Tableof Contents

 

 

 

**UNITED STATES**

**SECURITIES AND EXCHANGE COMMISSION**

**Washington,D.C. 20549**

 

**FORM 10-Q**

 

| **x** | **QUARTERLY  REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE  ACT OF 1934** |
|-------|---------------------------------------------------------------------------------------------------------|

 

**For thequarterly period ended March 31, 2009**

 

**OR**

 

| **o** | **TRANSITION REPORT PURSUANT TO  SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934** |
|-------|-----------------------------------------------------------------------------------------------|

 

**For thetransition period from                        to                           **

 

**Commissionfile number: 333-90273**

 

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

 

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

 

Address ofprincipal executive offices:

**BLAKELY &DRINKER ST.**

**DUNMORE,PENNSYLVANIA 18512**

 

TELEPHONE:

**570-342-8281**

 

Indicate by check markwhether the registrant (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 registrant was required to file suchreports), and (2) has been subjected to such filing requirements for thepast 90 days.  Yes xNo o

 

Indicate by check markwhether the registrant has submitted electronically and posted on its corporateWeb site, if any, every Interactive Data File required to be submitted andposted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) duringthe preceding 12 months (or for such shorter period that the registrant wasrequired to submit and post such files). Yes oNo o

 

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

 

| Large  accelerated filer o                    |   | Accelerated  filer o         |
|-----------------------------------------------|--------|------------------------------|
|                                          |   |                         |
| Non-accelerated  filer o                      |   | Smaller  reporting company x |
| (Do not check if a smaller reporting company) |   |                         |

 

Indicate by check markwhether the registrant is a shell company (as defined in Rule 12b-2 of theExchange Act).   Yes oNo x

 

The number of outstandingshares of Common Stock of Fidelity D & D Bancorp, Inc. at April 30,2009, the latest practicable date, was 2,072,085 shares.

 

 

 

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**FIDELITYD & D BANCORP, INC.**

 

Form 10-Q March 31,2009

 

Index

 
| ** **                             | ** **                                                                                                                | **Page** |
|----------------------------------------|---------------------------------------------------------------------------------------------------------------------------|----------|
| **Part I. Financial Information** |                                                                                                                      |
|                                   |                                                                                                                      |     |
| Item 1.                                | Financial Statements:                                                                                                     |     |
|                                   | Consolidated Balance Sheets as of  March 31, 2009 and December 31, 2008                                         | 3        |
|                                   | Consolidated Statements of  Income for the three months ended March 31, 2009 and 2008                                | 4        |
|                                   | Consolidated Statements of  Changes in Shareholders’ Equity for the three months ended March 31,  2009 and 2008 | 5        |
|                                   | Consolidated Statements of  Cash Flows for the three months ended March 31, 2009 and 2008                            | 6        |
|                                   | Notes to  Consolidated Financial Statements                                                                               | 7        |
|                                   |                                                                                                                      |     |
| Item 2.                                | Management’s  Discussion and Analysis of Financial Condition and Results of Operations                               | 13       |
|                                   |                                                                                                                      |     |
| Item 3.                                | Quantitative  and Qualitative Disclosure about Market Risk                                                                | 27       |
|                                   |                                                                                                                      |     |
| Item 4T.                               | Controls and  Procedures                                                                                                  | 31       |
|                                   |                                                                                                                      |     |
| **Part II. Other  Information**   |                                                                                                                      |
|                                   |                                                                                                                      |     |
| Item 1.                                | Legal Proceedings                                                                                                         | 32       |
|                                   |                                                                                                                      |     |
| Item 1A.                               | Risk Factors                                                                                                              | 32       |
|                                   |                                                                                                                      |     |
| Item 2.                                | Unregistered  Sales of Equity Securities and Use of Proceeds                                                              | 32       |
|                                   |                                                                                                                      |     |
| Item 3.                                | Defaults upon  Senior Securities                                                                                          | 32       |
|                                   |                                                                                                                      |     |
| Item 4.                                | Submission of  Matters to a Vote of Security Holders                                                                      | 32       |
|                                   |                                                                                                                      |     |
| Item 5.                                | Other Information                                                                                                         | 32       |
|                                   |                                                                                                                      |     |
| Item 6.                                | Exhibits                                                                                                                  | 32       |
|                                   |                                                                                                                      |     |
| Signatures                             |                                                                                                                      | 35       |
|                                   |                                                                                                                      |     |
| Exhibit index                     |                                                                                                                      | 36       |

 

2

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**PART I— Financial Information**

 

**Item 1:Financial Statements**

 

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

ConsolidatedBalance Sheets

 
| ** **                                                                                                                                                                          | ** ** | **March 31, 2009** | ** **  | **December 31, 2008** | ** ** |
|-------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|------------|--------------------|-------------|-----------------------|------------|
| ** **                                                                                                                                                                          | ** ** | **(unaudited)**    | ** **  | **(audited)**         | ** ** |
|                                                                                                                                                                                |       |               |        |                  |       |
| Assets:                                                                                                                                                                             |       |               |        |                  |       |
| Cash and due  from banks                                                                                                                                                            |       | $                  | 9,467,907   |                  | $          | 12,335,905 |   |
| Federal funds  sold                                                                                                                                                                 |       | 11,268,000         |        | —                |       |
| Interest-bearing  deposits with financial institutions                                                                                                                              |       | 64,825             |        | 435,242               |       |
|                                                                                                                                                                                |       |               |        |                  |       |
| Total cash and  cash equivalents                                                                                                                                                    |       | 20,800,732         |        | 12,771,147            |       |
|                                                                                                                                                                                |       |               |        |                  |       |
| Available-for-sale  securities                                                                                                                                                      |       | 78,067,789         |        | 83,278,132            |       |
| Held-to-maturity  securities                                                                                                                                                        |       | 881,714            |        | 909,447               |       |
| Federal Home  Loan Bank Stock                                                                                                                                                       |       | 4,781,100          |        | 4,781,100             |       |
| Loans and  leases, net (allowance for loan losses of $5,097,641 in 2009; $4,745,234 in  2008)                                                                                       |       | 420,497,135        |        | 436,207,460           |       |
| Loans  available-for-sale (fair value $681,416 in 2009; $85,312 in 2008)                                                                                                            |       | 675,205            |        | 84,000                |       |
| Bank premises  and equipment, net                                                                                                                                                   |       | 15,871,074         |        | 16,056,362            |       |
| Cash surrender  value of bank owned life insurance                                                                                                                                  |       | 8,886,844          |        | 8,807,784             |       |
| Other assets                                                                                                                                                                        |       | 12,708,615         |        | 8,929,917             |       |
| Accrued interest  receivable                                                                                                                                                        |       | 2,378,649          |        | 2,443,141             |       |
| Foreclosed  assets held-for-sale                                                                                                                                                    |       | 1,236,716          |        | 1,450,507             |       |
|                                                                                                                                                                                |       |               |        |                  |       |
| Total assets                                                                                                                                                                        |       | $                  | 566,785,573 |                  | $          | 575,718,997 |   |
|                                                                                                                                                                                |       |               |        |                  |       |
| Liabilities:                                                                                                                                                                        |       |               |        |                  |       |
| Deposits:                                                                                                                                                                           |       |               |        |                  |       |
| Interest-bearing                                                                                                                                                                    |       | $                  | 394,857,294 |                  | $          | 361,869,281 |   |
| Non-interest-bearing                                                                                                                                                                |       | 69,296,833         |        | 71,442,651            |       |
|                                                                                                                                                                                |       |               |        |                  |       |
| Total deposits                                                                                                                                                                      |       | 464,154,127        |        | 433,311,932           |       |
|                                                                                                                                                                                |       |               |        |                  |       |
| Accrued interest  payable and other liabilities                                                                                                                                     |       | 4,427,884          |        | 3,316,710             |       |
| Short-term  borrowings                                                                                                                                                              |       | 10,741,814         |        | 38,129,704            |       |
| Long-term debt                                                                                                                                                                      |       | 42,000,000         |        | 52,000,000            |       |
|                                                                                                                                                                                |       |               |        |                  |       |
| Total  liabilities                                                                                                                                                                  |       | 521,323,825        |        | 526,758,346           |       |
|                                                                                                                                                                                |       |               |        |                  |       |
| Shareholders’  equity:                                                                                                                                                         |       |               |        |                  |       |
| Preferred stock  authorized 5,000,000 shares with no par value; none issued                                                                                                         |       | —             |        | —                |       |
| Capital stock,  no par value (10,000,000 shares authorized; shares issued and outstanding,  respectively; 2,076,883 and 2,072,085 in 2009; 2,075,182 and 2,062,927 shares  in 2008) |       | 19,455,383         |        | 19,410,306            |       |
| Treasury stock,  at cost (4,798 shares in 2009; 12,255 shares in 2008)                                                                                                              |       | (132,728           | )           | (351,665              | )          |
| Retained  earnings                                                                                                                                                                  |       | 38,362,084         |        | 38,126,250            |       |
| Accumulated  other comprehensive loss                                                                                                                                               |       | (12,222,991        | )           | (8,224,240            | )          |
|                                                                                                                                                                                |       |               |        |                  |       |
| Total  shareholders’ equity                                                                                                                                                    |       | 45,461,748         |        | 48,960,651            |       |
|                                                                                                                                                                                |       |               |        |                  |       |
| Total  liabilities and shareholders’ equity                                                                                                                                    |       | $                  | 566,785,573 |                  | $          | 575,718,997 |   |

 

See notes to consolidatedfinancial statements

 

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

Consolidated Statements of Income

(unaudited)

 
| ** **                                             | ** ** | **Three Months Ended**  | ** ** |
|--------------------------------------------------------|------------|-------------------------|------------|
| ** **                                             | ** ** | **March 31, 2009** | ** ** | **March 31, 2008** | ** ** |
|                                                   |       |                    |       |   |   |
| Interest income:                                       |       |                    |       |   |   |
| Loans and  leases:                                     |       |                    |       |   |   |
| Taxable                                                |       | $                       | 6,560,748  |   | $ | 6,809,134 |   |
| Nontaxable                                             |       | 114,774                 |       | 78,076 |   |
| Interest-bearing  deposits with financial institutions |       | 111                     |       | 1,106 |   |
| Investment  securities:                                |       |                    |       |   |   |
| U.S. government  agency and corporations               |       | 767,371                 |       | 1,253,181 |   |
| States and  political subdivisions (nontaxable)        |       | 198,575                 |       | 144,130 |   |
| Other securities                                       |       | 185,050                 |       | 375,036 |   |
| Federal funds  sold                                    |       | 784                     |       | 84,169 |   |
|                                                   |       |                    |       |   |   |
| Total interest  income                                 |       | 7,827,413               |       | 8,744,832 |   |
|                                                   |       |                    |       |   |   |
| Interest  expense:                                     |       |                    |       |   |   |
| Deposits                                               |       | 2,191,772               |       | 3,233,736 |   |
| Securities sold  under repurchase agreements           |       | 8,474                   |       | 67,153 |   |
| Other short-term  borrowings and other                 |       | 26,140                  |       | 64,822 |   |
| Long-term debt                                         |       | 776,207                 |       | 832,285 |   |
|                                                   |       |                    |       |   |   |
| Total interest  expense                                |       | 3,002,593               |       | 4,197,996 |   |
|                                                   |       |                    |       |   |   |
| Net interest  income                                   |       | 4,824,820               |       | 4,546,836 |   |
|                                                   |       |                    |       |   |   |
| Provision for  loan losses                             |       | 425,000                 |       | — |   |
|                                                   |       |                    |       |   |   |
| Net interest  income after provision for loan losses   |       | 4,399,820               |       | 4,546,836 |   |
|                                                   |       |                    |       |   |   |
| Other income:                                          |       |                    |       |   |   |
| Service charges  on deposit accounts                   |       | 632,420                 |       | 763,269 |   |
| Gain (loss) on  sale or disposal of:                   |       |                    |       |   |   |
| Loans                                                  |       | 490,541                 |       | 91,606 |   |
| Investment  securities                                 |       | —                  |       | 1,134 |   |
| Premises and  equipment                                |       | (2,246                  | )          | — |   |
| Foreclosed  assets held-for-sale                       |       | 10,996                  |       | 8,704 |   |
| Other-than-temporary  impairment on securities         |       | (325,525                | )          | — |   |
| Fees and other  service charges                        |       | 507,176                 |       | 430,829 |   |
|                                                   |       |                    |       |   |   |
| Total other  income                                    |       | 1,313,362               |       | 1,295,542 |   |
|                                                   |       |                    |       |   |   |
| Other expenses:                                        |       |                    |       |   |   |
| Salaries and  employee benefits                        |       | 2,569,693               |       | 2,417,546 |   |
| Premises and  equipment                                |       | 906,422                 |       | 790,640 |   |
| Advertising                                            |       | 142,401                 |       | 168,356 |   |
| Other                                                  |       | 1,043,426               |       | 1,016,207 |   |
|                                                   |       |                    |       |   |   |
| Total other  expenses                                  |       | 4,661,942               |       | 4,392,749 |   |
|                                                   |       |                    |       |   |   |
| Income before  provision for income taxes              |       | 1,051,240               |       | 1,449,629 |   |
|                                                   |       |                    |       |   |   |
| Provision for  income taxes                            |       | 226,182                 |       | 360,682 |   |
|                                                   |       |                    |       |   |   |
| Net income                                             |       | $                       | 825,058    |   | $ | 1,088,947 |   |
|                                                   |       |                    |       |   |   |
| Per share data:                                        |       |                    |       |   |   |
| Net income -  basic                                    |       | $                       | 0.40       |   | $ | 0.52 |   |
| Net income - diluted                                   |       | $                       | 0.40       |   | $ | 0.52 |   |
| Dividends                                              |       | $                       | 0.25       |   | $ | 0.25 |   |

 

See notes toconsolidated financial statements

 

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

 

Consolidated Statements of Changes in Shareholders’Equity

For the threemonths ended March 31, 2009 and 2008

 
| ** **                                                                                                                     | ** ** | ** **         | ** ** | ** **          | ** ** | ** **   | ** ** | ** **        | ** ** | ** **   | ** ** | **Accumulated**    | ** ** | ** ** | ** ** |
|--------------------------------------------------------------------------------------------------------------------------------|------------|--------------------|------------|---------------------|------------|--------------|------------|-------------------|------------|--------------|------------|--------------------|------------|------------|------------|
| ** **                                                                                                                     | ** ** | ** **         | ** ** | ** **          | ** ** | ** **   | ** ** | ** **        | ** ** | ** **   | ** ** | **other**          | ** ** | ** ** | ** ** |
| ** **                                                                                                                     | ** ** | **Capital  stock** | ** ** | **Treasury  stock** | ** ** | **Retained** | ** ** | **comprehensive** | ** ** | ** **   | ** ** |
| ** **                                                                                                                     | ** ** | **Shares**         | ** ** | **Amount**          | ** ** | **Shares**   | ** ** | **Amount**        | ** ** | **earnings** | ** ** | **income  (loss)** | ** ** | **Total**  | ** ** |
|                                                                                                                           |       |               |       |                |       |         |       |              |       |         |       |               |       |       |       |
| Balance,  December 31, 2007                                                                                               |       | 2,072,929          |       | $                   | 19,223,363 |         | —     |              | $          | —       |       | $                  | 36,564,157 |       | $          | (596,226 | ) | $ | 55,191,294 |   |
| Total  comprehensive income:                                                                                                   |       |               |       |                |       |         |       |              |       |         |       |               |       |       |       |
| Net income                                                                                                                     |       |               |       |                |       |         |       |              |       | 1,088,947    |       |               |       | 1,088,947  |       |
| Change in net  unrealized holding losses on available-for-sale securities, net of reclassification  adjustment and tax effects |       |               |       |                |       |         |       |              |       |         |       | (59,310            | )          | (59,310    | )          |
| Change in cash  flow hedge intrinsic value                                                                                     |       |               |       |                |       |         |       |              |       |         |       | 365,136            |       | 365,136    |       |
| Comprehensive  income                                                                                                          |       |               |       |                |       |         |       |              |       |         |       |               |       | 1,394,773  |       |
| Issuance of  common stock through Employee Stock                                                                               |       |               |       |                |       |         |       |              |       |         |       |               |       |       |       |
| Purchase Plan                                                                                                                  |       | 2,253              |       | 57,891              |       |         |       |              |       |         |       |               |       | 57,891     |       |
| Stock-based  compensation expense                                                                                              |       |               |       | 67,791              |       |         |       |              |       |         |       |               |       | 67,791     |       |
| Cash dividends  declared                                                                                                       |       |               |       |                |       |         |       |              |       | (518,795     | )          |               |       | (518,795   | )          |
|                                                                                                                           |       |               |       |                |       |         |       |              |       |         |       |               |       |       |       |
| Balance,  March 31, 2008 (unaudited)                                                                                      |       | 2,075,182          |       | $                   | 19,349,045 |         | —     |              | $          | —       |       | $                  | 37,134,309 |       | $          | (290,400 | ) | $ | 56,192,954 |   |
|                                                                                                                           |       |               |       |                |       |         |       |              |       |         |       |               |       |       |       |
| Balance,  December 31, 2008                                                                                               |       | 2,075,182          |       | $                   | 19,410,306 |         | (12,255    | )                 | $          | (351,665     | )          | $                  | 38,126,250 |       | $          | (8,224,240 | ) | $ | 48,960,651 |   |
| Total  comprehensive income:                                                                                                   |       |               |       |                |       |         |       |              |       |         |       |               |       |       |       |
| Net income                                                                                                                     |       |               |       |                |       |         |       |              |       | 825,058      |       |               |       | 825,058    |       |
| Change in net  unrealized holding losses on available-for-sale securities, net of reclassification  adjustment and tax effects |       |               |       |                |       |         |       |              |       |         |       | (3,841,964         | )          | (3,841,964 | )          |
| Change in cash  flow hedge intrinsic value                                                                                     |       |               |       |                |       |         |       |              |       |         |       | (156,787           | )          | (156,787   | )          |
| Comprehensive  loss                                                                                                            |       |               |       |                |       |         |       |              |       |         |       |               |       | (3,173,693 | )          |
| Issuance of  common stock through Employee Stock                                                                               |       |               |       |                |       |         |       |              |       |         |       |               |       |       |       |
| Purchase Plan                                                                                                                  |       | 1,701              |       | 40,569              |       |         |       |              |       |         |       |               |       | 40,569     |       |
| Dividends  reinvested through Dividend                                                                                         |       |               |       |                |       |         |       |              |       |         |       |               |       |       |       |
| Reinvestment Plan                                                                                                              |       |               |       |                |       | 9,957        |       | 275,442           |       | (73,067      | )          |               |       | 202,375    |       |
| Stock-based  compensation expense                                                                                              |       |               |       | 4,508               |       |         |       |              |       |         |       |               |       | 4,508      |       |
| Purchase of  treasury stock                                                                                                    |       |               |       |                |       | (2,500       | )          | (56,505           | )          |         |       |               |       | (56,505    | )          |
| Cash dividends  declared                                                                                                       |       |               |       |                |       |         |       |              |       | (516,157     | )          |               |       | (516,157   | )          |
|                                                                                                                           |       |               |       |                |       |         |       |              |       |         |       |               |       |       |       |
| Balance,  March 31, 2009 (unaudited)                                                                                      |       | 2,076,883          |       | $                   | 19,455,383 |         | (4,798     | )                 | $          | (132,728     | )          | $                  | 38,362,084 |       | $          | (12,222,991 | ) | $ | 45,461,748 |   |

 

See notes toconsolidated financial statements

 

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**FIDELITY DEPOSIT & DISCOUNTBANCORP, INC. AND SUBSIDIARY**

Consolidated Statementsof Cash Flows

(unaudited)

 
| ** **                                                                         | ** ** | **Three months ended March 31,** | ** ** |
|------------------------------------------------------------------------------------|------------|---------------------------------------|------------|
| ** **                                                                         | ** ** | **2009**                              | ** ** | **2008** | ** ** |
|                                                                               |       |                                  |       |   |   |
| Cash flows from  operating activities:                                             |       |                                  |       |   |   |
| Net income                                                                         |       | $                                     | 825,058    |   | $ | 1,088,947 |   |
| Adjustments to  reconcile net income to net cash provided by operating activities: |       |                                  |       |   |   |
| Depreciation,  amortization and accretion                                          |       | 206,043                               |       | 143,933 |   |
| Provision for  loan losses                                                         |       | 425,000                               |       | — |   |
| Deferred income  tax (benefit) expense                                             |       | (38,076                               | )          | 159,737 |   |
| Stock-based  compensation expense                                                  |       | 4,508                                 |       | 67,791 |   |
| Loss from  investment in limited partnership                                       |       | 20,100                                |       | 20,100 |   |
| Proceeds from  sale of loans available-for-sale                                    |       | 38,786,069                            |       | 33,446,667 |   |
| Originations of  loans available-for-sale                                          |       | (27,746,937                           | )          | (4,096,160 | ) |
| Increase in cash  surrender value of life insurance                                |       | (79,060                               | )          | (76,287 | ) |
| Net gain on sale  of loans                                                         |       | (490,541                              | )          | (91,606 | ) |
| Net gain on sale  of investment securities                                         |       | —                                |       | (1,134 | ) |
| Net gain on sale  of foreclosed assets held for sale                               |       | (10,996                               | )          | (8,704 | ) |
| Loss on disposal  of equipment                                                     |       | 2,246                                 |       | — |   |
| Other-than-temporary  impairment on securities                                     |       | 325,525                               |       | — |   |
| Change in:                                                                         |       |                                  |       |   |   |
| Accrued interest  receivable                                                       |       | 34,581                                |       | (290,004 | ) |
| Other assets                                                                       |       | (960,450                              | )          | (950,950 | ) |
| Accrued interest  payable and other liabilities                                    |       | 41,925                                |       | 56,470 |   |
|                                                                               |       |                                  |       |   |   |
| Net cash  provided by operating activities                                         |       | 11,344,995                            |       | 29,468,800 |   |
|                                                                               |       |                                  |       |   |   |
| Cash flows from  investing activities:                                             |       |                                  |       |   |   |
| Held-to-maturity  securities:                                                      |       |                                  |       |   |   |
| Proceeds from  maturities, calls and principal pay-downs                           |       | 27,693                                |       | 39,133 |   |
| Available-for-sale  securities:                                                    |       |                                  |       |   |   |
| Proceeds from  sales                                                               |       | —                                |       | 12,881,733 |   |
| Proceeds from  maturities, calls and principal pay-downs                           |       | 6,283,129                             |       | 15,104,801 |   |
| Purchases                                                                          |       | (6,908,445                            | )          | (41,209,106 | ) |
| Net decrease in  FHLB stock                                                        |       | —                                |       | (84,900 | ) |
| Net decrease  (increase) in loans and leases                                       |       | 4,013,373                             |       | (2,324,907 | ) |
| Acquisition of  bank premises and equipment                                        |       | (212,285                              | )          | (651,129 | ) |
| Proceeds from  sale of foreclosed assets held-for-sale                             |       | 356,538                               |       | 62,090 |   |
|                                                                               |       |                                  |       |   |   |
| Net cash  provided by (used) in investing activities                               |       | 3,560,003                             |       | (16,182,285 | ) |
|                                                                               |       |                                  |       |   |   |
| Cash flows from  financing activities:                                             |       |                                  |       |   |   |
| Net increase in  deposits                                                          |       | 30,842,195                            |       | 30,135,115 |   |
| Net decrease in  short-term borrowings                                             |       | (27,387,890                           | )          | (29,776,817 | ) |
| Repayments of  long-term debt                                                      |       | (10,000,000                           | )          | (213,771 | ) |
| Purchase of  treasury stock                                                        |       | (56,505                               | )          | — |   |
| Proceeds from  employee stock purchase plan                                        |       | 40,569                                |       | 57,891 |   |
| Dividends paid,  net of dividends reinvested                                       |       | (313,782                              | )          | (518,795 | ) |
|                                                                               |       |                                  |       |   |   |
| Net cash used in  financing activities                                             |       | (6,875,413                            | )          | (316,377 | ) |
|                                                                               |       |                                  |       |   |   |
| Net increase in  cash and cash equivalents                                         |       | 8,029,585                             |       | 12,970,138 |   |
|                                                                               |       |                                  |       |   |   |
| Cash and cash  equivalents, beginning                                              |       | 12,771,147                            |       | 10,408,816 |   |
|                                                                               |       |                                  |       |   |   |
| Cash and cash  equivalents, ending                                                 |       | $                                     | 20,800,732 |   | $ | 23,378,954 |   |

 

See notes toconsolidated financial statements

 

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

 

**Notes toConsolidated Financial Statements**

**(unaudited)**

 

**1.   Nature of operations and critical accountingpolicies**

 

# **Nature of operations**

#  

# The Fidelity Deposit and Discount Bank (the Bank) is a commercial bankchartered in the Commonwealth of Pennsylvania and a wholly-owned subsidiary ofFidelity D & D Bancorp, Inc. (the Company or collectively, theCompany).  Having commenced operations in1903, the Bank is committed to provide superior customer service, whileoffering a full range of banking products and financial and trust services toboth our consumer and commercial customers from its main office located inDunmore and other branches throughout Lackawanna and Luzerne counties.

#  

# **Principles ofconsolidation**

#  

# The accompanying unaudited consolidated financial statements of theCompany and the Bank 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 include all of the information and footnotedisclosures required by GAAP for complete financial statements.  In the opinion of management, all normalrecurring adjustments necessary for a fair presentation of the financialcondition and results of operations for the periods have been included.  All significant inter-company balances andtransactions have been eliminated in consolidation.

#  

The preparation offinancial statements in conformity with GAAP requires management to makeestimates and assumptions that affect the reported amounts of assets andliabilities and disclosure of contingent assets and liabilities at the date ofthe financial statements and the reported amounts of revenues and expensesduring the reported periods.  Actualresults could differ from those estimates. For additional information and disclosures required under GAAP, refer tothe Company’s Annual Report on Form 10-K for the year ended December 31,2008.

 

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

 

In the opinion ofmanagement, the consolidated balance sheets as of March 31, 2009 and December 31,2008 and the related consolidated statements of income for the three monthsended March 31, 2009 and 2008 and changes in shareholders’ equity and cashflows for the three months ended March 31, 2009 and 2008 present fairlythe financial condition and results of operations of the Company.  All material adjustments required for a fairpresentation have been made.  Theseadjustments are of a normal recurring nature.

 

This Quarterly Report on Form 10-Qshould be read in conjunction with the Company’s audited financial statementsfor the year ended December 31, 2008, and the notes included therein,included within the Company’s Annual Report filed on Form 10-K.

 

# **Criticalaccounting policies**

#  

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

 

A material estimate thatis particularly susceptible to significant change relates to the determinationof the allowance for loan losses. Management believes that the allowance for loan losses at March 31,2009 is adequate and reasonable.  Giventhe subjective nature of identifying and valuing loan losses, it is likely thatwell-informed individuals could make different assumptions, and could,therefore calculate a materially different allowance value.  While management uses available informationto recognize losses on loans, changes in economic conditions may necessitaterevisions in the future.  In addition,various regulatory agencies, as an integral part of their examination process,periodically review the Company’s allowance for loan losses.  Such agencies may require the Company torecognize adjustments to the allowance based on their judgment of informationavailable to them at the time of their examination.

 

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Another material estimateis the calculation of fair values of the Company’s investment securities.  Except for the Company’s investment incorporate bonds, consisting of preferred term securities, fair values on theother investment securities are determined by prices provided by a third-partyvendor, who is a provider of financial market data, analytics and relatedservices to financial institutions.  Forthe trust preferred term securities, management was unable to obtain readilyattainable and realistic pricing from market traders due to lack of activemarket participants and therefore management has determined that the market forthese securities continues to be inactive. In order to determine the fair value of the preferred term securities, management relied on the use ofan income valuation approach (present value technique) that maximizes the useof relevant observable inputs and minimizes the use of unobservable inputs theresults of which are more representative of fair value than the market approachvaluation technique used for the other investment securities.

 

Based on experience,management is aware that estimated fair values of investment securities tend tovary among valuation services.  Accordingly,when selling investment securities, price quotes from more than one source maybe obtained.  A large majority of theCompany’s investment securities are classified as available-for-sale(AFS).  AFS securities are carried atfair value on the consolidated balance sheet, with unrealized gains and losses,net of income tax, reported separately within shareholders’ equity throughaccumulated other comprehensive income (loss).

 

The fair value ofresidential mortgage loans, classified as AFS, is obtained from the FederalNational Mortgage Association (FNMA) or the Federal Home Loan Bank (FHLB).  Generally, the market to which the Companysells mortgages it originates for sale is restricted and price quotes from othersources are not typically obtained.  Onoccasion, the Company may transfer loans from the loan and lease portfolio toloans AFS.  Under these circumstances,pricing may be obtained from other entities and the loans are transferred atthe lower of cost or market value and simultaneously sold.  For a further discussion on the accountingtreatment of AFS loans, see the section entitled “Loans available-for-sale,”contained within management’s discussion and analysis.  As of March 31, 2009 and December 31,2008, loans classified as AFS consisted of residential mortgages.

 

**2.  Earnings per share**

 

Basic earnings pershare (EPS) is computed by dividing income available to common shareholders bythe weighted-average number of common stock outstanding for the period.  Diluted EPS is computed in the same manner asbasic EPS but reflects the potential dilution that could occur if stock optionsto issue additional common stock were exercised, which would then result inadditional stock outstanding to share in or dilute the earnings of the Company.  The Company maintains two share-basedcompensation plans that may generate additional potential dilutive commonshares.  Generally, dilution would occurif Company-issued stock options were exercised and converted into commonstock.  There were no potentially dilutiveshares outstanding at March 31, 2009 or 2008.

 

In the computationof diluted EPS, the Company uses the treasury stock method to determine thedilutive effect of its granted but unexercised stock options.  Under the treasury stock method, the assumedproceeds received from shares issued, in a hypothetical stock option exercise,are assumed to be used to purchase treasury stock.  For a further discussion on the Company’sstock option plans, see Note No. 3, “Stock plans,” below.

 

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

 
| **Three months ended March 31,**          | ** ** | **2009**  | ** ** | **2008**  | ** ** |
|---------------------------------------------------------------|------------|-----------|------------|-----------|------------|
|                                                          |       |      |       |      |       |
| Net income  available to common shareholders                  |       | $         | 825,058    |      | $          | 1,088,947 |   |
| Weighted-average  common shares outstanding                   |       | 2,065,715 |       | 2,075,033 |       |
| Basic EPS                                                     |       | $         | 0.40       |      | $          | 0.52 |   |
|                                                          |       |      |       |      |       |
| Diluted EPS:                                                  |       |      |       |      |       |
| Net income  available to common shareholders                  |       | $         | 825,058    |      | $          | 1,088,947 |   |
| Weighted-average  common shares outstanding                   |       | 2,065,715 |       | 2,075,033 |       |
| Potentially  dilutive common shares                           |       | —    |       | —    |       |
| Weighted-average  common shares and dilutive potential shares |       | 2,065,715 |       | 2,075,033 |       |
| Diluted EPS                                                   |       | $         | 0.40       |      | $          | 0.52 |   |

 

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**3.  Stock plans**

 

The Company has twostock-based compensation plans (the stock option plans) and applies the fairvalue method of accounting for stock-based compensation provided underStatement of Financial Accounting Standard (SFAS) No. 123R, *Share Based Payment*. SFAS 123R requires that the cost of share-based payment transactions(including those with employees and non-employees) be recognized in thefinancial statements.

 

Under the stock optionplans, options are granted with an exercise price equal to the market price ofthe Company’s stock on the date of grant. The awards vest based on six months of continuous service from the dateof grant and have 10-year contractual terms. Stock-based compensation expense is recognized over the six-monthvesting period.  Generally, all sharesthat are granted become fully vested. Stock-based compensation is recorded in the consolidated incomestatement as a component of salaries and employee benefits.

 

The Company establishedthe 2000 Independent Directors Stock Option Plan and has reserved 55,000 sharesof its un-issued capital stock for issuance under the plan.  No stock options were awarded during thethree months ended March 31, 2009 and 2008.  As of March 31, 2009, there were 27,400unexercised stock options outstanding under this plan.

 

The Company alsoestablished the 2000 Stock Incentive Plan and has reserved 55,000 shares of itsun-issued capital stock for issuance under the plan.  There were no options awarded during thethree months ended March 31, 2009. During the three months ended March 31, 2008, 2,000 stock optionswere issued under this plan at a weighted-average grant-date fair value of$4.85 per share.  The Company uses the Black-ScholesOption Pricing Valuation Model to determine the fair value of awarded optionson the date of grant.  The modelconsiders expected volatility, expected dividends, risk-free interest rate andthe expected term.  As of March 31,2009, there were 12,390 unexercised stock options outstanding under this plan.

 

The following tablesillustrate stock-based compensation expense recognized during the three monthsended March 31, 2009 and 2008 and the unrecognized stock-basedcompensation expense as of March 31, 2009 and 2008.  There was no unrecognized stock-basedcompensation expense as of December 31, 2008:

 
| ** **                              | ** ** | **Three months ended** | ** ** |
|-----------------------------------------|------------|----------------------------------|------------|
| ** **                              | ** ** | **March 31,**               | ** ** |
| ** **                              | ** ** | **2009**                         | ** ** | **2008** | ** ** |
| Stock-based  compensation expense:      |       |                             |       |   |   |
| Director’s Plan                    |       | $                                | —     |   | $ | 48,471 |   |
| Incentive Plan                          |       | —                           |       | 16,380 |   |
|                                    |       |                             |       |   |   |
| Total  stock-based compensation expense |       | $                                | —     |   | $ | 64,851 |   |

 
| ** **                                      | ** ** | **As of:**              | ** ** |
|-------------------------------------------------|------------|------------------------------|------------|
| ** **                                      | ** ** | **March 31, 2009** | ** ** | **March 31, 2008** | ** ** |
| Unrecognized  stock-based compensation expense: |       |                         |       |   |   |
| Director’s Plan                            |       | $                            | —     |   | $ | 42,079 |   |
| Incentive Plan                                  |       | —                       |       | 19,182 |   |
|                                            |       |                         |       |   |   |
| Unrecognized  stock-based compensation expense  |       | $                            | —     |   | $ | 61,261 |   |

 

In addition to the two stock option plans, the Companyestablished the 2002 Employee Stock Purchase Plan (the ESPP) and reserved110,000 shares of its un-issued capital stock for issuance under the plan.  The plan was designed to promote broad-basedemployee ownership of the Company’s stock. Under the ESPP, employees may elect to purchase the Company’s capitalstock at a discounted price based on the fair market value of the Company’scapital stock on either the commencement date or termination date.  At March 31, 2009, 12,271 shares havebeen issued under the ESPP.  The Companyrecognizes compensation expense on its ESPP on the date the shares arepurchased.  For the three months ended March 31,2009 and 2008, compensation expense related to the ESPP approximated $5,000 and$3,000, respectively, and is included as components of salaries and employeebenefits in the consolidated statements of income.

 

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**4.  Derivative instruments**

 

As part of the Company’soverall interest rate risk management strategy, the Company has adopted apolicy whereby it may periodically use derivative instruments to minimizesignificant fluctuations in earnings caused by interest rate volatility.  This interest rate risk management strategyentails the use of interest rate floors, caps and swaps.  During the fourth quarter of 2006, theCompany entered into a three-year interest rate floor derivative agreement on$20,000,000 notional value of its prime-based loan portfolio.  The transaction required the payment of apremium by the Company to the seller for the right to receive payments in theevent national prime drops below a pre-determined level (strike rate),essentially converting floating rate loans to fixed rate loans when prime dropsbelow the contractual strike rate.  Whenpurchased, the Company recorded an asset representing the fair value of thehedge at the time of purchase.  TheCompany has designated this agreement as a cash flow hedge pursuant to SFAS No. 133,*Accounting for Derivative Instruments and HedgingActivities*.  Accordingly, thechange in the fair value of the instrument related to the hedge’s intrinsicvalue, or approximately ($157,000) and $365,000 for the three months ended March 31,2009 and 2008, respectively, is recorded as a component of other comprehensiveincome (loss) (OCI) in the consolidated statement of changes in shareholders’equity and the portion of the change in fair value related to the time valueexpiration, or approximately $1,000 and $23,000 for the three months ended March 31,2009 and 2008, respectively, is recorded in the consolidated statements ofincome as a reduction of interest income. No gain or loss has been recognized in earnings due to hedgeineffectiveness as of March 31, 2009. As of March 31, 2009, the Company does not expect to reclassify anyamount from OCI to earnings over the next three quarters and no hedge has beendiscontinued.  Also, as of March 31,2009 and December 31, 2008, the fair value of the derivative contractapproximated $478,000 and $636,000, respectively, and is recorded as acomponent of other assets in the consolidated balance sheet.  The following table illustrates the presentvalue, intrinsic value and time value components of the Company’s derivativecontract and the financial statement impact of the change in the fair value forthe periods indicated:

 
| ** **                   | ** ** | **Three months ended or as of March 31,** | ** ** |
|------------------------------|------------|------------------------------------------------------------------------------|------------|
| ** **                   | ** ** | **Present**                                                                  | ** ** | **Intrinsic** | ** ** | **Time** | ** ** |
| ** **                   | ** ** | **value**                                                                    | ** ** | **value** | ** ** | **value** | ** ** |
| ** **                   | ** ** | **Balance**                                                                  | ** ** | **Balance** | ** ** | **Income** | ** ** |
| ** **                   | ** ** | **sheet**                                                                    | ** ** | **sheet** | ** ** | **statement** | ** ** |
| ** **                   | ** ** | **Other assets**                                                        | ** ** | **OCI** | ** ** | **Interest income** | ** ** |
| **2009**                     |       |                                                                         |       |   |   |   |   |
| Beginning  Balance           |       | $                                                                            | 635,839    |   | $ | 606,492 |   |   |   |
|                         |       |                                                                         |       |   |   |   |   |
| Change in fair  value        |       | (158,200                                                                     | )          | (156,787 | ) | (1,413 | ) |
|                         |       |                                                                         |       |   |   |   |   |
| Balance  March 31, 2009 |       | $                                                                            | 477,639    |   | $ | 449,705 |   |   |   |
|                         |       |                                                                         |       |   |   |   |   |
| **2008**                     |       |                                                                         |       |   |   |   |   |
| Beginning  Balance           |       | $                                                                            | 440,593    |   | $ | 385,741 |   |   |   |
|                         |       |                                                                         |       |   |   |   |   |
| Change in fair  value        |       | 341,573                                                                      |       | 365,136 |   | (23,563 | ) |
|                         |       |                                                                         |       |   |   |   |   |
| Balance  March 31, 2008 |       | $                                                                            | 782,166    |   | $ | 750,877 |   |   |   |

 

As a result of the lownational prime rate relative to the contract’s strike rate, the Company earned$225,000 and $77,000 for the three months ended March 31, 2009 and 2008,respectively, and is included as a component of interest income from loans inthe consolidated income statements.  Thecontract is scheduled to expire in the fourth quarter of 2009.

 

The use of derivativeinstruments exposes the Company to credit risk in the event of non-performanceby the agreement’s counterparty to the derivative instrument.  In the event of default by the counterparty,the Company would be subject to an economic loss that corresponds to the costto replace the agreement.  The Companycontrols the credit risk associated with the derivative instrument by engagingcounterparties with high credit ratings, establishing counterparty exposurelimits and monitoring procedures.

 

**5.  Fair value measurements**

 

On January 1, 2008,the Company adopted SFAS 157, *Fair Value Measurements*.  SFAS 157 defines fair value, establishes aframework for measuring fair value and enhances disclosures about fair valuemeasurements required under other accounting pronouncements, but does notchange existing guidance as to whether or not an instrument is carried at fairvalue.  SFAS 157 establishes a valuationhierarchy for disclosure of the inputs used to measure fair value.  This hierarchy 

 

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prioritizes the inputsinto three broad levels as follows. Level 1 inputs are quoted prices (unadjusted) in active markets foridentical assets or liabilities.  Level 2inputs are quoted prices for similar assets and liabilities in active markets;quoted prices for identical or similar assets or liabilities in markets thatare not active; or inputs that are observable for the asset or liability,either directly or indirectly through market corroboration, for substantiallythe full term of the financial instrument. Level 3 inputs are unobservable inputs based on our own assumptions tomeasure assets and liabilities at fair value. Level 3 pricing for securities may also include unobservable inputsbased upon broker-traded transactions.  Afinancial asset or liability’s classification within the hierarchy isdetermined based on the lowest level input that is significant to the fairvalue measurement.  The adoption of thisstatement had no effect on the Company’s financial condition, results ofoperations and cash flows.

 

In February 2008 theFinancial Accounting Standards Board (FASB) issued FASB Staff Position (FSP)157-2, *Effective Date of FASB Statement No. 157*,which delays the effective date of SFAS 157 to fiscal years beginning after November 15,2008 for non-financial assets and non-financial liabilities that are notrecognized or disclosed at fair value in the financial statements on arecurring basis.  In October 2008,FASB issued FSP 157-3, Determining the Fair Value of a Financial Asset When theMarket for that Asset is not Active, which clarifies the application of FAS 157in a market that is not active and provides an example to illustrate keyconsiderations in determining the fair value of a financial asset when themarket for that financial asset is not active.

 

The following tableillustrates the financial instruments measured at fair value on a recurringbasis segregated by hierarchy fair value levels (dollars in thousands):

 
| ** **                     | ** ** | ** **                   | ** ** | **Fair value measurements at March 31, 2009:** | ** ** |
|--------------------------------|------------|------------------------------|------------|------------------------------------------------------------------------------|------------|
| ** **                     | ** ** | **Total carrying**      | ** ** | **Quoted prices**                                                       | ** ** | **Significant other** | ** ** | **Significant** | ** ** |
| ** **                     | ** ** | **value at**            | ** ** | **in active markets**                                              | ** ** | **observable inputs** | ** ** | **unobservable inputs** | ** ** |
| ** **                     | ** ** | **March 31, 2009** | ** ** | **(Level 1)**                                                           | ** ** | **(Level 2)** | ** ** | **(Level 3)** | ** ** |
| Assets:                        |       |                         |       |                                                                         |       |   |   |   |   |
| Available-for-sale  securities |       | $                            | 78,068     |                                                                         | $          | 387 |   | $ | 73,769 |   | $ | 3,912 |   |
| Loans  available-for-sale      |       | 675                          |       | —                                                                       |       | 675 |   | — |   |
| Derivative  instrument         |       | 478                          |       | —                                                                       |       | 478 |   | — |   |
| Total                          |       | $                            | 79,221     |                                                                         | $          | 387 |   | $ | 74,922 |   | $ | 3,912 |   |

 

Equitysecurities in the available-for-sale securities portfolio are measured at fairvalue using quoted market prices for identical assets and are classified withinLevel 1 of the valuation hierarchy. Other than the Company’s investment in corporate bonds, all other debtsecurities in the available-for-sale securities portfolio are measured at fairvalue using prices provided by a third-party vendor, who is a provider offinancial market data, analytics and related services to financialinstitutions.  The Company’s preferredterm securities, classified under corporate bonds, include both observable andunobservable inputs to determine fair value as described above and, therefore,are considered Level 3 inputs.  Once themarket activity, including new issues, begins to occur, and the unobservablesubjective inputs are replaced by market activity, management may transferthese securities out of Level 3 into a Level 2 classification.  For a further discussion on the fair valuedetermination of the Company’s preferred term securities, see the discussion in“Investments” under the caption “Comparison of financial condition at March 31,2009 and December 31, 2008” of Item 2,  Management’s Discussion and Analysis of Financial Condition and Resultsof Operations, incorporated herein.

 

Loans available-for-saleare measured at fair value from quotes received through secondary marketsources, i.e., FNMA or FHLB, who provide pricing for similar assets withsimilar terms in actively traded markets. The derivative instrument, included in other assets, is measured at fairvalue from pricing provided by a third party who considers observable interestrates, forward yield curves at commonly quoted intervals and volatility.

 

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The following tableillustrates the changes in Level 3 financial instruments measured at fair valueon a recurring basis for the periods indicated (dollars in thousands):

 
| ** **                                                                    | ** ** | **As of and for the** | ** ** | **As of and for the** | ** ** |
|-------------------------------------------------------------------------------|------------|-------------------------------------------|------------|-------------------------------------------|------------|
| ** **                                                                    | ** ** | **three months ended**          | ** ** | **three months ended**          | ** ** |
| ** **                                                                    | ** ** | **March 31, 2009**              | ** ** | **March 31, 2008**              | ** ** |
| Assets:                                                                       |       |                                      |       |                                      |       |
| Balance at  beginning of period                                               |       | $                                         | 10,260     |                                      | $          | 16,335 |   |
| Realized /  unrealized gains (losses):                                        |       |                                      |       |                                      |       |
| in earnings                                                                   |       | (326                                      | )          | —                                    |       |
| in comprehensive  income                                                      |       | (6,040                                    | )          | (1,341                                    | )          |
| Purchases,  sales, issuances and settlements, amortization and accretion, net |       | 18                                        |       | 4,549                                     |       |
| Transfers into  (out of) Level 3                                              |       | —                                    |       | —                                    |       |
| Balance at end  of period                                                     |       | $                                         | 3,912      |                                      | $          | 19,543 |   |

 

The following tableillustrates the financial instruments measured at fair value on a nonrecurringbasis segregated by hierarchy fair value levels (dollars in thousands):

 
| ** **     | ** ** | **Fair value measurements at March 31, 2009 using:** | ** ** |
|----------------|------------|-----------------------------------------------------------------------------------------|------------|
| ** **     | ** ** | **Total carrying**                                                                 | ** ** | **Quoted prices** | ** ** | **Significant other** | ** ** | **Significant** | ** ** |
| ** **     | ** ** | **value at**                                                                       | ** ** | **in active markets** | ** ** | **observable inputs** | ** ** | **unobservable inputs** | ** ** |
| ** **     | ** ** | **March 31, 2009**                                                            | ** ** | **(Level 1)** | ** ** | **(Level 2)** | ** ** | **(Level 3)** | ** ** |
| Assets:        | ** ** | ** **                                                                              | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** |
| Impaired loans |       | $                                                                                       | 1,974      |   | $ | 11 |   | $ | 1,108 |   | $ | 855 |   |
|                |            |                                                                                         |            |  |  |  |  |  |  |  |  |  |  |

 

Impaired loans that arecollateral dependent are written down to fair value through the establishmentof specific reserves.  Techniques used tovalue the collateral that secures the impaired loan include: quoted marketprices for identical assets classified as Level 1 inputs; observable inputs,employed by certified appraisers for similar assets classified as Level 2inputs.  In cases where valuationtechniques included inputs that are unobservable or are based on estimates andassumptions developed by management, with significant adjustments from the bestinformation available under each circumstance, the asset valuation isclassified as Level 3 inputs.

 

**6.  New Accounting Pronouncements**

 

On April 9, 2009the Financial Accounting Standards Board (FASB) issued three amendments to thefair value measurement, disclosure and other-than-temporary impairmentstandards as follows:

 

FASB Staff Position (FSP)No. FAS 157-4, *Determining Fair ValueWhen the Volume and Level of Activity for the Asset or Liability HaveSignificantly Decreased and Identifying Transactions That Are Not Orderly*(FSP 157-4).  FSP 157-4 providesadditional guidance for estimating fair value in accordance with FASB StatementNo. 157, *Fair Value Measurements*, when thevolume and level of activity for the asset or liability have significantlydecreased.  This FSP also includesguidance on identifying circumstances that indicate a transaction is notorderly.  This FSP emphasizes that evenif there has been a significant decrease in the volume and level of activityfor the asset or liability and regardless of the valuation technique(s) used,the objective of a fair value measurement remains the same.  Fair value is the price that would bereceived to sell an asset or paid to transfer a liability in an orderlytransaction (that is, not a forced liquidation or distressed sale) betweenmarket participants at the measurement date under current marketconditions.  The Company is currentlyevaluating the impact of the adoption of FSP 157-4 will have on itsconsolidated financial statements;

 

FSP No. FAS 115-2and FAS 124-2, *Recognition and Presentation ofOther-Than-Temporary-Impairments*(FSP 115-2 and 124-2).  FSP 115-2 and 124-2 amends theother-than-temporary-impairment (OTTI) guidance in U.S. GAAP for debtsecurities to make the guidance more operational and to improve thepresentation and disclosure of OTTI on debt and equity securities in thefinancial statements.  This FSP does notamend existing recognition and measurement guidance related to OTTI impairmentsof equity securities. The Company is currently evaluating the impact that theadoption of  FSP 115-2 and 124-2 willhave on its consolidated financial statements;

 

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FSP No. 107-1 and APB 28-1, *InterimDisclosure about Fair Value of Financial Instruments*, (FSP 107-1 andAPB 28-1).  FSP 107-1 and APB 28-1 amendsFASB Statement No. 107, *Disclosures about FairValue of Financial Instruments*, to require disclosures about fairvalue of financial instruments for interim reporting periods of publicly tradedcompanies as well as in annual financial statements.  This FSP also amends Accounting PrinciplesBoard Opinion No. 28, *Interim FinancialReporting*, to require those disclosures in summarized financialinformation at interim reporting periods. FSP 107-1 and APB 28-1 is not expected to have a material effect on theCompany’s consolidated financial statements.

 

The above three FSPsshall be effective for interim and annual reporting periods ending after June 15,2009.  Earlier adoption is permitted forperiods ending after March 15, 2009. If an entity early adopts any of these FSPs, it must also early adoptthe others.  The Company has not earlyadopted any one of these FSPs.

 

On January 1, 2009,the Company adopted FSP No. 142-3, *Determination of theUseful Life of Intangible Assets*, (FSP 142-3).  FSP 142-3 amends the factors that should beconsidered in developing renewal or extension assumptions used to determine theuseful life of a recognized intangible asset under FASB Statement No. 142,*Goodwill and Other Intangible Assets*.  The intent of FSP 142-3 is to improve theconsistency between the useful life of a recognized intangible asset and theperiod of expected cash flows, particularly as used to measure fair value inbusiness combinations.  FSP 142-3 iseffective for fiscal years beginning after December 15, 2008, and isimmaterial as it relates to the Company’s consolidated financial statements.

 

On January 1, 2009,the Company adopted Statement of Financial Accounting Standard (SFAS) No. 161,*Disclosures about Derivative Instruments andHedging Activities*. SFAS 161 amends and expands the disclosure requirements of SFAS133, *Accounting for Derivative Instruments and HedgingActivities*.  It requiresqualitative disclosures about objectives and strategies for using derivatives,quantitative disclosures about fair value amounts of gains and losses onderivative instruments, and disclosures about credit-risk-related contingentfeatures in derivative agreements.  Theadoption of SFAS No. 161 had no impact on the Company’s consolidatedfinancial statements.

 

**Item 2: Management’s Discussion and Analysis of Financial Condition and Resultsof Operations**

 

Thefollowing is management’s discussion and analysis of the significant changes inthe consolidated financial condition of the Company as of March 31, 2009compared to December 31, 2008 and the results of operations for the threemonths ended March 31, 2009 and 2008. Current performance may not be indicative of future results.  This discussion should be read in conjunctionwith the Company’s 2008 Annual Report filed on Form 10-K.

 

**Forward-looking statements**

 

ThisInterim Report on Form 10-Q contains a number of forward-lookingstatements within the meaning of Section 27A of the Securities Act of1933, as amended, or the Securities Act, and Section 21E of the SecuritiesExchange Act of 1934, as amended, or the Exchange Act.  These statements may be identified by the useof the words “anticipate,” “believe,” “could,” “estimate,” “expect,” “intend,” “may,”“outlook,” “plan,” “potential,” “predict,” “project,” “should,” “will,” “would”and similar terms and phrases, including references to assumptions.  Forward-looking statements include risks anduncertainties.

 

Forward-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 factorsmanagement believes are appropriate under the circumstances.  These statements are not guarantees of futureperformance and are subject to risks, uncertainties and other factors (many ofwhich are beyond our control) that could cause actual results to differmaterially from future results expressed or implied by such forward-lookingstatements.  These factors include,without limitation, the following:

 

·                  the timing and occurrence or non-occurrence of eventsmay be subject to circumstances beyond our control;

 

·                  volatilities in the securities market;

 

·                  deteriorating economic conditions;

 

·                  effects of deterioration of economic conditions oncustomers, specifically the effect on loan customers ability to repay theirloans;

 

·                  there may be increases in competitive pressure amongfinancial institutions or from non-financial institutions;

 

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·                  changes in the interest rate environment may reduceinterest margins;

 

·                  changes in deposit flows, loan demand or real estateand investment securities values may adversely affect our business;

 

·                  changes in accounting principles, policies orguidelines may cause our financial condition to be perceived differently;

 

·                  general economic conditions, either nationally orlocally in some or all areas in which we do business, or conditions in thesecurities markets or the banking industry may be less favorable than wecurrently anticipate;

 

·                  legislative or regulatory changes may adversely affectour business;

 

·                  technological changes may be more rapid, difficult orexpensive than we anticipate;

 

·                  success or consummation of new business initiativesmay be more difficult or expensive than we anticipate;

 

·                  acts of war or terrorism; and

 

·                  natural disaster.

 

Managementcautions readers not to place undue reliance on forward-looking statements,which reflect analyses only as of the date of this document.  We have no obligation to update anyforward-looking statements to reflect events or circumstances after the date ofthis document.

 

Readersshould review the risk factors described in other documents that we file orfurnish, from time to time, with the Securities and Exchange Commission,including Annual Reports to Shareholders, Annual Reports filed on Form 10-Kand other current reports filed or furnished on Form 8-K.

 

**General**

 

TheCompany’s principal revenues are derived from interest, dividends and feesearned on its interest-earning assets, which are comprised of loans, securitiesand other short-term investments.  TheCompany’s principal expenses consist of interest paid on its interest-bearingliabilities, which are comprised of deposits, short- and long-term borrowingsand operating and general expenses.  TheCompany’s profitability depends primarily on its net interest income.  Net interest income is the difference betweeninterest income and interest expense. Interest income is generated from yields on interest-earning assetswhich consist principally of loans and investment securities.  Interest expense is incurred from rates paidon interest-bearing liabilities, which consist of deposits and borrowings.  Net interest income is dependent upon theinterest-rate spread (i.e., the difference between the yields earned on itsinterest-earning assets and the rates paid on its interest-bearing liabilities)and the relative amounts of interest-earning assets and interest-bearingliabilities.  The interest rate spread issignificantly impacted by: changes in interest rates and market yield curvesand their related impact on cash flows; the composition and characteristics ofinterest-earning assets and interest-bearing liabilities; differences in thematurity and re-pricing characteristics of assets compared to the maturity andre-pricing characteristics of the liabilities that fund them and by thecompetition in our marketplace.

 

TheCompany’s profitability is also affected by the level of its non-interestincome and expenses, provision for loan losses and provision for incometaxes.  Non-interest income consists ofservice charges on the Bank’s loan and deposit products, trust and asset managementservice fees, increases in the cash surrender value of the bank owned lifeinsurance (BOLI), net gains or losses from sales of loans and securities AFS,sales of other real estate (ORE) properties and fromOther-than-temporary-impairment (OTTI) charges on investment securities.  Non-interest expense consists of compensationand related employee benefit expenses, occupancy, equipment, data processing,advertising, marketing, professional fees, insurance and other operatingoverhead.

 

TheCompany’s profitability is significantly affected by general economic andcompetitive conditions, changes in market interest rates, government policiesand actions of regulatory authorities. The Company’s loan portfolio is comprised principally of commercial andcommercial real estate loans.  Theproperties underlying the Company’s mortgages are concentrated in NortheasternPennsylvania.  Credit risk, whichrepresents the possibility of the Company not recovering amounts due from itsborrowers, is significantly related to local economic conditions in the areasthe properties are

 

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located as well as theCompany’s underwriting standards. Economic conditions affect the market value of the underlying collateralas well as the levels of adequate cash flow and revenue generation fromincome-producing commercial properties.

 

**Comparison of the results of operations**

**Three months ended March 31, 2009 and 2008**

 

**Overview**

 

Net income for the first quarter of 2009 was $825,000 compared to$1,089,000 recorded in the same quarter of 2008.  Diluted earnings per share were $0.40 and$0.52 for each of the respective quarters. The decrease in net income was principally the result of a $425,000provision for loan loss recorded in the current year’s quarter compared to noneduring the first quarter of 2008, a non-cash OTTI charge of $325,000 related tothe Company’s investment portfolio that did not occur in the first quarter of2008 and a $269,000 increase in non-interest operating expenses during thefirst three months of 2009 compared to the first three months of 2008.  These items were partially offset by anincrease in net interest income of $278,000, or a 6% improvement and increasedother non-interest income of $343,000 from mortgage banking activities.  For the three months ended March 31,2009 net income, excluding the OTTI charge would have been $1,040,000, or $0.50per share.  The following tablereconciles net income as reported to pro forma net operating income for theperiods indicated:

 
| ** **                       | ** ** | **Three Months Ended March 31,** | ** **      |
|----------------------------------|------------|---------------------------------------|-----------------|
| ** **                       | ** ** | **2009**                              | ** **      | **2008** | ** ** |
| ** **                       | ** ** | **Amount**                            | ** **      | **Per share** | ** ** | **Amount** | ** ** | **Per share** | ** ** |
|                             |       |                                  |            |   |   |   |   |   |   |
| Net income, as  reported         |       | $                                     |  825,058   |   | $ |  0.40 |   | $ |  1,088,947 |   | $ |  0.52 |   |
| Other-than-temporary  impairment |       | 325,525                               |            | 0.15 |   | — |   | — |   |
| Tax effect                       |       | (110,679                              | )               | (0.05 | ) | — |   | — |   |
| Net operating  earnings          |       | $                                     |  1,039,904 |   | $ |  0.50 |   | $ |  1,088,947 |   | $ |  0.52 |   |

 

Return on average assets (ROA) and return on averageshareholders’ equity (ROE) were 0.58% and 7.02%, respectively, for the threemonths ended March 31, 2009 compared to 0.74% and 7.80% for the sameperiod in 2008.  The lower net income inthe current year quarter was the primary cause of the decline in both ROA andROE.

 

*Net interest income and interestsensitive assets / liabilities*

* *

For the threemonths ended March 31, 2009, net interest income increased $278,000, or6%, to $4,825,000 compared to $4,547,000 recorded during the three months endedMarch 31, 2008.  The tax-equivalentnet interest margin improved to 3.73% for the three months ended March 31,2009 from 3.37% for the three months ended March 31, 2008.  The net interest rate spread increased to3.28% for the three months ended March 31, 2009 from 2.76% for the threemonths ended March 31, 2008.  Theprincipal cause of the improvements in net interest income, margin and spreadstems from lower rates paid on lower average balances of interest-bearingliabilities partially offset by lower yields earned on interest-earning assets.

 

Interest incomedeclined $917,000, or 10%, to $7,827,000 for the three months ended March 31,2009, from $8,744,000 for the three months ended March 31, 2008 primarilydue to a 42 basis point decrease in the average yield on interest-earningassets to 5.97% for the three months ended March 31, 2009 from 6.39% forthe three months ended March 31, 2008. The decrease in the average yield on interest-earning assets was fromthe sustaining effect of operating in the lower interest rate environment whichhad the most significant impact in the loan and investment portfolios whoseyields declined 56 basis points and 57 basis points, respectively in thecurrent year’s quarter compared to the same quarter of 2008.  The net decline in average balances ofinterest-earning assets had a relatively minor impact compared to the effectthe interest rate environment had on the Company’s overall interest incomeperformance.

 

Interest expensedecreased $1,195,000, or 28%, to $3,003,000 for the three months ended March 31,2009 from $4,198,000 for the three months ended March 31, 2008 largelyfrom a 52 basis point decrease in the average cost of interest-bearingliabilities to 2.76% from 3.28% for the comparative periods.  The rates paid on the Company’sinterest-bearing deposits declined by more than 100 basis points and was theprimary cause of the $1,042,000 decrease. The decrease in the average-balances of total borrowings alsocontributed to the $153,000 decline in interest expense.

 

The currentinterest rate environment has not changed drastically since year-end 2008however it is much different than a year ago. The interest rate environment was considerably lower during the firstquarter of 2009 compared to 2008, albeit the

 

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treasury yieldcurve is somewhat steeper today.  Thelower rates have caused assets to price and re-price at significantly lowerlevels thereby pressuring earning-yields downward.  Increased prepayment activity in assetportfolios, thereby shortening the duration of interest-earning assets as wellas loan refinancing all contribute to lower portfolio yields.  However, the steepness of the curve hasenabled the Company to help mitigate the lower yields earned from its assetportfolios.  To manage the interest ratemargin to acceptable levels, the Company’s Asset Liability Management (ALM)team meets regularly to discuss interest rate risk and when deemed necessaryadjusts interest rates on deposits and repurchase agreements and also useslower costing wholesale funding sources. The actions of the ALM team have helped minimize the effect rate changeshave had on interest income so that net interest income is notdisproportionately impacted during this lower yield environment.  During the first quarter of 2009, the Companyalso sold $10.8 million of lower yielding mortgage loans and used the proceedsto pay off a Federal Home Loan (FHLB) advance that was scheduled to mature in June ofthis year.  The Company’s proactiveattention to interest rate risk should continue to help contain the Company’snet interest income at acceptable levels.

 

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

 
| ** **                                       | ** ** | **Three months ended:** | ** ** |
|--------------------------------------------------|------------|-------------------------|------------|
| ** **                                       | ** ** | **March 31, 2009** | ** ** | **March 31, 2008** | ** ** |
| ** **                                       | ** ** | **Average**             | ** ** | ** ** | ** ** | **Yield /** | ** ** | **Average** | ** ** | ** ** | ** ** | **Yield /** | ** ** |
| ** **                                       | ** ** | **balance**             | ** ** | **Interest** | ** ** | **rate** | ** ** | **balance** | ** ** | **Interest** | ** ** | **rate** | ** ** |
| **Assets**                                       |       |                    |       |   |   |   |   |   |   |   |   |   |   |
| Interest-earning  assets:                        |       |                    |       |   |   |   |   |   |   |   |   |   |   |
| Loans and leases                                 |       | $                       | 438,804    |   | $ | 6,735 |   | 6.22 | % | $ | 411,093 |   | $ | 6,928 |   | 6.78 | % |
| Investments                                      |       | 102,485                 |       | 1,258 |   | 4.98 |   | 134,492 |   | 1,856 |   | 5.55 |   |
| Federal funds  sold                              |       | 1,446                   |       | 1 |   | 0.22 |   | 12,175 |   | 84 |   | 2.78 |   |
| Interest-bearing  deposits                       |       | 119                     |       | — |   | 0.38 |   | 152 |   | 1 |   | 2.93 |   |
| Total  interest-earning assets                   |       | 542,854                 |       | 7,994 |   | 5.97 |   | 557,912 |   | 8,869 |   | 6.39 |   |
| Non-interest-earning  assets                     |       | 29,442                  |       |   |   |   |   | 34,170 |   |   |   |   |   |
| Total Assets                                     |       | $                       | 572,296    |   |   |   |   |   | $ | 592,082 |   |   |   |   |   |
|                                             |       |                    |       |   |   |   |   |   |   |   |   |   |   |
| **Liabilities  and shareholders’ equity**   |       |                    |       |   |   |   |   |   |   |   |   |   |   |
| Interest-bearing  liabilities:                   |       |                    |       |   |   |   |   |   |   |   |   |   |   |
| Other  interest-bearing deposits                 |       | $                       | 207,234    |   | 569 |   | 1.11 | % | $ | 191,295 |   | 1,094 |   | 2.30 | % |
| Certificates of  deposit                         |       | 173,274                 |       | 1,623 |   | 3.80 |   | 189,601 |   | 2,140 |   | 4.54 |   |
| Borrowed funds                                   |       | 62,305                  |       | 803 |   | 5.22 |   | 68,697 |   | 897 |   | 5.25 |   |
| Repurchase  agreements                           |       | 10,362                  |       | 8 |   | 0.33 |   | 15,372 |   | 67 |   | 1.76 |   |
| Total  interest-bearing liabilities              |       | 453,175                 |       | 3,003 |   | 2.69 |   | 464,965 |   | 4,198 |   | 3.63 |   |
| Non-interest-bearing  deposits                   |       | 68,083                  |       |   |   |   |   | 66,504 |   |   |   |   |   |
| Other  non-interest-bearing liabilities          |       | 3,367                   |       |   |   |   |   | 4,457 |   |   |   |   |   |
| Shareholders’  equity                       |       | 47,671                  |       |   |   |   |   | 56,156 |   |   |   |   |   |
| Total  liabilities and shareholders’ equity |       | $                       | 572,296    |   |   |   |   |   | $ | 592,082 |   |   |   |   |   |
| Net interest  income / interest rate spread      |       |                    |       | $ | 4,991 |   | 3.28 | % |   |   | $ | 4,671 |   | 2.76 | % |
| Net interest  margin                             |       |                    |       |   |   | 3.73 | % |   |   |   |   | 3.37 | % |

 

In the table above, interestincome was adjusted to a tax-equivalent basis to recognize the income from thevarious tax-exempt assets as if the interest was fully taxable.  This treatment allows a uniform comparisonamong the yields on interest-earning assets. The calculations were computed on a fully tax-equivalent basis using thecorporate federal tax rate of 34%.  Netinterest spread represents the difference between the yield on interest-earningassets and the rate on interest-bearing liabilities.  Net interest margin represents the ratio ofnet interest income to total average interest-earning assets.

 

*Provision for loan losses*

 

The provision for loanlosses represents the necessary amount to charge against current earnings, thepurpose of which is to increase the allowance for loan losses to a level thatrepresents management’s best estimate of known and inherent losses in theCompany’s loan portfolio.  Loans andleases determined to be uncollectible are charged-off against the allowance forloan losses.  The required amount of theprovision for loan losses, based upon the adequate level of the allowance forloan losses, is subject to ongoing analysis of the loan portfolio.  The Company’s Special Asset Committee meetsperiodically to review problem loans and leases.  The committee is comprised of management,including the chief risk officer, loan workout officers and collectionpersonnel.  The committee reportsquarterly to the Credit Administration Committee of the Board of Directors.

 

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

 

·                  specific loansthat could have loss potential;

·                  levels of andtrends in delinquencies and non-accrual loans;

·                  levels of andtrends in charge-offs and recoveries;

·                  trends in volumeand terms of loans;

·                  changes in riskselection and underwriting standards;

·                  changes inlending policies, procedures and practices;

·                  experience,ability and depth of lending management;

·                  national andlocal economic trends and conditions; and

·                  changes incredit concentrations.

 

Provisions forloan losses of $425,000 were recorded during the quarter ended March 31,2009.  No provisions for loan losses werenecessary during the first quarter of 2008. During the first quarter of 2009, the provision was recorded to fundgrowth in commercial and commercial real estate loans and the down grading ofsome internally classified loans.  Thesetwo factors contributed to a higher calculated allowance for loan lossrequirement.  The allowance for loanlosses was $5,097,000 at March 31, 2009 compared to $4,745,000 at December 31,2008.  For a further discussion theallowance for loan losses, see “Allowance for loan losses” under the caption “Comparisonof financial condition at March 31, 2009 and December 31, 2008”,below.

 

*Other income*

* *

In the firstquarter of 2009, other (non-interest) income increased modestly, $18,000 or 1%,to $1,313,000 from $1,295,000 recorded in the first quarter of 2008.  During the current year quarter, the Companysold $38,296,000 of residential mortgage loans at a gain of $491,000.  Included in these sales were $10,838,000 ofloans transferred from the loan and lease portfolio to loans AFS andsimultaneously sold.  Partially offsettingthis gain was a non-cash OTTI charge of $325,000 from the investment portfolio.  The OTTI charge is related to the Company’sinvestment in a pooled preferred term security. The carrying value of this security was further written down to its fairmarket value as of March 31, 2009 as management has deemed the additionalimpairment to be other-than-temporary. There was no similar OTTI charge during the first quarter of 2008.  Service charges from deposit accountsdeclined $131,000, or 17%, due to a lower volume of overdrafttransactions.  The improvement in allother non-interest income was from increases in loan fees and financialservices revenue.

 

*Other operating expenses*

* *

For the quarterended March 31, 2009, other (non-interest) expenses increased $269,000, or6%, compared to the quarter ended March 31, 2008.  Salary and benefits increased due to: a fullquarter of operations of the Company’s new West Scranton branch that was notoperational during the first quarter of 2008; a Company’s executive officer wasre-employed in the middle of the 2008 quarter compared to a full quarter impactin the current year; higher commissions earned on production by our mortgagelenders and financial services staff; increased health care and partiallyoffset by lower stock-based compensation. The increase in premises and equipment is from added depreciationexpense for the new West Scranton branch expansion projected and increasedequipment maintenance in information technology.  The increase in the other category ofnon-interest expense includes a $62,000 increase in FDIC insurance premiums inthe current year compared to the three months ended March 31, 2008;increased ORE expenses related to the payment of delinquent taxes; partiallyoffset by lower branch related costs.

 

In late February 2009,the FDIC voted to impose a special assessment of 20 basis points on allFDIC-insured banks, on June 30, 2009, to be collected on September 30,2009.  The Company anticipates that thespecial assessment will range from 6 to 20 basis points and could adverselyaffect earnings by as much as $900,000 based on our current federally-insureddeposit amounts.  Furthermore, the FDIChas the authority, after June 30, 2009, to impose an additional 10 basispoint emergency special assessment on all FDIC-insured banks if it estimatesthe reserve ratio of the Deposit Insurance Fund will fall to a level that itbelieves would adversely affect public confidence or to a level which would beclose to zero or negative at the end of a calendar quarter.  At this time we cannot estimate theprobability of this event; however, any additional FDIC assessment and/orpremium would be adverse to our 2009 earnings.

 

*Provisionfor income taxes*

* *

The provision forincome taxes for the three months ended March 31, 2009 was lower comparedto the same periods in 2008 primarily from lower pretax income.

 

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**Comparison of financial condition at**

**March 31, 2009 and December 31, 2008**

 

*Overview*

 

Consolidatedassets declined $8,933,000, or 2%, during the three months ended March 31,2009.  The decline was caused by a$37,388,000, or 41%, reduction in total borrowings, a decline of $3,499,000 or7%, in shareholders’ equity, partially offset by a $30,842,000, or 7%, increasein total deposits.  The decline inshareholders’ equity was caused by increased levels of unrealized losses in thesecurities AFS portfolio.  The reductionin borrowings was from implementing a de-leveraging strategy that used theproceeds from the sale of residential mortgage loans to reduce a FHLB advancethat was scheduled to mature during the second quarter of 2009.  The increase in deposits was used to reduceovernight funding and fund commercial loan growth.

 

*Investment securities*

 

At the time ofpurchase, management classifies investment securities into one of threecategories: trading, AFS or held-to- maturity (HTM).  To date, management has not purchased anysecurities for trading purposes.  Most ofthe securities purchased are classified as AFS even though there is noimmediate intent to sell them.  The AFSdesignation affords management the flexibility to sell securities and positionthe balance sheet in response to capital levels, liquidity needs or changes inmarket conditions.  Securities AFS arecarried at net fair value in the consolidated balance sheet with an adjustmentto shareholders’ equity, net of tax, presented under the caption “Accumulatedother comprehensive income (loss).” Securities designated as HTM are carried at amortized cost and representdebt securities that the Company has the ability and intent to hold untilmaturity.

 

As of March 31,2009, the carrying value of investment securities totaled $78,950,000, or 14%of total assets, compared to $84,188,000, or 15% of total assets, at December 31,2008.  At March 31, 2009,approximately 15% of the carrying value of the investment portfolio wascomprised of mortgage-backed securities that amortize and provide monthly cashflow.  Agency, municipal and corporatebonds comprised 54%, 26% and 5%, respectively, of the investment portfolio at March 31,2009.

 

During the threemonths ended March 31, 2009, total investments decreased $5,238,000, netof a $5,821,000 decline in the market value of AFS investments.  The amortized cost and fair market value ofinvestment securities is comprised of HTM and AFS securities with carryingvalues of $882,000 and $78,068,000, respectively.  As of March 31, 2009, the AFS debtsecurities were recorded with a net unrealized loss in the amount of$19,266,000 and equity securities were recorded with an unrealized gain of$65,000.

 

A comparison ofinvestment securities at March 31, 2009 and December 31, 2008 is asfollows (dollars in thousands):

 
| ** **                               | ** ** | **March 31, 2009** | ** ** | **December 31, 2008** | ** ** |
|------------------------------------------|------------|-------------------------|------------|----------------------------|------------|
| ** **                               | ** ** | **Amount**              | ** ** | **%**                      | ** ** | **Amount** | ** ** | **%** | ** ** |
| U.S. government  agencies                |       | $                       | 42,213     |                       | 53.5       |   | $ | 43,507 |   | 51.6 |   |
| Mortgage-backed  securities              |       | 11,789                  |       | 14.9                       |       | 12,439 |   | 14.8 |   |
| State &  municipal subdivisions |       | 20,649                  |       | 26.1                       |       | 17,553 |   | 20.9 |   |
| Preferred term  securities               |       | 3,912                   |       | 5.0                        |       | 10,260 |   | 12.2 |   |
| Equity securities                        |       | 387                     |       | 0.5                        |       | 428 |   | 0.5 |   |
| Total  investments                       |       | $                       | 78,950     |                       | 100.0      |   | $ | 84,187 |   | 100.0 |   |

 

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The amortized costand fair value of investments at March 31, 2009 are as follows (dollars inthousands):

 
| ** **                                        | ** ** | **Amortized** | ** ** | **Gross unrealized** | ** ** | **Gross unrealized** | ** ** | **Fair**  | ** ** |
|---------------------------------------------------|------------|---------------|------------|----------------------|------------|----------------------|------------|-----------|------------|
| ** **                                        | ** ** | **cost**      | ** ** | **gains**            | ** ** | **losses**           | ** ** | **value** | ** ** |
|                                              |       |          |       |                 |       |                 |       |      |       |
| Held-to-maturity  securities:                     |       |          |       |                 |       |                 |       |      |       |
| Mortgage-backed  securities                       |       | $             | 882        |                 | $          | 51                   |       | $         | —     |   | $ | 933 |   |
|                                              |       |          |       |                 |       |                 |       |      |       |
| Available-for-sale  securities:                   |       |          |       |                 |       |                 |       |      |       |
| U.S. government  agencies and corporations        |       | $             | 44,244     |                 | $          | 77                   |       | $         | 2,108      |   | $ | 42,213 |   |
| Obligations of  states and political subdivisions |       | 21,207        |       | 99                   |       | 657                  |       | 20,649    |       |
| Corporate bonds                                   |       | 21,107        |       | —               |       | 17,195               |       | 3,912     |       |
| Mortgage-backed  securities                       |       | 10,389        |       | 518                  |       | —               |       | 10,907    |       |
|                                              |       |          |       |                 |       |                 |       |      |       |
| Total debt  securities                            |       | 96,947        |       | 694                  |       | 19,960               |       | 77,681    |       |
|                                              |       |          |       |                 |       |                 |       |      |       |
| Equity  securities                                |       | 322           |       | 90                   |       | 25                   |       | 387       |       |
|                                              |       |          |       |                 |       |                 |       |      |       |
| Total  available-for-sale                         |       | $             | 97,269     |                 | $          | 784                  |       | $         | 19,985     |   | $ | 78,068 |   |

 

The amortized costand fair value of debt securities at March 31, 2009 by contractualmaturity are as follows (dollars in thousands):

 
| ** **                                | ** ** | **Amortized** | ** ** | **Market** | ** ** |
|-------------------------------------------|------------|---------------|------------|------------|------------|
| ** **                                | ** ** | **cost**      | ** ** | **value**  | ** ** |
| Held-to-maturity  securities:             |       |          |       |       |       |
| Mortgage-backed  securities               |       | $             | 882        |       | $          | 933 |   |
|                                      |       |          |       |       |       |
| Available-for-sale  securities:           |       |          |       |       |       |
| Debt securities:                          |       |          |       |       |       |
| Due in one year  or less                  |       | $             | —     |       | $          | — |   |
| Due after one  year through five years    |       | —        |       | —     |       |
| Due after five  years through ten years   |       | 8,133         |       | 8,201      |       |
| Due after ten  years                      |       | 78,425        |       | 58,573     |       |
| Total debt  securities                    |       | 86,558        |       | 66,774     |       |
|                                      |       |          |       |       |       |
| Mortgage-backed  securities               |       | 10,389        |       | 10,907     |       |
|                                      |       |          |       |       |       |
| Total  available-for-sale debt securities |       | $             | 96,947     |       | $          | 77,681 |   |

 

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

 

Quarterly, managementperforms a review of the investment portfolio to determine the cause ofdeclines in the fair value of each security. The Company uses inputs provided by independent third parties todetermine the fair value of its investment securities portfolio.  Inputs provided by the third party arereviewed and corroborated by management. Evaluations of the causes of the unrealized losses are performed todetermine whether impairment, if any, is temporary orother-than-temporary.  Considerationssuch as the Company’s intent and ability to hold the securities to maturity,recoverability of the invested amounts over the intended holding period, thelength of time and the severity in pricing decline below cost, the interestrate environment, receipts of amounts contractually due and whether or notthere is an active market for the security, for example are applied, along withthe financial condition of the issuer for management to make a realisticjudgment of the

 

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probability that theCompany will be unable to collect all amounts (principal and interest) due indetermining whether a security is other-than-temporarily impaired.  If a decline in value is deemed to beother-than-temporary, the amortized cost of the security is reduced by theimpairment amount and a corresponding charge to earnings is recognized.  If at the time of sale, call or maturity theproceeds exceed the security’s amortized cost, the impairment charge may befully or partially recovered.

 

During 2008 and today,uncertainty in the financial markets increased the volatility in fair valueestimates for the securities in our investment portfolio.  Compared to year-end 2008, the fair values ofsecurities have declined.  Managementbelieves these changes were due mainly to liquidity problems in the financialmarkets, not deterioration in the creditworthiness of the issuers.

 

At March 31, 2009and December 31, 2008, the securities with the most significant reductionsin fair value and associated estimated unrealized losses were in the Company’scorporate bond portfolio consisting of collateralized debt obligation (CDO)securities that are backed by pooled trust preferred term securities (preferredterm securities) issued by banks, thrifts and insurance companies.

 

Except for preferred termsecurities, fair values on the other investment securities are determined byprices provided by a third-party vendor, who is a provider of financial marketdata, analytics and related services to financial institutions.  For the trust preferred term securities portfolio,management was unable to obtain readily attainable and realistic pricing frommarket traders due to lack of active market participants and thereforemanagement has determined that the market for these securities is continues tobe inactive.

 

The Company owns 13issues of preferred term securities.  Themarket for these securities at March 31, 2009 was not active and marketsfor similar securities were also not active. The inactivity was evidenced first by a significant widening of thebid-ask spread in the brokered markets in which preferred term securities tradeand then by a significant decrease in the volume of trades relative tohistorical levels.  The new issue marketis also inactive as no new preferred term securities have been issued since 2007.  There are currently very few marketparticipants who are willing and or able to transact for these securities.  Given conditions in the debt markets todayand the absence of observable transactions in the secondary and new issuemarkets, we determined:

 

·                  The few observable transactions andmarket quotations that were available were not reliable for purposes ofdetermining fair value at March 31, 2009,

 

·                  An income valuation approach (presentvalue technique) that maximizes the use of relevant observable inputs andminimizes the use of unobservable inputs will be equally or more representativeof fair value than the market approach valuation technique used at priormeasurement dates and

 

·                  Our preferred term securities will beclassified within Level 3 of the fair value hierarchy because we determinedthat significant adjustments are required to determine fair value at themeasurement date.  Our preferred termsecurities valuations were prepared by an independent third party.  Their approach to determining fair valueinvolved the following:

 

·                  Data about the issue structure asdefined in the indenture and the underlying collateral were collected.

 

·                  The credit quality of the collateralis estimated using average probability of default values for each issuer(adjusted for rating levels and stressed to reflect the current environment),

 

·                  The default probabilities alsoconsidered the potential for correlation among issuers within the same industry(e.g. banks with other banks),

 

·                  The loss given default was assumed tobe 100%,

 

·                  The cash flows were forecast for theunderlying collateral and applied to each CDO tranche to determine theresulting distribution among the securities,

 

·                  The expected cash flows werediscounted to calculate the present value of the security,

 

·                  The effective discount rates on anoverall basis range from 6.81% to 88.01% and are highly dependent upon thecredit quality of the collateral, the relative position of the tranche in thecapital structure of the CDO and the prepayment assumptions, and

 

·                  The calculations were modeled inseveral thousand scenarios using a Monte Carlo engine to establish adistribution of intrinsic values and the average was used for valuationpurposes.

 

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Based on the techniquedescribed, the Company determined that as of March 31, 2009, the fairvalue of one preferred term security had declined $326,000 below its amortizedcost and has deemed this security to be other-than-temporarily impaired.  Accordingly, this amount has been recorded asan impairment charge and is included as a component of other income in theconsolidated income statements for the three months ended March 31,2009.  Excluding, the impairment, themarket value of the Company’s investment in preferred term securities hasdeclined by $6,040,000 since December 31, 2008.  The Company closely monitors the preferredterm securities market and performs collateral sufficiency and cash flowanalyses on at least a quarterly basis. Future analyses could yield results that may indicate further impairmenthas occurred and therefore require additional write-downs and correspondingother-than-temporary charges to current earnings.  There was no other-than-temporary impairmentcharges recorded during the first three months of 2008.

 

At March 31, 2009,the AFS debt securities portfolio was carried at a net unrealized loss of$19,266,000 compared to a net unrealized loss of $13,486,000 at December 31,2008.  Management believes the cause ofthe unrealized losses is related to changes in interest rates or the limitedtrading activity due to recent debt market illiquid conditions and is notdirectly or fully related to credit quality, which is consistent with its pastexperience.  In addition, the Company hasthe ability and intent to hold its investments for a period of time sufficientfor the fair value of the securities to recover, which may be at maturity.

 

*Loans available-for-sale (AFS)*

* *

Generally, uponorigination, certain residential mortgages are classified as AFS.  In the event of market rate increases,fixed-rate loans and loans not immediately scheduled to re-price would nolonger produce yields consistent with the current market.  In a declining interest rate environment, theCompany would be exposed to prepayment risk and, as rates decrease, interestincome could be negatively affected. Consideration is given to the Company’s current liquidity position andprojected future liquidity needs.  Tobetter manage prepayment and interest rate risk, loans that meet theseconditions may be classified as AFS.  Thecarrying value of loans AFS is at the lower of cost or estimated fairvalue.  If the fair values of these loansfall below their original cost, the difference is written down and charged tocurrent earnings.  Subsequentappreciation in the portfolio is credited to current earnings but only to theextent of previous write-downs.

 

Loans AFS at March 31,2009 amounted to $675,000 with a corresponding fair value of $681,000, comparedto $84,000 and $85,000, respectively, at December 31, 2008.  During the three months ended March 31,2009, residential mortgage loans with principal balances of $38,296,000 weresold into the secondary market with net gains of approximately $491,000recognized.  Included in the sale was$10,838,000 of residential loans transferred from the loan and lease portfolio.

 

*Loans and leases*

* *

The Companyoriginates commercial and industrial (commercial) and commercial real estate(CRE) loans, residential mortgages, consumer, home equity and constructionloans.  The relative volume oforiginations is dependent upon customer demand, current interest rates and theperception and duration of future interest levels.  The broad spectrum of products providesdiversification that helps manage, to an extent, interest rate and creditconcentration risk.  Credit risk isfurther managed through underwriting policies and procedures and loanmonitoring practices.  Interest rate riskis managed using various asset/liability modeling techniques and analyses.  The interest rates on most commercial loansare adjustable with reset intervals of five years or less.

 

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

 

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The composition ofthe loan portfolio at March 31, 2009 and December 31, 2008, issummarized as follows (dollars in thousands):

 
| ** **                 | ** ** | **March 31, 2009** | ** ** | **December 31, 2008** | ** ** |
|----------------------------|------------|-------------------------|------------|----------------------------|------------|
| ** **                 | ** ** | **Amount**              | ** ** | **%**                      | ** ** | **Amount** | ** ** | **%** | ** ** |
| Commercial and  CRE        |       | $                       | 252,936    |                       | 59.4       |   | $ | 245,480 |   | 55.7 |   |
| Residential real  estate   |       | 80,119                  |       | 18.8                       |       | 98,510 |   | 22.3 |   |
| Consumer                   |       | 82,860                  |       | 19.5                       |       | 85,091 |   | 19.3 |   |
| Real estate  construction  |       | 9,253                   |       | 2.2                        |       | 11,427 |   | 2.6 |   |
| Direct financing  leases   |       | 427                     |       | 0.1                        |       | 444 |   | 0.1 |   |
| Gross loans                |       | 425,595                 |       | 100.0                      |       | 440,952 |   | 100.0 |   |
| Allowance for  loan losses |       | (5,098                  | )          |                       |       | (4,745 | ) |   |   |
| Net loans                  |       | $                       | 420,497    |                       |       |   | $ | 436,207 |   |   |   |

 

Gross loans decreasedfrom $440,952,000, as of December 31, 2008 to $425,595,000 at March 31,2009.  The decline was predominately fromthe transfer from the loan and lease portfolio, to the AFS portfolio, andsimultaneous sale of $10,838,000 of residential mortgage loans during the firstquarter of 2009.  The balance of thedecline is mostly from net pay-downs during the first quarter as borrowers’sentiment, during this low-rate environment is to re-finance their existingmortgage and home equity debt into new mortgage loans.  Most of the loans that were refinanced withthe Company were sold on a servicing-retained basis.  Commercial and CRE loans continue to builddue to the efforts and resulting success of the Company’s commercial lendingdepartment’s endeavor to generate new business.

 

*Allowance for loan losses*

* *

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

 

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

 

·                  identificationof specific impaired loans by loan category;

·                  calculation ofspecific allowances where required for the impaired loans based on collateraland other objective and quantifiable evidence;

·                  determination ofhomogenous pools by loan category and eliminating the impaired loans;

·                  application ofhistorical loss percentages (five-year average) to pools to determine theallowance allocation; and

·                  application ofqualitative factor adjustment percentages to historical losses for trends orchanges in the loan portfolio.

 

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

 

Each quarter, managementperforms an assessment of the allowance and the provision for loan losses.  The Company’s Special Assets Committee meetsquarterly and the applicable lenders discuss each relationship under review andreach a consensus on the appropriate estimated loss amount based on Statementof Financial Accounting Standards No. 114,

 

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“Accounting by Creditorsfor Impairment of a Loan,” (SFAS 114). The Special Assets Committee’s focus is on ensuring the pertinent factsare considered and the SFAS 114 reserve amounts are reasonable.  The assessment process includes the review ofall loans on a non-accruing basis as well as a review of certain loans to whichthe lenders or the Company’s Credit Administration function have assigned acriticized or classified risk rating.

 

Net charge-offs for thequarter ended March 31, 2009, were $73,000, compared to $445,000 in thefirst quarter of 2008.  Consumer loancharge-offs declined to $60,000 at March 31, 2009 versus $94,000 at March 31,2008.  Commercial loan net charge-offswere $10,000 for the quarter end March 31, 2009 compared to $320,000 inthe same quarter of 2008.  Mortgage loansshowed net charge-offs of $3,000 in the March 31, 2009 quarter compared to$32,000 in the like quarter of 2008.  Fora discussion on the provision for loan losses, see the “Provision for loanlosses,” located in the results of operations section of management’sdiscussion and analysis contained herein.

 

Managementbelieves that the current balance in the allowance for loan losses of$5,098,000 is sufficient to withstand the identified potential credit qualityissues that may arise and others unidentified but are inherent to theportfolio.  At March 31, 2009,management was unaware of any potential problem loans that have not beenreviewed.  Potential problem loans arethose where there is known information that leads management to believerepayment of principal and/or interest is in jeopardy and the loans are currentlyneither on non-accrual status or past due 90 days or more.  However, there could be certain instanceswhich become identified over the upcoming year that may require additionalcharge-offs and/or increases to the allowance. The ratio of allowance for loan losses to total loans was 1.20% at March 31,2009 compared to 1.10% at March 31, 2008.

 

The followingtables set forth the activity in the allowance for loan losses and certain keyratios for the period indicated:

 
| ** **                       | ** ** | **As of and for the**   | ** **  | **As of and for the**      | ** ** | **As of and for the**   | ** ** |
|----------------------------------|------------|-------------------------|-------------|----------------------------|------------|-------------------------|------------|
| ** **                       | ** ** | **three months ended**  | ** **  | **twelve months ended**    | ** ** | **three months ended**  | ** ** |
| ** **                       | ** ** | **March 31, 2009** | ** **  | **December 31, 2008** | ** ** | **March 31, 2008** | ** ** |
|                             |       |                    |        |                       |       |                    |       |
| Balance at  beginning of period  |       | $                       | 4,745,234   |                       | $          | 4,824,401               |       | $ | 4,824,401 |   |
|                             |       |                    |        |                       |       |                    |       |
| Provision  charged to operations |       | 425,000                 |        | 940,000                    |       | —                  |       |
|                             |       |                    |        |                       |       |                    |       |
| Charge-offs:                     |       |                    |        |                       |       |                    |       |
| Commercial                       |       | 17,118                  |        | 733,214                    |       | 378,107                 |       |
| Real estate                      |       | 3,157                   |        | 44,800                     |       | 31,871                  |       |
| Consumer                         |       | 63,728                  |        | 350,856                    |       | 109,127                 |       |
| Total                            |       | 84,003                  |        | 1,128,870                  |       | 519,105                 |       |
|                             |       |                    |        |                       |       |                    |       |
| Recoveries:                      |       |                    |        |                       |       |                    |       |
| Commercial                       |       | 7,587                   |        | 79,253                     |       | 58,463                  |       |
| Real estate                      |       | —                  |        | 97                         |       | 30                      |       |
| Consumer                         |       | 3,823                   |        | 30,353                     |       | 15,135                  |       |
| Total                            |       | 11,410                  |        | 109,703                    |       | 73,628                  |       |
|                             |       |                    |        |                       |       |                    |       |
| Net charge-offs                  |       | 72,593                  |        | 1,019,167                  |       | 445,477                 |       |
|                             |       |                    |        |                       |       |                    |       |
| Balance at end  of period        |       | $                       | 5,097,641   |                       | $          | 4,745,234               |       | $ | 4,378,924 |   |
|                             |       |                    |        |                       |       |                    |       |
| Total loans, end  of period      |       | $                       | 426,269,981 |                       | $          | 441,036,694             |       | $ | 399,582,768 |   |

 

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| ** **                                                                | ** ** | **As of and for the** | ** ** | **As of and for the** | ** ** | **As of and for the** | ** ** |
|---------------------------------------------------------------------------|------------|-------------------------------------------|------------|-------------------------------------------|------------|-------------------------------------------|------------|
| ** **                                                                | ** ** | **three months ended**          | ** ** | **twelve months ended**         | ** ** | **three months ended**          | ** ** |
| ** **                                                                | ** ** | **March 31, 2009**              | ** ** | **December 31, 2008**           | ** ** | **March 31, 2008**              | ** ** |
| Net charge-offs  to:                                                      |       |                                      |       |                                      |       |                                      |       |
| Loans, end of  period                                                     |       | 0.02                                      | %          | 0.23                                      | %          | 0.11                                      | %          |
| Allowance for  loan losses                                                |       | 1.42                                      | %          | 21.48                                     | %          | 10.17                                     | %          |
| Provision for  loan losses                                                |       | 0.17                                      | x          | 1.08                                      | x          | —                                    |       |
|                                                                      |       |                                      |       |                                      |       |                                      |       |
| Allowance for  loan losses to:                                            |       |                                      |       |                                      |       |                                      |       |
| Total loans                                                               |       | 1.20                                      | %          | 1.08                                      | %          | 1.10                                      | %          |
| Non-accrual  loans                                                        |       | 0.70                                      | x          | 1.36                                      | x          | 0.97                                      | x          |
| Non-performing  loans                                                     |       | 0.67                                      | x          | 1.16                                      | x          | 0.91                                      | x          |
| Net charge-offs                                                           |       | 70.22                                     | x          | 4.66                                      | x          | 9.83                                      | x          |
|                                                                      |       |                                      |       |                                      |       |                                      |       |
| Loans 30-89 days  past due and still accruing                             |       | $                                         | 3,911,373  |                                      | $          | 1,858,481                                 |       | $ | 3,582,873 |   |
| Loans 90 days  past due and accruing                                      |       | $                                         | 341,404    |                                      | $          | 604,140                                   |       | $ | 336,627 |   |
| Non-accrual  loans                                                        |       | $                                         | 7,236,780  |                                      | $          | 3,493,169                                 |       | $ | 4,498,424 |   |
| Allowance for  loan losses to loans 90 days or more past due and accruing |       | 14.93                                     | x          | 7.85                                      | x          | 13.01                                     | x          |

 

*Non-performing assets*

 

The Company definesnon-performing assets as accruing loans past due 90 days or more, non-accrualloans, restructured loans, other real estate owned (ORE) and repossessedassets.  As of March 31, 2009,non-performing assets represented 1.56% of total assets compared to 0.84% at March 31,2008.  The increase was driven by thehigher level of non-accruing loans and ORE at March 31, 2009.

 

In the review of loansfor both delinquency and collateral sufficiency, management concluded thatthere were a number of loans that lacked the ability to repay in accordancewith contractual terms.  The decision toplace loans or leases on a non-accrual status is made on an individual basisafter considering factors pertaining to each specific loan.

 

The majority of thenon-performing assets for the period are attributed to non-accruing commercialbusiness loans, non-accruing real estate loans and ORE.  Most of the loans are collateralized, therebymitigating the Company’s potential for loss. At March 31, 2009 non-performing loans were $7,578,000 compared to$4,097,000 at December 31, 2008. During the quarter ended March 31, 2009, the Company was notifiedby a customer of a significant adverse business event causing management toplace the customer’s $3,300,000 loan relationship on non-accrual status.  Management does not expect this will have amaterial impact on income going forward. Specific action plans for the resolution of each of the Company’snon-performing loans have been developed and are periodically updated asneeded.  There were no restructured loansor repossessed assets at March 31, 2009 or at December 31, 2008.  ORE at March 31, 2009 consisted of fiveproperties of which one had an agreement to sell pending.  At March 31, 2009, the non-accrual loansaggregated $7,237,000 as compared to $3,493,000 at December 31, 2008.  During the quarter loans totalingapproximately $4,269,000 were placed in non-accrual status.  These were partially offset by reductions orpayoffs of $258,000, charge-offs of $66,000, $132,000 of transfers to ORE and$69,000 of loans that returned to performing status.  Loans past due 90 days or more and accruingtotaled $341,000 at March 31, 2009 and were $604,000, at December 31,2008.  The percentage of non-performingassets to total assets was 1.56% at March 31, 2009, an increase from 0.96%at December 31, 2008, primarily due to the aforementioned non-accrualloans increase.  Non-performing loans tonet loans were 1.80% at March 31, 2009, and 0.94% at December 31,2008.  The 30-89 day past due loans at March 31,2009 were $3,911,000 and $1,858,000 at December 31, 2008.

 

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

 
| ** **                                                                         | ** ** | **March 31, 2009** | ** **  | **December 31, 2008** | ** ** | **March 31, 2008** | ** ** |
|------------------------------------------------------------------------------------|------------|-------------------------|-------------|----------------------------|------------|-------------------------|------------|
|                                                                               |       |                    |        |                       |       |                    |       |
| Loans past due  90 days or more and accruing                                       |       | $                       | 341,404     |                       | $          | 604,140                 |       | $ | 336,627 |   |
| Non-accrual  loans                                                                 |       | 7,236,780               |        | 3,493,169                  |       | 4,498,424               |       |
| Total  non-performing loans                                                        |       | 7,578,184               |        | 4,097,309                  |       | 4,835,051               |       |
|                                                                               |       |                    |        |                       |       |                    |       |
| Other real  estate owned                                                           |       | 1,236,716               |        | 1,450,507                  |       | 167,036                 |       |
| Total  non-performin1g assets                                                      |       | $                       | 8,814,900   |                       | $          | 5,547,816               |       | $ | 5,002,087 |   |
|                                                                               |       |                    |        |                       |       |                    |       |
| Net loans  including AFS                                                           |       | $                       | 421,172,340 |                       | $          | 436,291,460             |       | $ | 395,203,844 |   |
| Total assets                                                                       |       | $                       | 566,785,573 |                       | $          | 575,718,997             |       | $ | 593,876,533 |   |
| Non-accrual  loans to net loans                                                    |       | 1.72                    | %           | 0.80                       | %          | 1.14                    | %          |
| Non-performing  assets to net loans, foreclosed real estate and repossessed assets |       | 2.09                    | %           | 1.27                       | %          | 1.27                    | %          |
| Non-performing  assets to total assets                                             |       | 1.56                    | %           | 0.96                       | %          | 0.84                    | %          |
| Non-performing  loans to net loans                                                 |       | 1.80                    | %           | 0.94                       | %          | 1.22                    | %          |

 

*Foreclosed**assets held-for-sale*

 

Foreclosed assetsheld-for-sale, consisting of ORE, was $1,237,000 at March 31, 2009consisting of five properties, one of which was under an agreement to besold.  The remaining four properties arelisted for sale with a realtor.

 

At March 31, 2009,foreclosed assets held-for-sale was comprised of two ORE properties amountingto $1,429,000, which have been listed for sale with a local realtor.

 

*Other assets*

 

An increase in theCompany’s deferred tax asset, due to further decline in the fair value itssecurities portfolio, and pending securities purchases caused other assets toincrease $3,779,000, or 42%, during the first three months of 2009.

 

*Deposits*

 

The Bank is acommunity-based commercial financial institution, member FDIC, which offers avariety of deposit accounts with varying ranges of interest rates andterms.  Deposit products include savingsaccounts, interest-bearing checking (NOW), money market, non-interest bearingchecking (DDAs) and certificates of deposit accounts.  Certificates of deposit accounts, or CDs, aredeposits with stated maturities ranging from seven days to ten years.  The flow of deposits is significantlyinfluenced by general economic conditions, changes in prevailing interestrates, pricing and competition.  Most ofthe Company’s deposits are obtained from the communities surrounding its 12branch offices and are insured by the FDIC up to the full extent permitted bylaw.  The Bank attempts to attract andretain deposit customers via sales and marketing efforts, new products, qualityservice, competitive rates and maintaining long-standing customerrelationships.  To determine depositproduct interest rates, the Company considers local competition, market yieldsand the rates charged for alternative sources of funding such asborrowings.  Though we continue toexperience intense competition for deposits, our rate-setting strategy includesconsideration of liquidity needs, balance sheet structure and cost effectivestrategies that are mindful of the current interest rate environment.

 

During the first quarterof 2009, the Company began to use the Certificate of Deposit Account RegistryService (CDARS) in order to obtain FDIC insurance protection for customers whohave large deposits that at times exceed the FDIC maximum amount of$250,000.  In the CDARS program, depositsare sold at varying terms and interest rates, are originated in our own marketplace and are placed with other financial institutions that are members in theCDARS network.  By placing these depositsin other participating institutions, the deposits of our customers are fullyinsured by the FDIC.  In return fordeposits we place with network institutions, we can receive from networkinstitutions deposits that are approximately equal in amount of what was placedfor our customers.  Deposits that wereceive, or reciprocal deposits, from other institutions are consideredbrokered deposits.  As of March 31,2009, CDARS represented $5,826,000, or 1%, of total deposits.

 

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Compared to December 31,2008 total deposits grew $30,842,000, or 7%, during the three months of March 31,2009.  The growth in total deposits wasdue to increases in NOW, money market and savings accounts $20,751,000, or 41%,$10,202,000, or 11%,  and $2,446,000, or6%, respectively, partially offset by lower CD balances.  The opening of the West Scranton branchduring the third quarter of 2008, related bank-wide money market promotions andseasonal activity with municipal customers all contributed to growth indeposits during the first quarter of 2009.

 

The following tablerepresents the components of deposits as of the date indicated (dollars inthousands):

 
| ** **               | ** ** | **March 31, 2009** | ** **  | **December 31, 2008** | ** ** |
|--------------------------|------------|-------------------------|-------------|----------------------------|------------|
| ** **               | ** ** | **Amount**              | ** **  | **%**                      | ** ** | **Amount** | ** ** | **%** | ** ** |
| Money market             |       | $                       | 106,939,788 |                       | 23.0       |   | $ | 96,738,006 |   | 22.3 |   |
| NOW                      |       | 70,875,172              |        | 15.3                       |       | 50,123,744 |   | 11.6 |   |
| Savings and club         |       | 43,772,986              |        | 9.4                        |       | 41,326,616 |   | 9.5 |   |
| Certificates of  deposit |       | 167,443,473             |        | 36.1                       |       | 173,680,915 |   | 40.1 |   |
| CDARS                    |       | 5,825,875               |        | 1.3                        |       | — |   | — |   |
| Total  interest-bearing  |       | 394,857,294             |        | 85.1                       |       | 361,869,281 |   | 83.5 |   |
| Non-interest-bearing     |       | 69,296,833              |        | 14.9                       |       | 71,442,651 |   | 16.5 |   |
| Total deposits           |       | $                       | 464,154,127 |                       | 100.0      |   | $ | 433,311,932 |   | 100.0 |   |

 

Certificates of depositof $100,000 or more aggregated $66,565,000 and $74,250,000 at March 31,2009 and December 31, 2008, respectively. Certificates of deposit of $250,000 or more aggregated $25,122,000 and$35,108,000 at March 31, 2009 and December 31, 2008.

 

Approximately 63% oftotal CDs are scheduled to mature in 2009. Renewing CDs may re-price to market rates depending on the direction ofinterest rate movements, the shape of the yield curve, competition, the rate profileof the maturing accounts and depositor preference for alternativeproducts.  To help reduce the financialimpact of the unpredictable and highly volatile interest rate environment,management will deploy prudent strategies that will diversify the deposit mixacross the entire spectrum of products offered. Although we continue to experience intense competition for deposits, wehave not adjusted rates above market levels as we consider cost effectivestrategies as well as relationship retention and development when settinginterest rates on deposit accounts.

 

*Borrowings*

 

Borrowings areused as a complement to deposit generation as an alternative funding sourcewhereby the Bank will borrow under customer repurchase agreements in the localmarket, advances from the Federal Home Loan Bank of Pittsburgh (FHLB) and othercorrespondent banks for asset growth and liquidity needs.  Repurchase agreements are non-insuredinterest-bearing liabilities that have a security interest in qualifiedinvestment securities of the Bank and are offered in both sweep and fixed-termproducts.  A sweep account is designed toensure that, on a daily basis, an attached DDA is adequately funded and excessDDA funds are transferred, or swept, into an overnight interest-bearing repurchaseagreement account.  The balance incustomer repurchase agreement accounts can fluctuate daily because the dailysweep product is dependent on the level of available funds in depositoraccounts.  In addition, short-termborrowings may include overnight balances which the Bank may require to funddaily liquidity needs.  Overnightbalances and repurchase agreements are components of short-term borrowings andFHLB advances are components of long-term debt on the consolidated balancesheets.

 

The following tablerepresents the components of borrowings as of March 31, 2009 and December 31,2008 (dollars in thousands):

 
| ** **                  | ** ** | **March 31, 2009** | ** ** | **December 31, 2008** | ** ** |
|-----------------------------|------------|-------------------------|------------|----------------------------|------------|
| ** **                  | ** ** | **Amount**              | ** ** | **%**                      | ** ** | **Amount** | ** ** | **%** | ** ** |
| Overnight  borrowings       |       | $                       | —     |                       | —     |   | $ | 25,668 |   | 28.5 |   |
| Repurchase  agreements      |       | 10,131                  |       | 19.2                       |       | 11,412 |   | 12.6 |   |
| Demand note,  U.S. Treasury |       | 611                     |       | 1.2                        |       | 1,050 |   | 1.2 |   |
| FHLB advances               |       | 42,000                  |       | 79.6                       |       | 52,000 |   | 57.7 |   |
| Total borrowings            |       | $                       | 52,742     |                       | 100.0      |   | $ | 90,130 |   | 100.0 |   |

 

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Borrowings havedecreased $37,388,000, or 41%, during the three months ended March 31,2009.  Overnight borrowings and FHLBadvances have declined as a result of the Company’s balance sheet de-leveragingand deposit generation.  The reduction inrepurchase agreements was caused by a combination of pricing and the volatilenature of the sweep product.

 

*Accrued interest payable andother liabilities*

 

The $1,111,000, or34% increase is from securities purchase commitments that settled in April 2009.

 

**Item 3. Quantitative and Qualitative Disclosure About Market Risk**

 

*Management of interest rate riskand market risk analysis*

 

The Company is subject tothe interest rate risks inherent in its lending, investing and financingactivities.  Fluctuations of interestrates will impact interest income and interest expense along with affectingmarket values of all interest-earning assets and interest-bearing liabilities,except for those assets or liabilities with a short term remaining to maturity.  Interest rate risk management is an integralpart of the asset/liability management process. The Company has instituted certain procedures and policy guidelines tomanage the interest rate risk position. Those internal policies enable the Company to react to changes in marketrates to protect net interest income from significant fluctuations.  The primary objective in managing interestrate risk is to minimize the adverse impact of changes in interest rates on netinterest income along with creating an asset/liability structure that maximizesearnings.

 

*Asset/LiabilityManagement*.  One majorobjective of the Company when managing the rate sensitivity of its assets andliabilities is to stabilize net interest income.  The management of and authority to assumeinterest rate risk is the responsibility of the Company’s Asset/LiabilityCommittee (ALCO), which is comprised of senior management and members of theboard of directors.  ALCO meets quarterlyto monitor the relationship of interest sensitive assets to interest sensitiveliabilities.  The process to reviewinterest rate risk is a regular part of managing the Company.  Consistent policies and practices ofmeasuring and reporting interest rate risk exposure, particularly regarding thetreatment of non-contractual assets and liabilities, are in effect.  In addition, there is an annual process toreview the interest rate risk policy with the board of directors which includeslimits on the impact to earnings from shifts in interest rates.

 

*InterestRate Risk Measurement.* Interest rate risk is monitored through theuse of three complementary measures: static gap analysis, earnings at risksimulation and economic value at risk simulation.  While each of the interest rate riskmeasurements has limitations, taken together they represent a reasonablycomprehensive view of the magnitude of interest rate risk in the Company andthe distribution of risk along the yield curve, the level of risk through timeand the amount of exposure to changes in certain interest rate relationships.

 

*Static Gap*.  The ratio between assets and liabilitiesre-pricing in specific time intervals is referred to as an interest ratesensitivity gap.  Interest ratesensitivity gaps can be managed to take advantage of the slope of the yieldcurve as well as forecasted changes in the level of interest rate changes.

 

To manage this interestrate sensitivity gap position, an asset/liability model commonly known ascumulative gap analysis is used to monitor the difference in the volume of theCompany’s interest sensitive assets and liabilities that mature or re-pricewithin given time intervals.  A positivegap (asset sensitive) indicates that more assets will mature or re-price duringa given period compared to liabilities, while a negative gap (liabilitysensitive) has the opposite effect.  TheCompany employs computerized net interest income simulation modeling to assistin quantifying interest rate risk exposure. This process measures and quantifies the impact on net interest incomethrough varying interest rate changes and balance sheet compositions.  The use of this model assists the ALCO togauge the effects of the interest rate changes on interest-sensitive assets andliabilities in order to determine what impact these rate changes will have uponthe net interest spread.  At March 31,2009 the Bank maintained a one-year cumulative gap of positive $30.5 million,or 5.4%, of total assets.  The effect ofthis positive gap position provided a mismatch of assets and liabilities whichmay expose the Bank to interest rate risk during periods of falling interestrates.  Conversely, in an increasinginterest rate environment, net interest income could be positively impactedbecause more assets than liabilities would re-price upward during the one-yearperiod.

 

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

 

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The following table illustrates the Company’s interestsensitivity gap position at March 31, 2009 (dollars in thousands):

 
| ** **                                     | ** ** | **Three months** | ** ** | **Three to**      | ** ** | **One to**      | ** ** | **Over**        | ** ** | ** ** | ** ** |
|------------------------------------------------|------------|------------------|------------|-------------------|------------|-----------------|------------|-----------------|------------|------------|------------|
| ** **                                     | ** ** | **or less**      | ** ** | **twelve months** | ** ** | **three years** | ** ** | **three years** | ** ** | **Total**  | ** ** |
| Cash and cash  equivalents                     |       | $                | 11,350     |              | $          | —          |       | $               | —     |       | $          | 9,451 |   | $ | 20,801 |   |
| Investment  securities (1)(2)                  |       | 59,338           |       | 7,973             |       | 8,324           |       | 8,096           |       | 83,731     |       |
| Loans (2)                                      |       | 114,868          |       | 68,114            |       | 107,571         |       | 130,619         |       | 421,172    |       |
| Fixed and other  assets                        |       | —           |       | 8,887             |       | —          |       | 32,195          |       | 41,082     |       |
| Total assets                                   |       | $                | 185,556    |              | $          | 84,974          |       | $               | 115,895    |       | $          | 180,361 |   | $ | 566,786 |   |
| Total cumulative  assets                       |       | $                | 185,556    |              | $          | 270,530         |       | $               | 386,425    |       | $          | 566,786 |   |   |   |
|                                           |       |             |       |              |       |            |       |            |       |       |       |
| Non-interest  bearing transaction deposits (3) |       | $                | —     |              | $          | 6,929           |       | $               | 19,057     |       | $          | 43,311 |   | $ | 69,297 |   |
| Interest-bearing  transaction deposits (3)     |       | 78,703           |       | —            |       | 54,316          |       | 88,568          |       | 221,587    |       |
| Time deposits                                  |       | 25,223           |       | 118,468           |       | 22,724          |       | 6,855           |       | 173,270    |       |
| Repurchase  agreements                         |       | 10,131           |       | —            |       | —          |       | —          |       | 10,131     |       |
| Short-term  borrowings                         |       | 611              |       | —            |       | —          |       | —          |       | 611        |       |
| Long-term debt                                 |       | —           |       | —            |       | 21,000          |       | 21,000          |       | 42,000     |       |
| Other  liabilities                             |       | —           |       | —            |       | —          |       | 4,428           |       | 4,428      |       |
| Total  liabilities                             |       | $                | 114,668    |              | $          | 125,397         |       | $               | 117,097    |       | $          | 164,162 |   | $ | 521,324 |   |
| Total cumulative  liabilities                  |       | $                | 114,668    |              | $          | 240,065         |       | $               | 357,162    |       | $          | 521,324 |   |   |   |
|                                           |       |             |       |              |       |            |       |            |       |       |       |
| Interest  sensitivity gap                      |       | $                | 70,888     |              | $          | (40,423         | )          | $               | (1,202     | )          | $          | 16,199 |   |   |   |
|                                           |       |             |       |              |       |            |       |            |       |       |       |
| Cumulative gap                                 |       | $                | 70,888     |              | $          | 30,465          |       | $               | 29,263     |       | $          | 45,462 |   |   |   |
|                                           |       |             |       |              |       |            |       |            |       |       |       |
| Cumulative gap  to total assets                |       | 12.51            | %          | 5.38              | %          | 5.16            | %          | 8.02            | %          |       |       |

 

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(1)  Includes FHLB stockand the net unrealized gains/losses on securities AFS.

 

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

 

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

 

*Earnings at Risk and EconomicValue at Risk Simulations*. The Company recognizes that more sophisticated tools exist for measuringthe interest rate risk in the balance sheet that extend beyond staticre-pricing gap analysis.  Although itwill continue to measure its re-pricing gap position, the Company utilizesadditional modeling for identifying and measuring the interest rate risk in theoverall balance sheet.  The ALCO isresponsible for focusing on “earnings at risk” and “economic value at risk”,and how both relate to the risk-based capital position when analyzing theinterest rate risk.

 

*Earnings at Risk*.  Earnings at risk simulation measures thechange in net interest income and net income should interest rates rise andfall.  The simulation recognizes that notall assets and liabilities re-price one-for-one with market rates (e.g.,savings rate).  The ALCO looks at “earningsat risk” to determine income changes from a base case scenario under anincrease and decrease of 200 basis points in interest rate simulation models.

 

*EconomicValue at Risk.* Earnings at risk simulation measures theshort-term risk in the balance sheet. Economic value (or portfolio equity) at risk measures the long-term riskby finding the net present value of the future cash flows from the Company’sexisting assets and liabilities.  TheALCO examines this ratio quarterly utilizing an increase and decrease of 200basis points in interest rate simulation models.  The ALCO recognizes that, in some instances,this ratio may contradict the “earnings at risk” ratio.

 

The following table illustrates the simulated impact of 200 basispoints upward or downward movement in interest rates on net interest income,net income and the change in the economic value (portfolio equity).  This analysis assumes that interest-earning

 

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asset and interest-bearing liability levels at March 31, 2009remain constant.  The impact of the ratemovements was developed by simulating the effect of rates changing over atwelve-month period from the March 31, 2009 levels:

 
| ** **                                           | ** ** | **Rates +200** | ** ** | **Rates -200** | ** ** |
|------------------------------------------------------|------------|----------------|------------|----------------|------------|
| Earnings at  risk:                                   |       |           |       |           |       |
| Percent change  in:                                  |       |           |       |           |       |
| Net interest  income                                 |       | 2.4            | %          | 3.8            | %          |
| Net income                                           |       | 12.9           |       | 17.8           |       |
|                                                 |       |           |       |           |       |
| Economic value  at risk:                             |       |           |       |           |       |
| Percent change  in:                                  |       |           |       |           |       |
| Economic value  of equity                            |       | (27.8          | )          | (4.5           | )          |
| Economic value  of equity asa percent of book assets |       | (2.2           | )          | (0.4           | )          |

 

Economic value has themost meaning when viewed within the context of risk-based capital.  Therefore, the economic value may normallychange beyond the Company’s policy guideline for a short period of time as longas the risk-based capital ratio (after adjusting for the excess equityexposure) is greater than 10%.  At March 31,2009, the Company’s risk-based capital ratio was 11.6%.

 

The table belowsummarizes estimated changes in net interest income over a twelve-month periodbeginning April 1, 2009 under alternate interest rate scenarios using theincome simulation model described above (dollars in thousands):

 

| ** **                   | ** ** | **Net interest** | ** ** | **$**        | ** ** | **%**        | ** ** |
|------------------------------|------------|------------------|------------|--------------|------------|--------------|------------|
| **Change in interest rates** | ** ** | **income**       | ** ** | **variance** | ** ** | **variance** | ** ** |
|                         |       |             |       |         |       |         |       |
| +200 basis  points           |       | $                | 19,515     |         | $          | 458          |       | 2.4 | % |
| +100 basis  points           |       | 19,439           |       | 382          |       | 2.0          |       |
|   Flat  rate       |       | 19,057           |       | —       |       | —       |       |
| -100 basis  points           |       | 19,500           |       | 443          |       | 2.3          |       |
| -200 basis  points           |       | 19,777           |       | 720          |       | 3.8          |       |
|                              |            |                  |            |              |            |              |            |  |  |

 

Simulation models requireassumptions about certain categories of assets and liabilities.  The models schedule existing assets andliabilities by their contractual maturity, estimated likely call date or earliestre-pricing opportunity.  Mortgage-backedsecurities and amortizing loans are scheduled based on their anticipated cashflow including estimated prepayments. For investment securities, the Bank uses a third-party service toprovide cash flow estimates in the various rate environments.  Savings, money market and NOW accounts do nothave a stated maturity or re-pricing term and can be withdrawn or re-priced atany time.  This may impact the margin ifmore expensive alternative sources of deposits are required to fund loans ordeposit runoff.  Management projects there-pricing characteristics of these accounts based on historical performanceand assumptions that it believes reflect their rate sensitivity.  The model reinvests all maturities,repayments and prepayments for each type of asset or liability into the sameproduct for a new like term at current product interest rates provided bymanagement.  As a result, the mix ofinterest-earning assets and interest bearing-liabilities is held constant.

 

*Derivative FinancialInstruments. *As partof the Bank’s overall interest rate risk strategy, the Company has adopted apolicy whereby the Company may periodically use derivative instruments tominimize significant fluctuations in earnings caused by interest ratevolatility.  This interest rate riskmanagement strategy entails the use of interest rate floors, caps andswaps.  In October 2006, the Bankentered into an interest rate floor derivative agreement on $20,000,000notional value of its prime-based loan portfolio.  The purpose of the hedge is to help protectthe Bank’s interest income in the event interest rates decline below apre-determined contractual interest rate. The strategy is reflected in the scenarios for earnings and economicvalue at risk and the net interest income in the two immediately precedingtables.  For a further discussion on theBank’s derivative contract, see Note No. 4, “Derivative instruments,”contained within the notes to consolidated financial statements in Part I,Item 1.

 

*Liquidity*

 

Liquidity managementensures that adequate funds will be available to meet loan and investmentcommitments, deposit withdrawals and maturities and normal operatingrequirements of the Bank.  Currentsources of liquidity are cash and cash

 

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equivalents, assetmaturities, calls and principal repayments, loans and investments AFS, growthof core deposits, growth of repurchase agreements, increases in other borrowedfunds from correspondent banks and issuance of capital stock.  Although regularly scheduled investment andloan payments are dependable sources of daily funds, the sales of both loansand investments AFS, deposit activity and investment and loan prepayments aresignificantly influenced by general economic conditions and the level ofinterest rates.  During declininginterest rate environments, prepayments from interest-sensitive assets tend toaccelerate and provide significant liquidity which can be used to invest inother interest-earning assets but at lower market rates.  Conversely, in a period of rising interestrates, prepayment from interest-sensitive assets tend to decelerate causingcash flow from mortgage loans and mortgage-backed securities portfolio todecrease.  Deposit inflow may accelerateand be invested at higher market interest rates.  The Company closely monitors activity in thecapital markets and takes appropriate action to ensure that the liquiditylevels are adequate for funding, investing and operating activities.

 

For the three months ended March 31, 2009, the Company generatedapproximately $8.0 million of cash. During this period, the Company’s operations provided approximately $11.3million primarily from the sales of mortgages AFS net of originations and theinvesting activities provided approximately $3.6 million from pay-downs ofloans and from the sale of foreclosed properties held-for-sale.  Partially offsetting these cash generatorswas a use of $6.9 million in financing activities, mostly from the pay-down oftotal borrowings net of deposit growth. As of March 31, 2009, the Company maintained $20,801,000 in cashand cash equivalents, $78,068,000 of investments AFS and $675,000 of loansAFS.  In addition, as of March 31,2009 the Company had approximately $170,259,000 available to borrow from theFHLB and $30,000,000 available from other correspondent banks.  This combined total of $299,803,000represented 53% of total assets at March 31, 2009.  Management believes this level of liquidityto be strong and adequate to support current operations.

 

In October 2008, the FDIC announced the Temporary LiquidityGuarantee Program (TLGP) to strengthen confidence and encourage liquidity inthe banking system.  Among other things,this new program will provide full deposit insurance coverage for non-interestbearing deposit transaction accounts in FDIC-insured institutions regardless ofthe dollar amount.  To protect itsdepositors, the Company is participating in the TLGP.  Under the TLGP, all depositors who hold fundsin non-interest bearing accounts, or interest-bearing accounts with an interestrate of 0.50% or less, including the Lawyers Trust Accounts, will have atemporary unlimited guarantee from the FDIC until December 31, 2009.  The coverage of the TLGP is in addition toand separate from coverage available under the FDIC’s general deposit insurancerules, which insures accounts up to $250,000 until the end of 2009 unlessextended.

 

*Capital*

 

During the three monthsended March 31, 2009, shareholders’ equity decreased $3,499,000, or 7%,due principally from increased unrealized net losses in the securities AFSportfolio and the declaration of cash dividends.  Conversely, shareholders’ equity was enhancedby current year earnings and by stock issued from the Company’s Employee StockPurchase and Dividend Reinvestment Plans.

 

At March 31, 2009,the Company reported a net unrealized loss of $12,673,000, net of tax effect,from the securities AFS portfolio compared to a net unrealized loss of$8,831,000 as of December 31, 2008. The increase in the unrealized loss during the first quarter of 2009 wascaused by the prolonged economic downturn which has created uncertainty and incertain circumstances illiquidity in the financial and capital markets and hashad a sizable negative impact on the fair value estimates for securities inbanks’ investment portfolios.  Managementbelieves these changes are due mainly to liquidity problems in the financialmarkets and to a lesser extent the deterioration in the creditworthiness of theissuers.  For a further discussion on thefair value determination of the Company’s investment portfolio, see “Investments”under the caption “Comparison of financial condition at March 31, 2009 andDecember 31, 2008” of Part 1, Item 2, “Management’s Discussion andAnalysis of Financial Condition and Results of Operations;” and Note 5, “FairValue Measurements,” contained within the notes to the consolidated financial statements,and incorporated by reference in Part I, Item 1.

 

During the second quarterof 2008, the Company’s Board of Directors announced its intent to initiate acapital stock repurchase program covering up to 50,000 shares of itsoutstanding capital stock.  Therepurchased shares would become treasury stock and could be available forissuance under the Company’s various stock-based compensation, employee stockpurchase and dividend reinvestment (DRP) plans and for general corporatepurposes.  The repurchases will be madefrom time-to-time in open-market transactions, subject to availability,pursuant to safe harbor rule 10b-18 under the Securities Exchange Act of1934.  Management has temporarilysuspended repurchase plan activity as a prudent means, in light of the currenteconomic pressures on banking, to preserve and grow the Company’s capitalbase.  Currently, since the program’sinception, the Company has reacquired 4,798 shares, net of reissued shares toparticipants in the Company’s DRP, at a weighted-average cost of $27.66 pershare.  For a further discussion on thisprogram, see I**t**em 2, “Unregistered Sales ofEquity Securities and Use of Proceeds” included in Part II, “OtherInformation,” below.

 

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In October 2008, the U.S. Department of Treasury(Treasury), the Board of Governors of the Federal Reserve System (FRB) and theFDIC issued a joint statement announcing a voluntary capital purchase programwhere the Treasury will purchase senior preferred stock of certain financialinstitutions.  The Treasury had allocated$250 billion under the Troubled Asset Relief Program (TARP) created under theEconomic Stabilization Act of 2008 (ESSA) to purchase senior preferred stock inbanks through the Capital Purchase Program. The Company received preliminary approval from the U.S. TreasuryDepartment to participate in the TARP; however because of the Company’s strongcapital position as of December 31, 2008, the Company has decided not toparticipate as the effect of accepting the program was determined to not be inthe best interest of the Company’s shareholders.

 

The Company (on aconsolidated basis) and the Bank are subject to various regulatory capitalrequirements administered by the federal banking agencies.  Failure to meet minimum capital requirementscan initiate certain mandatory and possible additional discretionary actions byregulators that, if undertaken, could have a direct material effect on theCompany’s and the Bank’s financial statements. Under capital adequacy guidelines and the regulatory framework forprompt corrective action, the Company and the Bank must meet specific capitalguidelines that involve quantitative measures of their assets, liabilities andcertain off-balance-sheet items as calculated under regulatory accountingpractices.  The capital amounts andclassification are also subject to qualitative judgments by the regulatorsabout components, risk-weightings and other factors.  Prompt corrective action provisions are notapplicable to bank holding companies.

 

Under these guidelines, assets and certain off-balancesheet items are assigned to broad risk categories, each with appropriate weights.  The resulting capital ratios representcapital as a percentage of total risk-weighted assets and certain off-balancesheet items.  The appropriaterisk-weighting, pursuant to regulatory guidelines, required an increase in therisk-weighting of securities that were recently rated below investment grade,thus significantly inflating the total risk-weighted assets.  Compared to the previous quarter, the totalcapital and Tier I capital ratios were reduced by the increase in risk-weightedassets.  The guidelines require all banksand bank holding companies to maintain a minimum ratio of total risk-basedcapital to total risk-weighted assets (Total Risk Adjusted Capital) of 8%,including Tier I capital to total risk-weighted assets (Tier I Capital) of 4% andTier I capital to average total assets (Leverage Ratio) of at least 4%.  As of March 31, 2009, the Company andthe Bank met all capital adequacy requirements to which it was subject.

 

The following table depicts the capital amounts andratios of the Company and the Bank as of March 31, 2009:

 
| ** **                 | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** **            | ** ** | ** ** | ** **                  | ** ** | ** ** | **To be well capitalized** | ** ** |
|----------------------------|------------|------------|------------|------------|------------|------------|-----------------------|------------|------------|-----------------------------|------------|------------|----------------------------|------------|
| ** **                 | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | **For capital**       | ** ** | ** ** | **under prompt corrective** | ** ** |
| ** **                 | ** ** | **Actual** | ** ** | ** ** | ** ** | ** ** | **adequacy purposes** | ** ** | ** ** | **action provisions**       | ** ** |
| ** **                 | ** ** | **Amount** | ** ** | **Ratio**  | ** ** | ** ** | **Amount**            | ** ** | ** ** | **Ratio**                   | ** ** | ** ** | **Amount**                 | ** ** | ** ** | **Ratio** | ** ** |
| Total capital              |       |       |       |       |       |       |                  |       |       |                        |       |       |                       |       |   |   |   |
| (to  risk-weighted assets) |       |       |       |       |       |       |                  |       |       |                        |       |       |                       |       |   |   |   |
| Consolidated               |       | $          | 62,749,208 |       | 11.6       | %          | >             | $          | 43,364,576 |                        | >  | 8.0        | %                          |       | N/A |   |   | N/A |   |
| Bank                       |       | $          | 62,328,705 |       | 11.5       | %          | >             | $          | 43,355,088 |                        | >  | 8.0        | %                          | >  | $ | 54,193,860 |   | >  | 10.0 | % |
| Tier I capital             |       |       |       |       |       |       |                  |       |       |                        |       |       |                       |       |   |   |   |
| (to  risk-weighted assets) |       |       |       |       |       |       |                  |       |       |                        |       |       |                       |       |   |   |   |
| Consolidated               |       | $          | 57,610,480 |       | 10.6       | %          | >             | $          | 21,682,288 |                        | >  | 4.0        | %                          |       | N/A |   |   | N/A |   |
| Bank                       |       | $          | 57,230,944 |       | 10.6       | %          | >             | $          | 21,677,544 |                        | >  | 4.0        | %                          | >  | $ | 32,516,316 |   | >  | 6.0 | % |
| Tier I capital             |       |       |       |       |       |       |                  |       |       |                        |       |       |                       |       |   |   |   |
| (to average  assets)       |       |       |       |       |       |       |                  |       |       |                        |       |       |                       |       |   |   |   |
| Consolidated               |       | $          | 57,610,480 |       | 10.1       | %          | >             | $          | 22,885,472 |                        | >  | 4.0        | %                          |       | N/A |   |   | N/A |   |
| Bank                       |       | $          | 57,230,944 |       | 10.0       | %          | >             | $          | 22,869,891 |                        | >  | 4.0        | %                          | >  | $ | 28,587,364 |   | >  | 5.0 | % |

 

**Item 4T. Controls and Procedures**

 

As of the end of the period covered by this Quarterly Report on Form 10-Q, an evaluation was carried out by the Company’s management, with the participation of its Chief Executive Officer and Chief Financial Officer, of the effectiveness of the Company’s disclosure controls and procedures, as defined in Rule 13a-15(e) under the Securities Exchange Act of 1934.  Based on such evaluation, the Chief Executive Officer and Chief Financial Officer concluded that the Company’s disclosure controls and procedures are designed to ensure that information required to be disclosed in the reports the Company files or furnishes under the Securities Exchange Act of 1934 is recorded, processed, summarized and reported within the time periods specified in the SEC’s rules and regulations, and are operating in an effective manner.  The Company made no significant changes in its internal controls over financial reporting or in other factors that materially affected, or are reasonably likely to materially affect, these controls during the last fiscal quarter ended March 31, 2009.

 

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**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 theopinion of the Company, after consultation with legal counsel, no legalproceedings are pending, which, if determined adversely to the Company or theBank, would have a material effect on the Company’s undivided profits orfinancial condition.  No legalproceedings are pending other than ordinary routine litigation incidental tothe business of the Company and the Bank. In addition, to management’s knowledge, no governmental authorities haveinitiated or contemplated any material legal actions against the Company or theBank.

 

**Item 1A. Risk Factors**

 

Management of the Company doesnot believe there have been any material changes in risk factors that weredisclosed in the Form 10-K filed with the Securities and ExchangeCommission on March 12, 2009.

 

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

 

**(c)**   Thefollowing table summarizes the activity in the Company’s stock repurchaseprogram during the first quarter of 2009:

 
| ** **                                      | ** ** | **(a)**                  | ** ** | **(b)**                 | ** ** | **(c)**                      | ** ** | **(d)**                        | ** ** |
|-------------------------------------------------|------------|--------------------------|------------|-------------------------|------------|------------------------------|------------|--------------------------------|------------|
| ** **                                      | ** ** | ** **               | ** ** | ** **              | ** ** | **Total number of**          | ** ** | ** **                     | ** ** |
| ** **                                      | ** ** | ** **               | ** ** | ** **              | ** ** | **shares (or units)**        | ** ** | **Maximum number of**          | ** ** |
| ** **                                      | ** ** | **Total Number**         | ** ** | ** **              | ** ** | **purchased as part as**     | ** ** | **shares (or units) that may** | ** ** |
| ** **                                      | ** ** | **of shares (or units)** | ** ** | **Average price paid**  | ** ** | **publicly announced plans** | ** ** | **yet be purchased under the** | ** ** |
| **Period**                                      | ** ** | **purchased**            | ** ** | **per share (or unit)** | ** ** | **or programs**              | ** ** | **plans or programs**          | ** ** |
| January 1, 2009 to January 31, 2009   |       | —                   |       | $                       | —     |                         | —     |                           | 35,000     |   |
| February 1, 2009 to February 28, 2009 |       | 2,500                    |       | 22.60                   |       | 2,500                        |       | 32,500                         |       |
| March 1, 2009 to March 31, 2009       |       | —                   |       | —                  |       | —                       |       | 32,500                         |       |
| Total                                           |       | 2,500                    |       | $                       | 22.60      |                         | 2,500      |                           | 32,500     |   |

 

Inthe second quarter of 2008 the Company’s Board of Directors approved andpublicly announced its intent to initiate a capital stock repurchase programcovering up to 50,000 shares, or approximately 2.4% of its outstanding capitalstock as of May 31, 2008.  TheCompany has not made any purchases of its shares of capital that has not beenpublicly announced.  Neither anexpiration date nor a maximum dollar amount has been fixed to the program.  The repurchases will be made fromtime-to-time in open-market transactions, subject to availability.  The repurchased shares would become treasurystock and could be available for issuance under the Company’s variousstock-based compensation, employee stock purchase and dividend reinvestmentplans and for general corporate purposes. No repurchase program has expired or has been subject to a determinationto terminate during the period covered by the above table.  During the first quarter of 2009, 9,957shares were reissued to participants in the Company’s dividend reinvestmentplan at a re-issue price of $20.32 per share.

 

**Item 3. Default Upon Senior Securities**

None

 

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

None

 

**Item 5. Other Information**

None

 

**Item 6. Exhibits**

 

The followingexhibits are filed herewith or incorporated by reference as a part of this Form 10-Q:

 

32

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***3(i) Amendedand Restated Articles of Incorporation of Registrant.*** Incorporated by reference to Annex B of theProxy Statement/Prospectus included in Registrant’s Amendment 4 to itsRegistration Statement No. 333-90273 on Form S-4, filed with the SECon April 6, 2000.

 

***3(ii) Amendedand Restated Bylaws of Registrant.*** Incorporated by reference to Exhibit 3(ii) toRegistrant’s Form 8-K filed with the SEC on November 21, 2007.

 

****10.1 1998 Independent Directors Stock Option Plan of The FidelityDeposit and Discount Bank, as assumed by Registrant.*** Incorporated by reference to Exhibit 10.1to Registrant’s Registration Statement No. 333-90273 on Form S-4,filed with the SEC on November 3, 1999.

 

****10.21998 Stock Incentive Plan of The Fidelity Deposit and Discount Bank, as assumedby Registrant.*** Incorporated by reference to Exhibit 10.2of Registrant’s Registration Statement No. 333-90273 on Form S-4,filed with the SEC on November 3, 1999.

 

****10.3 Registrant’s 2000 Dividend Reinvestment Plan. ***Incorporated byreference to Exhibit 4 to Registrant’s Registration Statement No. 333-45668on Form S-1, filed with the SEC on September 12, 2000 and as amendedby Pre-Effective Amendment No. 1 on October 11, 2000, byPost-Effective Amendment No. 1 on May 30, 2001, by Post-EffectiveAmendment No. 2 on July 7, 2005 and by Registration Statement No.  333-152806on Form S-3 filed on August 6, 2008.

 

****10.4 Registrant’s 2000 Independent Directors Stock Option Plan. ***Incorporated byreference to Exhibit 4.3 to Registrant’s Registration Statement No. 333-64356on Form S-8 filed with the SEC on July 2, 2001.

 

****10.5 Amendment, dated October 2, 2007, to the Registrant’s 2000Independent Directors Stock Option Plan. ***Incorporated by reference to Exhibit 10.2to Registrant’s Form 8-K filed with the SEC on October 4, 2007.

 

****10.6 Registrant’s 2000 Stock Incentive Plan. ***Incorporated byreference to Exhibit 4.4 to Registrant’s Registration Statement No. 333-64356on Form S-8 filed with the SEC on July 2, 2001.

 

****10.7 Amendment, dated October 2, 2007, to the Registrant’s 2000Stock Incentive Plan. ***Incorporatedby reference to Exhibit 10.1 to Registrant’s Form 8-K filed with theSEC on October 4, 2007.

 

****10.8 Registrant’s 2002 Employee Stock Purchase Plan. ***Incorporated byreference to Exhibit 4.5 to Registrant’s Registration Statement No. 333-113339on Form S-8 filed with the SEC on March 5, 2004.

 

****10.9 Complete Settlement Agreement and General Release between MichaelF. Marranca, Registrant and The Fidelity Deposit and Discount Bank, dated July 30,2004***. Incorporated by reference to Exhibit 99.1 to Registrant’s CurrentReport on Form 8-K filed with the SEC on August 10, 2004.

 

****10.10 Amendment to the Complete Settlement Agreement and GeneralRelease between Michael F. Marranca, Registrant and The Fidelity Deposit andDiscount Bank, dated November 4, 2005*. **Incorporated by referenceto****Exhibit 99.1 to Registrant’sCurrent Report on Form 8-K filed with the SEC on November 9, 2005.

 

****10.11 Change of Control Agreements with Salvatore R. DeFrancesco,Registrant and The Fidelity Deposit and Discount Bank, dated March 21,2006. ***Incorporatedby reference to Exhibit 99.2 to Registrant’s Current Report on Form 8-Kfiled with the SEC on March 27, 2006.

 

****10.12 Amended and Restated Executive Employment Agreement betweenFidelity D & D Bancorp, Inc., The Fidelity Deposit and DiscountBank and Steven C. Ackmann, dated July 11, 2007.* **Incorporated by referenceto Exhibit 10.1 to Registrant’s Current Report on Form 8-K filed withthe SEC on July 13, 2007.

** **

****10.13 Executive Employment Agreement between Fidelity D & DBancorp, Inc., The Fidelity Deposit and Discount Bank******and Timothy P. O’Brien, dated January 3,2008. ***Incorporated byreference to Exhibit 10.1 to Registrant’s Current Report on Form 8-Kfiled with the SEC on January 10, 2008.

 

****10.14 Executive Employment Agreement between Fidelity D & DBancorp, Inc., The Fidelity Deposit and Discount Bank******and Daniel J. Santaniello, dated February 28,2008. ***Incorporated byreference to Exhibit 10.1 to Registrant’s Current Report on Form 8-Kfiled with the SEC on March 3, 2008.

 

33

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***11******Statement regarding computation of earnings pershare.***  Includedherein in Note No. 2, “Earnings per share,”                  contained within the Notes toConsolidated Financial Statements, and incorporated herein by reference.

** **

***  31.1 Rule 13a-14(a) Certificationof Principal Executive Officer, filed herewith.***

*** ***

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

*** ***

***  32.1 Certification of PrincipalExecutive Officer pursuant to 18 U.S.C. Section 1350,**** as adopted**pursuant toSection 906 of the Sarbanes-Oxley Act of 2002, filed herewith.***

*** ***

***  32.2 Certification of PrincipalFinancial Officer pursuant to 18 U.S.C. Section 1350,*** *as adopted pursuant**to Section 906 of the Sarbanes-Oxley Act of 2002, filed herewith.***

 

----

*** **Management contract or compensatory plan orarrangement.

 

34

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

 

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

 
| ** **             | ** ** | **FIDELITY D & D  BANCORP, INC.** |
|------------------------|------------|--------------------------------------------|
| ** **             | ** ** | ** **                                 |
| ** **             | ** ** | ** **                                 |
| Date: May 5, 2009 |       | /s/ Steven C. Ackmann                      |
|                   |       | Steven  C. Ackmann,                        |
|                   |       | President  and Chief Executive Officer     |
|                   |       |                                       |
|                   |       |                                       |
| Date: May 5, 2009 |       | /s/ Salvatore R.  DeFrancesco, Jr.    |
|                   |       | Salvatore  R. DeFrancesco, Jr.,       |
|                   |       | Treasurer  and Chief Financial Officer     |

 

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**EXHIBITINDEX**

 
| ** **                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                               | ** ** | **Page** |
|--------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|------------|----------|
| ***3(i) Amended  and Restated Articles of Incorporation of Registrant.*** Incorporated by reference to Annex B of the  Proxy Statement/Prospectus included in Registrant’s Amendment 4 to its  Registration Statement No. 333-90273 on Form S-4, filed with the  SEC on April 6, 2000.                                                                                                                                                                                                                                                     |       | *        |
|                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                     |       |     |
| ***3(ii) Amended  and Restated Bylaws of Registrant.*** Incorporated by reference to Exhibit 3(ii) to  Registrant’s Form 8-K filed with the SEC on November 21, 2007.                                                                                                                                                                                                                                                                                                                                                                 |       | *        |
|                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                     |       |     |
| ***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.                                                                                                                                                                                                                                                       |       | *        |
|                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                     |       |     |
| ***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.                                                                                                                                                                                                                                                                          |       | *        |
|                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                     |       |     |
| ***10.3  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, by Post-Effective Amendment No. 2 on  July 7, 2005 and by Registration Statement No.  333-152806 on  Form S-3 filed on August 6, 2008. |       | *        |
|                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                     |       |     |
| ***10.4  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.                                                                                                                                                                                                                                                                                                                |       | *        |
|                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                     |       |     |
| ***10.5  Amendment, dated October 2, 2007, to the Registrant’s 2000 Independent  Directors Stock Option Plan. ***Incorporated  by reference to Exhibit 10.2 to Registrant’s Form 8-K filed with  the SEC on October 4, 2007.                                                                                                                                                                                                                                                                                                          |       | *        |
|                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                     |       |     |
| ***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  Amendment, dated October 2, 2007, to the Registrant’s 2000 Stock  Incentive Plan. ***Incorporated  by reference to Exhibit 10.1 to Registrant’s Form 8-K filed with  the SEC on October 4, 2007.                                                                                                                                                                                                                                                                                                                             |       | *        |
|                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                     |       |     |
| ***10.8  Registrant’s 2002 Employee Stock Purchase Plan. ***Incorporated by  reference to Exhibit 4.5 to Registrant’s Registration Statement  No. 333-113339 on Form S-8 filed with the SEC on March 5,  2004.                                                                                                                                                                                                                                                                                                                        |       | *        |
|                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                     |       |     |
| ***10.9  Complete Settlement Agreement and General Release between Michael F.  Marranca, Registrant and The Fidelity Deposit and Discount Bank, dated  July 30, 2004***.   Incorporated by reference to Exhibit 99.1 to Registrant’s Current  Report on Form 8-K filed with the SEC on August 10, 2004.                                                                                                                                                                                                                                    |       | *        |
|                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                     |       |     |
| ***10.10  Amendment to the Complete Settlement Agreement and General Release between  Michael F. Marranca, Registrant and The Fidelity Deposit and Discount Bank, dated  November 4, 2005*. **Incorporated by reference to****Exhibit 99.1  to Registrant’s Current Report on Form 8-K filed with the SEC on  November 9, 2005.                                                                                                                                                                                                            |       | *        |
|                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                     |       |     |
| ***10.11  Change of Control Agreements with Salvatore R. DeFrancesco, Registrant and  The Fidelity Deposit and Discount Bank, dated March 21, 2006. ***Incorporated by  reference to Exhibit 99.2 to Registrant’s Current Report on  Form 8-K filed with the SEC on March 27, 2006.                                                                                                                                                                                                                                                        |       | *        |
|                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                     |       |     |
| ***10.12  Amended and Restated Executive Employment Agreement between Fidelity  D & D Bancorp, Inc., The Fidelity Deposit and Discount Bank and  Steven C. Ackmann, dated July 11, 2007.* **Incorporated by reference to  Exhibit 10.1 to Registrant’s Current Report on Form 8-K filed with  the SEC on July 13, 2007.                                                                                                                                                                                                      |       | *        |
|                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                     |       |     |
| ***10.13  Executive Employment Agreement between Fidelity D & D  Bancorp, Inc., The Fidelity Deposit and Discount Bank******and Timothy P. O’Brien, dated January 3,  2008. ***Incorporated by  reference to Exhibit 10.1 to Registrant’s Current Report on  Form 8-K filed with the SEC on January 10, 2008.                                                                                                                                                                                                           |       | *        |
|                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                     |       |     |
| ***10.14  Executive Employment Agreement between Fidelity D & D  Bancorp, Inc., The Fidelity Deposit and Discount Bank******and Daniel J. Santaniello, dated  February 28, 2008. ***Incorporated  by reference to Exhibit 10.1 to Registrant’s Current Report on  Form 8-K filed with the SEC on March 3, 2008.                                                                                                                                                                                                              |       | *        |
|                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                     |       |     |
| ***11******Statement regarding computation of earnings per  share.***                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                    |       | 8        |
|                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                     |       |     |
| ***31.1  Rule 13a-14(a) Certification of Principal Executive Officer.***                                                                                                                                                                                                                                                                                                                                                                                                                                                                                       |       | 38       |

 

 

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| ***31.2  Rule 13a-14(a) Certification of Principal Financial Officer.***                                                                                             |   | 39     |
|--------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|--------|--------|
|                                                                                                                                                                           |   |   |
| ***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.*** |   | 40     |
|                                                                                                                                                                           |   |   |
| ***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.*** |   | 41     |

 

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* Incorporated by Reference

 

37

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