**UNITED STATES**

**SECURITIES AND EXCHANGE COMMISSION**

**Washington,D.C. 20549**

 

**FORM 10-Q**

 

**QUARTERLY REPORT UNDER SECTION 13 OR 15(d) OF THE**

**SECURITIES EXCHANGE ACT OF 1934**

 

**FORQUARTER ENDED JUNE 30, 2005**

 

**COMMISSIONFILE NUMBER: 333-90273**

 

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

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

 

PRINCIPAL OFFICE:

**BLAKELY &DRINKER ST.**

**DUNMORE,PENNSYLVANIA 18512**

 

TELEPHONE:

**570-342-8281**

 

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

 

ý  YES    o  NO

 

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

 

o  YES    ý  NO

 

The number of outstandingshares of Common Stock of Fidelity D & D Bancorp, Inc. on July 29,2005, the latest practicable date, was 1,847,395 shares.

 

 

----

 

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

 

Form 10-QJune 30, 2005

 

Index

 
| **Part I.  Financial information** |                                                                                                                   |
|-----------------------------------------|------------------------------------------------------------------------------------------------------------------------|
|                                    |                                                                                                                   |   |
| Item 1. Financial  Statements:          |                                                                                                                   |
|                                    |                                                                                                                   |   |
|                                    | Consolidated Balance Sheets as of June 30,  2005 and December 31, 2004                                       |   |
|                                    | Consolidated Statements of  Income for the three and six months ended June 30, 2005 and 2004                      |   |
|                                    | Consolidated Statements of  Changes in Shareholders’ Equity for the six months ended June 30, 2005  and 2004 |   |
|                                    | Consolidated Statements of  Cash Flows for the six months ended June 30, 2005 and 2004                            |   |
|                                    | Notes to Consolidated  Financial Statements                                                                            |   |
|                                    |                                                                                                                   |   |
| Item 2.                                 | Management’s Discussion and  Analysis of Financial Condition and Results of Operations                            |   |
|                                    |                                                                                                                   |   |
| Item 3.                                 | Quantitative  and Qualitative Disclosure about Market Risk                                                             |   |
|                                    |                                                                                                                   |   |
| Item 4.                                 | Controls and  Procedures                                                                                               |   |
|                                    |                                                                                                                   |   |
| **Part II. Other  Information**    |                                                                                                                   |
|                                    |                                                                                                                   |   |
| Item 1.                                 | Legal Proceedings                                                                                                      |   |
|                                    |                                                                                                                   |   |
| Item 2.                                 | Unregistered  Sales of Equity Securities and Use of Proceeds                                                           |   |
|                                    |                                                                                                                   |   |
| Item 3.                                 | Defaults  upon Senior Securities                                                                                       |   |
|                                    |                                                                                                                   |   |
| Item 4.                                 | Submission of  Matters to a Vote of Security Holders                                                                   |   |
|                                    |                                                                                                                   |   |
| Item 5.                                 | Other Information                                                                                                      |   |
|                                    |                                                                                                                   |   |
| Item 6.                                 | Exhibits                                                                                                               |   |
|                                    |                                                                                                                   |   |
| Signatures                              |                                                                                                                   |
|                                    |                                                                                                                   |   |
| Exhibit index                      |                                                                                                                   |

 

2

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

ConsolidatedBalance Sheets

As of June 30,2005 and December 31, 2004

 
| ** **                                                                                                                                   | ** ** | **June 30, 2005** | ** **  | **December 31, 2004** | ** ** |
|----------------------------------------------------------------------------------------------------------------------------------------------|------------|------------------------|-------------|----------------------------|------------|
| ** **                                                                                                                                   | ** ** | **(unaudited)**        | ** **  | **(audited)**              | ** ** |
| **ASSETS**                                                                                                                                   |       |                   |        |                       |       |
| Cash  and due from banks                                                                                                                     |       | $                      | 10,450,074  |                       | $          | 9,013,060 |   |
| Interest-bearing  deposits with financial institutions                                                                                       |       | 402,676                |        | 1,203,334                  |       |
| Total  cash and cash equivalents                                                                                                             |       | 10,852,750             |        | 10,216,394                 |       |
| Available-for-sale  securities                                                                                                               |       | 107,955,147            |        | 112,612,513                |       |
| Held-to-maturity  securities                                                                                                                 |       | 2,703,782              |        | 3,056,305                  |       |
| Federal  Home Loan Bank Stock                                                                                                                |       | 4,306,100              |        | 4,568,700                  |       |
| Loans  and leases, net (allowance for loan losses of $5,873,378 in 2005 and  $5,987,798 in 2004)                                             |       | 382,299,701            |        | 381,546,375                |       |
| Loans  available-for-sale (fair value $76,935 in 2005 and $582,141 in 2004)                                                                  |       | 76,173                 |        | 576,378                    |       |
| Bank  premises and equipment, net                                                                                                            |       | 10,767,091             |        | 11,163,292                 |       |
| Cash  surrender value of bank-owned life insurance                                                                                           |       | 7,742,162              |        | 7,613,437                  |       |
| Other  assets                                                                                                                                |       | 4,102,811              |        | 3,385,790                  |       |
| Accrued  interest receivable                                                                                                                 |       | 2,062,886              |        | 1,722,850                  |       |
| Foreclosed  assets held for sale                                                                                                             |       | 452,034                |        | 213,104                    |       |
| **Total assets**                                                                                                                             |       | $                      | 533,320,637 |                       | $          | 536,675,138 |   |
| **LIABILITIES**                                                                                                                              |       |                   |        |                       |       |
| Deposits                                                                                                                                     |       |                   |        |                       |       |
| Non-interest-bearing                                                                                                                         |       | $                      | 69,233,001  |                       | $          | 65,357,535 |   |
| Certificates  of deposit of $100,000 or more                                                                                                 |       | 89,572,994             |        | 93,986,033                 |       |
| Other  interest-bearing deposits                                                                                                             |       | 210,372,330            |        | 206,271,767                |       |
| Total  deposits                                                                                                                              |       | 369,178,325            |        | 365,615,335                |       |
|                                                                                                                                         |       |                   |        |                       |       |
| Accrued  interest payable and other liabilities                                                                                              |       | 3,054,050              |        | 3,039,809                  |       |
| Short-term  borrowings                                                                                                                       |       | 42,267,004             |        | 50,534,046                 |       |
| Long-term  debt                                                                                                                              |       | 70,732,233             |        | 71,119,188                 |       |
| **Total liabilities**                                                                                                                        |       | 485,231,612            |        | 490,308,378                |       |
| **SHAREHOLDERS’ EQUITY**                                                                                                                |       |                   |        |                       |       |
| Preferred  stock authorized 5,000,000 shares with no par value; none issued                                                                  |       | —                 |        | —                     |       |
| Capital  stock authorized 10,000,000 shares with no par value; issued and outstanding  1,847,395 shares in 2005 and 1,839,572 shares in 2004 |       | 10,344,157             |        | 10,072,134                 |       |
| Retained  earnings                                                                                                                           |       | 37,740,613             |        | 36,396,027                 |       |
| Accumulated  other comprehensive income (loss)                                                                                               |       | 4,255                  |        | (101,401                   | )          |
| **Total shareholders’ equity**                                                                                                          |       | 48,089,025             |        | 46,366,760                 |       |
| **Total liabilities and shareholders’ equity**                                                                                          |       | $                      | 533,320,637 |                       | $          | 536,675,138 |   |

 

3

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

ConsolidatedStatements of Income

(unaudited)

 
| ** **                                               | ** ** | **Three Months Ended** | ** ** | **Six Months Ended**   | ** ** |
|----------------------------------------------------------|------------|------------------------|------------|------------------------|------------|
| ** **                                               | ** ** | **June 30, 2005** | ** ** | **June 30, 2004** | ** ** | **June 30, 2005** | ** ** | **June 30, 2004** | ** ** |
| **Interest income**                                      |       |                   |       |                   |       |   |   |   |   |
| Interest  and fees on loans:                             |       |                   |       |                   |       |   |   |   |   |
| Taxable                                                  |       | $                      | 5,738,145  |                   | $          | 5,461,234 |   | $ | 11,402,820 |   | $ | 10,873,586 |   |
| Nontaxable                                               |       | 116,119                |       | 74,428                 |       | 214,529 |   | 158,516 |   |
| Leases                                                   |       | 14,502                 |       | 42,926                 |       | 32,795 |   | 92,346 |   |
| Interest-bearing  deposits with financial institutions   |       | 6,283                  |       | 1,095                  |       | 8,971 |   | 2,210 |   |
| Investment  securities:                                  |       |                   |       |                   |       |   |   |   |   |
| US  Government agencies                                  |       | 921,085                |       | 1,073,414              |       | 1,831,242 |   | 2,292,009 |   |
| States  and political subdivisions (non-taxable)         |       | 128,105                |       | 116,328                |       | 240,560 |   | 251,706 |   |
| Other  securities                                        |       | 171,943                |       | 43,765                 |       | 298,758 |   | 95,932 |   |
| Federal  funds sold                                      |       | 6,635                  |       | —                 |       | 47,427 |   | 10,210 |   |
| **Total interest income**                                |       | 7,102,817              |       | 6,813,190              |       | 14,077,102 |   | 13,776,515 |   |
| **Interest expense**                                     |       |                   |       |                   |       |   |   |   |   |
| Certificates  of deposit of $100,000 or more             |       | 697,641                |       | 710,597                |       | 1,373,664 |   | 1,601,268 |   |
| Other  deposits                                          |       | 978,115                |       | 920,201                |       | 1,858,331 |   | 1,970,850 |   |
| Securities  sold under repurchase agreements             |       | 141,308                |       | 101,400                |       | 338,117 |   | 204,261 |   |
| Other  short- and long-term borrowings and other         |       | 967,604                |       | 989,827                |       | 1,913,037 |   | 1,976,026 |   |
| **Total interest expense**                               |       | 2,784,668              |       | 2,722,025              |       | 5,483,149 |   | 5,752,405 |   |
| **Net interest income**                                  |       | 4,318,149              |       | 4,091,165              |       | 8,593,953 |   | 8,024,110 |   |
| Provision for loan  losses                               |       | 300,000                |       | 400,000                |       | 380,000 |   | 1,250,000 |   |
| **Net interest income after provision for loan  losses** |       | 4,018,149              |       | 3,691,165              |       | 8,213,953 |   | 6,774,110 |   |
| **Other income:**                                        |       |                   |       |                   |       |   |   |   |   |
| Service  charges on deposit accounts                     |       | 674,210                |       | 540,291                |       | 1,272,531 |   | 1,066,220 |   |
| Gain  (loss) on:                                         |       |                   |       |                   |       |   |   |   |   |
| Investment  securities                                   |       | 2,643                  |       | —                 |       | 2,643 |   | 9,497 |   |
| Loans                                                    |       | 3,985                  |       | 70,776                 |       | (7,457 | ) | 94,387 |   |
| Leased  assets                                           |       | 919                    |       | (61,920                | )          | (33,954 | ) | (155,186 | ) |
| Foreclosed  assets held-for-sale                         |       | (8,016                 | )          | (8,218                 | )          | (7,611 | ) | (8,218 | ) |
| Write-down  lease residual                               |       | —                 |       | —                 |       | (220,000 | ) | — |   |
| Fees,  other service charges and other income            |       | 452,766                |       | 529,956                |       | 867,968 |   | 1,010,602 |   |
| **Total other income**                                   |       | 1,126,507              |       | 1,070,885              |       | 1,874,120 |   | 2,017,302 |   |
|                                                     |       |                   |       |                   |       |   |   |   |   |
| **Other operating expenses:**                            |       |                   |       |                   |       |   |   |   |   |
| Salaries  and employee benefits                          |       | 1,753,198              |       | 1,703,504              |       | 3,496,119 |   | 3,448,020 |   |
| Premises  and equipment                                  |       | 737,021                |       | 718,216                |       | 1,471,476 |   | 1,437,627 |   |
| Advertising                                              |       | 148,599                |       | 84,685                 |       | 279,808 |   | 145,192 |   |
| Professional  fees and services                          |       | 413,875                |       | 312,705                |       | 795,918 |   | 598,576 |   |
| Other                                                    |       | 559,571                |       | 719,598                |       | 1,134,855 |   | 1,184,320 |   |
| **Total other operating expenses**                       |       | 3,612,264              |       | 3,538,708              |       | 7,178,176 |   | 6,813,735 |   |
| **Income before provision for income taxes**             |       | 1,532,392              |       | 1,223,342              |       | 2,909,897 |   | 1,977,677 |   |
| Provision  for income taxes                              |       | 396,584                |       | 302,449                |       | 754,700 |   | 431,877 |   |
| **Net income**                                           |       | $                      | 1,135,808  |                   | $          | 920,893 |   | $ | 2,155,197 |   | $ | 1,545,800 |   |
| Per  share data:                                         |       |                   |       |                   |       |   |   |   |   |
| Net  income - basic                                      |       | $                      | 0.62       |                   | $          | 0.50 |   | $ | 1.17 |   | $ | 0.84 |   |
| Net  income - diluted                                    |       | $                      | 0.62       |                   | $          | 0.50 |   | $ | 1.17 |   | $ | 0.84 |   |
| Dividends                                                |       | $                      | 0.22       |                   | $          | 0.22 |   | $ | 0.44 |   | $ | 0.44 |   |

 

4

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

ConsolidatedStatements of Changes in Shareholders’ Equity

For the Six Months Ended June 30,2005 and 2004

 
| ** **                                                                                                                  | ** ** | ** **         | ** ** | ** **          | ** ** | ** **   | ** ** | **Accumulated  other** | ** ** | ** **   | ** ** |
|-----------------------------------------------------------------------------------------------------------------------------|------------|--------------------|------------|---------------------|------------|--------------|------------|------------------------|------------|--------------|------------|
| ** **                                                                                                                  | ** ** | **Capital  stock** | ** ** | **Treasury  stock** | ** ** | **Retained** | ** ** | **comprehensive**      | ** ** | ** **   | ** ** |
| ** **                                                                                                                  | ** ** | **Shares**         | ** ** | **Amount**          | ** ** | **Shares**   | ** ** | **Amount**             | ** ** | **earnings** | ** ** | **income  (loss)** | ** ** | **Total** | ** ** |
| Balance,  December 31, 2003 (audited)                                                                                  |       | 1,828,270          |       | $                   | 9,698,879  |         | (5,227     | )                      | $          | (196,048     | )          | $ | 34,641,976 |   | $ | (212,908 | ) | $ | 43,931,899 |   |
| Comprehensive  income:                                                                                                      |       |               |       |                |       |         |       |                   |       |         |       |   |   |   |   |
| Net  income                                                                                                                 |       |               |       |                |       |         |       |                   |       | 1,545,800    |       |   |   | 1,545,800 |   |
| Change  in net unrealized holding gains (losses) on available-for-sale securities,  net net of reclassification adjustments |       |               |       |                |       |         |       |                   |       |         |       | (1,542,613 | ) | (1,542,613 | ) |
| Comprehensive  income                                                                                                       |       |               |       |                |       |         |       |                   |       |         |       |   |   | 3,187 |   |
| Reissued  treasury stock through Employee Stock Purchase Plan                                                               |       |               |       | (8,329              | )          | 1,635        |       | 61,370                 |       |         |       |   |   | 53,041 |   |
| Dividends  reinvested through Dividend Reinvestment Plan                                                                    |       | 3,519              |       | 120,390             |       | 3,592        |       | 134,678                |       |         |       |   |   | 255,068 |   |
| Dividends  declared                                                                                                         |       |               |       |                |       |         |       |                   |       | (803,627     | )          |   |   | (803,627 | ) |
| Balance,  June 30, 2004 (unaudited)                                                                                    |       | 1,831,789          |       | $                   | 9,810,940  |         | —     |                   | $          | —       |       | $ | 35,384,149 |   | $ | (1,755,521 | ) | $ | 43,439,568 |   |
|                                                                                                                        |       |               |       |                |       |         |       |                   |       |         |       |   |   |   |   |
| Balance,  December 31, 2004 (audited)                                                                                  |       | 1,839,572          |       | $                   | 10,072,134 |         | —     |                   | $          | —       |       | $ | 36,396,027 |   | $ | (101,401 | ) | $ | 46,366,760 |   |
| Comprehensive  income:                                                                                                      |       |               |       |                |       |         |       |                   |       |         |       |   |   |   |   |
| Net income                                                                                                                  |       |               |       |                |       |         |       |                   |       | 2,155,197    |       |   |   | 2,155,197 |   |
| Change  in net unrealized holding gains (losses) on available-for-sale securities,  net net of reclassification adjustments |       |               |       |                |       |         |       |                   |       |         |       | 105,656 |   | 105,656 |   |
| Comprehensive  income                                                                                                       |       |               |       |                |       |         |       |                   |       |         |       |   |   | 2,260,853 |   |
| Stock  issued through Employee Stock Purchase Plan                                                                          |       | 1,031              |       | 31,671              |       |         |       |                   |       |         |       |   |   | 31,671 |   |
| Dividends  reinvested through Dividend Reinvestment Plan                                                                    |       | 6,792              |       | 240,352             |       |         |       |                   |       |         |       |   |   | 240,352 |   |
| Dividends  declared                                                                                                         |       |               |       |                |       |         |       |                   |       | (810,611     | )          |   |   | (810,611 | ) |
| Balance,  June 30, 2005 (unaudited)                                                                                    |       | 1,847,395          |       | $                   | 10,344,157 |         | —     |                   | $          | —       |       | $ | 37,740,613 |   | $ | 4,255 |   | $ | 48,089,025 |   |

 

5

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

Consolidated Statements of Cash Flows

(unaudited)

 
| ** **                                                                         | ** ** | **Six Months Ended**   | ** ** |
|------------------------------------------------------------------------------------|------------|------------------------|------------|
| ** **                                                                         | ** ** | **June 30, 2005** | ** ** | **June 30, 2004** | ** ** |
| **Cash flows from operating activities:**                                          |       |                   |       |   |   |
| Net  income                                                                        |       | $                      | 2,155,197  |   | $ | 1,545,800 |   |
| Adjustments  to reconcile net income to net cash provided by operating activities: |       |                   |       |   |   |
| Depreciation                                                                       |       | 562,985                |       | 615,541 |   |
| Amortization  of securities (net of accretion)                                     |       | 144,482                |       | 315,524 |   |
| Provision  for loan losses                                                         |       | 380,000                |       | 1,250,000 |   |
| Deferred  income tax                                                               |       | (85,283                | )          | (128,406 | ) |
| Write-down  of foreclosed assets held-for-sale                                     |       | 36,293                 |       | 73,701 |   |
| Write-down  lease residual                                                         |       | 220,000                |       | — |   |
| Increase  in cash surrender value of life insurance                                |       | (128,725               | )          | (161,665 | ) |
| Gain  on sale of investment securities                                             |       | (2,643                 | )          | (9,497 | ) |
| Gain  on sale of loans                                                             |       | (7,457                 | )          | (94,387 | ) |
| Loss  on sale of foreclosed assets held-for-sale                                   |       | 7,611                  |       | 8,218 |   |
| Loss  on sale of leased assets                                                     |       | 33,954                 |       | 155,186 |   |
| (Gain)  loss on disposal of equipment                                              |       | (589                   | )          | 3,736 |   |
| Amortization  of loan servicing rights                                             |       | 51,717                 |       | 56,319 |   |
| Change  in:                                                                        |       |                   |       |   |   |
| Accured  interest receivable                                                       |       | (340,036               | )          | (64,807 | ) |
| Other  assets                                                                      |       | (656,222               | )          | (273,465 | ) |
| Accrued  interest payable and other liabilities                                    |       | 15,051                 |       | (21,429 | ) |
| Net  cash provided by operating activities                                         |       | 2,386,335              |       | 3,270,369 |   |
| **Cash flows from investing activities:**                                          |       |                   |       |   |   |
| Held-to-maturity  securities:                                                      |       |                   |       |   |   |
| Proceeds  from maturities, calls and paydowns                                      |       | 349,441                |       | 1,243,638 |   |
| Available-for-sale  securities:                                                    |       |                   |       |   |   |
| Proceeds  from sales                                                               |       | 19,282,027             |       | 3,850,562 |   |
| Proceeds  from maturities, calls and paydowns                                      |       | 7,170,330              |       | 16,278,082 |   |
| Purchases                                                                          |       | (21,773,663            | )          | (6,035,552 | ) |
| Net  decrease FHLB stock                                                           |       | 262,600                |       | 11,300 |   |
| Proceeds  from sale of loans available-for-sale                                    |       | 807,434                |       | 11,331,731 |   |
| Net  increase in loans and leases                                                  |       | (2,564,544             | )          | (3,342,844 | ) |
| Proceeds  from sale of leased assets                                               |       | 407,660                |       | 502,924 |   |
| Acquisition  of bank premises and equipment                                        |       | (166,195               | )          | (146,924 | ) |
| Proceeds  from sale of foreclosed assets held-for-sale                             |       | 104,526                |       | 341,862 |   |
| Net  cash provided by investing activities                                         |       | 3,879,616              |       | 24,034,779 |   |
| **Cash flows from financing activities:**                                          |       |                   |       |   |   |
| Net  increase in noninterest-bearing deposits                                      |       | 3,875,466              |       | 1,569,165 |   |
| Net  decrease in certificates of deposit of $100,000 or more                       |       | (4,413,039             | )          | (10,409,620 | ) |
| Net  increase (decrease) in other interest-bearing deposits                        |       | 4,100,563              |       | (15,298,171 | ) |
| Net  decrease in short-term borrowings                                             |       | (8,267,042             | )          | (9,566,629 | ) |
| Net  decrease in long-term borrowings                                              |       | (386,955               | )          | (375,607 | ) |
| Dividends  paid, net of dividend reinvestment                                      |       | (570,259               | )          | (548,559 | ) |
| Proceeds  from employee stock purchase plan                                        |       | 31,671                 |       | 53,041 |   |
| Net  cash used in financing activities                                             |       | (5,629,595             | )          | (34,576,380 | ) |
| Net  increase (decrease) in cash and cash equivalents                              |       | 636,356                |       | (7,271,232 | ) |
| Cash  and cash equivalents, beginning                                              |       | 10,216,394             |       | 19,231,601 |   |
| Cash  and cash equivalents, ending                                                 |       | $                      | 10,852,750 |   | $ | 11,960,369 |   |

 

6

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

 

**Notes toConsolidated Financial Statements**

**(unaudited)**

 

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

 

# **Principles of consolidation**

 

The accompanyingunaudited consolidated financial statements of Fidelity D & D Bancorp, Inc.,and its wholly owned subsidiary, The Fidelity Deposit and Discount Bank (the Bankor collectively, the Company) have been prepared in accordance with accountingprinciples generally accepted in the United States of America (GAAP) forinterim financial information and with the instructions to this Form 10-Qand Rule 10-01 of Regulation S-X. Accordingly, they do not includeall of the information and footnote disclosures required by GAAP for completefinancial statements. In the opinion of Management, all normal recurringadjustments necessary for a fair presentation of the financial condition andresults of operations for the periods have been included. All significantinter-company balances and transactions have been eliminated in consolidation. Priorperiod amounts have been reclassified, when necessary, to conform to thecurrent period’s presentation.

 

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

 

# **Nature of operations**

 

The Bank is a commercialbank chartered in the Commonwealth of Pennsylvania and a wholly ownedsubsidiary of the Company. Having commenced operations in 1903, the Bankprovides a full range of traditional banking services, trust services andalternative financial products from its main office located in Dunmore andother branches throughout Lackawanna and Luzerne counties.

 

Management is responsiblefor the fairness, integrity and objectivity of the unaudited financialstatements included in this report. Management prepared the unaudited financialstatements in accordance with GAAP. In meeting its responsibility for thefinancial statements, Management depends on the Company’s accounting systemsand 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 financial statements present fairly the financial conditionand results of operations of the Company.

 

In the opinion of Management,the consolidated balance sheets as of June 30, 2005 and December 31,2004 and the related consolidated statements of income for each of the three andsix month periods ended June 30, 2005 and June 30, 2004 and changesin shareholders’ equity and cash flows for each of the six months ended June 30,2005 and June 30, 2004 present fairly the financial condition and resultsof operations of the Company. All material adjustments required for a fairpresentation have been made. These adjustments are of a normal recurring nature.There have been no material changes in accounting principles, practices or inthe method of application and there have been no retroactive adjustments duringthese periods. The results of operations for interim periods are not necessarilyindicative of the results of operations for the entire year.

 

This Quarterly Report on Form 10-Qshould be read in conjunction with the Company’s audited financial statementsfor the year ended December 31, 2004 and the notes included therein, includedwithin the Company’s Annual Report filed on Form 10-K.

 

# **Critical accountingpolicies**

 

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

 

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A material estimate thatis particularly susceptible to significant change is the determination of theallowance for loan losses (the allowance). Management believes that theallowance, as of June 30, 2005, is adequate and reasonable. Given thesubjective nature of identifying and valuing loan losses, it is likely thatwell-informed individuals could make materially different assumptions and could,therefore, calculate a materially different allowance value. While Managementuses available information to recognize losses on loans, changes in economicconditions may necessitate revisions in the future. In addition, variousregulatory agencies, as an integral part of their examination process,periodically review the Company’s allowance. Such agencies may require theCompany to recognize adjustments to the allowance based on their judgments ofinformation available to them at the time of their examination.

 

Another material estimateis the calculation of fair values of the Company’s investment securities. TheCompany receives estimated fair values of investment securities from anindependent valuation service. In developing these fair values, the valuationservice uses estimates of cash flows based on historical performance of similarinstruments in similar interest rate environments. Based on experience, Managementis aware that estimated fair values of investment securities tend to vary amongvaluation services. Accordingly, when selling investment securities, Managementtypically obtains price quotes from more than one source. The majority of theCompany’s investment securities are classified as available-for-sale (AFS). AFSsecurities are carried at fair market value on the consolidated balance sheet,with unrealized gains and losses, net of income tax, reported as a separate componentof shareholders’ equity in accumulated other comprehensive income (loss).

 

The fair market value of residential mortgage loans, classified as AFS,is obtained from the Federal National Mortgage Association (FNMA). The fairvalue of Small Business Administration (SBA) loans, classified as AFS, isobtained from an outside pricing source. To determine the fair market value ofstudent loans, classified as AFS, the Bank uses the pricing obtained from themost recent student loans sold from its AFS portfolio. The market to which theBank sells mortgage and other loans is restricted and price quotes from othersources are typically not obtained. As of June 30, 2005 and December 31,2004, the Company’s portfolio of loans AFS was comprised of student loans.

 

**2. Earnings per share**

 

Basic earnings per share (EPS) is computed using the weighted-averagenumber of shares of common stock outstanding. Diluted EPS is computed in thesame manner as basic EPS but reflects the potential dilution of common stockequivalents. Dilution would occur if Company-issued “in-the-money” stockoptions were exercised and converted into common stock. Stock options arein-the-money if the market value of the underlying stock is greater than theoption’s exercise or strike price. The Company uses the treasury stock methodto determine the dilutive effect of its unexercised stock options. Under thismethod, the proceeds received from shares issued in a hypothetical exercise ofstock options are assumed to be used to purchase treasury stock.

 

The following data illustrates the amounts used in computing EPS andthe effects on income and the weighted-average number of shares of potentially dilutivecommon stock for the six months ended June 30, 2005 and 2004:

 
| ** **                                  | ** ** | **Income  numerator** | ** ** | **Weighted-average  common shares  denominator** | ** ** | **EPS**    | ** ** |
|---------------------------------------------|------------|-----------------------|------------|--------------------------------------------------|------------|------------|------------|
| June 30,  2005                         |       |                  |       |                                             |       |       |       |   |   |
| Basic  EPS                                  |       | $                     | 2,155,197  |                                             | 1,843,048  |       | $          | 1.17 |   |
| Dilutive  effect of potential common stock: |       |                  |       |                                             |       |       |       |
| Stock  options:                             |       |                  |       |                                             |       |       |       |
| Exercise  of options outstanding            |       |                  |       | 7,700                                            |       |       |       |
| Hypothetical  share repurchase at $35.60    |       |                  |       | (7,203                                           | )          |       |       |
| Diluted  EPS                                |       | $                     | 2,155,197  |                                             | 1,843,545  |       | $          | 1.17 |   |
|                                        |       |                  |       |                                             |       |       |       |
| June 30, 2004                          | ** ** | ** **            | ** ** | ** **                                       | ** ** | ** ** | ** ** |
| Basic  EPS                                  |       | $                     | 1,545,800  |                                             | 1,826,886  |       | $          | 0.84 |   |
| Dilutive  effect of potential common stock: |       |                  |       |                                             |       |       |       |
| Stock  options:                             |       |                  |       |                                             |       |       |       |
| Exercise  of options outstanding            |       |                  |       | 5,100                                            |       |       |       |
| Hypothetical  share repurchase at $35.00    |       |                  |       | (4,517                                           | )          |       |       |
| Diluted  EPS                                |       | $                     | 1,545,800  |                                             | 1,827,469  |       | $          | 0.84 |   |

 

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**3. Stock plans**

 

The Company uses theintrinsic value method of accounting for stock-based compensation plans, under AccountingPrinciples Board (APB) Opinion No. 25*, Accounting for StockIssued to Employees* (APB No. 25), and as permitted by Statementof Financial Accounting Standards (SFAS) No. 123, *Accounting for Stock-Based Compensation* (SFAS No. 123). Under theintrinsic value method, compensation cost is measured by the excess of thequoted market price of the stock, as of the grant date (or other measurementdate) over the stock’s exercise price. Since all options issued under the Company’sstock-based compensation plans had an exercise price equal to the quoted marketvalue of the underlying common stock on the date of grant, the stock is deemedto have no intrinsic value. Accordingly, no compensation cost is recorded.

 

The alternative fairvalue method of accounting for stock-based compensation provided under SFAS No. 123requires the use of option valuation models, such as the Black-Scholes optionpricing model. The Black-Scholes option pricing model was not developed for usein valuing stock options granted under employer stock option plans. Rather, theBlack-Scholes option pricing model was developed for use in estimating the fairmarket value of short-term options traded in organized exchanges. Optionstraded in organized exchanges have no vesting restrictions and are fullytransferable. In addition, option valuation models require the input of highlysubjective assumptions including the expected or implied volatility of theoptions underlying stock. Since the options granted under the Company’s stockoption plans have characteristics significantly different from those of marketableoptions and because changes in the subjective input assumptions can materially impactthe estimated fair market value, in Management’s opinion, the existing valuationmodels do not necessarily provide a reliable single measure of the fair market valueof its employee stock options at the time of grant.

 

In December 2004,the Financial Accounting Standards Board issued SFAS 123(R) which replaces SFAS123, and supersedes APB No. 25. SFAS 123(R) requires that the cost ofshare-based payment transactions (including those with employees andnon-employees) be recognized in the financial statements. SFAS 123(R) appliesto all share-based payment transactions in which an entity acquires goods orservices by issuing (or offering to issue) its shares, share options, or otherequity instruments (except for those held by an ESOP) or by incurringliabilities (1) in amounts based (even in part) on the price of the entity’sshares or other equity instruments, or (2) that require (or may require)settlement by the issuance of an entity’s shares or other equity instruments. Publicentities such as the Company are not required to apply SFAS 123(R) until thebeginning of the first interim reporting period or fiscal year beginning after December 31,2005. The Company does not plan early implementation of the provisions of SFAS123(R).

 

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

 

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

 

The following is Management’sdiscussion and analysis of the significant changes in the consolidated financialcondition of the Company as of June 30, 2005 compared to December 31,2004 and the results of operations for the three and six month periods ended June 30,2005 compared to the respective periods ended June 30, 2004. Currentperformance may not be indicative of future results. This discussion should beread in conjunction with the Company’s 2004 Annual Report filed on Form 10-K.

 

**Forward looking statements**

 

This Quarterly Report on Form 10-Qcontains a number of forward-looking statements within the meaning of Section 27Aof the Securities Act of 1933, as amended, or the Securities Act, and Section 21Eof the Securities Exchange Act of 1934, as amended, or the Exchange Act. Thesestatements may be identified by the use of the words “anticipate,” “believe,” “could,”“estimate,” “expect,” “intend,” “may,” “outlook,” “plan,” “potential,” “predict,”“project,” “should,” “will,” “would” and similar terms and phrases, includingreferences to assumptions. Forward looking statements include risks anduncertainties.

 

Forward-lookingstatements are based on various assumptions and analyses made by us in light ofManagement’s experience and its perception of historical trends, currentconditions and expected future developments, as well as other factors itbelieves are appropriate under the circumstances. These statements are notguarantees of future performance and are subject to risks, uncertainties andother factors (many of which are beyond our control) that could cause actual

 

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results to differmaterially from future results expressed or implied by such forward-lookingstatements. These factors include, without limitation, the following:

 

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

 

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

 

•                  changesin the interest rate environment may reduce interest margins;

 

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

 

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

 

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

 

•                  legislativeor regulatory changes may adversely affect our business;

 

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

 

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

 

•                  actsof war or terrorism.

 

Management cautionsreaders not to place undue reliance on forward-looking statements, whichreflect analyses only as of the date of this document. We have no obligation toupdate any forward-looking statements to reflect events or circumstances afterthe 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 orfurnished on Form 8-K.

 

**General**

 

The Company’s results ofoperations depend primarily on its net interest income. Net interest income isthe difference between interest income and interest expense. Interest income isgenerated from yields on interest-earning assets which consist principally ofloans and investment securities. Interest expense is incurred from rates paidon interest-bearing liabilities which consist of deposits and borrowings. Netinterest income is determined by the Company’s interest rate spread (i.e., thedifference between the yields earned on its interest-earning assets and therates paid on its interest-bearing liabilities) and the relative amounts ofinterest-earning assets and interest-bearing liabilities. The interest ratespread is influenced by the overall interest rate environment, the compositionand characteristics of interest-earning assets and interest-bearing liabilitiesand by the competition in our marketplace. The interest rate spread and thechanges in the interest rate spread, from period-to-period, is also influencedby differences in the maturity and re-pricing characteristics of assetscompared to the maturity and re-pricing characteristics of the liabilities thatfund them.

 

The Company’sprofitability is also affected by the level of its non-interest income andexpenses, provision for loan losses and provision for income taxes. Non-interestincome consists of service charges on the Bank’s loan and deposit products,trust and asset management service fees, net gains or losses from sales ofleases, securities and loans AFS and increases in the cash surrender value ofthe bank-owned life insurance. Non-interest expense consists of compensationand related employee benefit expenses, occupancy, equipment, data processing,advertising, marketing, professional fees, insurance and other operatingoverhead.

 

The Company’sprofitability is significantly affected by general economic and competitiveconditions, changes in market interest rates, government policies and actionsof regulatory authorities. The Company’s loan portfolio is comprisedprincipally of commercial and commercial real estate loans. The propertiesunderlying the Company’s mortgages are concentrated in northeasternPennsylvania. Credit risk, which represents the possibility of the Company

 

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not recovering amountsdue from its borrowers, is significantly related to local economic conditionsin the areas the properties are located as well as the Company’s loan underwritingstandards. Economic conditions affect the market value of the underlyingcollateral as well as the levels of occupancy of multi-family dwellings andlevels of adequate cash flow and revenue generation from other income-producingproperties.

 

**COMPARISONOF FINANCIAL CONDITION ATJUNE 30, 2005 AND DECEMBER 31, 2004**

 

**Overview**

 

Consolidated assetsdecreased $3,355,000 or 0.6%, during the six months ended June 30, 2005 to$533,321,000. The decrease resulted from a decrease in total borrowings of$8,654,000, partially offset by increases in deposits of $3,563,000 andshareholders’ equity of $1,722,000. Since December 31, 2004, total investmentsdecreased $5,010,000, total loans increased $253,000 and cash and cashequivalents increased $636,000. All other assets increased $766,000. Theincrease in shareholders’ equity was attributable to earnings net of dividendspaid of $1,345,000, an increase in common stock of $272,000 and a $106,000 netunrealized holding gain on AFS securities recorded in other comprehensiveincome (loss).

 

A comparison of selectedbalance sheet information as of June 30, 2005 and December 31, 2004follows:

 

*Investment securities*

 

The Bank’s investmentpolicy is designed to complement its lending activities, generate a favorablereturn without incurring undue interest rate and credit risk, manage interestrate sensitivity, provide monthly cash flow and manage liquidity at acceptablelevels. In establishing investment strategies, the Bank considers its businessand growth or restructuring plans, the economic environment, the interest ratesensitivity position, the types of securities held, permissible purchases,credit quality, maturity and re-pricing terms, call or average-life intervalsand investment concentrations. The policy prescribes permissible investmentcategories that meet the policy standards and Management is responsible forstructuring and executing the specific investment purchases within these policyparameters. Management buys and sells investment securities from time-to-timedepending on market conditions, business trends, liquidity needs, capitallevels and structuring strategies. Investment security purchases provide a wayto quickly invest excess liquidity in order to generate additional earnings. TheBank generally earns a positive interest spread by assuming interest rate riskand using deposits and/or borrowings to purchase securities with longermaturities.

 

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 purchasedany securities for trading purposes. Management classifies most securities asAFS even though it has no immediate intent to sell them. The AFS designationaffords Management the flexibility to sell securities and adjust or restructurethe balance sheet in response to capital levels, liquidity needs, structuringstrategies and/or changes in market conditions. Securities AFS are carried atnet fair market value in the consolidated balance sheet with an adjustment to shareholders’equity, net of tax, which is presented under the caption “Accumulated othercomprehensive income (loss).”  Securitiesdesignated as HTM are carried at amortized cost.

 

During the second quarter,the Bank restructured approximately $19.5 million of investment securities holdingsto enhance current earnings while simultaneously addressing the interest raterisk in the portfolio from the continued flattening of the treasury yield curveat the mid- to long-term range. The restructuring included the sale andpurchase of securities that re-allocated the diversification away from heavilyweighted mortgage-backed securities. At June 30, 2005, approximately 47.2%of the investment portfolio was comprised of mortgage-backed securities thatamortize and provide monthly cash flow, compared to 55.7% at December 31,2004. Also at June 30, 2005, agency and municipal bonds comprised 29.5% and13.8%, respectively, of the investment portfolio. The carrying value ofinvestment securities totaled $110,659,000 or 20.7% of total assets as of June 30,2005 compared to $115,669,000 or 21.6% as of December 31, 2004. Currently,the portfolio is comprised of HTM and AFS securities with carrying values of$2,704,000 and $107,955,000, respectively.

 

At June 30, 2005,the AFS debt securities were recorded with a net unrealized loss in the amountof $173,000. Also at June 30, 2005, AFS equity securities were recorded inthe amount of $458,000 including an unrealized gain in the amount of $179,000.

 

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The amortized cost andfair value of investment securities HTM and AFS at June 30, 2005 consistedof the following (dollars in thousands):

 
| ** **                                        | ** ** | **Amortized  cost** | ** ** | **Gross unrealized  gains** | ** ** | **Gross unrealized  losses** | ** ** | **Fair  value** | ** ** |
|---------------------------------------------------|------------|---------------------|------------|-----------------------------|------------|------------------------------|------------|-----------------|------------|
|                                              |       |                |       |                        |       |                         |       |            |       |
| Held-to-maturity  securities:                     |       |                |       |                        |       |                         |       |            |       |
|                                              |       |                |       |                        |       |                         |       |            |       |
| Mortgage-backed  securities                       |       | $                   | 2,704      |                        | $          | 90                           |       | $               | —     |   | $ | 2,794 |   |
|                                              |       |                |       |                        |       |                         |       |            |       |
| Available-for-sale  securities:                   |       |                |       |                        |       |                         |       |            |       |
| U.S.  government agencies and corporations        |       | $                   | 33,014     |                        | $          | 1                            |       | $               | 374        |   | $ | 32,641 |   |
| Obligations  of states and municipal subdivisions |       | 14,997              |       | 278                         |       | 7                            |       | 15,268          |       |
| Corporate  bonds                                  |       | 10,027              |       | 41                          |       | 5                            |       | 10,063          |       |
| Mortgage-backed  securities                       |       | 49,632              |       | 189                         |       | 296                          |       | 49,525          |       |
|                                              |       |                |       |                        |       |                         |       |            |       |
| Sub  total                                        |       | 107,670             |       | 509                         |       | 682                          |       | 107,497         |       |
|                                              |       |                |       |                        |       |                         |       |            |       |
| Equity  securities                                |       | 279                 |       | 179                         |       | —                       |       | 458             |       |
|                                              |       |                |       |                        |       |                         |       |            |       |
| Total  available-for-sale                         |       | $                   | 107,949    |                        | $          | 688                          |       | $               | 682        |   | $ | 107,955 |   |
|                                              |       |                |       |                        |       |                         |       |            |       |
| Total  securities                                 |       | $                   | 110,653    |                        | $          | 778                          |       | $               | 682        |   | $ | 110,749 |   |

 

The amortized cost and fair value of investments HTMand AFS by contractual maturity at June 30, 2005 are as follows (dollarsin thousands):

 

| ** **                      | ** ** | **Amortized  cost** | ** ** | **Market  value** | ** ** |
|---------------------------------|------------|---------------------|------------|-------------------|------------|
| Held-to-maturity  securities:   |       |                |       |              |       |
| Mortgage-backed  securities     |       | $                   | 2,704      |              | $          | 2,794 |   |
|                            |       |                |       |              |       |
| Available-for-sale  securities: |       |                |       |              |       |
| Debt  securities:               |       |                |       |              |       |
| One  year or less               |       | $                   | 120        |              | $          | 120 |   |
| One  through five years         |       | 7,300               |       | 7,200             |       |
| Five  through ten years         |       | 24,055              |       | 23,889            |       |
| Over  ten years                 |       | 26,563              |       | 26,763            |       |
| Total  debt securities          |       | 58,038              |       | 57,972            |       |
|                            |       |                |       |              |       |
| Mortgage-backed  securities     |       | 49,632              |       | 49,525            |       |
| Equity  securities              |       | 279                 |       | 458               |       |
|                            |       |                |       |              |       |
| Total  available-for-sale       |       | $                   | 107,949    |              | $          | 107,955 |   |
|                            |       |                |       |              |       |
| Total  securities               |       | $                   | 110,653    |              | $          | 110,749 |   |

 

Expected maturities will differ from contractualmaturities because issuers and borrowers may have the right to call or repayobligations with or without call or prepayment penalty. Federal agency andmunicipal securities are included

 

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based upon their original stated maturity. Mortgage-backedsecurities, which are based on weighted-average lives and subject to monthlyprincipal pay-downs, are listed in total. Equity securities, which have nostated maturity, are carried at the lower of cost or fair market value.

 

*Loans available - for- sale (AFS)*

 

Generally, uponorigination, certain residential mortgages, the guaranteed portions of SBA loansand student loans may be classified as AFS. In the event of market interest rateincreases, fixed-rate loans and loans not immediately scheduled to re-pricewould no longer produce yields consistent with the current market. In adeclining interest rate environment, the Bank would be exposed to prepaymentrisk and, as rates on adjustable rate loans decrease, interest income would benegatively affected. To better manage prepayment and interest rate risk, loansthat meet these conditions may be classified as AFS. Consideration is also givento the Company’s current liquidity position and expected future liquidity needs.Loans AFS are carried at the lower of cost or estimated fair value. If the fairmarket values of these loans fall below their amortized cost, the loan iswritten down by the difference with a corresponding charge to current earnings.Subsequent appreciation, if any, is credited to current earnings but only tothe extent of previous write-downs.

 

At June 30, 2005,loans AFS amounted to $76,000 which approximated fair market value, compared to$576,000 at December 31, 2004. For the six months ended June 30, 2005,student loans with principal balances of $799,000 were sold into the secondarymarket with gains of approximately $8,000 being recognized. At June 30,2005 and December 31, 2004, the entire balance of loans AFS consisted ofstudent loans.

 

*Loans and leases*

 

The Bank originatescommercial and commercial real estate loans, residential, consumer, home equityand construction loans. The relative volume of originations is dependent uponcustomer demand, current interest rates and the perception and duration offuture interest levels. The Bank continues to focus its efforts on theexpansion of variable-rate portfolios of residential and consumer loans as wellas commercial loans and fixed-rate residential loans. The broad spectrum ofproducts provides diversification which helps manage, to an extent, interestrate risk and credit concentration risk. Credit risk is further managed throughunderwriting policies and procedures and loan monitoring practices. Interestrate risk is managed using various asset/liability modeling techniques andanalyses. The interest rates on most commercial loans are adjustable with resetintervals of five years or less. Whenever practical, the Bank originatesvariable-rate loans.

 

The majority of our loanportfolio is collateralized, at least in part, by real estate in the greaterLackawanna and Luzerne counties of Pennsylvania. Commercial lending activitiesgenerally involve a greater degree of credit risk than residential lendingbecause they typically have larger balances and are more affected by adverseconditions in the economy. Because payments on loans secured by commercial andcommercial real estate often depend upon the successful operation andmanagement of the properties and the businesses which operate from within them,repayment of such loans may be affected by factors outside the borrower’scontrol. Such factors may include adverse conditions in the real estate market,the economy, the industry or changes in government regulations. As such,commercial loans require more ongoing evaluation and monitoring which occurswith the Bank’s credit administration and outsourced loan review functions.

 

During the first quarterof 2005, the Bank established a reserve for estimated impairment from thefuture sales of its leased vehicles which was netted against the gross amountof direct finance leasing. The estimated impairment is based on the historicalsales performance of terminated leases which are typically sold below theirresidual value. The balance of the Bank’s leased vehicles should mature orpayoff during 2005 and periodic adjustments will be made to this reserve,during this timeframe. The amount of periodic adjustments will depend upon actualsales proceeds from the leased vehicles. Currently, the Company does not anticipatere-entering the direct finance lease business when the current agreementsexpire in 2005.

 

Loans, net of unearnedincome of $388,173,000 at June 30, 2005 increased $639,000 from$387,534,000 at December 31, 2004. The increase was from successfulimplementation and marketing strategies for residential mortgages and consumerhome equity lending partially offset by a decline in commercial loans andrun-off of receivables from the Bank’s auto leasing business. The decrease incommercial lending was from the sold participation of a loan during the firstquarter of 2005 and the maturity of an automobile dealer’s floor plan note thatwas not renewed. 

 

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The following table sets forth the composition of the loan portfolio atJune 30, 2005 and December 31, 2004:

 
| ** **                             | ** ** | **June 30, 2005** | ** **  | **December 31, 2004** | ** ** |
|----------------------------------------|------------|------------------------|-------------|----------------------------|------------|
| Commercial  and commercial real estate |       | $                      | 207,983,995 |                       | $          | 221,968,137 |   |
| Residential  real estate               |       | 95,672,565             |        | 91,294,401                 |       |
| Consumer  and home equity              |       | 70,790,958             |        | 61,487,608                 |       |
| Real  estate construction              |       | 12,475,700             |        | 10,620,472                 |       |
| Direct  financing leases               |       | 1,260,796              |        | 2,211,978                  |       |
| Gross  loans                           |       | 388,184,014            |        | 387,582,596                |       |
| Less:                                  |       |                   |        |                       |       |
| Unearned  discount                     |       | 10,935                 |        | 48,423                     |       |
| Allowance  for loan losses             |       | 5,873,378              |        | 5,987,798                  |       |
| Net  loans                             |       | $                      | 382,299,701 |                       | $          | 381,546,375 |   |
|                                   |       |                   |        |                       |       |
| Loans  available-for-sale              |       | $                      | 76,173      |                       | $          | 576,378 |   |
|                                   |       |                   |        |                       |       |
| Total  loans                           |       | $                      | 382,375,874 |                       | $          | 382,122,753 |   |

 

*Allowance for loan losses*

 

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

 

Management applies twoprimary components during the loan review process to determine the adequacy of allowancelevels. The two components consist of a specific loan loss allocation, forloans that are deemed impaired, and a general loan loss allocation for thoseloans where a specific loss has not been allocated. The methodology to analyzethe adequacy of the allowance is as follows:

 

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

•                  Calculationof specific allowances required based on collateral and other persuasiveevidence;

•                  Identificationof loans collateralized by cash and cash equivalents;

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

•                  Applicationof historical loss percentages (three-year average) to pools to determine theallowance allocation; and

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

 

Allocation of theallowance for different categories of loans is based on the methodology asexplained above. A key element of the methodology to determine the allowance isthe Company’s credit risk evaluation process, which includes creditrisk-grading of individual commercial loans. 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 includes reviewing borrowers’ current financialinformation, historical payment experience, credit documentation, publicinformation and other information specific to each individual borrower. Thechanges in the allocations from period to period are based upon reviews of theloan and lease portfolios.

 

Net charge-offs for the sixmonths ended June 30, 2005 were $494,000, compared to $371,000, for thesame period in 2004. Net charge-offs of commercial loans were $426,000 for the sixmonths ended June 30, 2005 compared to $148,000 in the first six months of2004. Real estate mortgage net charge-offs declined to $21,000 for the first six

 

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months of 2005 comparedto $115,000 in the first six months of 2004. Consumer loan net charge-offs were$47,000 for the first half of 2005 compared to $83,000 for the same 2004 period.There were no lease financing charge-offs during the first half of 2005. The deteriorationin the credit quality of a single commercial loan was the primary cause forincreased commercial loan charge-offs during the six months ended June 30,2005 compared to the same 2004 period.

 

Management believes thatthe current balance in the allowance for loans losses of $5,873,000 issufficient to withstand the identified potential credit quality issues that mayarise and are inherent to the portfolio. Currently, Management is unaware ofany potential problem loans that have not been reviewed. Potential problemloans are those where there is known information that leads Management tobelieve repayment of principal and/or interest is in jeopardy and the loans arecurrently neither on non-accrual status nor past due 90 days or more. However,there could be instances which become identified during the year that mayrequire additional charge-offs and/or increases to the allowance. The ratio ofallowance for loan losses to total loans was 1.51% at June 30, 2005compared 1.54% at both December 31, 2004 and June 30, 2004.

 

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

 
| ** **                       | ** ** | **As of and for the  six months ended  June 30, 2005** | ** **  | **As of and for the  year ended  December 31, 2004** | ** ** | **As of and for the  six months ended  June 30, 2004** | ** ** |
|----------------------------------|------------|-------------------------------------------------------------|-------------|-----------------------------------------------------------|------------|-------------------------------------------------------------|------------|
|                             |       |                                                        |        |                                                      |       |                                                        |       |
| Balance  at beginning of period  |       | $                                                           | 5,987,798   |                                                      | $          | 4,996,966                                                   |       | $ | 4,996,966 |   |
|                             |       |                                                        |        |                                                      |       |                                                        |       |
| Provision  charged to operations |       | 380,000                                                     |        | 2,150,000                                                 |       | 1,250,000                                                   |       |
|                             |       |                                                        |        |                                                      |       |                                                        |       |
| Charge-offs:                     |       |                                                        |        |                                                      |       |                                                        |       |
| Commercial                       |       | 728,516                                                     |        | 775,252                                                   |       | 319,370                                                     |       |
| Real  estate                     |       | 20,875                                                      |        | 266,324                                                   |       | 122,943                                                     |       |
| Consumer                         |       | 108,302                                                     |        | 480,462                                                   |       | 201,025                                                     |       |
| Lease  financing                 |       | —                                                      |        | 84,902                                                    |       | 44,519                                                      |       |
| Total                            |       | 857,693                                                     |        | 1,606,940                                                 |       | 687,857                                                     |       |
|                             |       |                                                        |        |                                                      |       |                                                        |       |
| Recoveries:                      |       |                                                        |        |                                                      |       |                                                        |       |
| Commercial                       |       | 302,204                                                     |        | 226,082                                                   |       | 171,184                                                     |       |
| Real  estate                     |       | 60                                                          |        | 20,039                                                    |       | 8,010                                                       |       |
| Consumer                         |       | 61,009                                                      |        | 178,727                                                   |       | 118,051                                                     |       |
| Lease  financing                 |       | —                                                      |        | 22,924                                                    |       | 19,824                                                      |       |
| Total                            |       | 363,273                                                     |        | 447,772                                                   |       | 317,069                                                     |       |
|                             |       |                                                        |        |                                                      |       |                                                        |       |
| Net  charge-offs                 |       | 494,420                                                     |        | 1,159,168                                                 |       | 370,788                                                     |       |
|                             |       |                                                        |        |                                                      |       |                                                        |       |
| Balance  at end of period        |       | $                                                           | 5,873,378   |                                                      | $          | 5,987,798                                                   |       | $ | 5,876,178 |   |
|                             |       |                                                        |        |                                                      |       |                                                        |       |
| Total  loans, end of period      |       | $                                                           | 388,249,252 |                                                      | $          | 388,110,551                                                 |       | $ | 382,767,632 |   |

 

15

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| ** **                                                                | ** ** | **As of and for the  six months ended  June 30, 2005** | ** ** | **As of and for the  year ended  December 31, 2004** | ** ** | **As of and for the  six months ended  June 30, 2004** | ** ** |
|---------------------------------------------------------------------------|------------|-------------------------------------------------------------|------------|-----------------------------------------------------------|------------|-------------------------------------------------------------|------------|
| Net  charge-offs to:                                                      |       |                                                        |       |                                                      |       |                                                        |       |
| Loans,  end of period                                                     |       | 0.13                                                        | %          | 0.30                                                      | %          | 0.10                                                        | %          |
| Allowance  for loan losses                                                |       | 8.42                                                        | %          | 19.36                                                     | %          | 6.31                                                        | %          |
| Provision  for loan losses                                                |       | 130.11                                                      | %          | 53.91                                                     | %          | 29.66                                                       | %          |
|                                                                      |       |                                                        |       |                                                      |       |                                                        |       |
| Allowance  for loan losses to:                                            |       |                                                        |       |                                                      |       |                                                        |       |
| Total  loans                                                              |       | 1.51                                                        | %          | 1.54                                                      | %          | 1.54                                                        | %          |
| Non-accrual  loans                                                        |       | 57.82                                                       | %          | 60.46                                                     | %          | 56.93                                                       | %          |
| Non-performing  loans                                                     |       | 54.91                                                       | %          | 57.24                                                     | %          | 54.28                                                       | %          |
| Net  charge-offs                                                          |       | 11.88                                                       | x          | 5.17                                                      | x          | 15.85                                                       | x          |
|                                                                      |       |                                                        |       |                                                      |       |                                                        |       |
| Loans  30-89 days past due and still accruing                             |       | $                                                           | 2,681,224  |                                                      | $          | 4,316,453                                                   |       | $ | 3,964,766 |   |
| Loans  90 days past due and accruing                                      |       | $                                                           | 537,588    |                                                      | $          | 557,492                                                     |       | $ | 502,686 |   |
| Non-accrual  loans                                                        |       | $                                                           | 10,158,361 |                                                      | $          | 9,904,276                                                   |       | $ | 10,322,405 |   |
| Allowance  for loan losses to loans 90 days or more past due and accruing |       | 10.93                                                       | x          | 10.75                                                     | x          | 11.69                                                       | x          |

 

*Non-performing assets*

 

The Bank definesnon-performing assets as accruing loans past due 90 days or more, non-accrualloans, restructured loans, other real estate owned and repossessed assets. Asof June 30, 2005, non-performing assets represented 2.09% of total assetscompared to 1.99% at December 31, 2004 and 2.04% at June 30, 2004.

 

The non-accrual loanbalance increased $254,000 during the first six months of 2005, but was down by$164,000 compared to June 30, 2004. The balance of non-accrual loansfluctuates upward and downward depending mostly on delinquency status, paydowns, charge offs, a history of satisfactory repayments during the period aloan is classified as non-accrual and acquisition through foreclosure. During2005, $3,381,000 of loans classified as non-accrual, including capitalizedexpenditures, were added to non-accrual, partially offset by payoffs or paydowns of $1,528,000, charge offs of $767,000, transfers to the Bank’s portfolioof other real estate owned (OREO) of $246,000 and $586,000 of loans that havereturned to performing status.

 

Non-performing loanswhich includes non-accrual loans and accruing loans past due 90 days or moreincreased $234,000 to $10,696,000 since December 31, 2004. The ratio ofnon-performing loans to end of period net loans increased six basis points,during the six month period ended June 30, 2005. For the same period in2004, the ratio of non-performing loans to net loans was 2.87%, compared to2.80% at June 30, 2005, or a decrease of seven basis points.

 

Foreclosed assets heldfor sale includes OREO and repossessed assets. OREO represents eight propertiesthat have been foreclosed upon and transferred from loans. Five of theproperties are currently under contracts for sale and the remaining three areavailable for sale. Repossessed assets represent indirect auto loans, thepayments of which have become delinquent and the vehicles repossessed.

 

16

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

 
| ** **                                                                         | ** ** | **June 30, 2005** | ** **  | **December 31, 2004** | ** ** | **June 30, 2004** | ** ** |
|------------------------------------------------------------------------------------|------------|------------------------|-------------|----------------------------|------------|------------------------|------------|
|                                                                               |       |                   |        |                       |       |                   |       |
| Loans  past due 90 days or more and accruing                                       |       | $                      | 537,588     |                       | $          | 557,492                |       | $ | 502,686 |   |
| Non-accrual  loans                                                                 |       | 10,158,361             |        | 9,904,276                  |       | 10,322,405             |       |
| Total  non-performing loans                                                        |       | 10,695,949             |        | 10,461,768                 |       | 10,825,091             |       |
|                                                                               |       |                   |        |                       |       |                   |       |
| Restructured  loans                                                                |       | —                 |        | —                     |       | —                 |       |
| Other  real estate owned                                                           |       | 351,550                |        | 163,000                    |       | 216,254                |       |
| Repossessed  assets                                                                |       | 100,484                |        | 50,104                     |       | 12,334                 |       |
| Total  non-performing assets                                                       |       | $                      | 11,147,983  |                       | $          | 10,674,872             |       | $ | 11,053,679 |   |
|                                                                               |       |                   |        |                       |       |                   |       |
| Net  loans including AFS                                                           |       | $                      | 382,375,874 |                       | $          | 382,122,753            |       | $ | 376,891,453 |   |
| Total  assets                                                                      |       | $                      | 533,320,637 |                       | $          | 536,675,138            |       | $ | 540,620,844 |   |
| Non-accrual  loans to net loans                                                    |       | 2.66                   | %           | 2.59                       | %          | 2.74                   | %          |
| Non-performing  assets to net loans, foreclosed real estate and repossessed assets |       | 2.91                   | %           | 2.79                       | %          | 2.93                   | %          |
| Non-performing  assets to total assets                                             |       | 2.09                   | %           | 1.99                       | %          | 2.04                   | %          |
| Non-performing  loans to net loans                                                 |       | 2.80                   | %           | 2.74                       | %          | 2.87                   | %          |

 

*Accrued interest receivable andother assets*

 

The increase in accruedinterest receivable of $340,000 or 19.7% from December 31, 2004 to June 30,2005 was due to the timing of cash receipts on interest-earning asset balances.The increase in other assets of $717,000 or 21.1%, for the same period, was duemostly to an increase in construction in process for expenditures associatedwith the Bank’s branch expansion plans. Generally, upon completion, theseexpenditures will be moved to bank premises and equipment at which timedepreciation will begin.

 

*Deposits*

 

The Bank is acommunity-based commercial financial institution and offers a variety ofdeposit accounts with a range of interest rates and terms. Deposit productsinclude passbook and statement savings accounts, NOW, money market, demanddeposit and certificates of deposit accounts. The flow of deposits issignificantly influenced by general economic conditions, changes in prevailinginterest rates, pricing and competition. Most of the Bank’s deposits areobtained from the communities surrounding its 12 branch offices. We attempt toattract and retain deposit customers via sales and marketing efforts with newproducts, quality service, competitive rates and long-standing customerrelationships.

 

To determine depositproduct interest rates, the Bank considers local competition, market yields andthe rates charged for alternative sources of funding such as borrowings. Althoughwe have experienced a continued intense competition for deposits, we have notincreased rates significantly as we only consider cost effective strategies whileoperating in a rising interest rate environment.

 

17

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The following tablerepresents the components of deposits as of June 30, 2005 and December 31,2004:

 
| ** **                                | ** ** | **June 30, 2005** | ** **  | **December 31, 2004** | ** ** | **Dollar  change** | ** ** | **Percent  change** | ** ** |
|-------------------------------------------|------------|------------------------|-------------|----------------------------|------------|--------------------|------------|---------------------|------------|
| **Non-interest-bearing  deposits**        |       |                   |        |                       |       |               |       |                |       |
| Personal                                  |       | $                      | 30,403,847  |                       | $          | 28,927,588         |       | $                   | 1,476,259  |   | 5.10 | % |
| Non-personal                              |       | 32,123,296             |        | 29,248,882                 |       | 2,874,414          |       | 9.83                | %          |
| Public  funds                             |       | 2,473,365              |        | 2,479,373                  |       | (6,008             | )          | -0.24               | %          |
| Bank  checks                              |       | 4,232,493              |        | 4,701,692                  |       | (469,199           | )          | -9.98               | %          |
| Total                                     |       | $                      | 69,233,001  |                       | $          | 65,357,535         |       | $                   | 3,875,466  |   | 5.93 | % |
| ** **                                |       |                   |        |                       |       |               |       |                |       |
| **Time  deposits of $100,000 or greater** |       |                   |        |                       |       |               |       |                |       |
| Personal                                  |       | $                      | 59,369,794  |                       | $          | 61,694,837         |       | $                   | (2,325,043 | ) | -3.77 | % |
| Non-personal                              |       | 16,652,164             |        | 17,749,896                 |       | (1,097,732         | )          | -6.18               | %          |
| Public  funds                             |       | 8,493,557              |        | 9,023,956                  |       | (530,399           | )          | -5.88               | %          |
| IRA’s                                |       | 5,057,479              |        | 5,517,344                  |       | (459,865           | )          | -8.33               | %          |
| Total                                     |       | $                      | 89,572,994  |                       | $          | 93,986,033         |       | $                   | (4,413,039 | ) | -4.70 | % |
| ** **                                |       |                   |        |                       |       |               |       |                |       |
| **Other  interest-bearing deposits**      |       |                   |        |                       |       |               |       |                |       |
| Time  deposits less than $100,000:        |       |                   |        |                       |       |               |       |                |       |
| Personal                                  |       | $                      | 62,289,098  |                       | $          | 66,918,765         |       | $                   | (4,629,667 | ) | -6.92 | % |
| Non-personal                              |       | 4,048,893              |        | 4,024,801                  |       | 24,092             |       | 0.60                | %          |
| Public  funds                             |       | 228,818                |        | 662,876                    |       | (434,058           | )          | -65.48              | %          |
| IRA’s                                |       | 17,562,884             |        | 19,090,551                 |       | (1,527,667         | )          | -8.00               | %          |
| sub total                                 |       | 84,129,693             |        | 90,696,993                 |       | (6,567,300         | )          | -7.24               | %          |
| NOW  accounts                             |       | 54,307,918             |        | 41,421,525                 |       | 12,886,393         |       | 31.11               | %          |
| Money  market deposits                    |       | 20,822,437             |        | 27,606,102                 |       | (6,783,665         | )          | -24.57              | %          |
| Savings  and clubs                        |       | 51,112,282             |        | 46,547,147                 |       | 4,565,135          |       | 9.81                | %          |
| Total                                     |       | $                      | 210,372,330 |                       | $          | 206,271,767        |       | $                   | 4,100,563  |   | 1.99 | % |
| ** **                                |       |                   |        |                       |       |               |       |                |       |
| **Total  deposits**                       |       |                   |        |                       |       |               |       |                |       |
| Noninterest-bearing  deposits             |       | $                      | 69,233,001  |                       | $          | 65,357,535         |       | $                   | 3,875,466  |   | 5.93 | % |
| Interest-bearing  deposits                |       | 299,945,324            |        | 300,257,800                |       | (312,476           | )          | -0.10               | %          |
| Total                                     |       | $                      | 369,178,325 |                       | $          | 365,615,335        |       | $                   | 3,562,990  |   | 0.97 | % |
|                                      |       |                   |        |                       |       |               |       |                |       |
| **Public  funds**                         |       |                   |        |                       |       |               |       |                |       |
| Noninterest-bearing                       |       | $                      | 2,473,365   |                       | $          | 2,479,373          |       | $                   | (6,008     | ) | -0.24 | % |
| Certificates  of deposit                  |       | 8,722,375              |        | 9,686,832                  |       | (964,457           | )          | -9.96               | %          |
| NOW  accounts                             |       | 25,644,421             |        | 8,406,827                  |       | 17,237,594         |       | 205.04              | %          |
| Money  market deposits                    |       | 1,304,280              |        | 4,710,720                  |       | (3,406,440         | )          | -72.31              | %          |
| Savings  and clubs                        |       | 1,190,559              |        | 1,266,834                  |       | (76,275            | )          | -6.02               | %          |
| Total                                     |       | $                      | 39,335,000  |                       | $          | 26,550,586         |       | $                   | 12,784,414 |   | 48.15 | % |
|                                      |       |                   |        |                       |       |               |       |                |       |
| Total  assets                             |       | $                      | 533,320,637 |                       | $          | 536,675,138        |       |                |       |   |   |
| Total  deposits to total assets           |       | 69.22                  | %           | 68.13                      | %          |               |       |                |       |
| Public  funds to total deposits           |       | 10.65                  | %           | 7.26                       | %          |               |       |                |       |
| Public  funds to total assets             |       | 7.38                   | %           | 4.95                       | %          |               |       |                |       |

 

Total deposits increased$3,563,000 or 1.0% during the six months ended June 30, 2005 to$369,178,000. The increase in total deposits was primarily due to a $12,886,000increase in NOW accounts caused by the receipt and retention of a seasonalincrease from the public sector including deposits from a municipal customerwho formerly used the Bank’s daily-sweep repurchase agreements. In addition,savings accounts increased $4,565,000 or 9.8% due mostly to the continuedsuccess from marketing our new savings product programs. Demand depositaccounts (DDA’s) increased $3,875,000 or 5.9% during the first six months of2005. Partially offsetting these increases was the continued time depositoutflow, which experienced a decline of $10,980,000 or 5.9% during the firsthalf of 2005, and a decline in money market accounts of $6,784,000 or 24.6%during the same period. Management believes the decrease in money markets aswell as time deposit accounts is due in part to the Bank’s new savings options,the seasonal decrease from the public sector and to the outflow to other alternativefinancial products. While Management, along with the Bank’s

 

18

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Asset/LiabilityCommittee, continues to monitor deposit interest rates in our communities, itremains poised to offer deposit rates that are prudent to producing meaningful interestrate spreads.

 

Total averageinterest-bearing deposits decreased $14,145,000 or 4.5% from $316,528,000, at December 31,2004 to $302,383,000 at June 30, 2005. The average deposit declineincluded a reduction in total time deposits of $25,683,000. Management’stactical plan is to continue to monitor but not actively participate in thecurrent competitive pricing pressure and will allow high-cost time deposits tocontinue to run-off in favor of growing its lower costing transaction andsavings account programs. Through continued success in marketing efforts, theaverage balance of these transaction and savings accounts increased byapproximately $11,538,000 during the first half of 2005.

 

Public funds continue tobe a relatively stable source of deposits and now represent $39,335,000 or10.7% of total deposits at June 30, 2005, up from $26,551,000 or 7.3% at December 31,2004. The Bank is able to maintain public funds due to long establishedrelationships and competitive product pricing. Public fund deposits aresensitive to the operating demands and business cycles of the various publicentities as well as the forever-changing political landscape. Accordingly, theBank could experience significant shifts and outflows of these balancesthroughout the year.

 

*Borrowings*

 

Borrowings totaled$112,999,000 at June 30, 2005 compared to $121,653,000 at December 31,2004.

 

Borrowings are used as acomplement to deposit generation as an alternative funding source whereby theBank will borrow from the Federal Home Loan Bank of Pittsburgh (FHLB) for assetgrowth and liquidity needs. Borrowings included $70,732,000 and $71,119,000 inlong-term advances from the FHLB at June 30, 2005 and December 31,2004, respectively. Also included in borrowings is short-term customerrepurchase (repos) agreements of $32,182,000 and $40,684,000, at June 30,2005 and December 31, 2004, respectively. Repos are non-insured low-costinterest-bearing liabilities that have a security interest in qualifiedinvestment securities of the Bank. Repos offered are either fixed-term or adaily-sweep product of the Bank. The balance in customer repos can fluctuatedaily because the daily-sweep product is dependent on the level of availablefunds in depositor accounts. In addition, short-term borrowings may include overnightbalances which the Bank may require from time-to-time to fund daily liquidityneeds. As of June 30, 2005, the balance in this account was $9,050,000compared to $8,760,000 at December 31, 2004.

 

The combined short- andlong-term weighted-average interest rate on borrowings was 4.05% and 3.57% at June 30,2005 and December 31, 2004, respectively.

 

*Accrued interest payable andother liabilities*

 

Accrued interest payableand other liabilities increased $14,000 during the first six months of 2005. Accruedinterest payable increased $57,000 while other liabilities and accrued expensesdecreased $43,000. Both changes are not unusual in nature and representfluctuations from normal recurring business transactions.

 

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

**JUNE 30,2005 AND JUNE 30, 2004**

 

**Overview**

 

Net income for the secondquarter of 2005 was $1,136,000, an increase of $215,000 or 23% from the $921,000recorded in the same quarter of 2004. Diluted earnings per share for the sameperiod improved $0.12 from $0.50 for the three months ended June 30, 2004to $0.62 for the three months ended June 30, 2005.

 

The quarter-to-quarter improvementin net income was primarily the results of an increase in net interest incomeand a decrease in the provision for loan losses. Non-interest income, non-interestexpense and the provision for income taxes increased in the second quarter of2005 compared to the same 2004 quarter.

 

Return on average assetsand return on average equity were 0.86% and 9.65%, respectively, for the three monthsended June 30, 2005 compared to 0.67% and 8.39%, respectively, for thesame period in 2004. The improvement in these ratios is principally due to theimproved earnings.

 

19

----

 

*Net interest income*

 

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

 

Net interest income increased$227,000, or 6%, to $4,318,000 for the second quarter of 2005, from $4,091,000 recordedin the same period of 2004. Interest income increased by approximately $290,000in the second quarter 2005 compared to the same 2004 quarter. The increase was primarilyattributable to a 42 basis point increase in the book yield earned on the Bank’sinterest-earning assets, to 5.65%, for the three months ended June 30,2005 compared to 5.23% for the three months ended June 30, 2004. Theincrease in the book yield more than offset reduced income from the effect of a$19,611,000 decrease in average interest-earning assets that occurred duringthe respective period. The Bank’s diverse portfolio of interest earning-assetsshould continue to benefit from the effect of the rising interest rateenvironment. The book yield on the Bank’s loan portfolio increased 34 basispoints due to continued increase in the national prime rate, the bench markrate to which floating rate loans originate and re-price to, and the pricing ofnew loan originations. The increase in rate combined with a modest decline inaverage balances, resulted in a $290,000 increase in interest income from the loanportfolio for the second quarter of 2005 compared to the same quarter in 2004. Theinvestment securities portfolio experienced a 51 basis point increase in itsbook yield in the second quarter of 2005 compared to the second quarter of 2004.However, because of a $17,502,000 decline in average balance, this portfolio’sinterest income declined approximately $13,000 in the second quarter of 2005compared to the same 2004 quarter.

 

During the second quarterof 2005, interest expense increased $63,000 to $2,785,000 from $2,722,000 forthe same 2004 quarter. The increasing rate environment has necessitated theneed for the Bank to increase offering rates on various deposit products aswell as recognition of higher interest charges from repurchase agreements (repos)and other wholesale funding sources. Rates paid on average interest-bearingliabilities increased 20 basis points and offset the effect of a $24,400,000decline in the average balances upon which they are paid. The continued declinein average balances in certificate of deposit accounts (CD’s) compounded withincreases in low-cost transaction and savings accounts continue to help strengthenthe Bank’s performance. Compared to the second quarter of 2004, the Bankexperienced an increase in the average balances of lower-costing transactionand savings accounts and a decrease in the average balances of CD’s and reposduring the second quarter of 2005. The growth in the savings accounts was causedby the success of the Bank’s continued efforts in the promotion of our newsavings products. The decrease in average balances of repos was caused by thecyclical nature of the sweep account and preference for exiting the repoproduct in favor of one of the Bank’s alternative interest-bearing checkingaccounts as was the case with one of our municipal customers. For the remainderof 2005, Management’s continued focus will be to attract and retain low-costtransaction accounts.

 

For the second quarter of2005, the Bank’s tax-equivalent spread and margin increased 25 and 32 basispoints, respectively, to 3.06% and 3.54% compared to 2.81% and 3.22% for the secondquarter of 2004. The increase in spread and margin is the result of the impactthe increasing rate environment has had on the performance of the Bank’s portfolioof interest-earning assets. Increases in rates at the short end of the yieldcurve will continue to pressure the Bank’s interest rate spread and margin asthe competition for deposits will continue to intensify. However, any periodicincreases in national prime should continue to bolster the performance of theBank’s interest income.

 

20

----

 

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

 
| ** **                                    | ** ** | **Three months ended  June 30,** | ** ** | **Six months ended  June 30,** | ** ** | **Year ended  December 31,** | ** ** |
|-----------------------------------------------|------------|---------------------------------------|------------|-------------------------------------|------------|-----------------------------------|------------|
| ** **                                    | ** ** | **2005**                              | ** ** | **2004**                            | ** ** | **2005**                          | ** ** | **2004** | ** ** | **2004** | ** ** |
| Average  interest-earning assets:             |       |                                  |       |                                |       |                              |       |   |   |   |   |
| Loans  and leases                             |       | $                                     | 386,579    |                                | $          | 390,048                           |       | $ | 386,216 |   | $ | 391,358 |   | $ | 387,292 |   |
| Investments                                   |       | 115,472                               |       | 132,974                             |       | 116,946                           |       | 137,410 |   | 132,130 |   |
| Federal  funds sold                           |       | 985                                   |       | —                              |       | 3,677                             |       | 2,204 |   | 1,530 |   |
| Interest-bearing  deposits                    |       | 909                                   |       | 534                                 |       | 776                               |       | 626 |   | 637 |   |
| Total                                         |       | $                                     | 503,945    |                                | $          | 523,556                           |       | $ | 507,615 |   | $ | 531,598 |   | $ | 521,589 |   |
|                                          |       |                                  |       |                                |       |                              |       |   |   |   |   |
| Average  interest-bearing liabilities:        |       |                                  |       |                                |       |                              |       |   |   |   |   |
| Other  interest-bearing deposits              |       | $                                     | 129,018    |                                | $          | 109,680                           |       | $ | 122,863 |   | $ | 110,639 |   | $ | 111,325 |   |
| Certificates  of deposit                      |       | 176,134                               |       | 206,010                             |       | 179,520                           |       | 216,863 |   | 205,203 |   |
| Borrowed  funds                               |       | 76,117                                |       | 82,534                              |       | 76,208                            |       | 78,821 |   | 78,318 |   |
| Repurchase  agreements                        |       | 32,600                                |       | 40,045                              |       | 40,701                            |       | 41,467 |   | 41,695 |   |
| Total                                         |       | $                                     | 413,869    |                                | $          | 438,269                           |       | $ | 419,292 |   | $ | 447,790 |   | $ | 436,541 |   |
|                                          |       |                                  |       |                                |       |                              |       |   |   |   |   |
| Interest  income:                             |       |                                  |       |                                |       |                              |       |   |   |   |   |
| Loans  and leases                             |       | $                                     | 5,929      |                                | $          | 5,618                             |       | $ | 11,761 |   | $ | 11,206 |   | $ | 22,431 |   |
| Investments  (1)                              |       | 1,292                                 |       | 1,296                               |       | 2,503                             |       | 2,777 |   | 5,385 |   |
| Federal  funds sold                           |       | 7                                     |       | —                              |       | 47                                |       | 10 |   | 17 |   |
| Interest-bearing  deposits                    |       | 6                                     |       | 1                                   |       | 9                                 |       | 2 |   | 6 |   |
| Total                                         |       | $                                     | 7,234      |                                | $          | 6,915                             |       | $ | 14,320 |   | $ | 13,995 |   | $ | 27,839 |   |
|                                          |       |                                  |       |                                |       |                              |       |   |   |   |   |
| Interest  expense:                            |       |                                  |       |                                |       |                              |       |   |   |   |   |
| Other  interest-bearing deposits              |       | $                                     | 355        |                                | $          | 179                               |       | $ | 587 |   | $ | 362 |   | $ | 742 |   |
| Certificates  of deposit                      |       | 1,321                                 |       | 1,452                               |       | 2,645                             |       | 3,210 |   | 5,994 |   |
| Borrowed  funds                               |       | 968                                   |       | 990                                 |       | 1,913                             |       | 1,976 |   | 3,980 |   |
| Repurchase  agreements                        |       | 141                                   |       | 101                                 |       | 338                               |       | 204 |   | 464 |   |
| Total                                         |       | $                                     | 2,785      |                                | $          | 2,722                             |       | $ | 5,483 |   | $ | 5,752 |   | $ | 11,180 |   |
|                                          |       |                                  |       |                                |       |                              |       |   |   |   |   |
| Net  interest income                          |       | $                                     | 4,449      |                                | $          | 4,193                             |       | $ | 8,837 |   | $ | 8,243 |   | $ | 16,659 |   |
|                                          |       |                                  |       |                                |       |                              |       |   |   |   |   |
| Yield  on average interest-earning assets     |       | 5.76                                  | %          | 5.31                                | %          | 5.69                              | %          | 5.29 | % | 5.34 | % |
| Rate  on average interest-bearing liabilities |       | 2.70                                  | %          | 2.50                                | %          | 2.64                              | %          | 2.58 | % | 2.56 | % |
|                                          |       |                                  |       |                                |       |                              |       |   |   |   |   |
| Net  interest spread                          |       | 3.06                                  | %          | 2.81                                | %          | 3.05                              | %          | 2.71 | % | 2.78 | % |
|                                          |       |                                  |       |                                |       |                              |       |   |   |   |   |
| Net  interest margin                          |       | 3.54                                  | %          | 3.22                                | %          | 3.51                              | %          | 3.12 | % | 3.19 | % |

 

Inthe table above, interest income was adjusted to a tax-equivalent basis torecognize the income from the various tax-exempt assets as if the interest was fullytaxable. This treatment allows a uniform comparison among the yields on interest-earningassets. The calculations were computed on a fully tax-equivalent basis usingthe corporate federal tax rate of 34%. Net interest spread represents thedifference between the yield on interest-earning assets and the rate oninterest-bearing liabilities. Net interest margin represents the ratio of netinterest income to total average interest-earning assets.

 

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

 

*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

 

21

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losses in the Bank’s loanportfolio. Loans and leases determined to be uncollectible are charged-offagainst the allowance for loan losses.

 

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

 

Management continuouslyreviews the risks inherent in the loan and lease portfolio. Specific factorsused to evaluate the adequacy of the loan loss provision during the formalprocess include:

 

•                  Specificloans that could have loss potential

•                  Levelsof and trends in delinquencies and non-accrual loans

•                  Levelsof and trends in charge-offs and recoveries

•                  Trendsin volume and terms of loans

•                  Changesin risk selection and underwriting standards

•                  Changesin lending policies, procedures and practices

•                  Experience,ability and depth of lending personnel

•                  Nationaland local economic trends and conditions

•                  Changesin credit concentrations

 

The provision for loanlosses was $300,000, for the three months ended June 30, 2005, compared to$400,000 for the three months ended June 30, 2004. The decrease in theprovision for loan losses was due to the reduced level of non-performing loans,which consist of loans past due 90 days or more and non-accrual loans. Thebalance of non-performing loans declined by $129,000 to $10,696,000 at June 30,2005 compared to $10,825,000 at June 30, 2004. The non-accrual componentof non-performing loans decreased $164,000 during the period. Further, thebalance of delinquent loans past due less than 90 days declined to $2,681,000at June 30, 2005 compared to $3,965,000 at June 30, 2004. The Bank’senhanced collection department staff has become more aggressive in thecollection of delinquent balances thereby preventing larger volumes of past dueaccounts from migrating to non-performing status.

 

*Other income*

 

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

 

Total other income increased$56,000, or 5% for the three months ended June 30, 2005 compared to thesame period in 2004. Service charges on deposit accounts grew by $134,000 or 25%due to the heightened effort to better manage the collection of overdraft and servicefees along with increased electronic banking related revenue. Sales of loansinto the secondary market have declined significantly in 2005. The Bank hasbeen absent of a sizable AFS loan portfolio since the restructure of thecombined loan portfolio and resulting transfer of loans AFS to the HTM portfolioin the latter part of 2004. The losses from sales of leased assets have alsodeclined as a result of the establishment of a lease loss reserve, during thefirst quarter of 2005. See below, “Other income,” under the caption “Comparisonof Results of Operations for the Six months Ended June 30, 2005 and June 30,2004” for further discussion on the lease loss reserve. Fees, other servicecharges and other non-interest related income decreased $77,000 or 15% principallyfrom reduced trust service fees, a decrease in loan servicing charges and areduction of the benefit crediting rates to the cash surrender value of BOLIduring the second quarter of 2005 compared to the same period of 2004.

 

*Other operating expenses*

 

Other (non-interest) expensesincreased $74,000, or 2% for the three months ended June 30, 2005 comparedto the same period in 2004. Professional service fees increased $101,000, or32% due to increased fees related to the Bank’s independent audit and to voluntarilybegin the Sarbanes-Oxley §404 compliance process, the cost for the participationin sales training programs, other consulting fees and increased FDICassessments. Advertising expenses for the second quarter of 2005 increased $64,000,or 75% from the same quarter of 2004. During the second quarter, the Bank

 

22

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procured and maintainedsignificant quantities of point-of-sale material used throughout its branchnetwork. There were increased expenses for signage inside all branches, drive-thruATM and teller lanes and in frequented public facilities. In addition, comparedto the second quarter of 2004, the 2005 quarter included expenses associatedwith additional sponsored events to support the businesses in the communitieswe serve. The $160,000, or 22% decline in the other component of otheroperating expenses, for the second quarter of 2005, was primarily due to theestablishment of a settlement reserve in 2004, for certain future obligationsrelated to retirement benefits that did not recur in 2005. This was partiallyoffset by increased other real estate (ORE) and collections expenses incurredto aggressively pursue non-performing assets.

 

*Income tax provision*

 

Income before provisionfor income taxes increased $309,000 for the second quarter of 2005 compared to thesecond 2004 quarter. The effective federal income tax rate was 25.9% and 24.7%for the respective quarters. The effective tax rate increase is attributable toa decrease in combined tax-free income as a ratio to total pre-tax income.

 

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

**JUNE 30,2005 AND JUNE 30, 2004**

 

**Overview**

 

Net income for the sixmonths ended June 30, 2005 was $2,155,000, an increase of $609,000 or 39%from the $1,546,000 recorded for the six months ended June 30, 2004. Dilutedearnings per share for the same period improved $0.33 from $0.84 for the sixmonths ended June 30, 2004 to $1.17 for the six months ended June 30,2005.

 

The period improvement innet income was primarily the results of an increase in net interest income and adecrease in the provision for loan losses. These items were partially offset bya decrease in non-interest income and increases in non-interest expense and theprovision for income taxes.

 

Return on average assetsand return on average equity were 0.81% and 9.26%, respectively, for the six monthsended June 30, 2005 compared to 0.55% and 7.01%, respectively, for thesame period in 2004. The improvement in these ratios is primarily due to improvedearnings.

 

*Net interest income*

 

Net interest incomeincreased $570,000, or 7%, to $8,594,000 for the first half of 2005, from $8,024,000recorded in the same period of 2004. The increase was primarily due to a 38basis point increase in the book yield earned on the Bank’s interest-earningassets, to 5.59%, for the six months ended June 30, 2005 compared to 5.21%for the same period in 2004. Similar to the quarterly analysis, the increase inyield more than offset reduced income from the effect of a $23,983,000 decreasein average interest-earning assets. The periodic increases in the nationalprime rate resulted in a 36 basis point increase in yield from the Bank’s loanportfolio during the six months ended June 30, 2005 compared to the same2004 period. During the same period, the average earning balances of the loanportfolio decreased $5,142,000 due to the sold participation loan in the firstquarter. The investment securities portfolio registered a 23 basis point increasein book yield in the first half of 2005 compared to first half of 2004;however, a $20,464,000 decline in their average balances has more than offsetthe effect of the increase in yield and has resulted in a decline in interestincome in the investment securities portfolio of $269,000.

 

For the six months ended June 30,2005, total interest expense decreased $269,000 to $5,483,000 from $5,752,000for the same 2004 period. Despite a six basis point increase in the combinedrate paid on average interest-bearing liabilities, interest expense declineddue to a $28,498,000 decrease in the average balances of interest-bearingliabilities during the first half of 2005 compared to the same 2004 period. Averagebalances of CD’s was the primary factor in the average balance decreasepartially offset by lower costing savings and transaction accounts whichincreased by approximately $12,224,000 in the first six months of 2005 comparedto the same period of 2004. Through the efforts of our marketing team,Management will continue its campaign to attract and retain low costing transactionand savings accounts.

 

For the six months ended June 30,2005, the Bank’s tax-equivalent spread and margin increased 34 and 39 basispoints, respectively, to 3.05% and 3.51% compared to 2.71% and 3.12% for the sixmonths ended June 30, 2004. The increase in spread and margin is primarilydue the increase in the interest rate environment currently favoring the Bank’sinterest-earning assets and a decrease in average interest-bearing liabilities.

 

23

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*Provision for loan losses*

 

The provision for loanlosses was $380,000, for the six months ended June 30, 2005, compared to $1,250,000for the six months ended June 30, 2004. The substantial reduction in the provisionfor loan loses is based upon Management’s assessment of the current loanportfolio. Many of the non-performing loans from the 2004 period have beenprovided for in the allowance, therefore, additional provisions at prior levelsis no longer deemed necessary. In addition, our collections department has beenworking diligently on past due and delinquent loans. This has resulted in thelevel of total past due loans over 30 days declining by $1,249,000 to$3,219,000 at June 30, 2005 compared to $4,467,000 at June 30, 2004. Duringthe same period, non-accrual loans also declined by $164,000 to $10,158,000 from$10,322,000.

 

*Other income*

 

Total other incomedecreased $143,000, or 7% for the six months ended June 30, 2005 comparedto the same period in 2004. During the first quarter the Bank recognized anestimated impairment charge of $220,000 in anticipation of projected realizedlosses from the future sales of its leased vehicles. The estimated losses werebased on the historical performance of terminated lease contracts that aretypically sold below their residual value. The balance of the Bank’s leasedvehicles should mature or pay-off during 2005 and, if necessary, periodicadjustments will be made to this estimate, throughout 2005. The finaldetermination will be dependent upon actual sales. Service charges on depositaccounts grew by $206,000 or 19% due to the improved collection of accountmaintenance and analysis fees charged to customers. For the first six months of2005, the Bank recorded a $7,000 net loss from the sale of loans AFS, comparednet gains of $94,000 for the first six months of 2004. The $101,000 variance wasdue to the 2004 balance sheet restructure that resulted, in part, in the saleof profitable mortgage loans into the secondary market. A similar event, withinloans AFS, did not recur in 2005. Fees, other service charges and othernon-interest related income decreased $143,000 or 14% in the first half of2005, principally from reduced benefit crediting rates to the cash surrendervalue of the BOLI and from decreased fees from both trust and financialservices caused by less transactional volume.

 

 *Other operating expenses*

 

Other expenses increased$364,000 or 5% for the six months ended June 30, 2005 compared to the sameperiod in 2004. Professional service fees increased $197,000, or 33% due toincreased fees related to the Bank’s required audits, Sarbanes-Oxley §404 complianceprocess, the cost for the Bank-wide participation in management skillsdevelopment and sales training programs and increased FDIC assessments. Advertisingexpenses for the first half of 2005 increased $135,000 or nearly doubled fromthe same period in of 2004. The Bank continues to concentrate its marketingendeavors with added sales campaigns for Bank product, use of alternative mediaadvertising, bank-wide signage, new demographic related research tools and moreBank sponsored events than in the prior year. Variances in other operatingexpenses, for the first half of 2005 included a decrease in settlement chargesfor the Company’s former chief executive officer, the reserve of which wasestablished in 2004 and increases in ancillary training expense for themanagement skills and sales training programs, an increase in Pennsylvaniashares tax and an increase in ORE and collections related expenses.

 

*Income tax provision*

 

Income before provisionfor income taxes increased $932,000 for the six months ended June 30, 2005compared to the six months ended June 30, 2004. The effective federalincome tax rate was 25.9% and 21.8% for the respective periods. The effectivetax rate increase is attributable to a decreased portion of combined tax-freeinterest income included in pre-tax earnings.

 

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

 

*Management of interest rate riskand market risk analysis*

 

The Company is subject tothe interest rate risks inherent in our lending, investing and financingactivities. Fluctuations of interest rates will impact interest income andinterest expense along with affecting market values of all interest-earning assetsand interest-bearing liabilities, except for those assets or liabilities with ashort-term remaining to maturity. Interest rate risk management is an integralpart of the asset/liability management process. The Company has institutedcertain procedures and policy guidelines to manage the interest rate riskposition. Those internal policies

 

24

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enable the Company toreact to changes in market rates to protect net interest income fromsignificant fluctuations. The primary objective in managing interest rate riskis to minimize the adverse impact of changes in interest rates on net interestincome 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 and authority to assume interest rate riskis the responsibility of the Company’s Asset/Liability Committee (ALCO), whichis comprised of senior management and Board members. ALCO meets quarterly tomonitor the ratio of interest sensitive assets to interest sensitiveliabilities. The process to review interest rate risk is a regular part ofmanaging the Company. Consistent policies and practices of measuring andreporting interest rate risk exposure, particularly regarding the treatment ofnon-contractual assets and liabilities, are in effect. In addition, there is anannual process to review the interest rate risk policy with the Board ofDirectors which includes limits on the impact to earnings from shifts ininterest rates.

 

*Interest Rate Risk Measurement:*Interest rate risk is monitored through the use of three complementarymeasures:  static gap analysis, earningsat risk simulation and economic value at risk simulation. While each of 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:* Theratio between assets and liabilities re-pricing in specific time intervals isreferred to as an interest rate sensitivity gap. Interest rate sensitivity gapscan be managed to take advantage of the slope of the yield curve as well asforecasted changes in the level of interest rate changes.

 

To manage this interestrate sensitivity position, an asset/liability model called ‘cumulative gapanalysis’ is used to monitor the difference in the volume of the Company’sinterest sensitive assets and liabilities that mature or re-price within givenperiods. A positive gap (asset sensitive) indicates that more assets re-priceduring a given period compared to liabilities, while a negative gap (liabilitysensitive) has the opposite effect. The Company employs computerized netinterest income simulation modeling to assist in quantifying interest rate riskexposure. This process measures and quantifies the impact on net interestincome through varying interest rate changes and balance sheet compositions. Theuse of this model assists the ALCO to gauge the effects of the interest ratechanges on interest sensitive assets and liabilities in order to determine whatimpact these rate changes will have upon the net interest spread.

 

At June 30, 2005,the Company maintained a one-year cumulative positive gap of $12.3 million or 2.3%of total assets. The effect of this positive gap position provided a mismatchof assets and liabilities, which may expose the Bank to an increased interestrate risk position during a period of declining interest rates. Conversely, in anincreasing interest rate environment, net income could be positively affectedbecause more assets will re-price upward during a one-year period.

 

25

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The following tableillustrates the Company’s interest sensitivity gap position at June 30,2005 (dollars in thousands):

 
| ** **                                     | ** ** | **3 months  or less** | ** ** | **3 through  12 months** | ** ** | **1 through  3 years** | ** ** | **Over  3 years** | ** ** | **Total** | ** ** |
|------------------------------------------------|------------|-----------------------|------------|--------------------------|------------|------------------------|------------|-------------------|------------|-----------|------------|
| Cash  and cash equivalents                     |       | $                     | 430        |                     | $          | —                 |       | $                 | —     |      | $          | 10,423 |   | $ | 10,853 |   |
| Investment  securities (1)(2)                  |       | 11,234                |       | 12,249                   |       | 35,421                 |       | 51,755            |       | 110,659   |       |
| Loans  (2)                                     |       | 136,479               |       | 67,158                   |       | 92,627                 |       | 86,112            |       | 382,376   |       |
| Fixed  and other assets                        |       | —                |       | 7,742                    |       | —                 |       | 21,691            |       | 29,433    |       |
| Total  assets                                  |       | $                     | 148,143    |                     | $          | 87,149                 |       | $                 | 128,048    |      | $          | 169,981 |   | $ | 533,321 |   |
| Total  cumulative assets                       |       | $                     | 148,143    |                     | $          | 235,292                |       | $                 | 363,340    |      | $          | 533,321 |   |   |   |
|                                           |       |                  |       |                     |       |                   |       |              |       |      |       |
| Non-interest  bearing transaction deposits (3) |       | $                     | —     |                     | $          | 6,924                  |       | $                 | 19,039     |      | $          | 43,270 |   | $ | 69,233 |   |
| Interest-bearing  transaction deposits (3)     |       | 29,226                |       | 48,509                   |       | 38,690                 |       | 9,818             |       | 126,243   |       |
| Time  deposits                                 |       | 21,525                |       | 74,663                   |       | 57,529                 |       | 19,986            |       | 173,703   |       |
| Repurchase  agreements                         |       | 20,542                |       | 5,657                    |       | 5,982                  |       | —            |       | 32,181    |       |
| Short-term  borrowings                         |       | 10,085                |       | —                   |       | —                 |       | —            |       | 10,085    |       |
| Long-term  debt                                |       | 5,205                 |       | 615                      |       | 1,640                  |       | 63,273            |       | 70,733    |       |
| Other  liabilities                             |       | —                |       | —                   |       | —                 |       | 3,054             |       | 3,054     |       |
| Total  liabilities                             |       | $                     | 86,583     |                     | $          | 136,368                |       | $                 | 122,880    |      | $          | 139,401 |   | $ | 485,232 |   |
| Total  cumulative liabilities                  |       | $                     | 86,583     |                     | $          | 222,951                |       | $                 | 345,831    |      | $          | 485,232 |   |   |   |
|                                           |       |                  |       |                     |       |                   |       |              |       |      |       |
| Interest  sensitivity gap                      |       | $                     | 61,560     |                     | $          | (49,219                | )          | $                 | 5,168      |      | $          | 30,580 |   |   |   |
|                                           |       |                  |       |                     |       |                   |       |              |       |      |       |
| Cumulative  gap                                |       | $                     | 61,560     |                     | $          | 12,341                 |       | $                 | 17,509     |      | $          | 48,089 |   |   |   |
|                                           |       |                  |       |                     |       |                   |       |              |       |      |       |
| Cumulative  gap to total assets                |       | 11.54                 | %          | 2.31                     | %          | 3.28                   | %          | 9.02              | %          |      |       |

 

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

 

(2)                                  Investmentsand loans are included in the earlier of the period in which interest rateswere next scheduled to adjust or the period in which they are due. In addition,loans are included in the periods in which they are scheduled to be repaidbased on scheduled amortization. For amortizing loans and mortgage-backedsecurities, annual prepayment rates are assumed reflecting historicalexperience as well as management’s knowledge and experience of its loanproducts.

 

(3)                                  TheBank’s demand and savings accounts are generally subject to immediatewithdrawal. However, management considers a certain amount of such accounts tobe core accounts having significantly longer effective maturities based on theretention experiences of such deposits in changing interest rate environments. Theeffective maturities presented are the recommended maturity distribution limitsfor non-maturing deposits based on historical deposit studies.

 

Certainshortcomings are inherent in the method of analysis presented in the above table.Although certain assets and liabilities may have similar maturities or periodsof re-pricing, they may react in different degrees to changes in marketinterest rates. The interest rates on certain types of assets and liabilitiesmay fluctuate in advance of changes in market interest rates, while interestrates on other types of assets and liabilities may lag behind changes in marketinterest rates. Certain assets, such as adjustable-rate mortgages, havefeatures which restrict changes in interest rates on a short-term basis andover the life of the loan. In the event of a change in interest rates,prepayment and early withdrawal levels may deviate significantly from thoseassumed in calculating the table. The ability of many borrowers to servicetheir adjustable-rate debt may decrease in the event of an interest rateincrease.

 

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

 

*Earnings at Risk:*Earnings at risk simulation measures the change in net interest income and netincome should interest rates rise and fall. The simulation recognizes that notall assets and liabilities re-price one-for-one with market rates (e.g.,savings rate). The ALCO looks at “earnings at risk” to determine income changesfrom a base case scenario under an increase and decrease of 200 basis points ininterest rate simulation models.

 

26

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*Economic Value at Risk:*Earnings at risk simulation measure the short-term risk in the balance sheet. Economicvalue (or portfolio equity) at risk measures the long-term risk by finding thenet present value of the future cash flows from the Company’s existing assetsand liabilities. The ALCO examines this ratio quarterly utilizing an increaseand decrease of 200 basis points in interest rates simulation model. The ALCOrecognizes that, in some instances, this ratio may contradict the “earnings atrisk” ratio.

 

The following tableillustrates the simulated impact of 200 basis points upward or downwardmovement in interest rates on net interest income, net income and the change ineconomic value (portfolio equity). This analysis assumed that interest-earningasset and interest-bearing liability levels at June 30, 2005 remainedconstant. The impact of the rate movements was developed by simulating theeffect of the rate change over a twelve-month period from the June 30,2005 levels:

 
| ** **                                            | ** ** | **Rates +200** | ** ** | **Rates -200** | ** ** |
|-------------------------------------------------------|------------|----------------|------------|----------------|------------|
| Earnings  at risk:                                    |       |           |       |           |       |
| Percent  change in:                                   |       |           |       |           |       |
| Net  interest income                                  |       | 7.0            | %          | (17.3          | )%         |
| Net  income                                           |       | 19.0           |       | (45.5          | )          |
|                                                  |       |           |       |           |       |
| Economic  value at risk:                              |       |           |       |           |       |
| Percent  change in:                                   |       |           |       |           |       |
| Economic  value of equity                             |       | (13.7          | )          | (13.2          | )          |
| Economic  value of equity as a percent of book assets |       | (1.5           | )          | (1.4           | )          |

 

Economic value has themost meaning when viewed within the context of risk-based capital. Therefore,the economic value may change beyond the Company’s policy guideline for a shortperiod of time as long as the risk-based capital ratio, after adjusting for theexcess equity exposure, is greater than 10%. At June 30, 2005, the Company’stotal risk-based capital ratio was 14.0%.

 

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

 
| **Change  in interest rates** | ** ** | **Net interest  income**   | ** ** | **Dollar  variance** | ** ** | **Percent  variance** | ** ** |
|-------------------------------|------------|----------------------------|------------|----------------------|------------|-----------------------|------------|
| ** **                    | ** ** | **(dollars in thousands)** | ** ** | ** **           | ** ** |
| +200  basis points            |       | $                          | 19,704     |                 | $          | 1,292                 |       | 7.0 | % |
| +100  basis points            |       | 19,109                     |       | 697                  |       | 3.8                   |       |
| Flat  rate                    |       | 18,412                     |       | —               |       | —                |       |
| -100  basis points            |       | 17,177                     |       | (1,235               | )          | (6.7                  | )          |
| -200  basis points            |       | 15,232                     |       | (3,180               | )          | (17.3                 | )          |
|                               |            |                            |            |                      |            |                       |            |  |  |

 

Simulation models requireassumptions about certain categories of assets and liabilities. The models schedule existingassets and liabilities by their contractual maturity, estimated likely calldate or earliest re-pricing opportunity. Mortgage-backed securities andamortizing loans are scheduled based on their anticipated cash flow includingestimated prepayments. For investment securities, we use a third party serviceto provide cash flow estimates in the various rate environments. Savingsaccounts, including passbook, statement savings, money market and interestchecking accounts do not have a stated maturity or re-pricing term and can bewithdrawn or re-price at any time. This may impact the margin if more expensivealternative sources of deposits are required to fund loans or deposit run-off. Managementprojects the re-pricing characteristics of these accounts based on historicalperformance and assumptions that it believes reflect their rate sensitivity. Thesimulation model reinvests all maturities, repayments and prepayments for eachtype of asset or liability into the same product for a new like-term andmaintains the size and relative relationships of assets and liabilities with similarre-pricing characteristics. As a result, the mix of interest-earning assets andinterest bearing-liabilities is held constant.

 

27

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*Liquidity*

 

Liquidity managementensures that adequate funds will be available to meet customers’ needs forborrowings, deposit withdrawals and maturities and normal operating expenses ofthe Bank. Current sources of liquidity are cash and cash equivalents, assetmaturities and pay downs within one year, loans and investments AFS, growth ofcore deposits, growth of repurchase agreements, increase of other borrowedfunds from correspondent banks and issuance of capital stock. Althoughregularly scheduled investment and loan payments are dependable sources ofdaily funds, the sale of loans and investment securities AFS, deposit activity,and investment and loan prepayments are significantly influenced by generaleconomic conditions and the level of interest rates.

 

At June 30, 2005, the Company maintained $10,853,000 in cash and cashequivalents. The Company also had $107,955,000 in investments AFS and $76,000 ofloans AFS. This combined total of $108,031,000 represented approximately 20% oftotal assets at June 30, 2005. In addition, as of June 30, 2005, theCompany had approximately $77,281,000 available to borrow from the FHLB. Managementbelieves that the present level of liquidity remains strong and adequate forcurrent operations.

 

*Capital*

 

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

 

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

 

Quantitative measures,established by regulation to ensure capital adequacy, require the Company tomaintain minimum amounts and ratios of total and Tier I capital torisk-weighted assets, and of Tier I capital to average assets. Capital isevaluated in relation to total assets and the risk associated with those assets.As of June 30, 2005, the Company meets all capital adequacy requirementsto which it is subject.

 

28

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The following tabledepicts the capital amounts and ratios of the Company and the Bank as of June 30,2005:

 
| ** **                 | ** ** | **Actual** | ** ** | **For capital  adequacy purposes** | ** ** | **To be well capitalized  under prompt corrective  action provisions** | ** ** |
|----------------------------|------------|------------|------------|------------------------------------|------------|------------------------------------------------------------------------|------------|
| ** **                 | ** ** | **Amount** | ** ** | **Ratio**                          | ** ** | **Amount**                                                             | ** ** | **Ratio** | ** ** | **Amount** | ** ** | **Ratio** | ** ** |
|                       |       |       |       |                               |       |                                                                   |       |   |   |   |   |   |   |
| Total  capital             |       |       |       |                               |       |                                                                   |       |   |   |   |   |   |   |
| (to  risk-weighted assets) |       |       |       |                               |       |                                                                   |       |   |   |   |   |   |   |
| Consolidated               |       | $          | 52,867,045 |                               | 14.00      | %                                                                      | $          | 30,216,500 |   | 8.00 | % | N/A |   | N/A |   |
| Bank                       |       | $          | 52,687,160 |                               | 13.53      | %                                                                      | $          | 31,148,478 |   | 8.00 | % | $ | 38,935,598 |   | 10.00 | % |
| Tier  I capital            |       |       |       |                               |       |                                                                   |       |   |   |   |   |   |   |
| (to  risk-weighted assets) |       |       |       |                               |       |                                                                   |       |   |   |   |   |   |   |
| Consolidated               |       | $          | 48,050,934 |                               | 12.72      | %                                                                      | $          | 15,108,250 |   | 4.00 | % | N/A |   | N/A |   |
| Bank                       |       | $          | 47,799,966 |                               | 12.28      | %                                                                      | $          | 15,574,239 |   | 4.00 | % | $ | 23,361,359 |   | 6.00 | % |
| Tier  I Capital            |       |       |       |                               |       |                                                                   |       |   |   |   |   |   |   |
| (to  average assets)       |       |       |       |                               |       |                                                                   |       |   |   |   |   |   |   |
| Consolidated               |       | $          | 48,050,934 |                               | 9.03       | %                                                                      | $          | 21,276,033 |   | 4.00 | % | N/A |   | N/A |   |
| Bank                       |       | $          | 47,799,966 |                               | 8.99       | %                                                                      | $          | 21,276,033 |   | 4.00 | % | $ | 26,595,042 |   | 5.00 | % |

 

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

 

The Company maintains controls and procedures designed to ensure that information required to be disclosed in the reports that the Company files or submits under the Securities Exchange Act of 1934 is recorded, processed, summarized and reported within the time periods specified in the rules and forms of the Securities and Exchange Commission. Based upon their evaluation of those controls and procedures as of the end of the period covered by this report, the Chief Executive and Chief Financial Officers of the Company concluded that the Company’s disclosure controls and procedures were adequate. There have been no changes to the Company’s internal control over financial reporting during the second quarter of 2005.

 

**PART II. Other Information**

 

**Item 1.          Legal Proceedings**

 

The nature of the Company’sbusiness generates some litigation involving matters arising in the ordinarycourse 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 effect onthe Company’s undivided profits or financial condition. No legal proceedingsare pending other than ordinary routine litigation incidental to the businessof the Company and the Bank. In addition, to Management’s knowledge, nogovernmental authorities have initiated or contemplated any material legalactions against the Company or the Bank.

 

**Item 2.          Unregistered Sales of Equity Securitiesand Use of Proceeds**

 

None

 

**Item 3.          Default upon Senior Securities**

 

None

 

29

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

 

At the annual meeting ofshareholders held on May 3, 2005, the judges of election made the reportconcerning the results of balloting. Holders of 1,447,001 shares of commonstock, representing 78.5% of the total number of shares outstanding, wererepresented in person or by proxy at the 2005 annual meeting of shareholders. Thefollowing votes were cast:

 

Election of Class BDirectors to serve for a three-year term:

 
| ** **                   | ** ** | **For**   | ** ** | **Withhold authority** | ** ** | **Abstain** | ** ** |
|------------------------------|------------|-----------|------------|------------------------|------------|-------------|------------|
| Samuel  C. Cali              |       | 1,416,664 |       | 30,336                 |       | -0-         |       |
| Mary  E. McDonald            |       | 1,427,261 |       | 19,739                 |       | -0-         |       |
| David  L. Tressler, Sr. |       | 1,394,910 |       | 52,091                 |       | -0-         |       |

 

In addition to the aboveelected Class B Directors, at the conclusion of its annual meeting, theCompany’s Board of Directors consisted of: Paul A. Barrett, Esq., John T.Cognetti and Michael J. McDonald, Esq., as Class A Directors whoseterm expires in 2006; and Brian J. Cali, Esq. and Patrick J. Dempsey, as Class CDirectors whose term expires in 2007.

 

Ratification of independentcertified public accountants:

 
| ** **             | ** ** | **For**   | ** ** | **Against** | ** ** | **Abstain** | ** ** |
|------------------------|------------|-----------|------------|-------------|------------|-------------|------------|
| Parente  Randolph, LLC |       | 1,439,040 |       | 6,337       |       | 1,623       |       |

 

**Item 5.          Other Information**

 

None

 

**Item 6.          Exhibits**

 
| **Exhibits** | ** **   | ** **   |
|--------------|--------------|--------------|
| ***3(i)***   | *** *** | *** *** | ***Amended  and Restated Articles of Incorporation of Registrant.***Incorporated  by reference to Exhibit 3(i) to Registrant’s Registration Statement  No. 333-90273 on Form S-4, filed with the SEC on November 3,  1999 and as amended on April 6, 2000. |
|         |         |         |   |
| ***3(ii)***  | *** *** | *** *** | ***Bylaws  of Registrant.***Incorporated by reference to Exhibit 3(ii) to  Registrant’s Registration Statement No. 333-90273 on Form S-4,  filed with the SEC on November 3, 1999 and as amended on April 6,  2000. |
|         |         |         |   |
| ***10.1***   | *** *** | *** *** | ***1998  Independent Directors Stock Option Plan of The Fidelity Deposit and Discount  Bank, as assumed by Registrant.***Incorporated by  reference to Exhibit 10.1 to Registrant’s Registration Statement No. 333-90273  on Form S-4, filed with the SEC on November 3, 1999 and as  amended on April 6, 2000. |
|         |         |         |   |
| ***10.2***   | *** *** | *** *** | ***1998  Stock Incentive Plan of The Fidelity Deposit and Discount Bank, as assumed by  Registrant.***Incorporated by reference to Exhibit 10.2  of Registrant’s Registration Statement No. 333-90273 on Form S-4,  filed with the SEC on November 3, 1999 and as amended on April 6,  2000. |
|         |         |         |   |
| ***10.3***   | *** *** | *** *** | ***Form of  Deferred Compensation Plan of The Fidelity Deposit and Discount Bank.***Incorporated  by reference to Exhibit 10.3 to Registrant’s Registration Statement  No.333-45668 on Form S-1, filed with the SEC on September 12,  2000 and as amended on October 11, 2000. |
|         |         |         |   |
| ***10.4***   | *** *** | *** *** | ***Registrant’s  2000 Dividend Reinvestment Plan.***Incorporated by  reference to Exhibit 4 to Registrant’s Registration Statement No. 333-45668  on Form S-1, filed with the SEC on September 12, 2000 and as  amended by Pre-Effective Amendment No. 1 on October 11, 2000, by  Post-Effective Amendment No. 1 on May 30, 2001 and by  Post-Effective Amendment No 2 on July 7, 2005. |

 

30

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| ***10.5*** | *** *** | *** *** | ***Registrant’s  2000 Independent Directors Stock Option Plan.***Incorporated  by reference to Exhibit 4.3 to Registrant’s Registration Statement No. 333-64356  on Form S-8 filed with the SEC on July 2, 2001.                                                                            |
|------------|--------------|--------------|---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
|       |         |         |                                                                                                                                                                                                                                                                                                                      |
| ***10.6*** | *** *** | *** *** | ***Registrant’s  2000 Stock Incentive Plan***. Incorporated by reference to  Exhibit 4.4 to Registrant’s Registration Statement No. 333-64356  on Form S-8 filed with the SEC on July 2, 2001.                                                                                              |
|       |         |         |                                                                                                                                                                                                                                                                                                                      |
| ***10.7*** | *** *** | *** *** | ***Registrant’s  2002 Employee Stock Purchase Plan.***Incorporated by  reference to Appendix A to Registrant’s Definitive Proxy Statement filed with  the SEC on March 28, 2002.                                                                                                                           |
|       |         |         |                                                                                                                                                                                                                                                                                                                      |
| ***10.***8 |         | *** *** | ***Employment  Agreement between Registrant, The Fidelity Deposit and Discount Bank and  Steven C. Ackmann, dated June 21, 2004.***Incorporated  by reference to Exhibit 99.1 to Registrant’s Current Report on Form 8-K  filed with the SEC on June 24, 2004.                                   |
|       |         |         |                                                                                                                                                                                                                                                                                                                      |
| ***10.9*** | *** *** | *** *** | ***Complete  Settlement Agreement and General Release between Michael F. Marranca,  Registrant and The Fidelity Deposit and Discount Bank, dated July 30,  2004.***Incorporated by reference to Exhibit 99.1 to  Registrant’s Current Report on Form 8-K filed with the SEC on August 10,  2004. |
|       |         |         |                                                                                                                                                                                                                                                                                                                      |
| ***11***   | *** *** | *** *** | ***Statement  regarding computation of earnings per share.***Included  herein 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.***                                                                                                                                 |

 

31

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

 

Pursuant to therequirements of the Securities Exchange Act of 1934, the Company has causedthis report to be signed on its behalf by the undersigned thereunto dulyauthorized.

 

 
|   | **FIDELITY  D & D BANCORP, INC.** |
|--------|--------------------------------------------|
|   | ** **                                 |
|   |                                       |
| Date:  | August 10, 2005                       |   | /s/ Steven C. Ackmann |   |
|   | Steven  C. Ackmann,                        |
|   | President and Chief  Executive Officer     |
|   |                                       |
|   |                                       |
| Date:  | August 10, 2005                       |   | /s/ Salvatore R.  DeFrancesco, Jr. |   |
|   | Salvatore  R. DeFrancesco, Jr.,       |
|   | Treasurer and Chief  Financial Officer     |
|        |                                            |  |  |  |  |  |

 

32

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

 

Exhibit Index

 

| ***3(i)***  | *** *** | ***Amended  and Restated Articles of Incorporation of Registrant.***  Incorporated by reference to Exhibit 3(i) to Registrant’s Registration  Statement No. 333-90273 on Form S-4, filed with the SEC  on November 3, 1999 and as amended on April 6, 2000.                                                                                                                                                   | *****      |
|-------------|--------------|--------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|------------|
|        |         |                                                                                                                                                                                                                                                                                                                                                                                                                                             | ** ** |
| ***3(ii)*** | *** *** | ***Bylaws  of Registrant***. Incorporated by reference to Exhibit 3  (ii) to Registrant’s Registration Statement No. 333-90273 on Form S-4,  filed with the SEC on November 3, 1999 and as amended on April 6,  2000.                                                                                                                                                                                         | *****      |
|        |         |                                                                                                                                                                                                                                                                                                                                                                                                                                             | ** ** |
| ***10.1***  | *** *** | ***1998  Independent Directors Stock Option Plan of The Fidelity Deposit and Discount  Bank, as assumed by Registrant.*** Incorporated by  reference to Exhibit 10.1 to Registrant’s Registration Statement No. 333-90273  on Form S-4, filed with the SEC on November 3, 1999 and as  amended on April 6, 2000.                                                                                                   | *****      |
|        |         |                                                                                                                                                                                                                                                                                                                                                                                                                                             | ** ** |
| ***10.2***  | *** *** | ***1998  Stock Incentive Plan of The Fidelity Deposit and Discount Bank, as assumed by  Registrant.***Incorporated by reference to Exhibit 10.2  of Registrant’s Registration Statement No. 333-90273 on Form S-4,  filed with the SEC on Nov. 3, 1999 and as amended on April 6, 2000.                                                                                                                            | *****      |
|        |         |                                                                                                                                                                                                                                                                                                                                                                                                                                             | ** ** |
| ***10.3***  | *** *** | ***Form of  Deferred Compensation Plan of The Fidelity Deposit and Discount Bank.***Incorporated  by reference to Exhibit 10.3 to Registrant’s Registration Statement No. 333-45668  on Form S-1, filed with the SEC on September 12, 2000 and as  amended on October 11, 2000.                                                                                                                               | *****      |
|        |         |                                                                                                                                                                                                                                                                                                                                                                                                                                             | ** ** |
| ***10.4***  | *** *** | ***Registrant’s  2000 Dividend Reinvestment Plan****.*Incorporated  by reference to Exhibit 4 to Registrant’s Registration Statement No. 333-45668  on Form S-1, filed with the SEC on September 12, 2000 and as  amended by Pre-Effective Amendment No. 1 on October 11, 2000, 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.                                                                                                                                                                                                                     | *****      |

 

33

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| ***10.7*** | *** *** | ***Registrant’s  2002 Employee Stock Purchase Plan.***Incorporated by  reference to Appendix A to Registrant’s Definitive Proxy Statement filed with  the SEC on March 28, 2002.                                                                                                                           | *      |
|------------|--------------|---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|--------|
|       |         |                                                                                                                                                                                                                                                                                                                      |   |
| ***10.8*** | *** *** | ***Employment  Agreement between Registrant, The Fidelity Deposit and Discount Bank and  Steven C. Ackmann, dated June 21, 2004****.*Incorporated by reference to Exhibit 99.1 to  Registrant’s Current Report on Form 8-K filed with the SEC on June 24,  2004***.***                           | *      |
|       |         |                                                                                                                                                                                                                                                                                                                      |   |
| ***10.9*** | *** *** | ***Complete  Settlement Agreement and General Release between Michael F. Marranca,  Registrant and The Fidelity Deposit and Discount Bank, dated July 30,  2004.***Incorporated by reference to Exhibit 99.1 to  Registrant’s Current Report on Form 8-K filed with the SEC on August 10,  2004. | *      |
|       |         |                                                                                                                                                                                                                                                                                                                      |   |
| ***11***   | *** *** | ***Statement  regarding computation of earnings per share***. Included  herein.                                                                                                                                                                                                                                           |   |
|       |         |                                                                                                                                                                                                                                                                                                                      |   |
| ***31.1*** | *** *** | ***Rule 13a-14(a) Certification  of Principal Executive Officer.***                                                                                                                                                                                                                                             |   |
|       |         |                                                                                                                                                                                                                                                                                                                      |   |
| ***31.2*** | *** *** | ***Rule 13a-14(a) Certification  of Principal Financial Officer.***                                                                                                                                                                                                                                             |   |
|       |         |                                                                                                                                                                                                                                                                                                                      |   |
| ***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.***                                                                                                                                                  |   |
|       |         |                                                                                                                                                                                                                                                                                                                      |   |
| ***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.***                                                                                                                                                  |   |

 

----

*******- Incorporated by Reference

 

34

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