** **

**UNITED STATES**

**SECURITIES AND EXCHANGE COMMISSION**

**Washington,D.C. 20549**

**FORM 10-Q**

**xQUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE**

**SECURITIES EXCHANGE ACT OF 1934**

**Forthe quarterly period ended March 31, 2007**

**OR**

**oTRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE**

**SECURITIES EXCHANGE ACT OF 1934**

**Forthe transition period from                  to                 **

**Commissionfile number: 333-90273**

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

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

 

Address of principalexecutive offices:

**BLAKELY & DRINKER ST.**

**DUNMORE,PENNSYLVANIA 18512**

TELEPHONE:

**570-342-8281**

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

xYES    oNO

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

Large accelerated filer o   Accelerated filer o   Non-accelerated filer x

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

oYES    xNO

The number of outstandingshares of Common Stock of Fidelity D & D Bancorp, Inc. at April 30, 2007,the latest practicable date, was 2,063,357 shares.

 

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**FIDELITYD & D BANCORP, INC.**

Form 10-Q March31, 2007

Index
| **Part I. Financial Information** |                                                                                                                 |
|-----------------------------------|----------------------------------------------------------------------------------------------------------------------|
| ** **                        |                                                                                                                 |
| Item 1.                           | Financial Statements:                                                                                                |   |
|                              | Consolidated  Balance Sheets as of March 31, 2007  and December 31, 2006                                             |   |
|                              | Consolidated Statements of Income for the three  months ended March 31, 2007 and 2006                                |   |
|                              | Consolidated Statements of Changes in Shareholders’  Equity  for the three months ended March 31, 2007 and 2006 |   |
|                              | Consolidated Statements of Cash Flows for the three  months  ended March 31, 2007 and 2006                           |   |
|                              | Notes to Consolidated Financial Statements                                                                           |   |
|                              |                                                                                                                 |   |
| Item 2.                           | Management’s  Discussion and Analysis of Financial Condition and Results of Operations                          |   |
|                              |                                                                                                                 |   |
| Item 3.                           | Quantitative  and Qualitative Disclosure about Market Risk                                                           |   |
|                              |                                                                                                                 |   |
| Item 4.                           | Controls and  Procedures                                                                                             |   |
|                              |                                                                                                                 |   |
| **Part  II. Other Information**   |                                                                                                                 |
| ** **                        |                                                                                                                 |
| Item 1.                           | Legal Proceedings                                                                                                    |   |
|                              |                                                                                                                 |   |
| Item  1A.                         | Risk  Factors                                                                                                        |   |
|                              |                                                                                                                 |   |
| Item 2.                           | Unregistered  Sales of Equity Securities and Use of Proceeds                                                         |   |
|                              |                                                                                                                 |   |
| Item 3.                           | Defaults Upon  Senior Securities                                                                                     |   |
|                              |                                                                                                                 |   |
| Item 4.                           | Submission of  Matters to a Vote of Security Holders                                                                 |   |
|                              |                                                                                                                 |   |
| Item 5.                           | Other Information                                                                                                    |   |
|                              |                                                                                                                 |   |
| Item  6.                          | Exhibits                                                                                                             |   |
|                              |                                                                                                                 |   |
| Signatures                        |                                                                                                                 |
|                              |                                                                                                                 |
| Exhibit index                     |                                                                                                                 |

 

2

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**PART I —Financial Information**

**Item 1:Financial Statements**

**FIDELITYD & D BANCORP, INC. AND SUBSIDIARY**

Consolidated Balance Sheets
| ** **                                                                                                                                   | ** ** | **March 31, 2007** | ** **  | **December 31, 2006** | ** ** |
|----------------------------------------------------------------------------------------------------------------------------------------------|------------|------------------------------|-------------|---------------------------------|------------|
| ** **                                                                                                                                   | ** ** | **(unaudited)**              | ** **  | **(audited)**                   | ** ** |
| **Assets**:                                                                                                                                  |       |                         |        |                            |       |
| Cash and due from banks                                                                                                                      |       | $                            | 14,339,563  |                            | $          | 13,732,137 |   |
| Interest-bearing  deposits with financial institutions                                                                                       |       | 96,175                       |        | 68,711                          |       |
| Total cash and  cash equivalents                                                                                                             |       | 14,435,738                   |        | 13,800,848                      |       |
| Available-for-sale  securities                                                                                                               |       | 99,921,920                   |        | 98,841,364                      |       |
| Held-to-maturity  securities                                                                                                                 |       | 1,369,657                    |        | 1,569,372                       |       |
| Federal Home Loan Bank  Stock                                                                                                                |       | 3,598,600                    |        | 3,795,100                       |       |
| Loans and leases, net  (allowance for loan losses of $5,359,758 in 2007 and $5,444,303 in 2006)                                              |       | 417,225,015                  |        | 417,199,048                     |       |
| Loans  available-for-sale (fair value $371,990 in 2007; $123,156 in 2006)                                                                    |       | 370,750                      |        | 122,000                         |       |
| Bank premises and  equipment, net                                                                                                            |       | 10,941,355                   |        | 11,324,465                      |       |
| Cash surrender value of  bank owned life insurance                                                                                           |       | 8,254,777                    |        | 8,177,961                       |       |
| Other assets                                                                                                                                 |       | 5,609,660                    |        | 4,788,105                       |       |
| Accrued interest  receivable                                                                                                                 |       | 2,614,412                    |        | 2,502,576                       |       |
| Foreclosed assets held  for sale                                                                                                             |       | 284,058                      |        | 197,149                         |       |
| **Total  assets**                                                                                                                            |       | $                            | 564,625,942 |                            | $          | 562,317,988 |   |
| ** **                                                                                                                                   |       |                         |        |                            |       |
| **Liabilities**:                                                                                                                             |       |                         |        |                            |       |
| Deposits:                                                                                                                                    |       |                         |        |                            |       |
| Interest-bearing                                                                                                                             |       | $                            | 342,443,261 |                            | $          | 336,592,620 |   |
| Non-interest-bearing                                                                                                                         |       | 71,623,735                   |        | 73,741,975                      |       |
| Total deposits                                                                                                                               |       | 414,066,996                  |        | 410,334,595                     |       |
|                                                                                                                                         |       |                         |        |                            |       |
| Accrued interest  payable and other liabilities                                                                                              |       | 3,985,911                    |        | 4,179,170                       |       |
| Short-term borrowings                                                                                                                        |       | 31,607,966                   |        | 33,656,150                      |       |
| Long-term debt                                                                                                                               |       | 62,331,630                   |        | 62,536,210                      |       |
| **Total  liabilities**                                                                                                                       |       | 511,992,503                  |        | 510,706,125                     |       |
|                                                                                                                                         |       |                         |        |                            |       |
| **Shareholders’  equity**:                                                                                                              |       |                         |        |                            |       |
| Preferred stock  authorized 5,000,000 shares with no par value; none issued                                                                  |       | —                       |        | —                          |       |
| Capital stock  authorized 10,000,000 shares with no par value; issued and outstanding  2,063,357 shares in 2007 and 2,057,433 shares in 2006 |       | 18,914,490                   |        | 18,702,537                      |       |
| Retained earnings                                                                                                                            |       | 34,465,335                   |        | 33,874,118                      |       |
| Accumulated other  comprehensive loss                                                                                                        |       | (746,386                     | )           | (964,792                        | )          |
| **Total  shareholders’ equity**                                                                                                         |       | 52,633,439                   |        | 51,611,863                      |       |
| **Total liabilities and  shareholders’ equity**                                                                                         |       | $                            | 564,625,942 |                            | $          | 562,317,988 |   |

 

See notes to consolidatedfinancial statements

3

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

Consolidated Statements ofIncome

(unaudited)
| ** **                                              | ** ** | **Three Months Ended** | ** ** |
|---------------------------------------------------------|------------|----------------------------------|------------|
| ** **                                              | ** ** | **March 31, 2007**     | ** ** | **March 31, 2006** | ** ** |
| **Interest  income:**                                   |       |                             |       |   |   |
| Loans and leases:                                       |       |                             |       |   |   |
| Taxable                                                 |       | $                                | 7,175,029  |   | $ | 6,498,618 |   |
| Nontaxable                                              |       | 109,517                          |       | 132,158 |   |
| Interest-bearing deposits with financial  institutions  |       | 2,792                            |       | 2,537 |   |
| Investment securities:                                  |       |                             |       |   |   |
| U.S. government agency and corporations                 |       | 919,288                          |       | 885,182 |   |
| States and political subdivisions (nontaxable)          |       | 124,839                          |       | 141,044 |   |
| Other securities                                        |       | 245,899                          |       | 198,410 |   |
| Federal funds sold                                      |       | 54,452                           |       | 35,488 |   |
| **Total interest income**                               |       | 8,631,816                        |       | 7,893,437 |   |
| **Interest  expense:**                                  |       |                             |       |   |   |
| Deposits                                                |       | 3,334,023                        |       | 2,396,906 |   |
| Securities sold under repurchase agreements             |       | 115,457                          |       | 135,449 |   |
| Other short-term borrowings and other                   |       | 73,073                           |       | 61,962 |   |
| Long-term debt                                          |       | 805,073                          |       | 1,068,811 |   |
| **Total interest expense**                              |       | 4,327,626                        |       | 3,663,128 |   |
| **Net interest income**                                 |       | 4,304,190                        |       | 4,230,309 |   |
| Provision for  loan losses                              |       | —                           |       | 75,000 |   |
| **Net interest income after provision for loan losses** |       | 4,304,190                        |       | 4,155,309 |   |
| **Other  income:**                                      |       |                             |       |   |   |
| Service charges on deposit accounts                     |       | 632,317                          |       | 631,727 |   |
| Gain (loss) on sale of:                                 |       |                             |       |   |   |
| Loans                                                   |       | 36,725                           |       | 14,985 |   |
| Investment securities                                   |       | —                           |       | (168 | ) |
| Premises and equipment                                  |       | 96,557                           |       | 1,560 |   |
| Leased assets                                           |       | —                           |       | 15,054 |   |
| Foreclosed assets held for sale                         |       | 15,128                           |       | 405 |   |
| Fees and other service charges                          |       | 432,936                          |       | 465,262 |   |
| **Total other income**                                  |       | 1,213,663                        |       | 1,128,825 |   |
| **Other  expenses:**                                    |       |                             |       |   |   |
| Salaries and employee benefits                          |       | 2,134,977                        |       | 2,006,814 |   |
| Premises and equipment                                  |       | 805,825                          |       | 800,851 |   |
| Advertising                                             |       | 159,005                          |       | 128,373 |   |
| Other                                                   |       | 1,013,236                        |       | 986,712 |   |
| **Total other expenses**                                |       | 4,113,043                        |       | 3,922,750 |   |
| **Income  before provision for income taxes**           |       | 1,404,810                        |       | 1,361,384 |   |
| Provision for  income taxes                             |       | 360,459                          |       | 329,753 |   |
| **Net income**                                          |       | $                                | 1,044,351  |   | $ | 1,031,631 |   |
| Per share data:                                         |       |                             |       |   |   |
| Net income - basic                                      |       | $                                | 0.51       |   | $ | 0.51 |   |
| Net income - diluted                                    |       | $                                | 0.51       |   | $ | 0.50 |   |
| Dividends                                               |       | $                                | 0.22       |   | $ | 0.22 |   |

 

See Notes to ConsolidatedFinancial Statements

4

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

Consolidated Statements ofChanges in Shareholders’ Equity

For the three months endedMarch 31, 2007 and 2006
| ** **                                                                                                                     | ** ** | ** **             | ** ** | ** **   | ** ** | ** **        | ** ** | **Accumulated other** | ** ** | ** ** | ** ** |
|--------------------------------------------------------------------------------------------------------------------------------|------------|------------------------|------------|--------------|------------|-------------------|------------|----------------------------|------------|------------|------------|
| ** **                                                                                                                     | ** ** | **Capital stock** | ** ** | **Retained** | ** ** | **comprehensive** | ** ** | ** **                 | ** ** |
| ** **                                                                                                                     | ** ** | **Shares**             | ** ** | **Amount**   | ** ** | **earnings**      | ** ** | **income (loss)**     | ** ** | **Total**  | ** ** |
| Balance, December 31,  2005 (audited)                                                                                          |       | 1,854,217              |       | $            | 10,594,901 |              | $          | 39,363,461                 |       | $          | (1,112,333 | ) | $ | 48,846,029 |   |
| Cumulative effect of  change in accounting principle, net of tax                                                               |       |                   |       |         |       | (343,717          | )          |                       |       | (343,717   | )          |
| Total comprehensive  income:                                                                                                   |       |                   |       |         |       |              |       |                       |       |       |       |
| Net income                                                                                                                     |       |                   |       |         |       | 1,031,631         |       |                       |       | 1,031,631  |       |
| Change in net  unrealized holding losses on available-for-sale securities, net of reclassification  adjustment and tax effects |       |                   |       |         |       |              |       | (698,263                   | )          | (698,263   | )          |
| Comprehensive  income                                                                                                          |       |                   |       |         |       |              |       |                       |       | 333,368    |       |
| Issuance of common  stock through Employee Stock Purchase Plan                                                                 |       | 1,571                  |       | 48,151       |       |              |       |                       |       | 48,151     |       |
| Dividends reinvested  through Dividend Reinvestment Plan                                                                       |       | 3,620                  |       | 141,180      |       |              |       |                       |       | 141,180    |       |
| Stock-based  compensation expense                                                                                              |       |                   |       | 21,913       |       |              |       |                       |       | 21,913     |       |
| Cash dividends declared                                                                                                        |       |                   |       |         |       | (449,060          | )          |                       |       | (449,060   | )          |
| Stock dividend declared                                                                                                        |       | 185,394                |       | 7,462,100    |       | (7,469,548        | )          |                       |       | (7,448     | )          |
| Balance, March 31, 2006  (unaudited)                                                                                           |       | 2,044,802              |       | $            | 18,268,245 |              | $          | 32,132,767                 |       | $          | (1,810,596 | ) | $ | 48,590,416 |   |
|                                                                                                                           |       |                   |       |         |       |              |       |                       |       |       |       |
|                                                                                                                           |       |                   |       |         |       |              |       |                       |       |       |       |
| Balance, December 31,  2006 (audited)                                                                                          |       | 2,057,433              |       | $            | 18,702,537 |              | $          | 33,874,118                 |       | $          | (964,792   | ) | $ | 51,611,863 |   |
| Total comprehensive  income:                                                                                                   |       |                   |       |         |       |              |       |                       |       |       |       |
| Net income                                                                                                                     |       |                   |       |         |       | 1,044,351         |       |                       |       | 1,044,351  |       |
| Change in net  unrealized holding losses on available-for-sale securities, net of reclassification  adjustment and tax effects |       |                   |       |         |       |              |       | 159,150                    |       | 159,150    |       |
| Change in cash  flow hedge intrinsic value                                                                                     |       |                   |       |         |       |              |       | 59,256                     |       | 59,256     |       |
| Comprehensive  income                                                                                                          |       |                   |       |         |       |              |       |                       |       | 1,262,757  |       |
| Issuance of common  stock through Employee Stock Purchase Plan                                                                 |       | 2,266                  |       | 67,820       |       |              |       |                       |       | 67,820     |       |
| Dividends reinvested  through Dividend Reinvestment Plan                                                                       |       | 3,658                  |       | 137,175      |       |              |       |                       |       | 137,175    |       |
| Stock-based  compensation expense                                                                                              |       |                   |       | 6,958        |       |              |       |                       |       | 6,958      |       |
| Cash dividends declared                                                                                                        |       |                   |       |         |       | (453,134          | )          |                       |       | (453,134   | )          |
| Balance, March 31, 2007 (unaudited)                                                                                            |       | 2,063,357              |       | $            | 18,914,490 |              | $          | 34,465,335                 |       | $          | (746,386   | ) | $ | 52,633,439 |   |

 

SeeNotes to Consolidated Financial Statements

5

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**FIDELITY DEPOSIT & DISCOUNT BANCORP, INC. AND SUBSIDIARY**

Consolidated Statements ofCash Flows

(unaudited)
| ** **                                                                         | ** ** | **Three Months Ended** | ** ** |
|------------------------------------------------------------------------------------|------------|----------------------------------|------------|
| ** **                                                                         | ** ** | **March 31, 2007**     | ** ** | **March 31, 2006** | ** ** |
| **Cash  flows from operating activities:**                                         |       |                             |       |   |   |
| Net income                                                                         |       | $                                | 1,044,351  |   | $ | 1,031,631 |   |
| Adjustments to reconcile net income to net cash  provided by operating activities: |       |                             |       |   |   |
| Depreciation, amortization and accretion                                           |       | 294,105                          |       | 340,178 |   |
| Provision for loan losses                                                          |       | —                           |       | 75,000 |   |
| Deferred income tax (benefit) expense                                              |       | (63,692                          | )          | 91,443 |   |
| Stock-based compensation expense                                                   |       | 6,958                            |       | 21,913 |   |
| Loss from investment in limited partnership                                        |       | 20,100                           |       | 22,500 |   |
| Proceeds from sale of loans available-for-sale                                     |       | 3,998,013                        |       | 1,777,954 |   |
| Originations of loans available-for-sale                                           |       | (4,210,038                       | )          | (2,287,637 | ) |
| Increase in cash surrender value of life insurance                                 |       | (76,816                          | )          | (70,409 | ) |
| Net gain on sale of loans                                                          |       | (36,725                          | )          | (14,985 | ) |
| Net loss on sale of investment securities                                          |       | —                           |       | 168 |   |
| Net gain on sale of foreclosed assets held-for-sale                                |       | (15,128                          | )          | (405 | ) |
| Net gain on disposal of premises and equipment                                     |       | (96,557                          | )          | (1,560 | ) |
| Change in:                                                                         |       |                             |       |   |   |
| Accrued interest receivable                                                        |       | (111,836                         | )          | (226,778 | ) |
| Other assets                                                                       |       | (301,492                         | )          | (516,168 | ) |
| Accrued interest payable and other liabilities                                     |       | (192,854                         | )          | 158,053 |   |
| Net cash provided by operating activities                                          |       | 258,389                          |       | 400,898 |   |
| **Cash  flows from investing activities:**                                         |       |                             |       |   |   |
| Held-to-maturity securities:                                                       |       |                             |       |   |   |
| Proceeds from maturities, calls and principal  pay-downs                           |       | 199,356                          |       | 85,055 |   |
| Available-for-sale securities:                                                     |       |                             |       |   |   |
| Proceeds from sales                                                                |       | —                           |       | 1,537,336 |   |
| Proceeds from maturities, calls and principal  pay-downs                           |       | 4,187,592                        |       | 1,542,173 |   |
| Purchases                                                                          |       | (4,943,639                       | )          | (22,776,490 | ) |
| Net decrease (increase) in FHLB stock                                              |       | 196,500                          |       | (70,800 | ) |
| Net increase in loans and leases                                                   |       | (270,967                         | )          | (7,385,044 | ) |
| Proceeds from sale of premises and equipment                                       |       | 247,008                          |       | 1,560 |   |
| Acquisition of bank premises and equipment                                         |       | (643,661                         | )          | (155,489 | ) |
| Proceeds from sale of foreclosed assets  held-for-sale                             |       | 172,814                          |       | — |   |
| Net cash used in investing activities                                              |       | (854,997                         | )          | (27,221,699 | ) |
| **Cash  flows from financing activities:**                                         |       |                             |       |   |   |
| Net increase in deposits                                                           |       | 3,732,401                        |       | 29,005,634 |   |
| Net decrease in short-term borrowings                                              |       | (2,048,184                       | )          | (1,350,461 | ) |
| Repayments of long-term debt                                                       |       | (204,580                         | )          | (2,674,840 | ) |
| Proceeds from employee stock purchase plan                                         |       | 67,820                           |       | 48,151 |   |
| Dividends paid, net of dividends reinvested                                        |       | (315,959                         | )          | (307,880 | ) |
| Cash payments in lieu of fractional shares on stock  dividend                      |       | —                           |       | (7,448 | ) |
| Net cash provided by financing activities                                          |       | 1,231,498                        |       | 24,713,156 |   |
| Net increase  (decrease) in cash and cash equivalents                              |       | 634,890                          |       | (2,107,645 | ) |
| Cash and cash  equivalents, beginning                                              |       | 13,800,848                       |       | 12,594,540 |   |
| Cash and cash  equivalents, ending                                                 |       | $                                | 14,435,738 |   | $ | 10,486,895 |   |

 

See notes to consolidatedfinancial statements

6

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

**Notes toConsolidated Financial Statements**

**(unaudited)**

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

# **Nature of operations**

# The Fidelity Deposit and Discount Bank (the Bank) is acommercial bank chartered in the Commonwealth of Pennsylvania and awholly-owned subsidiary of Fidelity D & D Bancorp, Inc. (the Company orcollectively, the Company).  Havingcommenced operations in 1903, the Bank is committed to provide superior customerservice, while offering a full range of banking products and financial andtrust services, to both our consumer and commercial customers from its mainoffice located in Dunmore and other branches throughout Lackawanna and Luzernecounties.

# **Principles of consolidation**

# The accompanying unaudited consolidated financialstatements of the Company and the Bank 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 footnotedisclosures required by GAAP for complete financial statements.  In the opinion of management, all normalrecurring adjustments necessary for a fair presentation of the financialcondition and results of operations for the periods have been included.  All significant inter-company balances andtransactions have been eliminated in consolidation.  Prior period amounts are reclassified whennecessary to conform to the current period’s presentation.

The preparation of financial statements in conformity with GAAPrequires management to make estimates and assumptions that affect the reportedamounts of assets and liabilities and disclosure of contingent assets andliabilities at the date of the financial statements and the reported amounts ofrevenues and expenses during the reported periods.  Actual results could differ from thoseestimates.  For additional informationand disclosures required under GAAP, refer to the Company’s Annual Report onForm 10-K for the year ended December 31, 2006.

Management is responsible for the fairness, integrity and objectivityof the unaudited financial statements included in this report.  Management prepared the unaudited financialstatements in accordance with GAAP.  Inmeeting its responsibility for the financial statements, management depends onthe Company’s accounting systems and related internal controls.  These systems and controls are designed toprovide reasonable, but not absolute, assurance that the financial recordsaccurately reflect the transactions of the Company, the Company’s assets aresafeguarded and that the financial statements present fairly the financialcondition and results of operations of the Company.

In the opinion of management, the consolidated balance sheets as ofMarch 31, 2007 and December 31, 2006 and the related consolidated statements ofincome for the three-month periods ended March 31, 2007 and 2006 and changes inshareholders’ equity and cash flows for the three month periods ended March 31,2007 and 2006 present fairly the financial condition and results of operationsof the Company.  All material adjustmentsrequired for a fair presentation have been made.  These adjustments are of a normal recurringnature.

This Quarterly Report on Form 10-Q should be read in conjunction withthe Company’s audited financial statements for the year ended December 31,2006, and the notes included therein, included within the Company’s AnnualReport filed on Form 10-K.

# **Critical accounting policies**

The presentation of financial statements in conformity with GAAPrequires management to make estimates and assumptions that affect many of thereported amounts and disclosures. 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, 2007, is adequateand reasonable.  Given the subjectivenature of identifying and valuing loan losses, it is likely that well-informedindividuals could make materially different assumptions and could, therefore,calculate a materially different allowance value.  While management uses available informationto recognize losses on loans, changes in economic conditions may necessitate

7

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revisions in thefuture.  In addition, various regulatoryagencies, as an integral part of their examination process, periodically reviewthe Company’s allowance.  Such agenciesmay require the Company to recognize adjustments to the allowance based ontheir judgments of information available to them at the time of theirexamination.

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

The fair value ofresidential mortgage loans, classified as AFS, is obtained from the FederalNational Mortgage Association  or thePennsylvania Housing Finance Authority. To determine the fair value of student loans, classified as AFS, theBank uses the pricing obtained from the most recent student loans sold from itsAFS portfolio.  From time-to-time, theBank may originate Small Business Administration (SBA) loans AFS.  The fair value of SBA loans, classified asAFS, is obtained from an outside pricing source.  The market to which the Bank sells mortgageand other loans is restricted and price quotes from other sources are nottypically obtained.  As of March 31, 2007and December 31, 2006, the AFS loan portfolio consisted of residentialmortgages and student loans.

**2.             Earnings per share**

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

In the computationof diluted EPS, the Company uses the treasury stock method to determine thedilutive effect of its granted but unexercised stock options.  Under this method, the assumed proceedsreceived from shares issued, in a hypothetical stock option exercise, are assumedto be used to purchase treasury stock. Pursuant to the guidance of Statement of Financial Accounting Standard(SFAS) No. 128, *Earnings Per Share,* proceedsinclude: proceeds from the exercise of outstanding stock options; compensationcost for future service that the Company has not yet recognized; and any “windfall”tax benefits that would be credited directly to shareholders’ equity when thegrant generates a tax deduction (or a reduction in proceeds if there is acharge to equity).  For a furtherdiscussion on the Company’s stock option plans, see Note 3, below.

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

| Three months ended March 31,              | ** ** | **2007**  | ** ** | **2006**  | ** ** |
|---------------------------------------------------------------|------------|-----------|------------|-----------|------------|
|                                                          |       |      |       |      |       |
| Basic EPS:                                                    |       |      |       |      |       |
|                                                          |       |      |       |      |       |
| Net income  available to common shareholders                  |       | $         | 1,044,351  |      | $          | 1,031,631 |   |
|                                                          |       |      |       |      |       |
| Weighted-average  common shares outstanding                   |       | 2,060,517 |       | 2,041,979 |       |
|                                                          |       |      |       |      |       |
| Basic EPS                                                     |       | $         | 0.51       |      | $          | 0.51 |   |
|                                                          |       |      |       |      |       |
| Diluted EPS:                                                  |       |      |       |      |       |
|                                                          |       |      |       |      |       |
| Net income  available to common shareholders                  |       | $         | 1,044,351  |      | $          | 1,031,631 |   |
|                                                          |       |      |       |      |       |
| Weighted-average  common shares outstanding                   |       | 2,060,517 |       | 2,041,979 |       |
|                                                          |       |      |       |      |       |
| Dilutive  potential common shares                             |       | 1,042     |       | 2,321     |       |
|                                                          |       |      |       |      |       |
| Weighted-average  common shares and dilutive potential shares |       | 2,061,559 |       | 2,044,300 |       |
|                                                          |       |      |       |      |       |
| Diluted EPS                                                   |       | $         | 0.51       |      | $          | 0.50 |   |

 

8

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**3.             Stock plans**

The Company usesthe fair value method of accounting for stock-based compensation provided underSFAS 123R, *Share Based Payment*.  SFAS 123R requires that the cost ofshare-based payment transactions (including those with employees andnon-employees) be recognized in the financial statements.  SFAS 123R applies to all share-based paymenttransactions in which an entity acquires goods or services by issuing (oroffering to issue) its shares, share options, or other equity instruments(except for those held by an ESOP) or by incurring liabilities (1) in amountsbased (even in part) on the price of the entity’s shares or other equityinstruments, or (2) that require (or may require) settlement by the issuance ofan entity’s shares or other equity instruments.

The Company hastwo stock-based compensation plans (the stock option plans).  The stock option plans wereshareholder-approved and permit the grant of share-based compensation awards toits directors, key officers and certain other employees.  The Company believes that these stock optionplans better align the interest of its directors, key officers and employeeswith the interest of its shareholders. The Company further believes that the granting of share-based awards,under the provisions of the stock option plans, is necessary to retain theknowledge base, continuity and expertise of its directors, key officers andcertain employees.

The Companyestablished the 2000 Independent Directors Stock Option Plan and has reserved55,000 shares of its un-issued capital stock for issuance under the plan.  Under the 2000 Independent Directors StockOption Plan, each outside director is awarded stock options to purchase 500shares of the Company’s common stock on the first business day of January, eachyear, at the fair market value on date of grant.  No stock options were awarded during thefirst three months of 2007 or for the year ended December 31, 2006, due to thedirectors’ voluntary election to forego the award.  At March 31, 2007 there were 14,850unexercised stock options outstanding under this plan.

The Company hasalso established the 2000 Stock Incentive Plan and has reserved 55,000 sharesof its un-issued capital stock for issuance under the plan.  Under the 2000 Stock Incentive Plan, keyofficers and certain other employees are eligible to be awarded qualified stockoptions to purchase the Company’s common stock at the fair market value on thedate of grant.  No stock options wereawarded during the first quarter of 2007. During the first quarter of 2006, 2,200 stock options were issued underthis plan at a grant-date fair value of $6.21 per share.  The options vest over a six month period andfor the three months ended March 31, 2006 approximately $7,000 of stock-basedcompensation expense was recorded and is included as a component of salariesand employee benefits in the consolidated statements of income.  As of March 31, 2007, there were 5,830unexercised stock options outstanding under this plan.

In addition to the twostock option plans above, the Company has established the 2002 Employee StockPurchase Plan (the ESPP) and has reserved 110,000 shares of its un-issuedcapital stock for issuance under the plan. The plan was designed to promote broad-based employee ownership of theCompany’s stock.  Under the 2002 ESPP,employees may have automatic payroll deductions to purchase the Company’scapital stock at a discounted price based on the fair market value of theCompany’s capital stock on either the commencement date or terminationdate.  At March 31, 2007, 8,317 shareshave been issued under the ESPP.  TheESPP is considered a compensatory plan and, as such, is required to comply withthe provisions of SFAS 123R.  The Companyrecognizes compensation expense on its ESPP Plan on the date the shares arepurchased.  For the three months endedMarch 31, 2007 and 2006, compensation expense related to the ESPP approximated$7,000 and $15,000, respectively, and is included as a component of salariesand employee benefits in the consolidated statements of income.

**4.             Derivative instruments**

As part of theCompany’s overall interest rate risk management strategy, the Company hasadopted a policy whereby the Company may periodically use derivativeinstruments to minimize significant fluctuations in earnings caused by interestrate volatility.  This interest rate riskmanagement strategy entails the use of interest rate floors, caps andswaps.  During the fourth quarter of2006, the Company entered into a three-year interest rate floor derivativeagreement on $20,000,000 notional value of its prime-based loan portfolio.  The transaction required the payment of a premiumby the Company to the seller for the right to receive payments in the eventnational prime drops below a pre-determined level (strike rate), essentiallyconverting floating rate loans to fixed rate loans when prime drops below thecontractual strike rate.  When purchased,the Company recorded an asset representing the fair value of the hedge at thetime of purchase.  The Company hasdesignated this agreement as a cash flow hedge pursuant to SFAS No. 133.  Accordingly, the change in the fair value ofthe instrument related to the hedge’s intrinsic value, or approximately$59,000, is recorded as a component of OCI in the consolidated statement ofchanges in shareholders’ equity and the portion of the change in fair valuerelated to the time value expiration, or approximately $51,000, is recorded inthe consolidated statements of income as a reduction of interest income.  No gain or loss has been recognized inearnings due to hedge ineffectiveness as of March 31, 2007.  As of March 31, 2007, the Company does notexpect to reclassify any amount from OCI to earnings over the next twelvemonths and no hedge has been discontinued. Also, as of March 31, 2007, the fair value of the derivative contractapproximated $233,000 and is a

9

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component of otherassets in the consolidated balance sheet.

**5.             Recent accounting pronouncements**

In July 2006, the Financial Accounting Standards Board(FASB) issued Interpretation No. 48, *Accounting for Uncertaintyin Income Taxes—an interpretation of FASB Statement No. 109* (FIN48).  FIN 48 clarifies the accounting foruncertainty in income taxes recognized in an enterprise’s financial statementsin accordance with FASB Statement 109, *Accounting for IncomeTaxes*.  FIN 48 is effectivefor the year ended December 31, 2007.

The Company has evaluated its material tax positionsas of March 31, 2007, and does not expect the adoption of this interpretationto have an immediate effect on its consolidated financial statements.  Under the “more-likely-than-not” thresholdguidelines, the Company believes no significant uncertain tax positions exist,either individually or in the aggregate, that would give rise to thenon-recognition of an existing tax benefit. In periods subsequent to March 31, 2007, determinations of potentiallyadverse material tax positions will be evaluated to determine whether anuncertain tax position may have previously existed or has been originated.  In the event an adverse tax position isdetermined to exist, penalty and interest will be accrued, in accordance withthe Internal Revenue Service guidelines, and recorded as a component of otherexpenses in the Company’s consolidated statements of income.

As of March 31, 2007, there were no unrecognized taxbenefits that, if recognized, would significantly affect the Company’seffective tax rate.  Also, as of March31, 2007, there were no penalties and interest recognized in the consolidatedstatements of income as a result of the adoption of FIN 48, nor does theCompany foresee a change in its material tax positions that would give rise tothe non-recognition of a an existing tax benefit during the forthcoming twelvemonths.

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

The following is management’s discussion and analysisof the significant changes in the consolidated financial condition of theCompany as of March 31, 2007 compared to December 31, 2006 and the results ofoperations for the three months ended March 31, 2007 and March 31, 2006.  Current performance may not be indicative offuture results.  This discussion shouldbe read in conjunction with the Company’s 2006 Annual Report filed on Form10-K.

**Forward-looking statements**

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

Forward-looking statements are based on variousassumptions and analyses made by us in light of management’s experience and itsperception of historical trends, current conditions and expected futuredevelopments, as well as other factors management believes are appropriateunder the circumstances.  Thesestatements are not guarantees of future performance and are subject to risks,uncertainties and other factors (many of which are beyond our control) thatcould cause actual results to differ materially from future results expressedor implied by such forward-looking statements. These factors include, without limitation, the following:

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

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

·                  changesin the interest rate environment may reduce interest margins;

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

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

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

·                  legislativeor regulatory changes may adversely affect our business;

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

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

·                  actsof war or terrorism; or

·                  naturaldisaster.

Management cautions readers not to place unduereliance on forward-looking statements, which reflect analyses only as of thedate of this document.  We have noobligation to update any forward-looking statements to reflect events orcircumstances after the date of this document.

Readers should review the risk factors described inother documents that we file or furnish, from time to time, with the Securitiesand Exchange Commission, including Annual Reports to Shareholders, AnnualReports filed on Form 10-K and other current reports filed or furnished on Form8-K.

**General**

The Company’s principal revenues are derived frominterest, dividends and fees earned on its interest-earning assets, which arecomprised of loans, securities and other short-term investments.  The Company’s principal expenses consist ofinterest paid on its interest-bearing liabilities, which are comprised ofdeposits, short-and long-term borrowings and operating and generalexpenses.  The Company’s profitabilitydepends primarily on its net interest income. Net interest income is thedifference between interest income and interest expense.  Interest income is generated from yields oninterest-earning assets which consist principally of loans and investmentsecurities. Interest expense is incurred from rates paid on interest-bearingliabilities, which consist of deposits and borrowings. Net interest income isdependent upon the interest-rate spread (i.e., the difference between theyields earned on its interest-earning assets and the rates paid on itsinterest-bearing liabilities) and the relative amounts of interest-earningassets and interest-bearing liabilities. The interest rate spread is significantly impacted by: changes ininterest rates and market yield curves and their related impact on cash flows;the composition and characteristics of interest-earning assets andinterest-bearing liabilities; differences in the maturity and re-pricingcharacteristics of assets compared to the maturity and re-pricingcharacteristics of the liabilities that fund them and by the competition in ourmarketplace.

The Company’s profitability is also affected by thelevel of its non-interest income and expenses, provision for loan losses andprovision for income taxes.  Non-interestincome consists mostly of service charges on the Bank’s loan and depositproducts, trust and asset management service fees, increases in the cashsurrender value of the bank owned life insurance (BOLI), net gains or lossesfrom sales of loans and securities AFS and from the sales of other real estate(ORE) properties.  Non-interest expenseconsists of compensation and related employee benefit expenses, occupancy,equipment, data processing, advertising, marketing, professional fees,insurance and other operating overhead.

The Company’s profitability is significantly affectedby general economic and competitive conditions, changes in market interestrates, government policies and actions of regulatory authorities.  The Company’s loan portfolio is comprisedprincipally of commercial and commercial real estate loans.  The properties underlying the Company’smortgages are concentrated in Northeastern Pennsylvania.  Credit risk, which represents the possibilityof the Company not recovering amounts due from its borrowers, is significantlyrelated to local economic conditions in the areas the properties are located aswell as the Company’s underwriting standards. Economic conditions affect the market value of the underlying collateralas well as the levels of adequate cash flow and revenue generation fromincome-producing commercial and multi-family properties.

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**COMPARISONOF RESULTS OF OPERATIONS**

**THREE MONTHS ENDED MARCH 31, 2007 AND MARCH 31,2006**

**Overview**

Net income for the first quarter of 2007 was$1,044,000, or a slight increase compared to $1,032,000 recorded in the samequarter in 2006.  Diluted earnings pershare were $0.51 and $0.50 for each of the respective periods.  The increase in net income was the result ofincreases in net interest income, non-interest income and a decrease in theprovision for loan losses, partially offset by increases in non-interestexpense and the provision for income taxes.

Return on average assets (ROA) and return on averageshareholders’ equity (ROE) were 0.75% and 8.12%, respectively, for the threemonths ended March 31, 2007 compared to 0.75% and 8.51%, respectively, for thesame period in 2006.  The change in ROEwas caused by higher average equity in the current period fueled by higherretained earnings.

*Net interest income and interestsensitive assets / liabilities*

Net interest income increased $74,000 to $4,304,000 for the firstquarter of 2007, from $4,230,000 recorded in the same period of 2006.  The increase was principally due to therestoration of some large commercial loans from non-performing to performingstatus during the second half of 2006. During the first quarter of 2007, the yield on the commercial loanportfolio increased 60 basis points compared to the first quarter of 2006.  In addition, all other categories of earningassets were either originated or re-priced at higher rates in the first quarterof 2007 compared to the first quarter of 2006. Partially offsetting the effect interest rates had on interest-earningassets was an increase in interest expense of $664,000, or 18%, caused mostlyby increases in rates paid on interest-bearing deposits.  The blended rate paid on all interest-bearingdeposits increased 87 basis points in the current year quarter compared to thecomparative quarter of 2006.  Theincrease in rates paid was due to deposit-gathering strategies and competitivepressure in conjunction with the prolonged inverted-shaped interest rate yieldcurve.  The average balance of totalinterest-bearing deposits increased $24,600,000 during the first quarter of2007 compared to the same quarter of 2006 and is also $14,600,000 higher onaverage than the average for the full year 2006.  The Bank will continue its quest to raisedeposit levels and reduce its dependency on high-cost borrowings.  Interest expense on borrowings and repurchaseagreements declined $273,000 due mostly to lower average-balances.  Average balances of borrowings declinedalmost $19,800,000.

During the first quarterof 2007, the Bank’s tax-equivalent margin and spread were 3.36% and 2.66%,respectively, compared to 3.34% and 2.77% during the first quarter of2006.  The decline in spread was frominterest costs outpacing the yields earned on assets.  The two basis point improvement in margin isfrom a slightly higher net interest income in the first quarter of 2007compared to the first quarter of 2006.

The inverted treasury yield curve will continue to pressure the Bank’snet interest income performance. However, our successful deposit gathering strategies, debt reduction,and improved credit quality of the Bank’s earning assets will help position theBank to optimize net interest income during this challenging rate environmentand should be further enhanced when the shape of the yield curve returns to amore normal slope.

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The following table sets forth, a comparison of average balance sheetamounts and their corresponding fully tax-equivalent (FTE) interest income andexpense and annualized tax-equivalent yield and cost for the periods indicated(dollars in thousands):

|                                               | ** ** | **Three months ended** | ** ** | **Year ended**   | ** ** |
|-----------------------------------------------|------------|----------------------------------|------------|-----------------------|------------|
| ** **                                    | ** ** | **March 31,**               | ** ** | **December 31,** | ** ** |
| ** **                                    | ** ** | **2007**                         | ** ** | **2006**              | ** ** | **2006** | ** ** |
| Average  interest-earning assets:             |       |                             |       |                  |       |   |   |
| Loans and leases                              |       | $                                | 425,380    |                  | $          | 414,410 |   | $ | 418,390 |   |
| Investments                                   |       | 104,521                          |       | 114,098               |       | 115,319 |   |
| Federal funds  sold                           |       | 4,178                            |       | 3,385                 |       | 2,479 |   |
| Interest-bearing  deposits                    |       | 211                              |       | 280                   |       | 240 |   |
| Total                                         |       | $                                | 534,290    |                  | $          | 532,173 |   | $ | 536,428 |   |
|                                          |       |                             |       |                  |       |   |   |
| Average  interest-bearing liabilities:        |       |                             |       |                  |       |   |   |
| Other  interest-bearing deposits              |       | $                                | 200,164    |                  | $          | 172,856 |   | $ | 185,786 |   |
| Certificates of  deposit                      |       | 154,738                          |       | 157,446               |       | 154,474 |   |
| Borrowed funds                                |       | 67,400                           |       | 87,158                |       | 79,627 |   |
| Repurchase  agreements                        |       | 17,873                           |       | 24,786                |       | 23,391 |   |
| Total                                         |       | $                                | 440,175    |                  | $          | 442,246 |   | $ | 443,278 |   |
|                                          |       |                             |       |                  |       |   |   |
| Interest income  (FTE):                       |       |                             |       |                  |       |   |   |
| Loans and leases                              |       | $                                | 7,341      |                  | $          | 6,699 |   | $ | 28,357 |   |
| Investments                                   |       | 1,362                            |       | 1,306                 |       | 5,612 |   |
| Federal funds  sold                           |       | 54                               |       | 35                    |       | 123 |   |
| Interest-bearing  deposits                    |       | 3                                |       | 3                     |       | 9 |   |
| Total                                         |       | $                                | 8,760      |                  | $          | 8,043 |   | $ | 34,101 |   |
|                                          |       |                             |       |                  |       |   |   |
| Interest  expense:                            |       |                             |       |                  |       |   |   |
| Other  interest-bearing deposits              |       | $                                | 1,630      |                  | $          | 1,050 |   | $ | 5,467 |   |
| Certificates of  deposit                      |       | 1,705                            |       | 1,347                 |       | 6,026 |   |
| Borrowed funds                                |       | 878                              |       | 1,131                 |       | 4,244 |   |
| Repurchase  agreements                        |       | 115                              |       | 135                   |       | 624 |   |
| Total                                         |       | $                                | 4,328      |                  | $          | 3,663 |   | $ | 16,361 |   |
|                                          |       |                             |       |                  |       |   |   |
| Net interest  income (FTE)                    |       | $                                | 4,432      |                  | $          | 4,380 |   | $ | 17,740 |   |
|                                          |       |                             |       |                  |       |   |   |
| Yield on average  interest-earning assets     |       | 6.65                             | %          | 6.13                  | %          | 6.36 | % |
| Rate on average  interest-bearing liabilities |       | 3.99                             | %          | 3.36                  | %          | 3.69 | % |
| Net interest  spread                          |       | 2.66                             | %          | 2.77                  | %          | 2.67 | % |
| Net interest margin                           |       | 3.36                             | %          | 3.34                  | %          | 3.31 | % |

 

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

*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 and lease portfolio.  Loans andleases determined to be uncollectible are charged off against the allowance forloan losses.

The required amount ofthe provision for loan losses, based upon the adequate level of the allowancefor loan losses, is subject to ongoing analysis of the loan portfolio.  The Bank’s Special Asset Committee meetsperiodically to review problem loans and leases.  The committee is comprised of Bankmanagement, including the chief risk officer, loan workout officers andcollection personnel.  The committeereports quarterly to the Credit Administration Committee of the Board ofDirectors.

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

·                  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 management

·                  Nationaland local economic trends and conditions

·                  Changes incredit concentrations

TheBank’s non-performing loans declined year-over-year by $5,476,000 to $3,520,000at March 31, 2007 compared to $8,996,000 at March 31, 2006.  The non-accrual component of non-performingloans showed a $5,666,000 decline in the same period as the Bank continues tomake progress in moving non-performing loans to performing status.

There was no provisionfor loan losses made at March 31, 2007 while $75,000 was provided for the March31, 2006 period.  After taking intoaccount charge-offs and recoveries during the period, the allowance was$5,360,000 at March 31, 2007 compared to $5,716,000 at March 31, 2006.  Both the decrease in the provision for loan losses andthe level of the allowance were driven by the decrease in the non-performingloans mentioned above.  Our SpecialAssets Department continues to make progress carrying out exit strategiesand/or resolution plans for each of the non-performing loans.

*Other income*

Total other(non-interest) income improved $85,000, or 8%, for the three months ended March31, 2007 compared to the three months ended March 31, 2006.  The current year quarter includes a $97,000gain from the sale of an owned commercial facility previously leased to anon-related third party.

*Other operating expenses*

For the first quarterended March 31, 2007, other (non-interest) expenses increased $190,000, or 5%,compared to the same 2006 quarter. Salaries and related employee benefits increased $128,000, or 6%, due toannual merit pay increases and interim recognition of performance-basedincentives.  The increase in advertisingwas caused by our first-time winter deposit-gathering campaign which included costsfor direct mail, point-of-sale promotional material and premiums.  The increase in the other component of otheroperating expense included increases in professional service and collectionfees partially offset by decreases in office supplies, ATM expenses, andoverdraft management service fees.

*Income tax provision*

The provision forincome taxes increased $31,000 in the first quarter of 2007 compared to therespective 2006 quarter.  The increasewas due to a combination of $43,000 in additional pre-tax income and a decreasein tax-free interest income from municipal securities, tax-free loans andearnings from the BOLI, collectively representing a smaller component ofpre-tax earnings in 2007 compared to 2006.

**COMPARISON OF FINANCIAL CONDITIONAT**

**MARCH 31,2007 AND DECEMBER 31, 2006**

*Overview*

Consolidated assetsincreased $2,308,000 during the three months ended March 31, 2007.  Contributing to the net asset increase wereincreases in total deposits of $3,732,000 and shareholders’ equity of$1,022,000 partially offset by a reduction in combined short- and long-termborrowings of $2,253,000.

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*Investment securities*

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

At March 31, 2007, thecarrying value of investment securities totaled $101,292,000, or 18% of totalassets compared to $100,411,000 or 18% of total assets at December 31,2006.  At March 31, 2007, approximately41% of the carrying value of the investment portfolio was comprised ofmortgage-backed securities that amortize and provide monthly cash flow.  Agency, corporate and municipal bondscomprised 32%, 15% and 12%, respectively, of the investment portfolio at March31, 2007.

As illustrated in thefollowing table of amortized cost and fair market value of investmentsecurities, the portfolio is comprised of HTM and AFS securities with carryingvalues of $1,370,000 and $99,922,000, respectively.  At March 31, 2007, the AFS debt securitieswere recorded with a net unrealized loss in the amount of $1,405,000 and equitysecurities were recorded with an unrealized gain of $183,000 (dollars inthousands):

|                                                  | ** ** | **Amortized** | ** ** | **Gross unrealized** | ** ** | **Gross unrealized** | ** ** | **Fair**  | ** ** |
|--------------------------------------------------|------------|---------------|------------|---------------------------|------------|---------------------------|------------|-----------|------------|
| ** **                                       | ** ** | **cost**      | ** ** | **gains**                 | ** ** | **losses**                | ** ** | **value** | ** ** |
|                                             |       |          |       |                      |       |                      |       |      |       |
| Held-to-maturity  securities:                    |       |          |       |                      |       |                      |       |      |       |
| Mortgage-backed securities                       |       | $             | 1,370      |                      | $          | 31                        |       | $         | —     |   | $ | 1,401 |   |
|                                             |       |          |       |                      |       |                      |       |      |       |
| Available-for-sale  securities:                  |       |          |       |                      |       |                      |       |      |       |
| U.S. government agencies and corporations        |       | $        | 33,078     |                      | $     | 9                         |       | $    | 576        |   | $  | 32,511 |   |
| Obligations of states and political subdivisions |       | 12,298        |       | 38                        |       | 16                        |       | 12,320    |       |
| Corporate bonds                                  |       | 14,690        |       | 44                        |       | 44                        |       | 14,690    |       |
| Mortgage-backed securities                       |       | 40,799        |       | 1                         |       | 861                       |       | 39,939    |       |
|                                             |       |          |       |                      |       |                      |       |      |       |
| Total debt securities                            |       | 100,865       |       | 92                        |       | 1,497                     |       | 99,460    |       |
|                                             |       |          |       |                      |       |                      |       |      |       |
| Equity securities                                |       | 279           |       | 183                       |       | —                    |       | 462       |       |
|                                             |       |          |       |                      |       |                      |       |      |       |
| Total  available-for-sale                        |       | $             | 101,144    |                      | $          | 275                       |       | $         | 1,497      |   | $ | 99,922 |   |

 

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The amortized cost and fair value of debt securitiesat March 31, 2007 by contractual maturity are as follows (dollars inthousands):

|                                           | ** ** | **Amortized** | ** ** | **Market** | ** ** |
|-------------------------------------------|------------|---------------|------------|------------|------------|
| ** **                                | ** ** | **cost**      | ** ** | **value**  | ** ** |
| Held-to-maturity  securities:             |       |          |       |       |       |
| Mortgage-backed securities                |       | $             | 1,370      |       | $          | 1,401 |   |
|                                      |       |          |       |       |       |
| Available-for-sale  securities:           |       |          |       |       |       |
| Debt securities:                          |       |          |       |       |       |
| Due in one year or less                   |       | $             | 1,000      |       | $          | 982 |   |
| Due after one year through five years     |       | 5,998         |       | 5,925      |       |
| Due after five years through ten years    |       | 18,654        |       | 18,453     |       |
| Due after ten years                       |       | 34,414        |       | 34,161     |       |
| Total debt securities                     |       | 60,066        |       | 59,521     |       |
|                                      |       |          |       |       |       |
| Mortgage-backed securities                |       | 40,799        |       | 39,939     |       |
|                                      |       |          |       |       |       |
| Total  available-for-sale debt securities |       | $             | 100,865    |       | $          | 99,460 |   |

 

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

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

At March 31, 2007, theAFS debt securities portfolio was carried at a net unrealized loss of$1,405,000 compared to a net unrealized loss of $1,656,000 at December 31,2006, or an improvement of $251,000.  Alarge portion of the unrealized losses was for a continuous period of more than12 months.  However, management believesthe cause of these unrealized losses is directly related to changes in marketinterest rates.  As of March 31, 2007,however, most all of the deterioration of the AFS debt portfolio is frominvestments that are guaranteed by the U.S. government or one of its agencies.  In analyzing an issuer’s financial condition,management considers whether the securities are issued by the U.S. government,its agencies or other governments, whether downgrades by bond rating agencieshave occurred and, if necessary, reviews of the issuer’s financialcondition.  Because the decline in marketvalues is attributable to changes in interest rates and not credit quality, andthe Company has the ability and intent to hold those securities until recoveryof fair value, which may be maturity, management views these unrealized lossesto be temporary.

The current interest rateenvironment, essentially a sustaining period of yield curve inversion,continues to preclude structured investment portfolio growth.  As such, the Company will attempt to replaceinvestment securities that mature, pay-down, are called or amortize with bondsthat provide incremental earnings above the Bank’s funding sources.  In addition, cash flows from investments maybe used to repay debt and fund growth in the loan portfolio.

*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 nolonger produce yields consistent with the current market.  In a declining interest rate environment, theBank would be exposed to prepayment risk and, as rates on adjustable rate loansdecrease, interest income would be negatively affected.  To better manage prepayment and interest raterisk, loans that meet these conditions may be considered for sale in thesecondary market.  Consideration is alsogiven to the Company’s current liquidity position and expected future liquidityneeds.  Loans AFS are carried at thelower of cost or estimated fair value. If the fair values of these

16

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loans fall below theiramortized cost, the difference is written down and charged to currentearnings.  Subsequent appreciation in theportfolio, if any, is credited to current earnings but only to the extent ofprevious write-downs.

At March 31, 2007, loansAFS amounted to $371,000 with a corresponding fair value of $372,000, comparedto $122,000 and $123,000, respectively, at December 31, 2006.  During the first quarter of 2007, residentialmortgage and student loans with principal balances of $3,982,000 were sold intothe secondary market with combined net gains of approximately $37,000recognized.

*Loans and leases  *

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

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

Gross loans, of$422,585,000 at March 31, 2007 were essentially unchanged from December 31,2006.  The composition of the loanportfolio at March 31, 2007 and December 31, 2006, is summarized as follows:

|                                        | ** ** | **March 31, 2007** | ** **  | **December 31, 2006** | ** ** |
|----------------------------------------|------------|------------------------------|-------------|---------------------------------|------------|
| ** **                             | ** ** | **Amount**                   | ** **  | **%**                           | ** ** | **Amount** | ** ** | **%** | ** ** |
| Commercial and  commercial real estate |       | $                            | 219,530,227 |                            |       | 51.9 |   |   | $ | 218,213,216 |   |   | 51.6 |   |   |
| Residential real  estate               |       | 113,494,762                  |        |                            | 26.9       |   |   | 112,742,692 |   |   | 26.7 |   |   |
| Consumer and  home equity              |       | 76,025,085                   |        |                            | 18.0       |   |   | 77,729,520 |   |   | 18.4 |   |   |
| Real estate  construction              |       | 12,968,521                   |        |                            | 3.1        |   |   | 13,369,712 |   |   | 3.2 |   |   |
| Direct financing  leases               |       | 566,178                      |        |                            | 0.1        |   |   | 588,211 |   |   | 0.1 |   |   |
| Gross loans                            |       | 422,584,773                  |        |                            | 100.0      |   |   | 422,643,351 |   |   | 100.0 |   |   |
| Allowance for loan losses              |       | (5,359,758                   | )           |                            |       | (5,444,303 | ) |   |   |
| Net loans                              |       | $                            | 417,225,015 |                            |       |   | $ | 417,199,048 |   |   |   |

 

*Allowance for loan losses*

Management continuallyevaluates the credit quality of the Bank’s loan and lease portfolio andperforms a formal review of the adequacy of the allowance for loan losses (theallowance), on a quarterly basis.  Theallowance reflects management’s best estimate of the amount of credit losses inthe loan portfolio.  Management’sjudgment is based on the evaluation of individual loans, past experience, theassessment of current economic conditions and other relevant factors includingthe amounts and timing of cash flows expected to be received on impairedloans.  Those estimates may besusceptible to significant change.  Theprovision for loan losses represents the amount necessary to maintain anappropriate allowance.  Loan losses arecharged directly against the allowance when loans are deemed to beuncollectible.  Recoveries frompreviously charged-off loans are added to the allowance when received.

17

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

·                  Identification of specific problemloans by loan category;

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

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

·                  Application of historical losspercentages (five-year average) to pools to determine the allowance allocation;and

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

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

Net charge-offs for thethree months ended March 31, 2007 were $85,000, compared to $343,000 for thesame period in 2006.  There were netrecoveries of commercial loans of $6,000 for the three months ended March 31,2007 compared to net charge-offs of $188,000 for the same three months of2006.  There were no commercial loancharge-offs in the first three months of 2007 with recoveries of $6,000.  By comparison, in the first three months of2006 there were gross commercial loan charge-offs of $213,000 and recoveries of$25,000.  Real estate mortgages had netrecoveries of $12,000 in the first three months of 2007 as compared to netcharge-offs of $32,000 in the first three months of 2006.  Consumer loan net charge-offs were $102,000in the quarter ended March 31, 2007 as compared to $124,000 for the samequarter of 2006.

Management believes thatthe current balance in the allowance for loans losses of $5,360,000 is sufficientto withstand the identified potential credit quality issues that may arise andare inherent to the portfolio. Currently, management is unaware of any potential problem loans thathave not been reviewed.  Potentialproblem loans are those where there is known information that leads managementto believe repayment of principal and/or interest is in jeopardy and the loansare neither on non-accrual status nor past due 90 days or more.  However, there could be instances whichbecome identified over the year that may require additional charge-offs and/orincreases to the allowance.  The ratio ofallowance for loan losses to total loans was 1.27% at March 31, 2007 comparedto 1.29% at December 31, 2006 and 1.37% at March 31, 2006.

18

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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**          | ** **  | **twelve months ended**         | ** ** | **three months ended**          | ** ** |
| ** **                       | ** ** | **March 31, 2007**              | ** **  | **December 31, 2006**           | ** ** | **March 31, 2006**              | ** ** |
|                             |       |                                      |        |                                      |       |                                      |       |
| Balance at beginning of  period  |       | $                                         | 5,444,303   |                                      | $          | 5,984,649                                 |       | $ | 5,984,649 |   |
|                             |       |                                      |        |                                      |       |                                      |       |
| Provision charged to  operations |       | —                                    |        | 325,000                                   |       | 75,000                                    |       |
|                             |       |                                      |        |                                      |       |                                      |       |
| Charge-offs:                     |       |                                      |        |                                      |       |                                      |       |
| Commercial                       |       | —                                    |        | 660,471                                   |       | 213,093                                   |       |
| Residential real  estate         |       | 1,585                                     |        | 109,164                                   |       | 31,626                                    |       |
| Consumer                         |       | 109,657                                   |        | 285,379                                   |       | 137,334                                   |       |
| Lease financing                  |       | —                                    |        | —                                    |       | —                                    |       |
| Total                            |       | 111,242                                   |        | 1,055,014                                 |       | 382,053                                   |       |
|                             |       |                                      |        |                                      |       |                                      |       |
| Recoveries:                      |       |                                      |        |                                      |       |                                      |       |
| Commercial                       |       | 5,723                                     |        | 64,173                                    |       | 25,576                                    |       |
| Residential real  estate         |       | 13,563                                    |        | 532                                       |       | 30                                        |       |
| Consumer                         |       | 7,411                                     |        | 124,763                                   |       | 13,071                                    |       |
| Lease financing                  |       | —                                    |        | 200                                       |       | 200                                       |       |
| Total                            |       | 26,697                                    |        | 189,668                                   |       | 38,877                                    |       |
|                             |       |                                      |        |                                      |       |                                      |       |
| Net charge-offs                  |       | 84,545                                    |        | 865,346                                   |       | 343,176                                   |       |
|                             |       |                                      |        |                                      |       |                                      |       |
| Balance at end of  period        |       | $                                         | 5,359,758   |                                      | $          | 5,444,303                                 |       | $ | 5,716,473 |   |
|                             |       |                                      |        |                                      |       |                                      |       |
| Total loans, end of period       |       | $                                         | 422,955,523 |                                      | $          | 422,765,351                               |       | $ | 416,096,315 |   |

 
| ** **                                                                     | ** ** | **As of and for the** | ** ** | **As of and for the** | ** ** | **As of and for the** | ** ** |
|--------------------------------------------------------------------------------|------------|-------------------------------------------|------------|-------------------------------------------|------------|-------------------------------------------|------------|
| ** **                                                                     | ** ** | **three months ended**          | ** ** | **twelve months ended**         | ** ** | **three months ended**          | ** ** |
| ** **                                                                     | ** ** | **March 31, 2007**              | ** ** | **December 31, 2006**           | ** ** | **March 31, 2006**              | ** ** |
| Net charge-offs to:                                                            |       |                                      |       |                                      |       |                                      |       |
| Loans, end of  period                                                          |       | 0.02                                      | %          | 0.20                                      | %          | 0.08                                      | %          |
| Allowance for  loan losses                                                     |       | 1.58                                      | %          | 15.89                                     | %          | 6.00                                      | %          |
| Provisions for  loan losses                                                    |       | —                                    | x          | 2.66                                      | x          | 4.58                                      | x          |
|                                                                           |       |                                      |       |                                      |       |                                      |       |
| Allowance for loan  losses to:                                                 |       |                                      |       |                                      |       |                                      |       |
| Total loans                                                                    |       | 1.27                                      | %          | 1.29                                      | %          | 1.37                                      | %          |
| Non-accrual  loans                                                             |       | 1.69                                      | x          | 1.62                                      | x          | 0.65                                      | x          |
| Non-performing  loans                                                          |       | 1.52                                      | x          | 1.58                                      | x          | 0.64                                      | x          |
| Net charge-offs                                                                |       | 63.40                                     | x          | 6.29                                      | x          | 16.66                                     | x          |
|                                                                           |       |                                      |       |                                      |       |                                      |       |
| Loans 30-89 days past  due and still accruing                                  |       | $                                         | 4,482,637  |                                      | $          | 2,570,825                                 |       | $ | 1,180,974 |   |
| Loans 90 days past due  and accruing                                           |       | $                                         | 347,200    |                                      | $          | 80,603                                    |       | $ | 156,640 |   |
| Non-accrual loans                                                              |       | $                                         | 3,172,782  |                                      | $          | 3,357,718                                 |       | $ | 8,838,950 |   |
| Allowance for loan losses to loans 90  days or more past due and accruing |       | 15.44                                     | x          | 67.54                                     | x          | 36.49                                     | x          |

 

The increase in the 30-89days past due category as of March 31, 2007 was caused by a few loans thatmigrated beyond 30 days.  These loans aresecured and are expected to be brought current during the second quarter of2007.

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*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, 2007, non-performing assetsrepresented 0.67% of total assets compared to 0.65% at December 31, 2006 and1.60% at March 31, 2006.

Thenon-accrual loans declined by $185,000 during the first three months of 2007 to$3,173,000.  There were additions to thenon-accrual loans totaling $363,000 during the first three months of 2007.  These additions were offset by payoffs or paydowns of $133,000, $93,000 of loans returned to accruing status, charge-offs of$76,000 and $245,000 of loans that were transferred to other real estate owned.

Otherreal estate owned at quarter end March 31, 2007 totaled $284,000 consisting oftwo residential properties that were foreclosed upon and transferred to otherreal estate from loans.   Both propertiesare under contracts for sale.  There wereno repossessed assets at quarter end March 31, 2007.

Non-performingloans were $3,520,000 at March 31, 2007, an increase of $82,000 from year-end2006, but a substantial decline of $5,476,000 compared to March 31, 2006.  Although the decline occurred substantiallyin the commercial loans, reductions occurred in the residential real estate andconsumer portfolios as well.  The SpecialAssets Department had developed specific action plans for each of the Bank’snon-performing loans.  During calendaryear 2006, several of those plans came to a conclusion resulting in asubstantial reduction of the non-performing loans.  The ratio of non-accrual loans to net loansdeclined by 139 basis points to 0.76%, at March 31, 2007 when compared to 2.15%at March 31, 2006.  It was also downslightly from the year-end ratio of 0.80%. At March 31, 2007, the ratio of non-performing loans to net loans was0.84% compared to 0.82% at December 31, 2006 and 2.19% at March 31, 2006.

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

|                                                                                    | ** ** | **March 31, 2007** | ** **  | **December 31, 2006** | ** ** | **March 31, 2006** | ** ** |
|------------------------------------------------------------------------------------|------------|------------------------------|-------------|---------------------------------|------------|------------------------------|------------|
|                                                                               |       |                         |        |                            |       |                         |       |
| Loans past due  90 days or more and accruing                                       |       | $                            | 347,200     |                            | $          | 80,603                       |       | $ | 156,640 |   |
| Non-accrual  loans                                                                 |       | 3,172,782                    |        | 3,357,718                       |       | 8,838,950                    |       |
| Total non-performing loans                                                         |       | 3,519,982                    |        | 3,438,321                       |       | 8,995,590                    |       |
|                                                                               |       |                         |        |                            |       |                         |       |
| Restructured  loans                                                                |       | —                       |        | —                          |       | —                       |       |
| Other real  estate owned                                                           |       | 284,058                      |        | 197,149                         |       | 92,999                       |       |
| Repossessed  assets                                                                |       | —                       |        | —                          |       | —                       |       |
| Total non-performing assets                                                        |       | $                            | 3,804,040   |                            | $          | 3,635,470                    |       | $ | 9,088,589 |   |
|                                                                               |       |                         |        |                            |       |                         |       |
| Net loans  including AFS                                                           |       | $                            | 417,595,765 |                            | $          | 417,321,048                  |       | $ | 411,333,094 |   |
| Total assets                                                                       |       | $                            | 564,625,942 |                            | $          | 562,317,988                  |       | $ | 569,286,783 |   |
| Non-accrual  loans to net loans                                                    |       | 0.76                         | %           | 0.80                            | %          | 2.15                         | %          |
| Non-performing  assets to net loans, foreclosed real estate and repossessed assets |       | 0.91                         | %           | 0.87                            | %          | 2.21                         | %          |
| Non-performing  assets to total assets                                             |       | 0.67                         | %           | 0.65                            | %          | 1.60                         | %          |
| Non-performing loans to  net loans                                                 |       | 0.84                         | %           | 0.82                            | %          | 2.19                         | %          |

 

*Other assets*

The increase in otherassets of $822,000, or 17%, from December 31, 2006 to March 31, 2007 wasprincipally due to increased prepaid expenses that are periodically charged tocurrent earnings when the expense is incurred plus increased capitalizedconstruction costs for activities related to the Company’s branch expansionprojects.

*Deposits*

The Bank is acommunity-based commercial financial institution that offers a variety ofdeposit accounts with a range of interest rates and terms.  Deposit products include passbook andstatement savings accounts, interest-bearing checking (NOW), money market,non-interest bearing, or demand deposit accounts (DDAs), and certificates of depositaccounts.  The

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flow of deposits issignificantly influenced by general economic conditions, changes in prevailinginterest rates, pricing and competition. Most of the Bank’s deposits are obtained from the communitiessurrounding its 12 branch offices.  TheBank attempts to attract and retain deposit customers via sales and marketingefforts with new products, quality service, competitive rates, and maintaininglong-standing customer relationships.  Todetermine deposit product interest rates, the Bank considers local competition,market yields and the rates charged for alternative sources of funding such asborrowings.  To be competitive in ourmarkets and continue to bolster our deposit base, we have increased rates onmost deposit products; however, we have not increased rates above market rates,as we only consider cost effective rate-setting tactics in all interest rateenvironments.

Compared to December 31,2006 total deposits increased $3,700,000, or slightly less than 1%, during thethree months ended March 31, 2007.  Thegrowth in total deposits was primarily due to increases in money market and NOWaccounts of $8,200,000, or 11%, and $4,900,000, or 8%, respectively.  The $13,100,000 increase in these twoaccounts was due to the continued success in the implementation of deposit-gatheringstrategies in conjunction with increased promotional interest rates.  The decline in certificates of deposits wasdue to the reduction in the public sector partially offset by growth inpersonal and non-personal certificates.

The following table representsthe major components of deposits as of March 31, 2007 and December 31, 2006:

|                          | ** ** | **March 31, 2007** | ** **  | **December 31, 2006** | ** ** |
|--------------------------|------------|------------------------------|-------------|---------------------------------|------------|
| ** **               | ** ** | **Amount**                   | ** **  | **%**                           | ** ** | **Amount** | ** ** | **%** | ** ** |
| Money market             |       | $                            | 80,555,895  |                            | 19.5       |   | $ | 72,359,157 |   | 17.6 |   |
| NOW                      |       | 70,044,307                   |        | 16.9                            |       | 65,121,770 |   | 15.9 |   |
| Savings and club         |       | 44,838,949                   |        | 10.8                            |       | 45,300,838 |   | 11.0 |   |
| Certificates of  deposit |       | 147,004,110                  |        | 35.5                            |       | 153,810,855 |   | 37.5 |   |
| Total interest-bearing   |       | 342,443,261                  |        | 82.7                            |       | 336,592,620 |   | 82.0 |   |
| Non-interest-bearing     |       | 71,623,735                   |        | 17.3                            |       | 73,741,975 |   | 18.0 |   |
| Total deposits           |       | $                            | 414,066,996 |                            | 100.0      |   | $ | 410,334,595 |   | 100.0 |   |

 

Certificates of deposit,of $100,000 or more aggregated $54,600,000 and $63,000,000 at March 31, 2007and December 31, 2006, respectively.

*Borrowings*

Borrowings are used as acomplement to deposit generation as an alternative funding source whereby theBank will borrow under customer repurchase agreements in the local market andadvances from the Federal Home Loan Bank of Pittsburgh (FHLB) and correspondentbanks for asset growth and liquidity needs. Borrowings included $62,332,000 and $62,536,000 in long-term advancesfrom the FHLB at March 31, 2007 and December 31, 2006, respectively.  Also included in borrowings were short-termrepurchase agreements of $16,900,000 and $22,224,000, as of the respectiveperiods.  Repurchase agreements arenon-insured interest-bearing liabilities that have a security interest inqualified investment securities of the Bank and are offered in both sweep andfixed-term products.  A sweep account isdesigned to ensure that, on a daily basis, an attached DDA is adequately fundedand excess DDA funds are transferred, or swept into an overnightinterest-bearing repurchase agreement account. The balance in customer repurchase agreement accounts can fluctuatedaily because the daily sweep product is dependent on the level of availablefunds in depositor accounts.  Inaddition, short-term borrowings may include overnight balances which the Bankmay require from time-to-time to fund daily liquidity needs.  As of March 31, 2007, the Bank had$14,000,000 in overnight balances compared to $10,400,000 at December 31, 2006.

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

*Management of interest rate riskand market risk analysis*

The Company is subject tothe interest rate risks inherent in our lending, investing and financingactivities.  Fluctuations of interestrates will impact interest income and interest expense along with affectingmarket values of all interest-earning assets and interest-bearing liabilities,except for those assets or liabilities with a short term remaining tomaturity.  Interest rate risk managementis an integral part of the asset/liability management process.  The Company has instituted certain proceduresand policy guidelines to manage the interest rate risk position.  Those internal policies enable the Company to

21

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react to changes inmarket rates to protect net interest income from significant fluctuations.  The primary objective in managing interestrate risk is to minimize the adverse impact of changes in interest rates on netinterest income along with creating an asset/liability structure that maximizesearnings.

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

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

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

To manage this interest rate sensitivity gap position,an asset/liability model commonly known as cumulative gap analysis is used tomonitor the difference in the volume of the Company’s interest sensitive assetsand liabilities that mature or re-price within given periods.  A positive gap (asset sensitive) indicatesthat more assets will re-price during a given period compared to liabilities,while a negative gap (liability sensitive) has the opposite effect.  The Company employs computerized net interestincome simulation modeling to assist in quantifying interest rate riskexposure.  This process measures andquantifies the impact on net interest income through varying interest ratechanges and balance sheet compositions. The use of this model assists the ALCO to gauge the effects of theinterest rate changes on interest sensitive assets and liabilities in order todetermine what impact these rate changes will have upon the net interestspread.  At March 31, 2007, the Companymaintained a negative one-year cumulative gap of $72,000,000 or -12.7% of totalassets.  The effect of this negative gapposition provided a mismatch of assets and liabilities which may expose theBank to interest rate risk during periods of rising interest rates.  Conversely, in a declining interest rateenvironment, net interest income could be positively impacted because moreliabilities than assets will re-price downward during a one-year period.

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

22

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The followingtable illustrates the Company’s interest sensitivity gap position at March 31,2007 (dollars in thousands):
| ** **                                     | ** ** | **Three months** | ** ** | **Three to**      | ** ** | **One to**      | ** ** | **Over**             | ** ** | ** ** | ** ** |
|------------------------------------------------|------------|-----------------------|------------|------------------------|------------|----------------------|------------|----------------------|------------|------------|------------|
| ** **                                     | ** ** | **or less**      | ** ** | **twelve months** | ** ** | **three years** | ** ** | **three years** | ** ** | **Total**  | ** ** |
| Cash and cash  equivalents                     |       | $                     | 179        |                   | $          | —               |       | $                    | —     |       | $          | 14,257 |   | $ | 14,436 |   |
| Investment securities(1)(2)                    |       | 16,494                |       | 6,471                  |       | 27,959               |       | 53,966               |       | 104,890    |       |
| Loans (2)                                      |       | 109,122               |       | 63,876                 |       | 99,874               |       | 144,724              |       | 417,596    |       |
| Fixed and other assets                         |       | —                |       | 8,255                  |       | —               |       | 19,449               |       | 27,704     |       |
| Total assets                                   |       | $                     | 125,795    |                   | $          | 78,602               |       | $                    | 127,833    |       | $          | 232,396 |   | $ | 564,626 |   |
| Total cumulative  assets                       |       | $                     | 125,795    |                   | $          | 204,397              |       | $                    | 332,230    |       | $          | 564,626 |   |   |   |
|                                           |       |                  |       |                   |       |                 |       |                 |       |       |       |
| Non-interest-bearing  transaction deposits (3) |       | $                     | —     |                   | $          | 7,162                |       | $                    | 19,697     |       | $          | 44,765 |   | $ | 71,624 |   |
| Interest-bearing  transaction deposits (3)     |       | 106,583               |       | —                 |       | 35,598               |       | 53,258               |       | 195,439    |       |
| Certificates of deposit                        |       | 37,671                |       | 84,345                 |       | 17,510               |       | 7,478                |       | 147,004    |       |
| Repurchase agreements                          |       | 16,628                |       | 231                    |       | —               |       | —               |       | 16,859     |       |
| Short-term borrowings                          |       | 14,749                |       | —                 |       | —               |       | —               |       | 14,749     |       |
| Long-term debt                                 |       | 8,210                 |       | 631                    |       | 491                  |       | 53,000               |       | 62,332     |       |
| Other liabilities                              |       | —                |       | —                 |       | —               |       | 3,986                |       | 3,986      |       |
| Total  liabilities                             |       | $                     | 183,841    |                   | $          | 92,369               |       | $                    | 73,296     |       | $          | 162,487 |   | $ | 511,993 |   |
| Total cumulative  liabilities                  |       | $                     | 183,841    |                   | $          | 276,210              |       | $                    | 349,506    |       | $          | 511,993 |   |   |   |
|                                           |       |                  |       |                   |       |                 |       |                 |       |       |       |
| Interest sensitivity  gap                      |       | $                     | (58,046    | )                      | $          | (13,767              | )          | $                    | 54,537     |       | $          | 69,909 |   |   |   |
|                                           |       |                  |       |                   |       |                 |       |                 |       |       |       |
| Cumulative gap                                 |       | $                     | (58,046    | )                      | $          | (71,813              | )          | $                    | (17,276    | )          | $          | 52,633 |   |   |   |
|                                           |       |                  |       |                   |       |                 |       |                 |       |       |       |
| Cumulative gap to total assets                 |       | (10.28                | )%         | (12.72                 | )%         | (3.06                | )%         | 9.32                 | %          |       |       |

----

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

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

(3)          The Bank’s demand andsavings accounts are generally subject to immediate withdrawal.  However, management considers a 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.

*Earnings at Risk and Economic Value at RiskSimulations.* The Company recognizes that more sophisticatedtools exist for measuring the interest rate risk in the balance sheet beyondstatic re-pricing gap analysis.  Althoughit will continue to measure its re-pricing gap position, the Company utilizes additionalmodeling for identifying and measuring the interest rate risk in the overallbalance sheet.  The ALCO is responsiblefor focusing on “earnings at risk” and “economic value at risk”, and how bothrelate to the risk-based capital position when analyzing the interest raterisk.

*Earnings at Risk. *Earnings at risk simulation measures the change in netinterest income and net income should interest rates rise and fall.  The simulation recognizes that not all assetsand liabilities re-price one-for-one with market rates (e.g., 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 simulationmeasures the short-term risk in the balance sheet.  Economic value (or portfolio equity) at riskmeasures the long-term risk by finding the net present value of the future cashflows from the Company’s existing assets and liabilities.  The ALCO examines this ratio quarterly utilizingan increase and decrease of 200 basis points in interest rates simulationmodels.  The ALCO recognizes that, insome instances, this ratio may contradict the “earnings at risk” ratio.

23

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The following table illustrates the simulated impact of 200 basis pointsupward or downward movement in interest rates on net interest income, netincome and the change in the economic value (portfolio equity).  This analysis assumed that interest-earningasset and interest-bearing liability levels at March 31, 2007 remainedconstant.  The impact of the ratemovements was developed by simulating the effect of rates changing over atwelve-month period from the March 31, 2007 levels:

|                                                        | ** ** | **Rates +200** | ** ** | **Rates -200** | ** ** |
|--------------------------------------------------------|------------|---------------------|------------|---------------------|------------|
| Earnings at  risk:                                     |       |                |       |                |       |
| Percent change in:                                     |       |                |       |                |       |
| Net interest income                                    |       | (9.6                | )%         | 4.3                 | %          |
| Net income                                             |       | (33.1               | )          | 14.7                |       |
|                                                   |       |                |       |                |       |
| Economic value  at risk:                               |       |                |       |                |       |
| Percent change in:                                     |       |                |       |                |       |
| Economic value of equity                               |       | (28.5               | )          | 1.1                 |       |
| Economic value  of equity as a percent of total assets |       | (3.1                | )          | 0.1                 |       |

 

Economic value has themost meaning when viewed within the context of risk-based capital.  Therefore, the economic value may normallychange beyond the Company’s policy guideline for a short period of time as longas the risk-based capital ratio (after adjusting for the excess equityexposure) is greater than 10%.  At March31, 2007, the Company’s risk-based capital ratio was 13.4%.

The table belowsummarizes estimated changes in net interest income over a twelve-month periodbeginning April 1, 2007 under alternate interest rate scenarios using theincome simulation model described above (dollars in thousands):

|                                             | ** ** | **Net interest** | ** ** | **$**        | ** ** | **%**        | ** ** |
|---------------------------------------------|------------|-----------------------|------------|--------------|------------|--------------|------------|
| **Change in interest rates** | ** ** | **income**            | ** ** | **variance** | ** ** | **variance** | ** ** |
|                                        |       |                  |       |         |       |         |       |
| +200 basis  points                          |       | $                     | 16,077     |         | $          | (1,710       | )          | (9.6 | )% |
| +100 basis  points                          |       | 16,975                |       | (812         | )          | (4.6         | )          |
| Flat rate                                   |       | 17,787                |       | —       |       | —       |       |
| -100 basis  points                          |       | 18,546                |       | 759          |       | 4.3          |       |
| -200 basis points                           |       | 18,560                |       | 773          |       | 4.3          |       |
|                                             |            |                       |            |              |            |              |            |  |  |

 

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, the Bank uses athird-party service to provide cash flow estimates in the various rateenvironments.  Savings accounts,including passbook, statement savings, money market and NOW accounts, do nothave a stated maturity or re-pricing term and can be withdrawn or re-priced atany time.  This may impact the margin ifmore expensive alternative sources of deposits are required to fund loans ordeposit runoff.  Management projects there-pricing characteristics of these accounts based on historical performanceand assumptions that it believes reflect their rate sensitivity.  The model reinvests all maturities,repayments and prepayments for each type of asset or liability into the sameproduct for a new like term at current product interest rates provided bymanagement.  As a result, the mix ofinterest-earning assets and interest bearing-liabilities is not held constant.

*Derivative Financial Instruments. *As part of the Bank’soverall interest rate risk management strategy, the Company has adopted apolicy whereby the Bank may periodically use derivative instruments to minimizesignificant fluctuations in earnings caused by interest rate volatility.  This interest rate risk management strategyentails the use of interest rate floors, caps and swaps.  The Bank entered into an interest rate flooragreement in 2006 and is reflected in the scenarios for earnings and economicvalue at risk and the net interest income in the two immediately precedingtables.

24

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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 repurchaseagreements, increases in other borrowed funds from correspondent banks andissuance of capital stock.  Although regularlyscheduled investment and loan payments are dependable sources of daily funds,the sales of both loans and investments AFS, deposit activity, and investmentand loan prepayments are significantly influenced by general economicconditions and the level of interest rates.

As of March 31, 2007, the Company maintained $14,400,000 in cash andcash equivalents, $99,900,000 of investments AFS and $371,000 of loansAFS.  In addition, as of March 31, 2007,the Company had approximately $77,900,000 available to borrow from the FHLB and$26,400,000 available from other correspondent banks.  This combined total of $216,000,000represented 38% of total assets at March 31, 2007.  Management believes this level of liquidityto be strong and adequate to support current operations.

*Capital*

Shareholders’ equityincreased from net income, stock issuance from the Company’s various sponsoredstock plans, a decline in the unrealized loss on AFS securities, an increase inthe intrinsic value of the Bank’s cash flow hedge, partially offset by thedeclaration of cash dividends.  TheCompany is subject to various regulatory capital requirements administered bythe federal banking agencies.  Failure tomeet minimum capital requirements can initiate certain mandatory and possibleadditional discretionary actions by regulators that, if undertaken, could havea direct material effect on the Company’s financial statements.  Under capital adequacy guidelines and theregulatory framework for prompt corrective action, the Company must meetspecific capital guidelines that involve quantitative measures of the Company’sassets, liabilities and certain off-balance-sheet items as calculated underregulatory accounting practices.  TheCompany’s capital amounts and classification are also subject to qualitativejudgments by the regulators about components, risk-weightings and otherfactors.

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

As of March 31, 2007, theCompany and the Bank met all capital adequacy requirements to which it was subject.  The following table depicts the capitalamounts and ratios of the Company and the Bank as of March 31, 2007:
| ** **                | ** ** | ** ** | ** ** | ** ** | ** ** | ** **                 | ** ** | ** **                            | ** ** | **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              |       | $          | 58,789,045 |       | 13.4       | %  3             | $          | 35,053,371                            | 3     | 8.0                                       | %              | N/A |   | N/A |   |
| Bank                      |       | $          | 58,427,252 |       | 13.3       | %  3             | $          | 35,045,467                            | 3     | 8.0                                       | %  3 | $ | 43,806,834 | 3 | 10.0 | % |
| Tier I capital            |       |       |       |       |       |                       |       |                                  |       |                                      |           |   |   |
| (to risk-weighted assets) |       |       |       |       |       |                       |       |                                  |       |                                      |           |   |   |
| Consolidated              |       | $          | 53,346,799 |       | 12.2       | %  3             | $          | 17,526,685                            | 3     | 4.0                                       | %              | N/A |   | N/A |   |
| Bank                      |       | $          | 53,060,440 |       | 12.1       | %  3             | $          | 17,522,734                            | 3     | 4.0                                       | %  3 | $ | 26,284,101 | 3 | 6.0 | % |
| Tier I capital            |       |       |       |       |       |                       |       |                                  |       |                                      |           |   |   |
| (to average assets)       |       |       |       |       |       |                       |       |                                  |       |                                      |           |   |   |
| Consolidated              |       | $          | 53,346,799 |       | 9.4        | %  3             | $          | 22,652,202                            | 3     | 4.0                                       | %              | N/A |   | N/A |   |
| Bank                      |       | $          | 53,060,440 |       | 9.4        | %  3             | $          | 22,636,809                            | 3     | 4.0                                       | %  3 | $ | 28,296,011 | 3 | 5.0 | % |

 

**Item4.  Controls and Procedures**

The Company maintains controls and procedures designed to ensure that information required to be disclosed in the reports that the Company files or submits under the Securities Exchange Act of 1934 is recorded, processed, summarized and reported within the time periods specified in the rules and forms of the Securities and Exchange Commission. Based upon

25

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their evaluation of those controls and procedures as of the end of the period covered by this report, the Chief Executive and Chief Financial Officers of the Company concluded that the Company’s disclosure controls and procedures were adequate.

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

**PART II - Other Information**

**Item 1. Legal Proceedings**

The nature of the Company’s business generates some litigationinvolving matters arising in the ordinary course of business.  However, in the opinion of the Company, afterconsulting with legal counsel, no legal proceedings are pending, which, ifdetermined adversely to the Company or the Bank, would have a material effecton the Company’s undivided profits or financial condition.  No legal proceedings are pending other thanordinary routine litigation incidental to the business of the Company and theBank.  In addition, to management’sknowledge, no governmental authorities have initiated or contemplated anymaterial legal actions against the Company or the Bank.

**Item 1A.   Risk Factors**

Management of the Companydoes not believe there have been any material changes in the risk factors thatwere disclosed in the Form 10-K filed with the Securities and ExchangeCommission on March 20, 2007.

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

None

**Item 3.    Default Upon Senior Securities**

None

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

None

**Item 5.    Other Information**

None

**Item 6.   Exhibits**

The followingexhibits are filed herewith or incorporated by reference as a part of this Form10-Q:
|              | ***3(i)***  | ***Amended  and Restated Articles of Incorporation of Registrant****.*Incorporated by reference to Exhibit 3(i) to  Registrant’s Registration Statement No. 333-90273 on Form S-4/A, filed with  the SEC on November 3, 1999 and as amended on April 6, 2000.                                                       |
|--------------|-------------|--------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
|         |        |                                                                                                                                                                                                                                                                                                                     |
| *** *** | ***3(ii)*** | ***Bylaws  of Registrant.*****Incorporated  by reference to Exhibit 3(ii) to Registrant’s Registration Statement No.  333-90273 on Form S-4/A, filed with the SEC on November 3, 1999 and as  amended on April 6, 2000*.*                                                                                           |
|         |        |                                                                                                                                                                                                                                                                                                                     |
| *** *** | ****10.1*** | ***1998  Independent Directors Stock Option Plan of The Fidelity Deposit and Discount  Bank, as assumed by Registrant.*****Incorporated  by reference to Exhibit 10.1 to Registrant’s Registration Statement No.  333-90273 on Form S-4/A, filed with the SEC on November 3, 1999 and as  amended on April 6, 2000. |
|         |        |                                                                                                                                                                                                                                                                                                                     |
| *** *** | ****10.2*** | ***1998  Stock Incentive Plan of The Fidelity Deposit and Discount Bank, as assumed by  Registrant.*****Incorporated  by reference to Exhibit 10.2 of Registrant’s Registration Statement No.  333-90273 on Form S-4/A, filed with the SEC on 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/A, filed with the SEC on  September 12, 2000 and as amended on October 11, 2000.                                  |
|         |        |                                                                                                                                                                                                                                                                                                                     |

 

26

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|        | ****10.4***  | ***Registrant’s  2000 Dividend Reinvestment Plan.*****Incorporated  by reference to Exhibit 4 to Registrant’s Registration Statement No.  333-45668 on Form S-1/A, filed with the SEC on September 12, 2000 and as                                                                                                                             |
|--------|--------------|----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
|        |         | amended by  Pre-Effective Amendment No. 1 on October 11, 2000, by Post-Effective  Amendment No. 1 on May 30, 2001 and by Post-Effective Amendment No. 2 on July  7, 2005.                                                                                                                                                                                |
|   |         |                                                                                                                                                                                                                                                                                                                                                     |
|   | ****10.5***  | ***Registrant’s  2000 Independent Directors Stock Option Plan.***  Incorporated by reference to Exhibit 4.3 to Registrant’s Registration  Statement No. 333-64356 on Form S-8 filed with the SEC on July 2, 2001.                                                                                                                              |
|   |         |                                                                                                                                                                                                                                                                                                                                                     |
|   | ****10.6***  | ***Registrant’s  2000 Stock Incentive Plan.***Incorporated by reference to  Exhibit 4.4 to Registrant’s Registration Statement No. 333-64356 on Form S-8  filed with the SEC on July 2, 2001.                                                                                                                                                  |
|   |         |                                                                                                                                                                                                                                                                                                                                                     |
|   | ****10.7***  | ***Registrant’s  2002 Employee Stock Purchase Plan.*** Incorporated by  reference to Exhibit 4.5 to Registrant’s Registration Statement No.  333-113339 on Form S-8 filed with the SEC on March 5, 2004.                                                                                                                                       |
|   |         |                                                                                                                                                                                                                                                                                                                                                     |
|   | ****10.8***  | ***Employment  Agreement between Fidelity D & D Bancorp, Inc., The Fidelity Deposit and  Discount Bank and Steven C. Ackmann, dated June 21, 2004.***  Incorporated by reference to Exhibit 99.1 to Registrant’s Current Report on  Form 8-K filed with the SEC on June 24, 2004.                                                               |
|   |         |                                                                                                                                                                                                                                                                                                                                                     |
|   | ****10.9***  | ***Complete  Settlement Agreement and General Release between Michael F. Marranca,  Registrant and The Fidelity Deposit and Discount Bank, dated July 30, 2004.***  Incorporated by reference to Exhibit 99.1 to Registrant’s Current Report on  Form 8-K filed with the SEC on August 10, 2004.                                                    |
|   |         |                                                                                                                                                                                                                                                                                                                                                     |
|   | ****10.10*** | ***Change  of Control and Severance Agreement between James T. Gorman, Registrant and  The Fidelity Deposit and Discount Bank, dated September 19, 2005.***  Incorporated by reference to Exhibit 99.1 to Registrant’s Current Report on  Form 8-K filed with the SEC on September 22, 2005.                                                        |
|   |         |                                                                                                                                                                                                                                                                                                                                                     |
|   | ****10.11*** | ***Amendment  and Termination of the Deferred Compensation Agreement with Joseph J. Earyes,  Daniel Santaniello, Registrant and The Fidelity Deposit and Discount Bank,  dated November 1, 2005.*** Incorporated by reference to  Exhibits 99.1 and 99.2 to Registrant’s Current Report on Form 8-K filed with  the SEC on November 3, 2005.        |
|   |         |                                                                                                                                                                                                                                                                                                                                                     |
|   | ****10.12*** | ***Amendment  to the Complete Settlement Agreement and General Release between Michael F.  Marranca, Registrant and The Fidelity Deposit and Discount Bank, dated November  4, 2005.***Incorporated by reference to Exhibit 99.1 to  Registrant’s Current Report on Form 8-K filed with the SEC on November 9,  2005.                               |
|   |         |                                                                                                                                                                                                                                                                                                                                                     |
|   | ****10.13*** | ***Change  of Control Agreements with Daniel J. Santaniello, Salvatore R. DeFrancesco,  James T. Gorman, Registrant and The Fidelity Deposit and Discount Bank, dated  March 21, 2006.***Incorporated by reference to Exhibit  99.1, 99.2 and 99.3, respectively, to Registrant’s Current Report on Form 8-K  filed with the SEC on March 27, 2006. |
|   |         |                                                                                                                                                                                                                                                                                                                                                     |
|   | ***11***     | ***Statement  regarding computation of earnings per share.***Included  herein in Note 2, “Earnings per share,” contained within the Notes to  Consolidated Financial Statements, and incorporated herein by reference.                                                                                                                         |
|   |         |                                                                                                                                                                                                                                                                                                                                                     |
|   | ***31.1***   | ***Rule  13a-14(a) Certification of Principal Executive Officer, filed herewith.***                                                                                                                                                                                                                                                                      |
|   |         |                                                                                                                                                                                                                                                                                                                                                     |
|   | ***31.2***   | ***Rule  13a-14(a) Certification of Principal Financial Officer, filed herewith.***                                                                                                                                                                                                                                                                      |
|   |         |                                                                                                                                                                                                                                                                                                                                                     |
|   | ***32.1***   | ***Certification  of Principal Executive Officer pursuant to 18 U.S.C. Section 1350, as adopted  pursuant to Section 906 of the Sarbanes-Oxley Act of 2002, filed herewith.***                                                                                                                                                                           |
|   |         |                                                                                                                                                                                                                                                                                                                                                     |
|   | ***32.2***   | ***Certification  of Principal Financial Officer pursuant to 18 U.S.C. Section 1350, as adopted  pursuant to Section 906 of the Sarbanes-Oxley Act of 2002, filed herewith.***                                                                                                                                                                           |

----

* Managementcontract or compensatory plan or arrangement.

27

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

Pursuant to the requirements of the Securities Exchange Act of 1934,the registrant has duly caused this report to be signed on its behalf by theundersigned thereunto duly authorized.
|                    | **FIDELITY D & D BANCORP, INC.** |
|--------------------|--------------------------------------|
| ** **         | ** **                           |
| ** **         | ** **                           |
| Date: May 1,  2007 | /s/ Steven C. Ackmann                |   |
|               |                                 | Steven C.  Ackmann, |
|               |                                 | President and  Chief Executive Officer |
|               |                                 |
|               |                                 |
| Date: May 1,  2007 | /s/ Salvatore R. DeFrancesco, Jr.    |   |
|               |                                 | Salvatore R. DeFrancesco, Jr., |
|               |                                 | Treasurer and  Chief Financial Officer |
|                    |                                      |  |  |

 

28

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EXHIBIT INDEX
|                                                                                                                                                                                                                                                                                                                                                                                                           | ** ** | **Page**   |
|-----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|------------|------------|
| ** **                                                                                                                                                                                                                                                                                                                                                                                                | ** ** | ** ** |
| ***3(i)  Amended and Restated Articles of Incorporation of Registrant. Incorporated by  reference to Exhibit 3(i) to Registrant’s Registration Statement No.  333-90273 on Form S-4/A, filed with the SEC on November 3, 1999 and as  amended on April 6, 2000.***                                                                                                                                   |       | *          |
|                                                                                                                                                                                                                                                                                                                                                                                                      |       |       |
| ***3(ii)  Bylaws of Registrant. Incorporated by reference to Exhibit 3 (ii) to  Registrant’s Registration Statement No. 333-90273 on Form S-4/A, filed  with the SEC on November 3, 1999 and as amended on April 6, 2000.***                                                                                                                                                                    |       | *          |
|                                                                                                                                                                                                                                                                                                                                                                                                      |       |       |
| ***10.1  1998 Independent Directors Stock Option Plan of The Fidelity Deposit and  Discount Bank, as assumed by Registrant. Incorporated by reference to Exhibit  10.1 to Registrant’s Registration Statement No. 333-90273 on Form S-4/A,  filed with the SEC on November 3, 1999 and as amended on April 6, 2000.***                                                                               |       | *          |
|                                                                                                                                                                                                                                                                                                                                                                                                      |       |       |
| ***10.2  1998 Stock Incentive Plan of The Fidelity Deposit and Discount Bank, as  assumed by Registrant. Incorporated by reference to Exhibit 10.2 of  Registrant’s Registration Statement No. 333-90273 on Form S-4/A, filed with  the SEC on Nov. 3, 1999 and as amended on April 6, 2000.***                                                                                                      |       | *          |
|                                                                                                                                                                                                                                                                                                                                                                                                      |       |       |
| ***10.3  Form of Deferred Compensation Plan of The Fidelity Deposit and Discount Bank.  Incorporated by reference to Exhibit 10.3 to Registrant’s Registration  Statement No. 333-45668 on Form S-1/A, filed with the SEC on September 12,  2000 and as amended on October 11, 2000.***                                                                                                              |       | *          |
|                                                                                                                                                                                                                                                                                                                                                                                                      |       |       |
| ***10.4  Registrant’s 2000 Dividend Reinvestment Plan. Incorporated by reference to  Exhibit 4 to Registrant’s Registration Statement No. 333-45668 on Form S-1/A,  filed with the SEC on September 12, 2000 and as amended by Pre-Effective  Amendment No. 1 on October 11, 2000, by Post-Effective Amendment No. 1 on May  30, 2001 and by Post-Effective Amendment No. 2 on July 7, 2005.*** |       | *          |
|                                                                                                                                                                                                                                                                                                                                                                                                      |       |       |
| ***10.5  Registrant’s 2000 Independent Directors Stock Option Plan. Incorporated by  reference to Exhibit 4.3 to Registrant’s Registration Statement No. 333-64356  on Form S-8 filed with the SEC on July 2, 2001.***                                                                                                                                                                          |       | *          |
|                                                                                                                                                                                                                                                                                                                                                                                                      |       |       |
| ***10.6  Registrant’s 2000 Stock Incentive Plan. Incorporated by reference to Exhibit  4.4 to Registrant’s Registration Statement No. 333-64356 on Form S-8 filed  with the SEC on July 2, 2001.***                                                                                                                                                                                             |       | *          |
|                                                                                                                                                                                                                                                                                                                                                                                                      |       |       |
| ***10.7  Registrant’s 2002 Employee Stock Purchase Plan. Incorporated by reference to  Exhibit 4.5 to Registrant’s Registration Statement No. 333-113339 on Form S-8  filed with the SEC on March 5, 2004.***                                                                                                                                                                                   |       | *          |
|                                                                                                                                                                                                                                                                                                                                                                                                      |       |       |
| ***10.8  Employment Agreement between Fidelity D & D Bancorp, Inc., The Fidelity  Deposit and Discount Bank and Steven C. Ackmann, dated June 21, 2004.  Incorporated by reference to Exhibit 99.1 to Registrant’s Current Report on  Form 8-K filed with the SEC on June 24, 2004.***                                                                                                           |       | *          |
|                                                                                                                                                                                                                                                                                                                                                                                                      |       |       |
| ***10.9  Complete Settlement Agreement and General Release between Michael F.  Marranca, Registrant and The Fidelity Deposit and Discount Bank, dated July  30, 2004. Incorporated by reference to Exhibit 99.1 to Registrant’s Current  Report on Form 8-K filed with the SEC on August 10, 2004.***                                                                                                |       | *          |
|                                                                                                                                                                                                                                                                                                                                                                                                      |       |       |
| ***10.10  Change of Control and Severance Agreement between James T. Gorman, Registrant  and the Fidelity Deposit and Discount Bank, dated September 19, 2005.  Incorporated by reference to Exhibit 99.1 to Registrant’s Current Report on  Form 8-K filed with the SEC on September 22, 2005.***                                                                                                   |       | *          |
|                                                                                                                                                                                                                                                                                                                                                                                                      |       |       |
| ***10.11  Amendment and Termination of the Deferred Compensation Agreement with Joseph  J. Earyes, Daniel Santaniello, Registrant and The Fidelity Deposit and  Discount Bank, dated November 1, 2005. Incorporated by reference to Exhibits  99.1 and 99.2 to Registrant’s Current Report on Form 8-K filed with the SEC  on November 3, 2005.***                                                   |       | *          |
|                                                                                                                                                                                                                                                                                                                                                                                                      |       |       |
| ***10.12  Amendment to the Complete Settlement Agreement and General Release between  Michael F. Marranca, Registrant and The Fidelity Deposit and Discount Bank,  dated November 4, 2005. Incorporated by reference to Exhibit 99.1 to  Registrant’s Current Report on Form 8-K filed with the SEC on November 9,  2005.***                                                                         |       | *          |
| *** ***                                                                                                                                                                                                                                                                                                                                                                                              |       |       |
| ***10.13  Change of Control Agreements with Daniel J. Santaniello, Salvatore R.  DeFrancesco, James T. Gorman, Registrant and The Fidelity Deposit and  Discount Bank, dated March 21, 2006. Incorporated by reference to Exhibit  99.1, 99.2 and 99.3, respectively, to Registrant’s Current Report on Form 8-K  filed with the SEC on March 27, 2006.***                                           |       | *          |
| *** ***                                                                                                                                                                                                                                                                                                                                                                                              |       |       |
| ***11  Statement regarding computation of earnings per share. Included herein.***                                                                                                                                                                                                                                                                                                                         |       | 8          |
|                                                                                                                                                                                                                                                                                                                                                                                                      |       |       |
| ***31.1  Rule 13a-14(a) Certification of Principal Executive Officer.***                                                                                                                                                                                                                                                                                                                                  |       | 31         |
|                                                                                                                                                                                                                                                                                                                                                                                                      |       |       |
| ***31.2  Rule 13a-14(a) Certification of Principal Financial Officer.***                                                                                                                                                                                                                                                                                                                                  |       | 32         |
|                                                                                                                                                                                                                                                                                                                                                                                                      |       |       |

 

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| ***32.1 Certification of Principal Executive Officer  pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the  Sarbanes-Oxley Act of 2002.*** |   | 33     |
|---------------------------------------------------------------------------------------------------------------------------------------------------------------------|--------|--------|
|                                                                                                                                                                |   |   |
| ***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.*** |   | 33     |

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* Incorporated byReference

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