * *   | * *     | * *                                                                                                                                                                                  |
| ***32.1*** | *** *** | ***Certification  of Principal Executive Officer pursuant to 18 U.S.C. Section 1350, as  adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002, filed  herewith.*** |
| * *   | * *     | * *                                                                                                                                                                                  |
| ***32.2*** | *** *** | ***Certification  of Principal Financial Officer pursuant to 18 U.S.C. Section 1350, as  adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002, filed  herewith.*** |

 

31

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

 

Pursuant to the requirementsof the Securities Exchange Act of 1934, the Company has caused this report tobe signed on its behalf by the undersigned thereunto duly authorized.

 

 
|              | **FIDELITY D & D BANCORP,  INC.**       |
|-------------------|---------------------------------------------|
|              |                                        |
|              |                                        |
| Date: May 3, 2005 | /s/ Steven C. Ackmann                       |   |
|              |   Steven  C. Ackmann,             |
|              | President  and Chief Executive Officer      |
|              |                                        |
|              |                                        |
| Date: May 3, 2005 | /s/ Salvatore R.  DeFrancesco, Jr.          |   |
|              |   Salvatore  R. DeFrancesco, Jr., |
|              | Treasurer  and Chief Financial Officer      |

 

32

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

 

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, 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, 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, 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, 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, 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, filed with the SEC on September 12, 2000 and as  amended by Pre-Effective Amendment No. 1 on October 11, 2000 and by  Post-Effective Amendment No. 1 on May 30, 2001. | *** *** | *******  |
|        |         |                                                                                                                                                                                                                                                                                                                                                       |         |     |
| ***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.                                                                                                                                               | *** *** | *******  |

 

33

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| ***10.7***   | *** *** | ***Registrant’s  2002 Employee Stock Purchase Plan.***                                                                                                                                                                                                                          |         | *        |
|--------------|--------------|--------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|--------------|----------|
|         |         | Incorporated by  reference to Appendix A to Registrant’s Definitive Proxy Statement filed with  the SEC on March 28, 2002.                                                                                                                                                 |         |     |
|         |         |                                                                                                                                                                                                                                                                                 |         |     |
| ***10.8***   | *** *** | ***Employment  Agreement between Registrant, 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.                         | * *     | * * |
|         |         |                                                                                                                                                                                                                                                                                 |         |     |
| ***11***     | *** *** | ***Statement  regarding computation of earnings per share***. Included  herein.                                                                                                                                                                                                      | *** *** | ***9***  |
|         |         |                                                                                                                                                                                                                                                                                 |         |     |
| ***31.1***   | *** *** | ***Rule  13a-14(a) Certification of Principal Executive Officer.***                                                                                                                                                                                                                  | *** *** | ***35*** |
| * *     | * *     | * *                                                                                                                                                                                                                                                                             | * *     | * * |
| ***31.2***   | *** *** | ***Rule  13a-14(a) Certification of Principal Financial Officer.***                                                                                                                                                                                                                  | *** *** | ***36*** |
| * *     | * *     | * *                                                                                                                                                                                                                                                                             | * *     | * * |
| ***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.***                                                                                                             | *** *** | ***37*** |
| * *     | * *     | * *                                                                                                                                                                                                                                                                             | * *     | * * |
| ***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.***                                                                                                             | *** *** | ***38*** |

 

----

*******-Incorporated by Reference

 

34

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