** **

**UNITEDSTATES**

**SECURITIES AND EXCHANGECOMMISSION**

**Washington,D.C. 20549**

 

**FORM 10-Q**

 

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

**SECURITIES EXCHANGE ACT OF 1934**

 

 

**FORQUARTER ENDED SEPTEMBER 30, 2005**

 

 

**COMMISSIONFILE NUMBER: 333-90273**

 

 

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

 

 

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

 

PRINCIPALOFFICE:

**BLAKELY& DRINKER ST.**

**DUNMORE,PENNSYLVANIA 18512**

 

 

TELEPHONE:

**570-342-8281**

 

The Company (1) has filed all reports required to be filed by Section13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12months (or for such shorter period that the Company was required to file suchreports), and (2) has been subject to such filing requirements for the past 90days.

 

ý  YES    o  NO

 

 

TheRegistrant is an accelerated filer (as defined in Exchange Act Rule 12b-2).

 

o  YES    ý  NO

 

 

Indicate by check mark whether the Registrantis a shell company (as defined in Rule 12b-2 of the Exchange Act).

o  YES    ý  NO

 

 

The number of outstandingshares of Common Stock of Fidelity D & D Bancorp, Inc. on October 31, 2005,the latest practicable date, was 1,851,024 shares.

 

 

----

 

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

 

Form10-Q September 30, 2005

 

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

 

 

2

----

 

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

ConsolidatedBalance Sheets

Asof September 30, 2005 and December 31, 2004

** **
| ** **                                                                                                                                   | ** ** | **September 30, 2005** | ** **  | **December 31, 2004** | ** ** |
|----------------------------------------------------------------------------------------------------------------------------------------------|------------|-----------------------------|-------------|-----------------------|------------|
| ** **                                                                                                                                   | ** ** | **(unaudited)**             | ** **  | **(audited)**         | ** ** |
| **ASSETS**                                                                                                                                   |       |                        |        |                  |       |
| Cash and due from banks                                                                                                                      |       | $                           | 10,855,055  |                  | $          | 9,013,060 |   |
| Interest-bearing deposits  with financial institutions                                                                                       |       | 106,763                     |        | 1,203,334             |       |
| Total cash and cash equivalents                                                                                                              |       | 10,961,818                  |        | 10,216,394            |       |
| Available-for-sale  securities                                                                                                               |       | 104,503,869                 |        | 112,612,513           |       |
| Held-to-maturity  securities                                                                                                                 |       | 2,224,161                   |        | 3,056,305             |       |
| Federal Home Loan Bank  Stock                                                                                                                |       | 4,409,800                   |        | 4,568,700             |       |
| Loans  and leases, net (allowance for loan losses of $6,034,549 in 2005 and  $5,987,798 in 2004)                                             |       | 390,338,304                 |        | 381,546,375           |       |
| Loans  available-for-sale (fair value $702,356 in 2005 and $582,141 in 2004)                                                                 |       | 697,456                     |        | 576,378               |       |
| Bank premises and  equipment, net                                                                                                            |       | 10,671,310                  |        | 11,163,292            |       |
| Cash surrender value of  bank-owned life insurance                                                                                           |       | 7,816,244                   |        | 7,613,437             |       |
| Other assets                                                                                                                                 |       | 4,748,463                   |        | 3,385,790             |       |
| Accrued interest  receivable                                                                                                                 |       | 1,959,704                   |        | 1,722,850             |       |
| Foreclosed assets held for  sale                                                                                                             |       | 103,382                     |        | 213,104               |       |
| **Total assets**                                                                                                                             |       | $                           | 538,434,511 |                  | $          | 536,675,138 |   |
| **LIABILITIES**                                                                                                                              |       |                        |        |                  |       |
| Deposits                                                                                                                                     |       |                        |        |                  |       |
| Non-interest-bearing                                                                                                                         |       | $                           | 70,331,584  |                  | $          | 65,357,535 |   |
| Certificates of deposit of $100,000 or more                                                                                                  |       | 86,893,558                  |        | 93,986,033            |       |
| Other interest-bearing deposits                                                                                                              |       | 212,191,121                 |        | 206,271,767           |       |
| Total deposits                                                                                                                               |       | 369,416,263                 |        | 365,615,335           |       |
| Accrued interest payable  and other liabilities                                                                                              |       | 6,067,621                   |        | 3,039,809             |       |
| Short-term borrowings                                                                                                                        |       | 44,026,811                  |        | 50,534,046            |       |
| Long-term debt                                                                                                                               |       | 70,536,586                  |        | 71,119,188            |       |
| **Total liabilities**                                                                                                                        |       | 490,047,281                 |        | 490,308,378           |       |
| **SHAREHOLDERS’ EQUITY**                                                                                                                |       |                        |        |                  |       |
| Preferred  stock authorized 5,000,000 shares with no par value; none issued                                                                  |       | —                      |        | —                |       |
| Capital  stock authorized 10,000,000 shares with no par value; issued and outstanding  1,851,024 shares in 2005 and 1,839,572 shares in 2004 |       | 10,471,172                  |        | 10,072,134            |       |
| Retained earnings                                                                                                                            |       | 38,628,530                  |        | 36,396,027            |       |
| Accumulated other  comprehensive loss                                                                                                        |       | (712,472                    | )           | (101,401              | )          |
| **Total shareholders’ equity**                                                                                                          |       | 48,387,230                  |        | 46,366,760            |       |
| **Total liabilities and shareholders’ equity**                                                                                          |       | $                           | 538,434,511 |                  | $          | 536,675,138 |   |
|                                                                                                                                              |            |                             |             |                       |            |  |  |  |  |

 

 

3

----

 

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

ConsolidatedStatements of Income

(unaudited)

 

 
| ** **                                               | ** ** | **Three Months Ended**       | ** ** | **Nine Months Ended**        | ** ** |
|----------------------------------------------------------|------------|------------------------------|------------|------------------------------|------------|
| ** **                                               | ** ** | **September 30,  2005** | ** ** | **September 30,  2004** | ** ** | **September 30,  2005** | ** ** | **September 30,  2004** | ** ** |
| **Interest income**                                      |       |                         |       |                         |       |   |   |   |   |
| Interest and fees on loans:                              |       |                         |       |                         |       |   |   |   |   |
| Taxable                                                  |       | $                            | 6,012,028  |                         | $          | 5,386,418 |   | $ | 17,414,848 |   | $ | 16,260,004 |   |
| Nontaxable                                               |       | 120,630                      |       | 75,264                       |       | 335,159 |   | 233,780 |   |
| Leases                                                   |       | 7,056                        |       | 34,089                       |       | 39,851 |   | 126,435 |   |
| Interest-bearing deposits with financial institutions    |       | 3,263                        |       | 1,861                        |       | 12,234 |   | 4,071 |   |
| Investment securities:                                   |       |                         |       |                         |       |   |   |   |   |
| US Government agencies                                   |       | 861,777                      |       | 1,064,878                    |       | 2,693,019 |   | 3,356,887 |   |
| States and political subdivisions (non-taxable)          |       | 156,931                      |       | 114,858                      |       | 397,491 |   | 366,564 |   |
| Other securities                                         |       | 162,285                      |       | 59,303                       |       | 461,043 |   | 155,235 |   |
| Federal funds sold                                       |       | —                       |       | 1,028                        |       | 47,427 |   | 11,238 |   |
| **Total interest income**                                |       | 7,323,970                    |       | 6,737,699                    |       | 21,401,072 |   | 20,514,214 |   |
| **Interest expense**                                     |       |                         |       |                         |       |   |   |   |   |
| Certificates of deposit of $100,000 or more              |       | 722,680                      |       | 700,172                      |       | 2,096,344 |   | 2,301,440 |   |
| Other deposits                                           |       | 1,023,540                    |       | 903,016                      |       | 2,881,871 |   | 2,873,866 |   |
| Securities sold under repurchase agreements              |       | 148,677                      |       | 119,240                      |       | 486,794 |   | 323,501 |   |
| Other short- and long-term borrowings and other          |       | 1,066,817                    |       | 997,357                      |       | 2,979,854 |   | 2,973,383 |   |
| **Total interest expense**                               |       | 2,961,714                    |       | 2,719,785                    |       | 8,444,863 |   | 8,472,190 |   |
| **Net interest income**                                  |       | 4,362,256                    |       | 4,017,914                    |       | 12,956,209 |   | 12,042,024 |   |
| Provision for loan losses                                |       | 300,000                      |       | 450,000                      |       | 680,000 |   | 1,700,000 |   |
| **Net interest income after provision for loan  losses** |       | 4,062,256                    |       | 3,567,914                    |       | 12,276,209 |   | 10,342,024 |   |
| **Other income:**                                        |       |                         |       |                         |       |   |   |   |   |
| Service charges on deposit accounts                      |       | 689,435                      |       | 554,394                      |       | 1,961,966 |   | 1,620,614 |   |
| Gain (loss) on:                                          |       |                         |       |                         |       |   |   |   |   |
| Investment securities                                    |       | —                       |       | —                       |       | 2,643 |   | 9,497 |   |
| Loans                                                    |       | 8,468                        |       | 61,065                       |       | 1,011 |   | 155,452 |   |
| Leased assets                                            |       | 22,626                       |       | (50,690                      | )          | (11,328 | ) | (205,876 | ) |
| Foreclosed assets held-for-sale                          |       | 41,472                       |       | 4,102                        |       | 33,861 |   | (4,116 | ) |
| Write-down lease residual                                |       | —                       |       | —                       |       | (220,000 | ) | — |   |
| Fees, other service charges and other income             |       | 466,186                      |       | 579,867                      |       | 1,334,154 |   | 1,590,469 |   |
| **Total other income**                                   |       | 1,228,187                    |       | 1,148,738                    |       | 3,102,307 |   | 3,166,040 |   |
| **Other operating expenses:**                            |       |                         |       |                         |       |   |   |   |   |
| Salaries and employee benefits                           |       | 1,755,611                    |       | 1,745,107                    |       | 5,251,730 |   | 5,193,127 |   |
| Premises and equipment                                   |       | 750,266                      |       | 690,847                      |       | 2,221,742 |   | 2,128,474 |   |
| Advertising                                              |       | 127,709                      |       | 158,193                      |       | 407,517 |   | 303,385 |   |
| Professional fees and services                           |       | 290,619                      |       | 273,447                      |       | 1,086,537 |   | 872,023 |   |
| Other                                                    |       | 666,582                      |       | 790,200                      |       | 1,801,437 |   | 1,974,520 |   |
| **Total other operating expenses**                       |       | 3,590,787                    |       | 3,657,794                    |       | 10,768,963 |   | 10,471,529 |   |
| **Income before provision for  income taxes**            |       | 1,699,656                    |       | 1,058,858                    |       | 4,609,553 |   | 3,036,535 |   |
| Provision for income taxes                               |       | 405,311                      |       | 245,346                      |       | 1,160,011 |   | 677,223 |   |
| **Net income**                                           |       | $                            | 1,294,345  |                         | $          | 813,512 |   | $ | 3,449,542 |   | $ | 2,359,312 |   |
| Per share data:                                          |       |                         |       |                         |       |   |   |   |   |
| Net income - basic                                       |       | $                            | 0.70       |                         | $          | 0.45 |   | $ | 1.87 |   | $ | 1.29 |   |
| Net income - diluted                                     |       | $                            | 0.70       |                         | $          | 0.45 |   | $ | 1.87 |   | $ | 1.29 |   |
| Dividends                                                |       | $                            | 0.22       |                         | $          | 0.22 |   | $ | 0.66 |   | $ | 0.66 |   |
|                                                          |            |                              |            |                              |            |  |  |  |  |  |  |  |  |  |

 

 

4

----

 

 

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

ConsolidatedStatements of Changes in Shareholders’ Equity

For the Nine Months Ended September 30, 2005 and2004

 

 
| ** **                                                                                                                   | ** ** | **Capital stock** | ** ** | **Treasury stock** | ** ** | **Retained** | ** ** | **Accumulated other comprehensive** | ** ** | ** **   | ** ** |
|------------------------------------------------------------------------------------------------------------------------------|------------|-------------------|------------|--------------------|------------|--------------|------------|-------------------------------------|------------|--------------|------------|
| ** **                                                                                                                   | ** ** | **Shares**        | ** ** | **Amount**         | ** ** | **Shares**   | ** ** | **Amount**                          | ** ** | **earnings** | ** ** | **income (loss)** | ** ** | **Total** | ** ** |
| Balance,  December 31, 2003 (audited)                                                                                        |       | 1,828,270         |       | $                  | 9,698,879  |         | (5,227     | )                                   | $          | (196,048     | )          | $ | 34,641,976 |   | $ | (212,908 | ) | $ |  43,931,899 |   |
| Comprehensive  income:                                                                                                       |       |              |       |               |       |         |       |                                |       |         |       |   |   |   |   |
| Net income                                                                                                                   |       |              |       |               |       |         |       |                                |       | 2,359,312    |       |   |   | 2,359,312 |   |
| Change in net  unrealized holding gains (losses) on available-for-sale securities, net, net  of reclassification adjustments |       |              |       |               |       |         |       |                                |       |         |       | 363,620 |   | 363,620 |   |
| Comprehensive  income                                                                                                        |       |              |       |               |       |         |       |                                |       |         |       |   |   | 2,722,932 |   |
| Reissued  treasury stock through Employee Stock Purchase Plan                                                                |       |              |       | (8,329             | )          | 1,635        |       | 61,370                              |       |         |       |   |   | 53,041 |   |
| Dividends  reinvested through Dividend Reinvestment Plan                                                                     |       | 7,192             |       | 243,615            |       | 3,592        |       | 134,678                             |       |         |       |   |   | 378,293 |   |
| Dividends  declared                                                                                                          |       |              |       |               |       |         |       |                                |       | (1,206,621   | )          |   |   | (1,206,621 | ) |
| Balance,  September 30, 2004 (unaudited)                                                                                |       | 1,835,462         |       | $                  | 9,934,165  |         | —     |                                | $          | —       |       | $ | 35,794,667 |   | $ | 150,712 |   | $ | 45,879,544 |   |
|                                                                                                                         |       |              |       |               |       |         |       |                                |       |         |       |   |   |   |   |
| Balance,  December 31, 2004 (audited)                                                                                        |       | 1,839,572         |       | $                  | 10,072,134 |         | —     |                                | $          | —       |       | $ | 36,396,027 |   | $ | (101,401 | ) | $ | 46,366,760 |   |
| Comprehensive  income:                                                                                                       |       |              |       |               |       |         |       |                                |       |         |       |   |   |   |   |
| Net income                                                                                                                   |       |              |       |               |       |         |       |                                |       | 3,449,542    |       |   |   | 3,449,542 |   |
| Change in net  unrealized holding gains (losses) on available-for-sale securities, net, net  of reclassification adjustments |       |              |       |               |       |         |       |                                |       |         |       | (611,071 | ) | (611,071 | ) |
| Comprehensive  income                                                                                                        |       |              |       |               |       |         |       |                                |       |         |       |   |   | 2,838,471 |   |
| Stock issued  through Employee Stock Purchase Plan                                                                           |       | 1,031             |       | 31,671             |       |         |       |                                |       |         |       |   |   | 31,671 |   |
| Dividends  reinvested through Dividend Reinvestment Plan                                                                     |       | 10,421            |       | 367,367            |       |         |       |                                |       |         |       |   |   | 367,367 |   |
| Dividends  declared                                                                                                          |       |              |       |               |       |         |       |                                |       | (1,217,039   | )          |   |   | (1,217,039 | ) |
| Balance,  September 30, 2005 (unaudited)                                                                                |       | 1,851,024         |       | $                  | 10,471,172 |         | —     |                                | $          | —       |       | $ | 38,628,530 |   | $ | (712,472 | ) | $ | 48,387,230 |   |

 

 

5

----

 

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

ConsolidatedStatements of Cash Flows

(unaudited)

 
| ** **                                                  | ** ** | **Nine Months Ended**       | ** ** |
|-------------------------------------------------------------|------------|-----------------------------|------------|
| ** **                                                  | ** ** | **September 30, 2005** | ** ** | **September 30, 2004** | ** ** |
| **Cash flows from operating  activities:**                  |       |                        |       |   |   |
| Net income                                                  |       | $                           | 3,449,542  |   | $ | 2,359,312 |   |
| Adjustments to reconcile net income to net                  |       |                        |       |   |   |
| cash provided by operating activities:                      |       |                        |       |   |   |
| Depreciation                                                |       | 880,897                     |       | 911,171 |   |
| Amortization of securities (net of accretion)               |       | 180,449                     |       | 441,223 |   |
| Provision for loan losses                                   |       | 680,000                     |       | 1,700,000 |   |
| Deferred income tax                                         |       | (184,956                    | )          | (594,889 | ) |
| Write-down of foreclosed assets held-for-sale               |       | 50,451                      |       | 121,789 |   |
| Write-down lease residual                                   |       | 220,000                     |       | — |   |
| Increase in cash surrender value of life insurance          |       | (202,807                    | )          | (240,365 | ) |
| Gain on sale of investment securities                       |       | (2,643                      | )          | (9,497 | ) |
| Gain on sale of loans                                       |       | (1,011                      | )          | (155,452 | ) |
| (Gain) loss on sale of foreclosed assets held-for-sale      |       | (33,861                     | )          | 4,116 |   |
| Loss on sale of leased assets                               |       | 11,328                      |       | 205,876 |   |
| Loss on disposal of equipment                               |       | 589                         |       | 3,661 |   |
| Amortization of loan servicing rights                       |       | 71,871                      |       | 71,078 |   |
| Change in:                                                  |       |                        |       |   |   |
| Accured interest receivable                                 |       | (236,854                    | )          | (265,828 | ) |
| Other assets                                                |       | (861,362                    | )          | 80,950 |   |
| Accrued interest payable and other liabilities              |       | 221,490                     |       | (146,708 | ) |
| Net cash provided by operating activities                   |       | 4,243,123                   |       | 4,486,437 |   |
| **Cash flows from investing  activities:**                  |       |                        |       |   |   |
| Held-to-maturity securities:                                |       |                        |       |   |   |
| Proceeds from maturities, calls and paydowns                |       | 827,760                     |       | 1,445,868 |   |
| Available-for-sale securities:                              |       |                        |       |   |   |
| Proceeds from sales                                         |       | 19,282,027                  |       | 3,850,562 |   |
| Proceeds from maturities, calls and paydowns                |       | 11,934,551                  |       | 19,920,791 |   |
| Purchases                                                   |       | (24,207,222                 | )          | (11,080,552 | ) |
| Net decrease FHLB stock                                     |       | 158,900                     |       | 11,300 |   |
| Proceeds from sale of loans available-for-sale              |       | 1,561,456                   |       | 15,491,238 |   |
| Net increase in loans and leases                            |       | (9,770,169                  | )          | (8,648,029 | ) |
| Proceeds from sale of leased assets                         |       | 766,598                     |       | 753,007 |   |
| Acquisition of bank premises and equipment                  |       | (389,504                    | )          | (187,993 | ) |
| Proceeds from sale of foreclosed assets held-for-sale       |       | 444,814                     |       | 411,514 |   |
| Net cash provided by investing activities                   |       | 609,211                     |       | 21,967,706 |   |
| **Cash flows from financing  activities:**                  |       |                        |       |   |   |
| Net increase in noninterest-bearing deposits                |       | 4,974,049                   |       | 1,222,968 |   |
| Net decrease in certificates of deposit of $100,000 or more |       | (7,092,475                  | )          | (13,648,229 | ) |
| Net increase (decrease) in other interest-bearing deposits  |       | 5,919,354                   |       | (13,587,583 | ) |
| Net decrease in short-term borrowings                       |       | (6,507,235                  | )          | (10,267,020 | ) |
| Net (decrease) increase in long-term borrowings             |       | (582,602                    | )          | 4,434,483 |   |
| Dividends paid, net of dividend reinvestment                |       | (849,672                    | )          | (828,328 | ) |
| Proceeds from employee stock purchase plan                  |       | 31,671                      |       | 53,041 |   |
| Net cash used in financing activities                       |       | (4,106,910                  | )          | (32,620,668 | ) |
| Net increase (decrease) in  cash and cash equivalents       |       | 745,424                     |       | (6,166,525 | ) |
| Cash and cash equivalents,  beginning                       |       | 10,216,394                  |       | 19,231,601 |   |
| Cash and cash equivalents,  ending                          |       | $                           | 10,961,818 |   | $ | 13,065,076 |   |

 

 

6

----

 

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

 

**Notesto Consolidated Financial Statements**

**(unaudited)**

 

**1. Nature of operations andcritical accounting policies**

 

**Principles of consolidation**

 

The accompanying unauditedconsolidated financial statements of Fidelity D & D Bancorp, Inc., and itswholly owned subsidiary, The Fidelity Deposit and Discount Bank (the Bank orcollectively, the Company) have been prepared in accordance with accountingprinciples generally accepted in the United States of America (GAAP) forinterim financial information and with the instructions to this Form 10-Q andRule 10-01 of Regulation S-X. Accordingly, they do not include all of the information and footnotedisclosures required by GAAP for complete financial statements.  In the opinion of Management, all normalrecurring adjustments necessary for a fair presentation of the financialcondition and results of operations for the periods have been included.  All significant inter-company balances andtransactions have been eliminated in consolidation.  Prior period amounts have been reclassified,when necessary, to conform to the current period’s presentation.

 

The preparation of financialstatements in conformity with GAAP requires management to make estimates andassumptions that affect the reported amounts of assets and liabilities anddisclosure of contingent assets and liabilities at the date of the financialstatements and the reported amounts of revenues and expenses during thereported periods.  Actual results coulddiffer from those estimates.  Foradditional information and disclosures required under GAAP, please refer to theCompany’s Annual Report on Form 10-K for the year ended December 31, 2004.

 

**Nature of operations**

 

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

 

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

 

In the opinion ofManagement, the consolidated balance sheets as of September 30, 2005 andDecember 31, 2004 and the related consolidated statements of income for each ofthe three and nine month periods ended September 30, 2005 and September 30,2004 and changes in shareholders’ equity and cash flows for each of the ninemonths ended September 30, 2005 and September 30, 2004 present fairly thefinancial 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. There have been no material changes in accounting principles, practicesor in the method of application and there have been no retroactive adjustmentsduring these periods.  The results ofoperations for interim periods are not necessarily indicative of the results ofoperations for the entire year.

 

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

 

**Critical accounting policies**

 

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

 

7

----

 

A material estimate that is particularly susceptible to significantchange is the determination of the allowance for loan losses (theallowance).  Management believes that theallowance, as of September 30, 2005, is adequate and reasonable.  Given the subjective nature of identifyingand valuing loan losses, it is likely that well-informed individuals could makematerially different assumptions and could, therefore, calculate a materiallydifferent allowance value.  WhileManagement uses available information to recognize losses on loans, changes ineconomic conditions may necessitate revisions in the future.  In addition, various regulatory agencies, asan integral part of their examination process, periodically review the Company’sallowance.  Such agencies may require theCompany to recognize adjustments to the allowance based on their judgments ofinformation available to them at the time of their examination.

 

Other material estimatesinclude the determinations of fair values of the Company’s investmentsecurities and loans classified as available-for-sale (AFS).  The Company receives estimated fair values ofinvestment securities from an independent valuation service.  In developing these fair values, thevaluation service uses estimates of cash flows based on historical performanceof similar instruments in similar interest rate environments.  Based on experience, Management is aware thatestimated fair values of investment securities tend to vary among valuationservices.  Accordingly, when sellinginvestment securities, Management typically obtains price quotes from more thanone source.  The majority of the Company’sinvestment securities are classified as AFS. AFS securities are carried at fair market value on the consolidatedbalance sheet, with unrealized gains and losses, net of income tax, reported asa separate component of shareholders’ equity in accumulated other comprehensiveincome (loss).

 

The fair market value of residential mortgage loans, classified as AFS,is obtained from the Federal National Mortgage Association (FNMA). The fairvalue of Small Business Administration (SBA) loans, classified as AFS, is obtainedfrom an outside pricing source. To determine the fair market value of studentloans, classified as AFS, the Bank uses the pricing obtained from the mostrecent student loans sold from its AFS portfolio. The market to which the Banksells mortgage and other loans is restricted and price quotes from othersources are typically not obtained. As of September 30, 2005, the Company’sportfolio of loans AFS was comprised of residential mortgage loans and studentloans. At December 31, 2004, the portfolio was comprised of only student loans.

 

**2. Earnings per share**

 

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

 

The following data illustrates the amounts used in computing EPS andthe effects on income and the weighted-average number of shares of potentiallydilutive common stock for the nine months ended September 30, 2005 and 2004:

 

8

----

 

 

| ** **                                  | ** ** | ** **    | ** **      | **Weighted-average** | ** ** | ** ** | ** ** |
|---------------------------------------------|------------|---------------|-----------------|----------------------|------------|------------|------------|
| ** **                                  | ** ** | **Income**    | ** **      | **common shares**    | ** ** | ** ** | ** ** |
| **September 30, 2005**                      | ** ** | **numerator** | ** **      | **denominator**      | ** ** | **EPS**    | ** ** |
| Basic EPS                                   |       | $             | 3,449,542       |                 | 1,844,792  |       | $          | 1.87 |   |
| Dilutive effect of  potential common stock: |       |          |            |                 |       |       |       |
| Stock options:                              |       |          |            |                 |       |       |       |
| Exercise of options outstanding             |       |          |            | 7,700                |       |       |       |
| Hypothetical share repurchase at $35.50     |       |          |            | (7,224               | )          |       |       |
| Diluted EPS                                 |       | $             |  3,449,542 |                 | 1,845,268  |       | $          |  1.87 |   |
|                                        |       |          |            |                 |       |       |       |
| **September 30, 2004**                      | ** ** | ** **    | ** **      | ** **           | ** ** | ** ** | ** ** |
| Basic EPS                                   |       | $             | 2,359,312       |                 | 1,828,814  |       | $          | 1.29 |   |
| Dilutive effect of potential common stock:  |       |          |            |                 |       |       |       |
| Stock options:                              |       |          |            |                 |       |       |       |
| Exercise of options outstanding             |       |          |            | 5,100                |       |       |       |
| Hypothetical share repurchase at $35.00     |       |          |            | (4,517               | )          |       |       |
| Diluted EPS                                 |       | $             |  2,359,312 |                 | 1,829,397  |       | $          |  1.29 |   |
|                                             |            |               |                 |                      |            |            |            |  |  |  |  |  |

 

**3. Stock plans**

 

The Company uses the intrinsic value method of accounting forstock-based compensation plans, under Accounting Principles Board (APB) OpinionNo. 25*, Accounting for Stock Issued to Employees*(APB No. 25), and as permitted by Statement of Financial Accounting Standards(SFAS) No. 123, *Accounting for Stock-BasedCompensation* (SFAS No.123).  Under the intrinsic valuemethod, compensation cost is measured by the excess of the quoted market priceof the stock, as of the grant date (or other measurement date) over the stock’sexercise price.  Since all options issuedunder the Company’s stock-based compensation plans had an exercise price equalto the quoted market value of the underlying common stock on the date of grant,the stock is deemed to have no intrinsic value. Accordingly, no compensation cost is recorded.

 

Thealternative fair value method of accounting for stock-based compensationprovided under SFAS No. 123 requires the use of option valuation models, suchas the Black-Scholes option pricing model. The Black-Scholes option pricing model was not developed for use invaluing stock options granted under employer stock option plans.  Rather, the Black-Scholes option pricingmodel was developed for use in estimating the fair market value of short-termoptions traded in organized exchanges. Options traded in organized exchanges have no vesting restrictions andare fully transferable.  In addition,option valuation models require the input of highly subjective assumptionsincluding the expected or implied volatility of the options underlyingstock.  Since the options granted underthe Company’s stock option plans have characteristics significantly differentfrom those of marketable options and because changes in the subjective inputassumptions can materially impact the estimated fair market value, inManagement’s opinion, the existing valuation models do not necessarily providea reliable single measure of the fair market value of its employee stockoptions at the time of grant.

 

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

 

In2004 and for the first nine months of 2005, the Company did not grant stockoptions under any of its stock plans.

 

 

9

----

 

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

 

The following is Management’s discussion andanalysis of the significant changes in the consolidated financial condition ofthe Company as of September 30, 2005 compared to December 31, 2004 and theresults of operations for the three and nine month periods ended September 30,2005 compared to the respective periods ended September 30, 2004.  Current performance may not be indicative offuture results. This discussion should be read in conjunction with the Company’s2004 Annual Report filed on Form 10-K.

 

**Forward looking statements**

 

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

 

Forward-looking statements are based onvarious assumptions and analyses made by us in light of Management’s experienceand its perception of historical trends, current conditions and expected futuredevelopments, as well as other factors it believes are appropriate under thecircumstances.  These statements are notguarantees of future performance and are subject to risks, uncertainties andother factors (many of which are beyond our control) that could cause actual resultsto differ materially from future results expressed or implied by suchforward-looking statements.  Thesefactors include, without limitation, the following:

 

•                  the timing and occurrence ornon-occurrence of events may be subject to circumstances beyond our control;

 

•                  there may be increases incompetitive pressure among financial institutions or from non-financialinstitutions;

 

•                  changes in the interest rateenvironment may reduce interest margins;

 

•                  changes in deposit flows,loan demand or real estate values may adversely affect our business;

 

•                  changes in accountingprinciples, policies or guidelines may cause our financial condition to be perceiveddifferently;

 

•                  general economic conditions,either nationally or locally in some or all areas in which we do business, orconditions in the securities markets or the banking industry may be lessfavorable than we currently anticipate;

 

•                  legislative or regulatorychanges may adversely affect our business;

 

•                  technological changes may bemore rapid, difficult or expensive than we anticipate;

 

•                  success or consummation ofnew business initiatives may be more difficult or expensive than we anticipate;or

 

•                  acts of war, terrorism ornatural disaster.

 

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

 

**General**

 

The Company’s results of operations dependprimarily on its net interest income. Net interest income is the difference between interest income andinterest expense.  Interest income isgenerated from yields on interest-earning assets which consist principally ofloans and investment securities. Interest expense is incurred from rates paid on interest-bearing 

 

 

10

----

 

liabilities which consist of deposits andborrowings.  Net interest income isdetermined by the Company’s interest rate spread (i.e., the difference betweenthe yields earned on its interest-earning assets and the rates paid on itsinterest-bearing liabilities) and the relative amounts of interest-earningassets and interest-bearing liabilities. The interest rate spread is influenced by the overall interest rateenvironment, the composition and characteristics of interest-earning assets andinterest-bearing liabilities and by the competition in our marketplace.  The interest rate spread and the changes inthe interest rate spread, from period-to-period, is also influenced bydifferences in the maturity and re-pricing characteristics of assets comparedto the maturity and re-pricing characteristics of the liabilities that fundthem.

 

The Company’s profitability is also affectedby the level of its non-interest income and expenses, provision for loan lossesand provision for income taxes. Non-interest income consists of service charges on the Bank’s loan anddeposit products, trust and asset management service fees, net gains or lossesfrom sales of leases, securities and loans AFS and increases in the cashsurrender value of the bank-owned life insurance.  Non-interest expense consists of compensationand related employee benefit expenses, occupancy, equipment, data processing,advertising, marketing, professional fees, insurance and other operatingoverhead.

 

The Company’s profitability is significantlyaffected by general economic and competitive conditions, changes in marketinterest rates, government policies and actions of regulatory authorities.  The Company’s loan portfolio is comprisedprincipally of commercial and commercial real estate loans.  The properties underlying the Company’s mortgagesare concentrated in northeastern Pennsylvania. Credit risk, which represents the possibility of the Company notrecovering amounts due from its borrowers, is significantly related to localeconomic conditions in the areas the properties are located as well as theCompany’s loan underwriting standards. Economic conditions affect the market value of the underlying collateralas well as the levels of occupancy of multi-family dwellings and levels ofadequate cash flow and revenue generation from other income-producingcommercial properties.

 

 

**COMPARISON OF FINANCIAL CONDITIONAT**

**SEPTEMBER 30, 2005 AND DECEMBER31, 2004**

 

**Overview**

 

Consolidated assets increased $1,759,000 or0.3%, during the nine months ended September 30, 2005 to $538,435,000.  The increase resulted from increases in totaldeposits of $3,801,000, accrued expenses and other liabilities of $3,028,000and total stockholders’ equity of $2,020,000.  These items were partially offset by a decrease in total borrowings of$7,090,000.  Since December 31, 2004, thecarrying value of total loans increased $8,913,000 and cash and cashequivalents increased $745,000.  Thecarrying value of the Bank’s investment portfolio declined $8,940,000.  The increase in shareholders’ equity wasattributable to earnings net of dividends declared of $2,233,000, an increasein common stock of $399,000, partially offset by a $611,000 net unrealizedholding loss on AFS securities recorded in other comprehensive income (loss).

 

A comparison of selected balance sheetinformation as of September 30, 2005 and December 31, 2004 follows:

 

*Investment securities*

 

The Bank’s investment policy is designed tocomplement its lending activities, generate a favorable return withoutincurring undue interest rate and credit risk, manage interest ratesensitivity, provide monthly cash flow and manage liquidity at acceptablelevels.  In establishing investmentstrategies, the Bank considers its business and growth or restructuring plans,the economic environment, the interest rate sensitivity position, the types ofsecurities held, permissible purchases, credit quality, maturity and re-pricingterms, call or average-life intervals and investment concentrations.  The policy prescribes permissible investmentcategories that meet the policy standards and Management is responsible forstructuring and executing the specific investment purchases within these policyparameters.  Management buys and sellsinvestment securities from time-to-time depending on market conditions,business trends, liquidity needs, capital levels and structuringstrategies.  Investment securitypurchases provide a way to quickly invest excess liquidity in order to generateadditional earnings.  The Bank generallyearns a positive interest spread by assuming interest rate risk and usingdeposits and/or borrowings to purchase securities with longer maturities.

 

At the time of purchase, the Bank classifiesinvestment securities into one of three categories: trading, AFS or held-to-maturity (HTM).  To date, Management hasnot purchased any securities for trading purposes.  Management classifies most securities as AFSeven though it has no immediate intent to sell them.  The AFS designation affords Management the flexibilityto sell securities and adjust or restructure the balance sheet in response tocapital levels, liquidity needs, structuring strategies and/or changes inmarket conditions.  Securities AFS arecarried at net fair market value in the

 

 

11

----

 

consolidated balance sheet with an adjustmentto shareholders’ equity, net of tax, which is presented under the caption “Accumulatedother comprehensive income (loss).” Securities designated as HTM are carried at amortized cost.

 

During the second quarter, the Bankrestructured approximately $19.5 million of investment securities holdings toenhance current earnings while simultaneously addressing the interest rate riskin the portfolio from the continued flattening of the treasury yield curve.  The restructuring included the sale andpurchase of securities that re-allocated the diversification away from heavilyweighted mortgage-backed securities.  AtSeptember 30, 2005, approximately 45.4% of the carrying value of the investmentportfolios was comprised of mortgage-backed securities that amortize andprovide monthly cash flow, compared to 55.7% at December 31, 2004.  Also at September 30, 2005, agency andmunicipal bonds comprised 30.3% and 14.4%, respectively, of the investmentportfolios.  The carrying value ofinvestment securities totaled $106,728,000 or 19.8% of total assets as ofSeptember 30, 2005 compared to $115,669,000 or 21.6% as of December 31,2004.  At September 30, 2005, theportfolio is comprised of HTM and AFS securities with carrying values of$2,224,000 and $104,504,000, respectively.

 

At September 30, 2005, the AFS debtsecurities were recorded with a net unrealized loss in the amount of$1,246,000.  The increase in theunrealized loss is due to the relative increase in the interest rateenvironment which has an inverse relationship with the market values of debtsecurities.  Also at September 30, 2005,AFS equity securities were recorded in the amount of $445,000 including anunrealized gain in the amount of $166,000.

 

The amortized cost and fair value ofinvestment securities HTM and AFS at September 30, 2005 consisted of thefollowing (dollars in thousands):

 

| ** **                                       | ** ** | **Amortized** | ** ** | **Gross unrealized** | ** ** | **Gross unrealized** | ** ** | **Fair**  | ** ** |
|--------------------------------------------------|------------|---------------|------------|----------------------|------------|----------------------|------------|-----------|------------|
| ** **                                       | ** ** | **cost**      | ** ** | **gains**            | ** ** | **losses**           | ** ** | **value** | ** ** |
| Held-to-maturity  securities:                    |       |          |       |                 |       |                 |       |      |       |
|                                             |       |          |       |                 |       |                 |       |      |       |
| Mortgage-backed securities                       |       | $             | 2,224      |                 | $          | 65                   |       | $         | —     |   | $ | 2,289 |   |
|                                             |       |          |       |                 |       |                 |       |      |       |
| Available-for-sale  securities:                  |       |          |       |                 |       |                 |       |      |       |
| U.S. government agencies and corporations        |       | 33,001        |       | 1                    |       | 643                  |       | 32,359    |       |
| Obligations of states and municipal subdivisions |       | 15,339        |       | 124                  |       | 58                   |       | 15,405    |       |
| Corporate bonds                                  |       | 10,023        |       | 44                   |       | 14                   |       | 10,053    |       |
| Mortgage-backed securities                       |       | 46,942        |       | 14                   |       | 714                  |       | 46,242    |       |
|                                             |       |          |       |                 |       |                 |       |      |       |
| Sub total                                        |       | 105,305       |       | 183                  |       | 1,429                |       | 104,059   |       |
|                                             |       |          |       |                 |       |                 |       |      |       |
| Equity securities                                |       | 279           |       | 166                  |       | —               |       | 445       |       |
|                                             |       |          |       |                 |       |                 |       |      |       |
| Total available-for-sale                         |       | 105,584       |       | 349                  |       | 1,429                |       | 104,504   |       |
|                                             |       |          |       |                 |       |                 |       |      |       |
| Total securities                                 |       | $             | 107,808    |                 | $          | 414                  |       | $         | 1,429      |   | $ | 106,793 |   |

 

 

12

----

 

The amortized cost and fair value of investments HTM and AFS bycontractual maturity at September 30, 2005 are as follows (dollars inthousands):

 
| ** **                      | ** ** | **Amortized** | ** ** | **Market** | ** ** |
|---------------------------------|------------|---------------|------------|------------|------------|
| ** **                      | ** ** | **cost**      | ** ** | **value**  | ** ** |
| Held-to-maturity  securities:   |       |          |       |       |       |
| Mortgage-backed securities      |       | $             | 2,224      |       | $          | 2,289 |   |
|                            |       |          |       |       |       |
| Available-for-sale  securities: |       |          |       |       |       |
| Debt securities:                |       |          |       |       |       |
| One year or less                |       | 120           |       | 120        |       |
| One through five years          |       | 7,310         |       | 7,139      |       |
| Five through ten years          |       | 24,127        |       | 23,798     |       |
| Over ten years                  |       | 26,806        |       | 26,760     |       |
| Total debt securities           |       | 58,363        |       | 57,817     |       |
|                            |       |          |       |       |       |
| Mortgage-backed securities      |       | 46,942        |       | 46,242     |       |
| Equity securities               |       | 279           |       | 445        |       |
|                            |       |          |       |       |       |
| Total available-for-sale        |       | 105,584       |       | 104,504    |       |
|                            |       |          |       |       |       |
| Total securities                |       | $             | 107,808    |       | $          | 106,793 |   |

 

Expected maturities will differ from contractual maturities becauseissuers and borrowers may have the right to call or repay obligations with orwithout call or prepayment penalty. Federal agency and municipal securities areincluded based on their original stated maturity. Mortgage-backed securities,which are based on weighted-average lives and subject to monthly principalpay-downs, are listed in total. Equity securities, which have no statedmaturity, are carried at the lower of cost or fair market value.

 

*Loans available - for- sale (AFS)*

 

Generally, upon origination, certainresidential mortgages, the guaranteed portions of SBA loans and student loansmay be classified as AFS.  In the eventof market interest rate increases, fixed-rate loans and loans not immediatelyscheduled to re-price would no longer produce yields consistent with thecurrent market.  In a declining interestrate environment, the Bank would be exposed to prepayment risk and, as rates onadjustable rate loans decrease, interest income would be negatively affected.  To better manage prepayment and interest raterisk, loans that meet these conditions may be classified as AFS.  Consideration is also given to the Company’scurrent liquidity position and expected future liquidity needs.  Loans AFS are carried at the lower of cost orestimated fair value.  If the fair marketvalues of these loans fall below their amortized cost, the loan is written downby the difference with a corresponding charge to current earnings.  Subsequent appreciation, if any, is creditedto current earnings but only to the extent of previous write-downs.

 

At September 30, 2005, loans AFS amounted to$697,000 with a corresponding fair value of $703,000, compared to $576,000 and$582,000, respectively at December 31, 2004. For the nine months ended September 30, 2005, residential and studentloans with principal balances of $878,000 and $682,000, respectively were soldinto the secondary market with combined net gains of approximately $16,000being recognized.  At September 30, 2005the balance of loans AFS consisted of $413,000 of residential mortgages and$285,000 of student loans.  At December31, 2004, the entire balance of loans AFS consisted of student loans.

 

*Loans and leases*

 

The Bank originates commercial and commercialreal estate loans, residential, consumer, home equity and constructionloans.  The relative volume oforiginations is dependent upon customer demand, current interest rates and theperception and duration of future interest rate levels.  The Bank focuses its efforts, wheneverpossible, on the expansion of variable-rate portfolios of residential andconsumer loans as well as commercial loans, along with fixed-rate residentialreal estate loans.  The broad spectrum ofproducts provides diversification which helps manage, to an extent, interest

 

 

13

----

 

rate risk and credit concentration risk.  Credit risk is further managed throughunderwriting policies and procedures and loan monitoring practices.  Interest rate risk is managed using variousasset/liability modeling techniques and analyses.  The interest rates on most commercial loansare adjustable with reset intervals of five years or less.  Whenever practical, the Bank originatesvariable-rate loans.

 

The majority of our loan portfolio iscollateralized, at least in part, by real estate in the greater Lackawanna andLuzerne counties of Pennsylvania. Commercial lending activities generally involve a greater degree ofcredit risk than residential lending because they typically have largerbalances and are more affected by adverse conditions in the economy.  Because payments on loans secured bycommercial and commercial real estate often depend upon the successfuloperation and management of the properties and the businesses which operatefrom within them, repayment of such loans may be affected by factors outsidethe borrower’s control.  Such factors mayinclude adverse conditions in the real estate market, the economy, the industryor changes in government regulations.  Assuch, commercial loans require more ongoing evaluation and monitoring whichoccurs with the Bank’s credit administration and outsourced loan reviewfunctions.

 

During the first quarter of 2005, the Bank established a reserve forestimated impairment from the future sales of its leased vehicles which wasnetted against the gross amount of direct finance leasing.  The estimated impairment was based on thehistorical sales performance of terminated leases which are typically soldbelow their residual value.  The balanceof the Bank’s leased vehicles should mature or payoff during the remainder of2005.  As of September 30, 2005, theCompany expects the current balance of the reserve to be adequate to absorb theremaining anticipated losses.  Currently,the Company does not anticipate re-entering the direct finance lease businesswhen the current agreements expire in 2005.

 

Loans, net of unearned income of $396,373,000at September 30, 2005 increased $8,839,000 from $387,534,000 at December 31,2004.  The increase was from successfulimplementation and marketing strategies for residential mortgages and consumerhome equity installment lending partially offset by a decline in commercialloans and run-off of receivables from the Bank’s auto leasing business.  The decrease in commercial lending wasprimarily from a sold loan participation during the first quarter of 2005 andthe maturity of an automobile dealer’s floor plan note that was notrenewed.  

 

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

 
| ** **                             | ** ** | **September 30, 2005** | ** **  | **December 31, 2004** | ** ** |
|----------------------------------------|------------|------------------------|-------------|-----------------------|------------|
| Commercial and commercial  real estate |       | $                      | 212,046,121 |                  | $          | 221,968,137 |   |
| Residential real estate                |       | 99,800,950             |        | 91,294,401            |       |
| Consumer and home equity               |       | 71,625,825             |        | 61,487,608            |       |
| Real estate construction               |       | 12,043,129             |        | 10,620,472            |       |
| Direct financing leases                |       | 858,189                |        | 2,211,978             |       |
| Gross loans                            |       | 396,374,214            |        | 387,582,596           |       |
| Less:                                  |       |                   |        |                  |       |
| Unearned discount                      |       | 1,361                  |        | 48,423                |       |
| Allowance for loan losses              |       | 6,034,549              |        | 5,987,798             |       |
| Net loans                              |       | 390,338,304            |        | 381,546,375           |       |
|                                   |       |                   |        |                  |       |
| Loans available-for-sale               |       | 697,456                |        | 576,378               |       |
|                                   |       |                   |        |                  |       |
| Total loans                            |       | $                      | 391,035,760 |                  | $          | 382,122,753 |   |
|                                        |            |                        |             |                       |            |  |  |  |

 

*Allowance for loan losses*

 

Management continually evaluates the creditquality of the Bank’s loan portfolio and, on a quarterly basis, performs aformal review of the adequacy of the allowance for loan losses (theallowance).  The allowance reflectsmanagement’s best estimate of the amount of credit losses in the loanportfolio.  Management’s judgment isbased on the evaluation of individual loans, past experience, the assessment ofcurrent economic conditions and other relevant factors including the amountsand timing of cash flows expected to be received on impaired loans.  Those estimates may be susceptible to significantchange.  The provision for loan lossesrepresents the amount necessary to maintain an appropriate allowance. Loanlosses are charged directly against the allowance when loans are deemed to beuncollectible.  Recoveries on previouslycharged-off loans are added to the allowance when received.

 

 

14

----

 

Management applies two primary componentsduring the loan review process to determine the adequacy of allowancelevels.  The two components consist of aspecific loan loss allocation, for loans that are deemed impaired, and ageneral loan loss allocation for those loans where a specific loss has not beenallocated.  The methodology to analyzethe adequacy of the allowance is as follows:

 

•                  Identification of specificproblem loans by loan category;

•                  Calculation of specificallowances required based on collateral and other persuasive evidence;

•                  Identification of loanscollateralized by cash and cash equivalents;

•                  Determination of remaininghomogenous pools by loan category and eliminating loans collateralized by cashand cash equivalents and eliminating loans with specific loss allocations;

•                  Application of historicalloss percentages (three-year average) to pools to determine the allowanceallocation; and

•                  Application of qualitativefactor adjustment percentages to historical losses for trends or changes in theloan portfolio.

 

Allocation of the allowance for differentcategories of loans is based on the methodology as explained above.  A key element of the methodology to determinethe allowance is the Company’s credit risk evaluation process, which includescredit risk-grading of individual commercial loans.  Commercial loans are assigned credit riskgrades based on the Company’s assessment of conditions that affect the borrower’sability to meet its contractual obligations under the loan agreement.  That process includes reviewing borrowers’current financial information, historical payment experience, creditdocumentation, public information and other information specific to eachindividual borrower.  The changes in theallocations from period to period are based upon reviews of the loan and leaseportfolios.

 

Net charge-offs for the nine months endedSeptember 30, 2005 were $633,000, compared to $588,000, for the same period in2004.  Net charge-offs of commercialloans were $588,000 for the nine months ended September 30, 2005 compared to$176,000 in the first nine months of 2004. Real estate mortgage net charge-offs declined to $11,000 for the firstnine months of 2005 compared to $220,000 in the first nine months of 2004.  Consumer loan net charge-offs were $34,000for the first nine months of 2005 compared to $146,000 for the same 2004period.  There were no lease financingcharge-offs or recoveries during the current period.  Some deterioration in the credit quality ofvarious non-performing commercial loans caused an increase of commercial loancharge-offs during the nine months ended September 30, 2005 compared to thesame 2004 period. Improvement in the credit quality and collection effort helpedto reduce the real estate and consumer charge-offs.  In addition, recoveries for the 2005 periodinclude $115,000 from the sale of previously charged-off loans.

 

Management believes that the current balancein the allowance for loans losses of $6,035,000 is sufficient to withstand theidentified potential credit quality issues that may arise and are inherent tothe portfolio.  Management is unaware ofany potential problem loans that have not been reviewed.  Potential problem loans are those where thereis known information that leads Management to believe repayment of principaland/or interest is in jeopardy and the loans are neither on non-accrual statusnor past due 90 days or more.  However,there could be instances which become identified during the year that mayrequire additional charge-offs and/or increases to the allowance.  The ratio of allowance for loan losses tototal loans was 1.52% at September 30, 2005 compared 1.54% at December 31, 2004and 1.59% September 30, 2004.

 

 

15

----

 

The following tables set forth the activityin the allowance for loan losses and certain key ratios for the periodindicated:

 
| ** **                       | ** ** | **As of and for the**   | ** **  | **As of and for the**  | ** ** | **As of and for the**   | ** ** |
|----------------------------------|------------|-------------------------|-------------|------------------------|------------|-------------------------|------------|
| ** **                       | ** ** | **nine months ended**   | ** **  | **year ended**         | ** ** | **nine months ended**   | ** ** |
|                             |       | **September  30, 2005** | ** **  | **December  31, 2004** | ** ** | **September  30, 2004** |       |
| Balance at beginning of  period  |       | $                       | 5,987,798   |                   | $          | 4,996,966               |       | $ | 4,996,966 |   |
|                             |       |                    |        |                   |       |                    |       |
| Provision charged to  operations |       | 680,000                 |        | 2,150,000              |       | 1,700,000               |       |
|                             |       |                    |        |                   |       |                    |       |
| Charge-offs:                     |       |                    |        |                   |       |                    |       |
| Commercial                       |       | 940,911                 |        | 775,252                |       | 380,900                 |       |
| Real estate                      |       | 20,875                  |        | 266,324                |       | 229,087                 |       |
| Consumer                         |       | 183,659                 |        | 480,462                |       | 298,253                 |       |
| Lease financing                  |       | —                  |        | 84,902                 |       | 69,210                  |       |
| Total                            |       | 1,145,445               |        | 1,606,940              |       | 977,450                 |       |
|                             |       |                    |        |                   |       |                    |       |
| Recoveries:                      |       |                    |        |                   |       |                    |       |
| Commercial                       |       | 352,413                 |        | 226,082                |       | 205,183                 |       |
| Real estate                      |       | 9,698                   |        | 20,039                 |       | 9,000                   |       |
| Consumer                         |       | 150,085                 |        | 178,727                |       | 152,543                 |       |
| Lease financing                  |       | —                  |        | 22,924                 |       | 22,724                  |       |
| Total                            |       | 512,196                 |        | 447,772                |       | 389,450                 |       |
|                             |       |                    |        |                   |       |                    |       |
| Net charge-offs                  |       | 633,249                 |        | 1,159,168              |       | 588,000                 |       |
|                             |       |                    |        |                   |       |                    |       |
| Balance at end of period         |       | $                       | 6,034,549   |                   | $          | 5,987,798               |       | $ | 6,108,966 |   |
|                             |       |                    |        |                   |       |                    |       |
| Total loans, end of period       |       | $                       | 397,070,309 |                   | $          | 388,110,551             |       | $ | 383,185,529 |   |
|                                  |            |                         |             |                        |            |                         |            |  |  |  |  |  |  |

 
| ** **                                                                | ** ** | **As of and for the**  | ** ** | **As of and for the** | ** ** | **As of and for the**  | ** ** |
|---------------------------------------------------------------------------|------------|------------------------|------------|-----------------------|------------|------------------------|------------|
| ** **                                                                | ** ** | **nine months ended**  | ** ** | **year ended**        | ** ** | **nine months ended**  | ** ** |
| ** **                                                                | ** ** | **September 30, 2005** | ** ** | **December 31, 2004** | ** ** | **September 30, 2004** | ** ** |
| Net charge-offs to:                                                       |       |                   |       |                  |       |                   |       |
| Loans, end of period                                                      |       | 0.16                   | %          | 0.30                  | %          | 0.15                   | %          |
| Allowance for loan losses                                                 |       | 10.49                  | %          | 19.36                 | %          | 9.63                   | %          |
| Provision for loan losses                                                 |       | 93.12                  | %          | 53.91                 | %          | 34.59                  | %          |
|                                                                      |       |                   |       |                  |       |                   |       |
| Allowance for loan losses  to:                                            |       |                   |       |                  |       |                   |       |
| Total loans                                                               |       | 1.52                   | %          | 1.54                  | %          | 1.59                   | %          |
| Non-accrual loans                                                         |       | 64.47                  | %          | 60.46                 | %          | 62.14                  | %          |
| Non-performing loans                                                      |       | 60.26                  | %          | 57.24                 | %          | 59.39                  | %          |
| Net charge-offs                                                           |       | 9.53                   | x          | 5.17                  | x     | 10.39                  | x     |
|                                                                      |       |                   |       |                  |       |                   |       |
| Loans 30-89 days past due  and still accruing                             |       | $                      | 2,396,798  |                  | $          | 4,316,453              |       | $ | 3,791,855 |   |
| Loans 90 days past due and  accruing                                      |       | $                      | 654,084    |                  | $          | 557,492                |       | $ | 455,872 |   |
| Non-accrual loans                                                         |       | $                      | 9,360,643  |                  | $          | 9,904,276              |       | $ | 9,831,170 |   |
| Allowance for loan losses to loans 90 days or more past due and  accruing |       | 9.23                   | x          | 10.75                 | x          | 13.40                  | x          |
|                                                                           |            |                        |            |                       |            |                        |            |  |  |  |  |  |  |

 

 

16

----

 

*Non-performing assets*

 

The Bank defines non-performing assets asaccruing loans past due 90 days or more, non-accrual loans, restructured loans,other real estate owned and repossessed assets. As of September 30, 2005, non-performing assets represented 1.88% oftotal assets compared to 1.99% at December 31, 2004 and 1.95% at September 30,2004.

 

The non-accrual loan balance declined$544,000 during the first nine months of 2005, and was down by $471,000compared to September 30, 2004.  Thebalance of non-accrual loans fluctuates upward and downward depending mostly ondelinquency status, pay downs, charge-offs, a history of satisfactoryrepayments during the period a loan is classified as non-accrual andacquisition through foreclosure.  Duringthe nine months ended September 30, 2005, $3,952,000 of loans classified asnon-accrual, including capitalized expenditures, were added to non-accrual,partially offset by payoffs or pay downs of $2,441,000, charge offs of$999,000, transfers to the Bank’s portfolio of other real estate owned (OREO)of $246,000 and $810,000 of loans that have returned to performing status.

 

Non-performing loans which includesnon-accrual loans and accruing loans past due 90 days or more decreased$447,000 to $10,015,000 since December 31, 2004.  While loans past due 90 days or moreincreased by $97,000, this increase was more than offset by non-accrual loansdeclining $544,000.   The ratio ofnon-performing loans to end of period net loans declined 18 basis points to2.56%, during the nine month period ended September 30, 2005, compared to 2.74%as of December 31, 2004.  As of September30, 2004, the ratio of non-performing loans to net loans was 2.73%.

 

Foreclosed assets held for sale includes OREOand repossessed assets.  OREO representstwo properties that have been foreclosed upon and transferred from loans.  Both of the properties are currently underagreements for sale. Repossessed assets represent indirect auto loans, thepayments of which have become delinquent and the vehicles repossessed.

 

The following table sets forth non-performingassets data as of the period indicated:

 
| ** **                                                                         | ** ** | **September 30, 2005** | ** **  | **December 31, 2004** | ** ** | **September 30, 2004** | ** ** |
|------------------------------------------------------------------------------------|------------|------------------------|-------------|-----------------------|------------|------------------------|------------|
|                                                                               |       |                   |        |                  |       |                   |       |
| Loans past due 90 days or more and accruing                                        |       | $                      | 654,084     |                  | $          | 557,492                |       | $ | 455,872 |   |
| Non-accrual loans                                                                  |       | 9,360,643              |        | 9,904,276             |       | 9,831,170              |       |
| Total non-performing loans                                                         |       | 10,014,727             |        | 10,461,768            |       | 10,287,042             |       |
|                                                                               |       |                   |        |                  |       |                   |       |
| Restructured loans                                                                 |       | —                 |        | —                |       | —                 |       |
| Other real estate owned                                                            |       | 77,750                 |        | 163,000               |       | 277,804                |       |
| Repossessed assets                                                                 |       | 25,632                 |        | 50,104                |       | 47,365                 |       |
| Total non-performing assets                                                        |       | $                      | 10,118,109  |                  | $          | 10,674,872             |       | $ | 10,612,211 |   |
|                                                                               |       |                   |        |                  |       |                   |       |
| Net loans including AFS                                                            |       | $                      | 391,035,760 |                  | $          | 382,122,753            |       | $ | 377,076,563 |   |
| Total assets                                                                       |       | $                      | 538,434,511 |                  | $          | 536,675,138            |       | $ | 545,171,022 |   |
| Non-accrual loans to net  loans                                                    |       | 2.39                   | %           | 2.59                  | %          | 2.61                   | %          |
| Non-performing assets to net loans, foreclosed real estate and  repossessed assets |       | 2.59                   | %           | 2.79                  | %          | 2.81                   | %          |
| Non-performing assets to  total assets                                             |       | 1.88                   | %           | 1.99                  | %          | 1.95                   | %          |
| Non-performing loans to  net loans                                                 |       | 2.56                   | %           | 2.74                  | %          | 2.73                   | %          |

 

*Accrued interest receivable and other assets*

 

The increase in accrued interest receivableof $237,000 or 13.7% from December 31, 2004 to September 30, 2005 was due tothe timing of cash receipts on interest-earning asset balances.  The increase in other assets of $1,363,000was due primarily an increase in construction in process for expendituresassociated with the Bank’s branch expansion plans.  Generally, upon completion, theseexpenditures will be transferred to bank premises and equipment at which timedepreciation will begin.

 

 

17

----

 

*Deposits*

 

The Bank is a community-based commercialfinancial institution and offers a variety of deposit accounts with a range ofinterest rates and terms.  Depositproducts consist of passbook and statement savings accounts, NOW, money market,demand deposit and certificates of deposit accounts.  The flow of deposits is significantlyinfluenced by general economic conditions, changes in prevailing interest rates,pricing and competition.  Most of theBank’s deposits are obtained from the communities surrounding its 12 branchoffices.  We attempt to attract andretain deposit customers via sales and marketing efforts with new products,quality service, competitive rates and long-standing customer relationships.

 

To determine deposit product interest rates,the Bank considers local competition, market yields and the rates charged foralternative sources of funding such as borrowings.  Although we have experienced a continuedintense competition for deposits, we have not increased rates significantly aswe only consider cost effective strategies while operating in a rising interestrate environment.

 

 

18

----

 

The following table represents the componentsof deposits as of September 30, 2005 and December 31, 2004:

 
| ** **                                | ** ** | **September 30, 2005** | ** **  | **December 31, 2004** | ** ** | **Dollar change** | ** ** | **Percent change** | ** ** |
|-------------------------------------------|------------|------------------------|-------------|-----------------------|------------|-------------------|------------|--------------------|------------|
| **Non-interest-bearing deposits**         |       |                   |        |                  |       |              |       |               |       |
| Personal                                  |       | $                      | 31,445,829  |                  | $          | 28,927,588        |       | $                  | 2,518,241  |   | 8.71 | % |
| Non-personal                              |       | 31,191,738             |        | 29,248,882            |       | 1,942,856         |       | 6.64               | %          |
| Public funds                              |       | 1,232,581              |        | 2,479,373             |       | (1,246,792        | )          | -50.29             | %          |
| Bank checks                               |       | 6,461,436              |        | 4,701,692             |       | 1,759,744         |       | 37.43              | %          |
| Total                                     |       | $                      | 70,331,584  |                  | $          | 65,357,535        |       | $                  | 4,974,049  |   | 7.61 | % |
|                                      |       |                   |        |                  |       |              |       |               |       |
| **Total deposits of $100,000 or greater** |       |                   |        |                  |       |              |       |               |       |
| Personal                                  |       | $                      | 56,231,071  |                  | $          | 61,694,837        |       | $                  | (5,463,766 | ) | -8.86 | % |
| Non-personal                              |       | 17,435,376             |        | 17,749,896            |       | (314,520          | )          | -1.77              | %          |
| Public funds                              |       | 8,690,629              |        | 9,023,956             |       | (333,327          | )          | -3.69              | %          |
| IRA’s                                |       | 4,536,482              |        | 5,517,344             |       | (980,862          | )          | -17.78             | %          |
| Total                                     |       | $                      | 86,893,558  |                  | $          | 93,986,033        |       | $                  | (7,092,475 | ) | -7.55 | % |
| **Other interest-bearing deposits**       |       |                   |        |                  |       |              |       |               |       |
| Time deposits less than  $100,000:        |       |                   |        |                  |       |              |       |               |       |
| Personal                                  |       | $                      | 61,391,784  |                  | $          | 66,918,765        |       | $                  | (5,526,981 | ) | -8.26 | % |
| Non-personal                              |       | 3,563,118              |        | 4,024,801             |       | (461,683          | )          | -11.47             | %          |
| Public funds                              |       | 232,785                |        | 662,876               |       | (430,091          | )          | -64.88             | %          |
| IRA’s                                |       | 17,331,121             |        | 19,090,551            |       | (1,759,430        | )          | -9.22              | %          |
| sub total                                 |       | 82,518,808             |        | 90,696,993            |       | (8,178,185        | )          | -9.02              | %          |
| NOW accounts                              |       | 59,579,838             |        | 41,421,525            |       | 18,158,313        |       | 43.84              | %          |
| Money market deposits                     |       | 18,464,331             |        | 27,606,102            |       | (9,141,771        | )          | -33.12             | %          |
| Savings and clubs                         |       | 51,628,144             |        | 46,547,147            |       | 5,080,997         |       | 10.92              | %          |
| Total                                     |       | $                      | 212,191,121 |                  | $          | 206,271,767       |       | $                  | 5,919,354  |   | 2.87 | % |
| **Total deposits**                        |       |                   |        |                  |       |              |       |               |       |
| Noninterest-bearing  deposits             |       | $                      | 70,331,584  |                  | $          | 65,357,535        |       | $                  | 4,974,049  |   | 7.61 | % |
| Interest-bearing deposits                 |       | 299,084,679            |        | 300,257,800           |       | (1,173,121        | )          | -0.39              | %          |
| Total                                     |       | $                      | 369,416,263 |                  | $          | 365,615,335       |       | $                  | 3,800,928  |   | 1.04 | % |
| **Public funds**                          |       |                   |        |                  |       |              |       |               |       |
| Noninterest-bearing                       |       | $                      | 1,232,581   |                  | $          | 2,479,373         |       | $                  | (1,246,792 | ) | -50.29 | % |
| Certificates of deposit                   |       | 8,923,414              |        | 9,686,832             |       | (763,418          | )          | -7.88              | %          |
| NOW accounts                              |       | 27,330,921             |        | 8,406,827             |       | 18,924,094        |       | 225.10             | %          |
| Money market deposits                     |       | 580,390                |        | 4,710,720             |       | (4,130,330        | )          | -87.68             | %          |
| Savings and clubs                         |       | 888,320                |        | 1,266,834             |       | (378,514          | )          | -29.88             | %          |
| Total                                     |       | $                      | 38,955,626  |                  | $          | 26,550,586        |       | $                  | 12,405,040 |   | 46.72 | % |
|                                      |       |                   |        |                  |       |              |       |               |       |
| Total assets                              |       | $                      | 538,434,511 |                  | $          | 536,675,138       |       |               |       |   |   |
| Total deposits to total  assets           |       | 68.61                  | %           | 68.13                 | %          |              |       |               |       |
| Public funds to total  deposits           |       | 10.55                  | %           | 7.26                  | %          |              |       |               |       |
| Public funds to total  assets             |       | 7.23                   | %           | 4.95                  | %          |              |       |               |       |
|                                           |            |                        |             |                       |            |                   |            |                    |            |  |  |  |  |  |

 

Total deposits increased $3,801,000 or 1.0%during the nine months ended September 30, 2005 to $369,416,000.  The increase in total deposits was primarilydue to an $18,158,000 or 43.8% increase in NOW accounts caused by the receiptand retention of deposits from the public sector including deposits from amunicipal customer who formerly used the Bank’s daily-sweep repurchase agreements.  In addition, savings accounts increased$5,080,000 or 10.9% due mostly to the continued success from marketing our newsavings product programs.  Demand depositaccounts (DDA’s) increased $4,974,000 or 7.6% during the first nine months of2005.  Partially offsetting theseincreases was the continued time deposit outflow, which experienced a declineof $15,271,000 or 8.4% during the nine months ended September 30, 2005, and adecline in money market accounts of $9,142,000 or 33.1% during the same period.  Management believes the decrease in moneymarkets as well as time deposit accounts is due in part to the growth from theBank’s new savings options, the decrease from the public sector and to theoutflow to other alternative financial products.  While Management, along with the Bank’sAsset/Liability Committee, continues to monitor deposit interest rates in ourcommunities, it remains poised to offer deposit rates that are prudent toproducing meaningful interest rate spreads.

 

Total average interest-bearing depositsdecreased $15,031,000 or 4.7% from $316,528,000, at December 31, 2004 to

 

 

19

----

 

$301,497,000 at September 30, 2005.  The average deposit decline included areduction in total time deposits of $28,559,000.  Management’s tactical plan is to continue tomonitor but not actively participate in the current competitive pricingpressure across the entire spectrum of time deposits and will allow high-costlonger termed time deposits to continue to run-off in favor of promoting andgrowing its short-term time deposits and its lower costing transaction andsavings account programs.  Throughcontinued success in marketing efforts, the average balance of these transactionand savings accounts increased by approximately $13,528,000 during the firstnine months of 2005.

 

Public funds continue to be a relativelyconstant source of deposits and now represent $38,955,000 or 10.6% of totaldeposits at September 30, 2005, up from $26,551,000 or 7.3% at December 31, 2004.  The Bank is able to maintain public funds dueto long established relationships and competitive product pricing.  Public fund deposits are sensitive to theoperating demands and business cycles of the various public entities as well asthe forever-changing political landscape. Accordingly, the Bank could experience significant shifts and outflowsof these balances throughout the year.

 

*Borrowings*

 

Borrowings totaled $114,563,000 at September30, 2005 compared to $121,653,000 at December 31, 2004.

 

Borrowings are used as a complement todeposit generation as an alternative funding source whereby the Bank willborrow from the Federal Home Loan Bank of Pittsburgh (FHLB) for asset growthand liquidity needs.  Borrowings included$70,537,000 and $71,119,000 in long-term advances from the FHLB at September30, 2005 and December 31, 2004, respectively. Also included in borrowings is short-term customer repurchase (repos)agreements of $31,438,000 and $40,684,000, at September 30, 2005 and December31, 2004, respectively.  Repos arenon-insured low-cost interest-bearing liabilities that have a security interestin qualified investment securities of the Bank. Repos offered are either fixed-term or a daily-sweep product of theBank.  The balance in customer repos canfluctuate daily because the daily-sweep product is dependent on the level ofavailable funds in depositor accounts. In addition, short-term borrowings may include overnight balances whichthe Bank may require from time-to-time to fund daily liquidity needs.  As of September 30, 2005, the balance in thisaccount was $11,570,000 compared to $8,760,000 at December 31, 2004.

 

The combined short- and long-termweighted-average interest rate on borrowings increased to 4.17% at September30, 2005 compared to 3.57% at December 31, 2004.  The increase in interest rates resultedprimarily from increases in short-term and overnight rates due to the FederalOpen Market Committee (FOMC) actions.

 

*Accrued interest payable and other liabilities*

 

Accrued interest payable and otherliabilities doubled to $6,068,000 during the nine months ended September 30,2005.   The increase was principallycaused by the Bank’s recognition of a purchase obligation in the amount of$2,808,000 caused by a participant’s non-renewal notification of a loanparticipation agreement.  Thistransaction settled on October 18, 2005. Accrued interest payable increased $67,000 while other liabilities andaccrued expenses increased $154,000. Both changes represent fluctuations from normal business transactions.

 

 

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

**SEPTEMBER30, 2005 AND SEPTEMBER 30, 2004**

 

**Overview**

 

Net income for the third quarter of 2005 was$1,294,000, an increase of $480,000 or 59% from the $814,000 recorded in thesame quarter of 2004.  Diluted earningsper share for the same period improved $0.25 from $0.45 for the three monthsended September 30, 2004 to $0.70 for the three months ended September 30,2005.

 

The quarter-to-quarter improvement in netincome was primarily from the results of increases in net interest andnon-interest income and decreases in the provision for loan losses andnon-interest expense.  The provision forincome taxes increased during the comparable periods due to improved earnings.

 

Return on average assets and return onaverage equity were 0.96% and 10.62%, respectively, for the three months endedSeptember 30, 2005 compared to 0.60% and 7.29%, respectively, for the sameperiod in 2004.  The improvement in theseratios is principally due to the improved earnings.

 

 

20

----

 

*Net interest income*

 

Net interest income is the Company’s primarysource of earnings and is influenced primarily by the amount, distribution andre-pricing characteristics of its interest-earning assets and interest-bearingliabilities as well as the relative levels and movements of interest rates.

 

Net interest income increased $344,000, or9%, to $4,362,000 for the third quarter of 2005, from $4,018,000 recorded inthe same period of 2004.  Interest incomeincreased by approximately $586,000 in the third quarter 2005 compared to thethird quarter of 2004.  The increase wasprimarily attributable to a 50 basis point increase in the book yield earned onthe Bank’s interest-earning assets, to 5.76%, for the three months endedSeptember 30, 2005 compared to 5.26% for the three months ended September 30,2004.  The effect of the increase in bookyield more than offset reduced income from the effect of a $5,095,000 decreasein average interest-earning assets that occurred during the respectiveperiod.  The Bank’s diverse portfolio ofinterest earning-assets should continue to benefit from the effect of therising interest rate environment.  Thebook yield on the Bank’s loan portfolio increased 49 basis points due toincreases in the national prime rate, the bench mark rate to which floatingrate loans originate and re-price to, and the pricing of new loanoriginations.  The increase in rate morethan offset the effect of a decline in average balances and netted a $644,000increase in interest income from the loan portfolio for the third quarter of2005 compared to the same quarter in 2004. The investment securities portfolio experienced a 26 basis pointincrease in its book yield in the third quarter of 2005 compared to the secondquarter of 2004.  However, because of a$14,088,000 decline in average balance, this portfolio’s interest incomedeclined by approximately $58,000 in the third quarter of 2005 compared to thesame 2004 quarter.

 

During the third quarter of 2005, interestexpense increased $242,000 to $2,962,000 from $2,720,000 for the same 2004quarter.  The increasing rate environmenthas necessitated the need for the Bank to increase offering rates on variousdeposit products as well as recognition of higher interest charges fromrepurchase agreements (repos) and other borrowing sources.  Rates paid on average interest-bearingliabilities increased 30 basis points and offset the effect of an $11,761,000decline in the average balances upon which they are paid.  The continued decline in average balances incertificate of deposit accounts (CD’s) compounded with increases in low-costtransaction and savings account balances should help strengthen the Bank’sperformance.  Compared to the thirdquarter of 2004, the Bank experienced an increase in the average balances oflower-costing transaction and savings accounts and a decrease in the averagebalances of CD’s and repos during the third quarter of 2005.  The growth in the savings accounts was causedby the success of the Bank’s continued efforts in the promotion of new savingsproducts.  The decrease in averagebalances of repos was caused by the cyclical nature of the sweep account andpreference for exiting the repo product in favor of one of the Bank’salternative interest-bearing checking accounts as was the case for a municipalcustomer.  In the near-term, Management’sfocus will be to continue to attract and retain low-cost transaction andshort-term CD accounts.

 

For the third quarter of 2005, the Bank’stax-equivalent spread and margin increased 23 and 33 basis points,respectively, to 3.03% and 3.55% compared to 2.80% and 3.22% for the thirdquarter of 2004.  The increase in spreadand margin is the result of the impact the increasing rate environment has hadon the performance of the Bank’s portfolio of interest-earning assets.  Increases in rates at the short end of therelatively flat yield curve will continue to pressure the Bank’s interest ratespread and margin as the competition for deposits will continue tointensify.  However, any periodicincreases in national prime should continue to bolster the performance of theBank’s interest income.

 

 

21

----

 

The following table sets forth, a comparisonof average balance sheet amounts and their corresponding tax-equivalentinterest income and expense and annualized tax-equivalent yield and cost forthe periods indicated (dollars in thousands):

 

| ** **                                    | ** ** | **Three months ended** | ** ** | **Nine months ended** | ** ** | **Year ended**   | ** ** |
|-----------------------------------------------|------------|------------------------|------------|-----------------------|------------|------------------|------------|
| ** **                                    | ** ** | **September 30,**      | ** ** | **September 30,**     | ** ** | **December 31,** | ** ** |
| ** **                                    | ** ** | **2005**               | ** ** | **2004**              | ** ** | **2005**         | ** ** | **2004** | ** ** | **2004** | ** ** |
| Average interest-earning  assets:             |       |                   |       |                  |       |             |       |   |   |   |   |
| Loans and leases                              |       | $                      | 390,829    |                  | $          | 381,227          |       | $ | 387,754 |   | $ | 387,981 |   | $ | 387,292 |   |
| Investments                                   |       | 113,632                |       | 127,720               |       | 115,842          |       | 134,180 |   | 132,130 |   |
| Federal funds sold                            |       | —                 |       | 308                   |       | 2,451            |       | 1,572 |   | 1,530 |   |
| Interest-bearing deposits                     |       | 400                    |       | 701                   |       | 650              |       | 651 |   | 637 |   |
| Total                                         |       | $                      | 504,861    |                  | $          | 509,956          |       | $ | 506,697 |   | $ | 524,384 |   | $ | 521,589 |   |
|                                          |       |                   |       |                  |       |             |       |   |   |   |   |
| Average interest-bearing  liabilities:        |       |                   |       |                  |       |             |       |   |   |   |   |
| Other interest-bearing  deposits              |       | $                      | 128,830    |                  | $          | 110,946          |       | $ | 124,853 |   | $ | 110,741 |   | $ | 111,325 |   |
| Certificates of deposit                       |       | 170,893                |       | 197,586               |       | 176,644          |       | 210,437 |   | 205,203 |   |
| Borrowed funds                                |       | 84,309                 |       | 76,668                |       | 78,909           |       | 78,103 |   | 78,318 |   |
| Repurchase agreements                         |       | 29,686                 |       | 40,279                |       | 37,029           |       | 41,071 |   | 41,695 |   |
| Total                                         |       | $                      | 413,718    |                  | $          | 425,479          |       | $ | 417,435 |   | $ | 440,352 |   | $ | 436,541 |   |
|                                          |       |                   |       |                  |       |             |       |   |   |   |   |
| Interest income:                              |       |                   |       |                  |       |             |       |   |   |   |   |
| Loans and leases                              |       | $                      | 6,202      |                  | $          | 5,535            |       | $ | 17,963 |   | $ | 16,741 |   | $ | 22,431 |   |
| Investments(1)                                |       | 1,270                  |       | 1,301                 |       | 3,773            |       | 4,078 |   | 5,385 |   |
| Federal funds sold                            |       | —                 |       | 1                     |       | 47               |       | 11 |   | 17 |   |
| Interest-bearing deposits                     |       | 3                      |       | 2                     |       | 12               |       | 4 |   | 6 |   |
| Total                                         |       | $                      | 7,475      |                  | $          | 6,839            |       | $ | 21,795 |   | $ | 20,834 |   | $ | 27,839 |   |
|                                          |       |                   |       |                  |       |             |       |   |   |   |   |
| Interest expense:                             |       |                   |       |                  |       |             |       |   |   |   |   |
| Other interest-bearing  deposits              |       | $                      | 419        |                  | $          | 186              |       | $ | 1,006 |   | $ | 547 |   | $ | 742 |   |
| Certificates of deposit                       |       | 1,327                  |       | 1,418                 |       | 3,972            |       | 4,628 |   | 5,994 |   |
| Borrowed funds                                |       | 1,067                  |       | 997                   |       | 2,980            |       | 2,973 |   | 3,980 |   |
| Repurchase agreements                         |       | 149                    |       | 119                   |       | 487              |       | 324 |   | 464 |   |
| Total                                         |       | $                      | 2,962      |                  | $          | 2,720            |       | $ | 8,445 |   | $ | 8,472 |   | $ | 11,180 |   |
|                                          |       |                   |       |                  |       |             |       |   |   |   |   |
| Net interest income                           |       | $                      | 4,513      |                  | $          | 4,119            |       | $ | 13,350 |   | $ | 12,362 |   | $ | 16,659 |   |
|                                          |       |                   |       |                  |       |             |       |   |   |   |   |
| Yield on average  interest-earning assets     |       | 5.87                   | %          | 5.34                  | %          | 5.75             | %          | 5.31 | % | 5.34 | % |
| Rate on average  interest-bearing liabilities |       | 2.84                   | %          | 2.54                  | %          | 2.70             | %          | 2.57 | % | 2.56 | % |
| Net interest spread                           |       | 3.03                   | %          | 2.80                  | %          | 3.05             | %          | 2.74 | % | 2.78 | % |
| Net interest margin                           |       | 3.55                   | %          | 3.22                  | %          | 3.52             | %          | 3.15 | % | 3.19 | % |

 

----

(1)          The 2004 taxequivalent calculations were adjusted to eliminate the effect attributable tothe dividend from the Federal Home Loan Bank.

 

In the table above, interest income was adjusted to a tax-equivalentbasis to recognize the income from the various tax-exempt assets as if theinterest was fully taxable.  Thistreatment allows a uniform comparison among the yields on interest-earningassets.  The calculations were computedon a fully tax-equivalent basis using the corporate federal tax rate of34%.  Net interest spread represents thedifference between the yield on interest-earning assets and the rate oninterest-bearing liabilities.  Netinterest margin represents the ratio of net interest income to total averageinterest-earning assets.

 

 

22

----

 

 

*Provision for loan losses*

 

The provision for loan losses represents thenecessary amount to charge against current earnings, the purpose of which is toincrease the allowance for loan losses to a level that represents Management’sbest estimate of known and inherentlosses in the Bank’s loan portfolio.  Loans and leases determined to beuncollectible are charged-off against the allowance for loan losses.

 

The required amount of the provision for loanlosses, based upon the adequate level of the allowance for loan losses, issubject to ongoing analysis of the loan portfolio. The Bank maintains a SpecialAsset Committee which meets periodically to review problem loans and leases.The committee is comprised of Bank management, including the creditadministration officer, loan workout officers and collection personnel.  The committee reports quarterly to the CreditAdministration Committee of the Board of Directors.

 

Management continuously reviews the risksinherent in the loan and lease portfolio. Specific factors used to evaluate the adequacy of the loan lossprovision during the formal process include:

 

•                  Specific loans that couldhave loss potential

•                  Levels of and trends indelinquencies and non-accrual loans

•                  Levels of and trends in charge-offsand recoveries

•                  Trends in volume and termsof loans

•                  Changes in risk selectionand underwriting standards

•                  Changes in lending policies,procedures and practices

•                  Experience, ability anddepth of lending personnel

•                  National and local economictrends and conditions

•                  Changes in creditconcentrations

 

The provision for loan losses was $300,000,for the three months ended September 30, 2005, compared to $450,000 for thethree months ended September 30, 2004. The decrease in the provision for loan losses were due to increasedrecoveries along with the reduced charge-off level of non-performing loans,which consist of loans past due 90 days or more and non-accrual loans.  In addition, certain non-accrual loanbalances were reduced and therefore require a reduced level of allowance forloan losses.  The balance ofnon-performing loans declined by $272,000 to $10,015,000 at September 30, 2005compared to $10,287,000 at September 30, 2004. The non-accrual component of non-performing loans decreased $471,000during that period.  Further, the balanceof delinquent loans past due less than 90 days declined by $1,395,000 to$2,397,000 at September 30, 2005 compared to $3,792,000 at September 30, 2004.  The Bank’s enhanced collection departmentstaff has become more aggressive in the collection of delinquent balancesthereby preventing larger volumes of past due accounts from migrating tonon-performing status which in turn necessitates a lower allowance for loanlosses.

 

*Other income*

 

Other (non-interest) income consists ofservice charges or fees collected on the Bank’s various deposit and loanproducts, net mortgage servicing revenue, fees from trust, asset management andother financial services, the increase in the cash surrender value ofbank-owned life insurance (BOLI), the net realized gains and losses from thesales of investment securities, loans, leased assets and foreclosed assets heldfor sale and other various classifications of non-interest related income.

 

Total other income increased $79,000, or 7%for the three months ended September 30, 2005 compared to the same period in2004.  Service charges on depositaccounts grew by $135,000 or 24% due to the heightened effort to better managethe collection of overdraft and service fees along with increased electronicbanking related revenue.  Sales of loansinto the secondary market have declined significantly in 2005 as compared to2004.  The Bank has been absent of asizable AFS loan portfolio since the restructure of the combined loan portfolioand resulting transfer of loans AFS to the HTM portfolio in the latter part of2004.  For the first time in 2005, theBank sold mortgage loans, into the secondary market, during the third quarter.  While operating in an increasing rateenvironment, the Bank will be more poised to sell newly originated fixed-rateresidential mortgages.  The losses fromsales of leased assets have also declined as a result of the establishment of alease loss reserve, during the first quarter of 2005.  See below, “Other income,” under the caption “Comparisonof Results of Operations for the Nine months Ended September 30, 2005 andSeptember 30, 2004” for further discussion on the lease loss reserve.  The $37,000 improvement from the sale offoreclosed property was due to insurance proceeds received, from a claim andthe subsequent sale of the land.  Fees,other service charges and other non-interest related income decreased $114,000or 20% principally from reduced trust

 

 

23

----

 

and financial services fees, a decrease inloan servicing charges and a reduction of the benefit crediting rates to thecash surrender value of BOLI during the third quarter of 2005 compared to thesame period of 2004.

 

*Other operating expenses*

 

Other (non-interest) expenses decreased$67,000, or 2% for the three months ended September 30, 2005 compared to thesame period in 2004.  Other expensesdeclined $124,000 or 16% due primarily to a reduction in the recognition of settlementexpenses.  The Bank established asettlement reserve in 2004 for future obligations related to certain retirementbenefits.  During the third quarter of2005, the reserve was increased by approximately $58,000 due to increasedmedical insurance premiums and a decrease in the discount rate used tocalculate future benefit costs.  Thiscompares to $198,000 recognized in the third quarter of 2004.  This was partially offset by increasedcollection expenses incurred caused by the sustained and aggressive pursuit ofnon-performing assets.  Advertisingdecreased during the third quarter of 2005 compared to the third quarter of2004 because more of the sales campaigns, initiatives, programs andsponsorships were concentrated in the first half of the year which the Bank hasdetermined to be more representative of its marketing cycle.  Compared to the third quarter of 2004,premises and equipment expenses are up due to increased depreciation andincreased equipment maintenance. Professional service fees increased due to increased fees related to theBank’s continued activities related to Sarbanes-Oxley §404 compliance process.

 

*Income tax provision*

 

An increase in pre-tax income of $641,000 resulted in an increased taxprovision of $160,000 in the third quarter of 2005 compared to the third 2004quarter.  The effective federal incometax rate was 23.8% and 23.1% for the respective quarters.  The effective tax rate increase isattributable to a decrease in combined tax-free income as a ratio to totalpre-tax income.

 

 

**COMPARISON OF RESULTS OF OPERATIONS FOR THE NINE MONTHS ENDED**

**SEPTEMBER30, 2005 AND SEPTEMBER 30, 2004**

 

**Overview**

 

Net income for the nine months endedSeptember 30, 2005 was $3,450,000, an increase of $1,091,000 or 46% from the$2,359,000 recorded for the nine months ended September 30, 2004.  Diluted earnings per share for the sameperiod improved $0.58 from $1.29 for the nine months ended September 30, 2004to $1.87 for the nine months ended September 30, 2005.

 

The period improvement in net income wasprimarily from the result of an increase in net interest income and a decreasein the provision for loan losses.   Theseitems were partially offset by a decrease in non-interest income and increasesin non-interest expense and the provision for income taxes.

 

Return on average assets and return onaverage equity were 0.86% and 9.73%, respectively, for the nine months endedSeptember 30, 2005 compared to 0.57% and 7.11%, respectively, for the sameperiod in 2004.  The improvement in theseratios is primarily due to improved earnings.

 

*Net interest income*

 

Net interest income increased $914,000, or8%, to $12,956,000 for the nine months ended September 30, 2005, from$12,042,000 recorded for the nine months ended September 30, 2004.  The increase was primarily due to a 42 basispoint increase in the book yield earned on the Bank’s interest-earning assets,to 5.65%, for the nine months ended September 30, 2005 compared to 5.23% forthe first nine months of 2004.  Theincrease in yield more than offset reduced income from the effect of a $17,687,000decrease in average interest-earning assets. The periodic increases in the national prime rate resulted in a 41 basispoint increase in yield from the Bank’s loan portfolio during the nine monthsended September 30, 2005 compared to the same 2004 period.  During the same period, the average earningbalances of the loan portfolio decreased modestly.  The investment securities portfolioregistered a 24 basis point increase in book yield during the nine months endedSeptember 30, 2005 compared to same 2004 period; however, a $18,338,000 declinein their average balances has more than offset the income effect of theincrease in yield and has resulted in a decline in interest income in theinvestment securities portfolio of $327,000.

 

For the nine months ended September 30, 2005,total interest expense decreased $27,000 to $8,445,000 from $8,472,000 for thesame 2004 period.  Despite a 13 basispoint increase in the combined rate paid on average interest-bearing liabilities,interest expense declined due to a $22,917,000 net decrease in the averagebalances of interest-bearing liabilities 

 

 

24

----

 

during the first nine months of 2005 comparedto the same 2004 period.  A $33,793,000decreases in average balances of CD’s were the primary factor in the netaverage balance decrease.  The decreasein average CD balances were partially offset by lower costing savings andtransaction accounts which increased by approximately $14,112,000 in the firstnine months of 2005 compared to the same period of 2004.

 

For the nine months ended September 30, 2005,the Bank’s tax-equivalent spread and margin increased 31 and 37 basis points,respectively, to 3.05% and 3.52% compared to 2.74% and 3.15% for the ninemonths ended September 30, 2004.  Theincrease in spread and margin is primarily due the increase in the interestrate environment currently favoring the Bank’s interest-earning assets and adecrease in average interest-bearing liabilities.  Notwithstanding a flat interest rate yieldcurve, a continuance of increases in national prime coupled with prolongedsuccess in the Bank’s ability to continue to attract lower costing transactionand savings account should have a positive effect on the performance of theBank’s interest rate spread and margin.

 

*Provision for loan losses*

 

The provision for loan losses was $680,000,for the nine months ended September 30, 2005, compared to $1,700,000 for thenine months ended September 30, 2004. The substantial reduction in the provision for loan losses is based uponManagement’s assessment of the current loan portfolio.  Many of the non-performing loans from the2004 period have been provided for in the allowance and some have been writtendown, therefore, additional provisions at prior levels was no longer deemednecessary.   In addition, our collectionsdepartment has been working diligently on past due and delinquent loans.  This has resulted in the level of total pastdue loans over 30 days declining by $1,197,000 to $3,051,000 at September 30,2005 compared to $4,248,000 at September 30, 2004.  During the same period, non-accrual loansalso declined by $470,000 to $9,361,000 from $9,831,000.

 

*Other income*

 

Total other income decreased $64,000, or 2%for the nine months ended September 30, 2005 compared to the same period in2004.  During the first quarter the Bankrecognized an estimated impairment charge of $220,000 in anticipation ofprojected realized losses from the future sales of its leased vehicles.  The estimated losses were based on thehistorical performance of terminated lease contracts that were typically soldbelow their residual value.  The balanceof the Bank’s leased vehicles should mature or pay-off during 2005.  Service charges on deposit accounts grew by$341,000 or 21% due to the improved collection of account maintenance andoverdraft fees charged to customers as well as improvements in revenue fromelectronic banking.  For the nine monthsended September 30, 2005, the Bank recorded a $1,000 net gain from the sales ofloans AFS, compared to $155,000 for the nine months ended September 30,2004.  The $154,000 variance was dueprimarily to the 2004 balance sheet restructure that resulted, in part, in thesale of a sizable portfolio of profitable mortgage loans into the secondarymarket.  Fees, other service charges andother non-interest related income decreased $256,000 or 16% in the first ninemonths of 2005, principally from reduced benefit crediting rates to the cashsurrender value of the BOLI and from decreased fees from both trust andfinancial services.

 

 *Other operating expenses*

 

Other expenses increased $297,000 or 3% forthe nine months ended September 30, 2005 compared to the same period in2004.  Professional service feesincreased $215,000, or 25% due to increased fees related to the Bank’s requiredindependent financial audits, Sarbanes-Oxley §404 compliance process, the costfor the Bank-wide participation in management skills development and salestraining programs and increased FDIC assessments.  Advertising expenses for the first ninemonths of 2005 increased $104,000 or 34% from the same period in of 2004.  The Bank has concentrated its marketingeffort with added initiatives for Bank product, use of alternative media advertising,bank-wide signage, new demographic related research tools, a new website andmore Bank sponsored events than in the prior year.  Variances in other operating expenses, forthe comparable periods included a decrease in settlement expense accruals andincreases in ancillary training expense for the management skills and salestraining programs, an increase in Pennsylvania shares tax and an increase inOREO and collection related expenses.

 

*Income tax provision*

 

Income before provision for income taxes increased $1,573,000 for thenine months ended September 30, 2005 compared to the nine months endedSeptember 30, 2004.  As a result, theBank’s income tax provision increased $483,000 during the same period.  The effective federal income tax rate was25.2% and 22.3% for the respective periods. The effective tax rate increase is attributable to a lower proportion ofcombined tax-free interest income to total pre-tax earnings.

 

 

25

----

 

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

 

*Management of interest rate risk and market risk analysis*

 

The Company is subject to the interest rate risks inherent in ourlending, investing and financing activities. Fluctuations of interest rates will impact interest income and interestexpense along with affecting market values of all interest-earning assets andinterest-bearing liabilities, except for those assets or liabilities with ashort-term remaining to maturity. Interest rate risk management is an integral part of the asset/liabilitymanagement process.  The Company hasinstituted certain procedures and policy guidelines to manage the interest raterisk position.  Those internal policiesenable the Company to react to changes in market rates to protect net interestincome from significant fluctuations. The primary objective in managing interest rate risk is to minimize theadverse impact of changes in interest rates on net interest income along withcreating an asset/liability structure that maximizes earnings.

 

*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 Boardmembers.  ALCO meets quarterly to monitorthe ratio of interest sensitive assets to interest sensitive liabilities.  The process to review interest rate risk is aregular part of managing the Company. Consistent policies and practices of measuring and reporting interestrate risk exposure, particularly regarding the treatment of non-contractualassets and liabilities, are in effect. In addition, there is an annual process to review the interest rate riskpolicy with the Board of Directors which includes limits on the impact toearnings from shifts in interest rates.

 

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

 

*StaticGap:* The ratio between assets and liabilities re-pricing in specific timeintervals is referred to as an interest rate sensitivity gap.  Interest rate sensitivity gaps can be managedto take advantage of the slope of the yield curve as well as forecasted changesin the level of interest rate changes.

 

Tomanage this interest rate sensitivity position, an asset/liability model called‘cumulative gap analysis’ is used to monitor the difference in the volume ofthe Company’s interest sensitive assets and liabilities that mature or re-pricewithin given periods.  A positive gap(asset sensitive) indicates that more assets re-price during a given periodcompared to liabilities, while a negative gap (liability sensitive) has theopposite effect.  The Company employscomputerized net interest income simulation modeling to assist in quantifyinginterest rate risk exposure.  Thisprocess measures and quantifies the impact on net interest income throughvarying 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 September 30, 2005, the Company maintained a one-year cumulativenegative gap of $2,083,000 million or -0.39% of total assets.  The effect of this negative gap positionprovided a mismatch of assets and liabilities, which may expose the Bank to anincreased interest rate risk position during a period of increasing interestrates.  Conversely, in a decreasing interestrate environment, net income could be positively affected because moreliabilities will re-price downward during a one-year period.

 

 

26

----

The following table illustrates the Company’s interest sensitivity gapposition at September 30, 2005 (dollars in thousands):

 
| ** **                                   | ** ** | **3 months** | ** ** | **3  through** | ** ** | **1  through** | ** ** | **Over**    | ** ** | ** ** | ** ** |
|----------------------------------------------|------------|--------------|------------|----------------|------------|----------------|------------|-------------|------------|------------|------------|
|                                         |       | **or less**  | ** ** | **12  months** | ** ** | **3 years**    | ** ** | **3 years** | ** ** | **Total**  |       |
| Cash and cash equivalents                    |       | $            | 134        |           | $          | —         |       | $           | —     |       | $          | 10,828 |   | $ | 10,962 |   |
| Investment securities(1)(2)                  |       | 8,025        |       | 14,172         |       | 28,000         |       | 56,531      |       | 106,728    |       |
| Loans(2)                                     |       | 130,619      |       | 69,434         |       | 89,570         |       | 101,413     |       | 391,036    |       |
| Fixed and other assets                       |       | —       |       | 7,816          |       | —         |       | 21,893      |       | 29,709     |       |
| Total assets                                 |       | $            | 138,778    |           | $          | 91,422         |       | $           | 117,570    |       | $          | 190,665 |   | $ | 538,435 |   |
| Total cumulative assets                      |       | $            | 138,778    |           | $          | 230,200        |       | $           | 347,770    |       | $          | 538,435 |   |   |   |
|                                         |       |         |       |           |       |           |       |        |       |       |       |
| Non-interest bearing transaction deposits(3) |       | $            | —     |           | $          | 7,027          |       | $           | 19,343     |       | $          | 43,963 |   | $ | 70,333 |   |
| Interest-bearing transaction deposits(3)     |       | 24,046       |       | 52,813         |       | 41,755         |       | 11,057      |       | 129,671    |       |
| Time deposits                                |       | 32,989       |       | 71,899         |       | 43,636         |       | 20,888      |       | 169,412    |       |
| Repurchase agreements                        |       | 21,158       |       | 3,939          |       | 6,340          |       | —      |       | 31,437     |       |
| Short-term borrowings                        |       | 12,589       |       | —         |       | —         |       | —      |       | 12,589     |       |
| Long-term debt                               |       | 5,206        |       | 617            |       | 1,646          |       | 63,068      |       | 70,537     |       |
| Other liabilities                            |       | —       |       | —         |       | —         |       | 6,069       |       | 6,069      |       |
| Total liabilities                            |       | $            | 95,988     |           | $          | 136,295        |       | $           | 112,720    |       | $          | 145,045 |   | $ | 490,048 |   |
| Total cumulative liabilities                 |       | $            | 95,988     |           | $          | 232,283        |       | $           | 345,003    |       | $          | 490,048 |   |   |   |
|                                         |       |         |       |           |       |           |       |        |       |       |       |
| Interest sensitivity gap                     |       | $            | 42,790     |           | $          | (44,873        | )          | $           | 4,850      |       | $          | 45,620 |   |   |   |
|                                         |       |         |       |           |       |           |       |        |       |       |       |
| Cumulative gap                               |       | $            | 42,790     |           | $          | (2,083         | )          | $           | 2,767      |       | $          | 48,387 |   |   |   |
|                                         |       |         |       |           |       |           |       |        |       |       |       |
| Cumulative gap to total  assets              |       | 7.95         | %          | -0.39          | %          | 0.51           | %          | 8.99        | %          |       |       |
|                                              |            |              |            |                |            |                |            |             |            |            |            |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |

 

----

(1)                                      Includes netunrealized gains/losses on securities AFS.

 

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

 

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

 

Certainshortcomings are inherent in the method of analysis presented in the abovetable.  Although certain assets andliabilities may have similar maturities or periods of re-pricing, they mayreact in different degrees to changes in market interest rates.  The interest rates on certain types of assetsand liabilities may fluctuate in advance of changes in market interest rates,while interest rates on other types of assets and liabilities may lag behindchanges in market interest rates. Certain assets, such as adjustable-rate mortgages, have features whichrestrict changes in interest rates on a short-term basis and over the life ofthe loan.  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.

 

*Earningsat Risk and Economic Value at Risk Simulations:* The Company recognizes thatmore sophisticated tools exist for measuring the interest rate risk in thebalance sheet beyond static re-pricing gap analysis.  Although it will continue to measure itsre-pricing gap position, the Company utilizes additional modeling for identifyingand measuring the interest rate risk in the overall balance sheet.  The ALCO is responsible for focusing on “earningsat risk” and “economic value at risk”, and how both relate to the risk-basedcapital position when analyzing the interest rate risk.

 

*Earningsat Risk:* Earnings at risk simulation measures the change innet interest income and net income should interest rates rise and fall.  The simulation recognizes that not all assetsand liabilities re-price one-for-one with market rates (e.g., savingsrate).  The ALCO looks at “earnings atrisk” to determine income changes from a base case scenario under an increaseand decrease of 200 basis points in interest rate simulation models.

 

*EconomicValue at Risk:* Earnings at risk simulation measure the short-termrisk in the balance sheet.  Economicvalue (or portfolio equity) at risk measures the long-term risk by finding thenet present value of the future cash flows from 

 

27

----

 

theCompany’s existing assets and liabilities. The ALCO examines this ratio quarterly utilizing an increase anddecrease of 200 basis points in interest rates simulation model.  The ALCO recognizes that, in some instances,this ratio may contradict the “earnings at risk” ratio.

 

The following tableillustrates the simulated impact of 200 basis points upward or downwardmovement in interest rates on net interest income, net income and the change ineconomic value (portfolio equity).  Thisanalysis assumed that interest-earning asset and interest-bearing liability levelsat September 30, 2005 remained constant. The impact of the rate movements was developed by simulating the effectof the rate change over a twelve-month period from the September 30, 2005levels:

 
| ** **                                           | ** ** | **Rates +200** | ** ** | **Rates -200** | ** ** |
|------------------------------------------------------|------------|----------------|------------|----------------|------------|
| Earnings at risk:                                    |       |           |       |           |       |
| Percent change in:                                   |       |           |       |           |       |
| Net interest income                                  |       | 5.8            | %          | (14.1          | )%         |
| Net income                                           |       | 15.0           |       | (35.3          | )          |
|                                                 |       |           |       |           |       |
| Economic value at risk:                              |       |           |       |           |       |
| Percent change in:                                   |       |           |       |           |       |
| Economic value of equity                             |       | (17.6          | )          | (7.9           | )          |
| Economic value of equity as a percent of book assets |       | (1.9           | )          | (0.9           | )          |

 

Economic value has the mostmeaning when viewed within the context of risk-based capital.  Therefore, the economic value may changebeyond the Company’s policy guideline for a short period of time as long as therisk-based capital ratio, after adjusting for the excess equity exposure, isgreater than 10%.  At September 30, 2005,the Company’s total risk-based capital ratio was 13.7%.

 

The table below summarizes estimated changesin net interest income over a twelve-month period beginning October 1, 2005,under alternate interest rate scenarios using the income simulation modeldescribed above:

 
| ** **                   | ** ** | **Net interest**           | ** ** | **Dollar**   | ** ** | **Percent**  | ** ** |
|------------------------------|------------|----------------------------|------------|--------------|------------|--------------|------------|
| **Change in interest rates** | ** ** | **income**                 | ** ** | **variance** | ** ** | **variance** | ** ** |
| ** **                   | ** ** | **(dollars in thousands)** | ** ** | ** **   | ** ** |
| +200 basis points            |       | $                          | 20,206     |         | $          | 1,100        |       | 5.8 | % |
| +100 basis points            |       | 19,655                     |       | 549          |       | 2.9          |       |
| Flat rate                    |       | 19,106                     |       | —       |       | —       |       |
| -100 basis points            |       | 18,110                     |       | (996         | )          | (5.2         | )          |
| -200 basis points            |       | 16,411                     |       | (2,695       | )          | (14.1        | )          |
|                              |            |                            |            |              |            |              |            |  |  |

 

Simulation models require assumptions aboutcertain categories of assets and liabilities. The models schedule existing assets and liabilities by their contractualmaturity, estimated likely call date or earliest re-pricing opportunity.  Mortgage-backed securities and amortizingloans are scheduled based on their anticipated cash flow including estimatedprepayments.  For investment securities,we use a third party service to provide cash flow estimates in the various rateenvironments.  Savings accounts,including passbook, statement savings, money market and interest checking accountsdo not have a stated maturity or re-pricing term and can be withdrawn orre-price at any time.  This may impactthe margin if more expensive alternative sources of deposits are required tofund loans or deposit run-off. Management projects the re-pricing characteristics of these accountsbased on historical performance and assumptions that it believes reflect theirrate sensitivity.  The simulation modelreinvests all maturities, repayments and prepayments for each type of asset orliability into the same product for a new like-term and maintains the size andrelative relationships of assets and liabilities with similar re-pricingcharacteristics.  As a result, the mix ofinterest-earning assets and interest bearing-liabilities is held constant.

 

 

28

----

 

*Liquidity*

 

Liquidity management ensuresthat adequate funds will be available to meet customers’ needs for borrowings,deposit withdrawals and maturities and normal operating expenses of theBank.  Current sources of liquidity are cashand cash equivalents, asset maturities and pay downs within one year, loans andinvestments AFS, growth of core deposits, growth of repurchase agreements,increase of other borrowed funds from correspondent banks and issuance ofcapital stock.  Although regularlyscheduled investment and loan payments are dependable sources of daily funds,the sale of loans and investment securities AFS, deposit activity, andinvestment and loan prepayments are significantly influenced by generaleconomic conditions and the level of interest rates.

 

At September 30, 2005, the Company maintained $10,962,000 in cash andcash equivalents. The Company also had $104,504,000 in investments AFS and$697,000 of loans AFS. This combined total of $105,201,000 representedapproximately 20% of total assets at September 30, 2005. In addition, as ofSeptember 30, 2005, the Company had approximately $79,396,000 available toborrow from the FHLB. Management believes that the present level of liquidityremains strong and adequate for current operations.

 

*Capital*

 

The Company is subject to various regulatory capital requirementsadministered by the federal banking agencies. Failure to meet minimum capitalrequirements can initiate certain mandatory and possible additionaldiscretionary actions by regulators that, if undertaken, could have a directmaterial effect on the Company’s financial statements. Under capital adequacyguidelines and the regulatory framework for prompt corrective action, theCompany must meet specific capital guidelines that involve quantitativemeasures of the Company’s assets, liabilities and certain off-balance-sheetitems as calculated under regulatory accounting practices.  The Company’s capital amounts andclassification are also subject to qualitative judgments by the regulatorsabout components, risk-weightings and other factors.

 

Capital is fundamental to support ourcontinued growth. In addition, the Company and Bank are subject to variousregulatory capital requirements. Regulatory capital is defined in terms of TierI capital (shareholders’ equity plus the allowable portion of the minorityinterest in equity of subsidiaries, minus unrealized gains or plus unrealizedlosses on AFS, and minus certain intangible assets), Tier II capital (whichincludes the allowable portion of the allowance for loan losses, minorityinterest in equity of subsidiaries and subordinated debt), and total capital(Tier I plus Tier II). Risk-based capital ratios are expressed as percentagesof risk-weighted assets.  Risk-weightedassets are determined by assigning various weights to all assets andoff-balance sheet financial instruments, such as letters of credit and loancommitments, based on associated risk. Regulators have also adopted minimum Tier I leverage ratio standards,which measure the ratio of Tier I capital to total average quarterly assets.

 

Quantitative measures, established by regulation to ensure capitaladequacy, require the Company to maintain minimum amounts and ratios of totaland Tier I capital to risk-weighted assets, and of Tier I capital to averageassets.  Capital is evaluated in relationto total assets and the risk associated with those assets.  As of September 30, 2005, the Company exceedsall capital adequacy requirements to which it is subject.

 

 

29

----

 

The following table depicts the capital amounts and ratios of theCompany and the Bank as of September 30, 2005:

 
| ** **                                | ** ** | **Actual** | ** ** | **For capital adequacy purposes** | ** ** | **To be well capitalized under prompt corrective action provisions** | ** ** |
|-------------------------------------------|------------|------------|------------|-----------------------------------|------------|----------------------------------------------------------------------|------------|
| ** **                                | ** ** | **Amount** | ** ** | **Ratio**                         | ** ** | **Amount**                                                           | ** ** | **Ratio** | ** ** | **Amount** | ** ** | **Ratio** | ** ** |
| Total capital  (to risk-weighted assets)  |       |       |       |                              |       |                                                                 |       |   |   |   |   |   |   |
| Consolidated                              |       | $          | 54,106,517 |                              | 13.66      | %                                                                    | $          | 31,687,810 |   | 8.00 | % | N/A |   | N/A |   |
| Bank                                      |       | $          | 53,795,990 |                              | 13.58      | %                                                                    | $          | 31,689,700 |   | 8.00 | % | $ | 39,612,125 |   | 10.00 | % |
| Tier I capital  (to risk-weighted assets) |       |       |       |                              |       |                                                                 |       |   |   |   |   |   |   |
| Consolidated                              |       | $          | 49,067,311 |                              | 12.39      | %                                                                    | $          | 15,843,905 |   | 4.00 | % | N/A |   | N/A |   |
| Bank                                      |       | $          | 48,825,793 |                              | 12.33      | %                                                                    | $          | 15,844,850 |   | 4.00 | % | $ | 23,767,275 |   | 6.00 | % |
| Tier I Capital  (to average assets)       |       |       |       |                              |       |                                                                 |       |   |   |   |   |   |   |
| Consolidated                              |       | $          | 49,067,311 |                              | 9.20       | %                                                                    | $          | 21,338,264 |   | 4.00 | % | N/A |   | N/A |   |
| Bank                                      |       | $          | 48,825,793 |                              | 9.16       | %                                                                    | $          | 21,320,158 |   | 4.00 | % | $ | 26,650,197 |   | 5.00 | % |

 

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

 

The Company maintains controls and procedures designed to ensure thatinformation required to be disclosed in the reports that the Company files orsubmits under the Securities Exchange Act of 1934 is recorded, processed,summarized and reported within the time periods specified in the rules andforms of the Securities and Exchange Commission. Based upon their evaluation ofthose controls and procedures as of the end of the period covered by thisreport, the Chief Executive Officer and Chief Financial Officer of the Companyconcluded that the Company’s disclosure controls and procedures were adequate. Therehave been no changes to the Company’s internal control over financial reportingduring the third quarter of 2005.

 

 

**PART II. Other Information**

 

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

 

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

 

 

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

                          None

 

 

**Item3.        Default upon Senior Securities**

                          None

 

 

**Item4.         Submission of Matters to aVote of Security Holders**

                          None

 

30

----

 

**Item 5.         Other Information**

                          None

 

 

**Item 6.       Exhibits**

 

     Exhibits

***3(i)******                                  ******Amended and Restated Articles of Incorporation of Registrant.***Incorporated byreference to Exhibit 3(i) to Registrant’s Registration Statement No. 333-90273on Form S-4, filed with the SEC on November 3, 1999 and as amended on April 6,2000.

 

***3(ii)******                              ******Bylawsof Registrant.***Incorporated by reference to Exhibit 3(ii) toRegistrant’s Registration Statement No. 333-90273 on Form S-4, filed with theSEC on November 3, 1999 and as amended on April 6, 2000.

 

***10.1******                             ******1998Independent Directors Stock Option Plan of The Fidelity Deposit and DiscountBank, as assumed by Registrant.***Incorporated by reference toExhibit 10.1 to Registrant’s Registration Statement No. 333-90273 on Form S-4,filed with the SEC on November 3, 1999 and as amended on April 6, 2000.

 

***10.2******                             ******1998Stock Incentive Plan of The Fidelity Deposit and Discount Bank, as assumed byRegistrant.***Incorporated by reference to Exhibit 10.2 ofRegistrant’s Registration Statement No. 333-90273 on Form S-4, filed with theSEC on November 3, 1999 and as amended on April 6, 2000.

 

***10.3******                             ******Formof Deferred Compensation Plan of The Fidelity Deposit and Discount Bank.***Incorporated byreference to Exhibit 10.3 to Registrant’s Registration Statement No.333-45668on Form S-1, filed with the SEC on September 12, 2000 and as amended on October11, 2000.

 

***10.4******                             ******Registrant’s2000 Dividend Reinvestment Plan.***Incorporated by reference toExhibit 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-EffectiveAmendment No. 1 on October 11, 2000, by Post-Effective Amendment No. 1 on May30, 2001 and by Post-Effective Amendment No 2 on July  7, 2005.

 

***10.5******                             ******Registrant’s2000 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.

 

***10.6******                             ******Registrant’s2000 Stock Incentive Plan***. Incorporated by referenceto Exhibit 4.4 to Registrant’s Registration Statement No. 333-64356 on Form S-8filed with the SEC on July 2, 2001.

 

***10.7******                             ******Registrant’s 2002 Employee Stock Purchase Plan.***Incorporated byreference to Appendix A to Registrant’s Definitive Proxy Statement filed withthe SEC on March 28, 2002.

 

***10.***8                               ***Employment Agreementbetween Registrant, The Fidelity Deposit and Discount Bank and Steven C.Ackmann, dated June 21, 2004.***Incorporated by reference toExhibit 99.1 to Registrant’s Current Report on Form 8-K filed with the SEC onJune 24, 2004.

 

***10.9******                             ******CompleteSettlement 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 toRegistrant’s Current Report on Form 8-K filed with the SEC on August 10, 2004.

 

***10.10******                      ******Change of Control andSeverance Agreement between James T. Gorman, Registrant and The FidelityDeposit and Discount Bank, dated September 19, 2005.*** Incorporated by reference to Exhibit 99.1 to Registrant’sCurrent Report on Form 8-K filed with the SEC on September 22, 2005.

 

 

31

----

 

***11******                                       ******Statementregarding computation of earnings per share.***Included hereinin Note 2 “Earnings per Share”, contained within the Notes to ConsolidatedFinancial Statements, and incorporated herein by reference.

*** ***

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

 

***31.2          Rule13a-14(a) Certification of Principal Financial Officer, filed herewith.***

 

***32.1******                             ******Certificationof Principal Executive Officer pursuant to 18 U.S.C. Section 1350,  as adopted pursuant to Section 906 of theSarbanes-Oxley Act of 2002, filed herewith.***

 

***32.2******                             ******Certificationof Principal Financial Officer pursuant to 18 U.S.C. Section 1350  as adopted pursuant to Section 906 of theSarbanes-Oxley Act of 2002, filed herewith.***

 

 

32

----

 

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

 

 

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

 

 

 
| Date:  | November 10, 2005 |                                   | /s/ |  Steven C. Ackmann |   |
|--------|-------------------|----------------------------------------|-----|-------------------------|--------|
|   |              | Steven C. Ackmann,                     |
|   |              | President and Chief  Executive Officer |

 
| Date:  | November 10, 2005 |   | /s/    | Salvatore R. DeFrancesco,  Jr.         |   |
|--------|-------------------|--------|--------|----------------------------------------|--------|
|   |              |   |   | Salvatore R. DeFrancesco,  Jr.,        |
|   |              |   |   | Treasurer and Chief  Financial Officer |

 

 

33

----

 

ExhibitIndex
| ** **  | ** **   |                                                                                                                                                                                                                                                                                                                                                                                              |         | **Page** |
|-------------|--------------|---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|--------------|----------|
|        |         |                                                                                                                                                                                                                                                                                                                                                                                              |         |     |
| ***3(i)***  | *** *** | ***Amended and Restated Articles of Incorporation ofRegistrant.*** Incorporated by reference to Exhibit 3(i) to  Registrant’s Registration Statement No. 333-90273 on Form S-4, filed with the  SEC on November 3, 1999 and as amended on April 6, 2000.                                                                                                                                     | *** *** | *******  |
|        |         |                                                                                                                                                                                                                                                                                                                                                                                              |         |     |
| ***3(ii)*** | *** *** | ***Bylaws of Registrant***. Incorporatedby reference to Exhibit 3 (ii) to  Registrant’s Registration Statement No. 333-90273 on Form S-4, filed with the  SEC on November 3, 1999 and as amended on April 6, 2000.                                                                                                                                                                           | *** *** | *******  |
|        |         |                                                                                                                                                                                                                                                                                                                                                                                              |         |     |
| ***10.1***  | *** *** | ***1998 Independent Directors StockOption Plan of The Fidelity Deposit  and Discount Bank, as assumed by Registrant.*** Incorporated by reference to Exhibit 10.1 to  Registrant’s Registration Statement No. 333-90273 on Form S-4, filed with the  SEC on November 3, 1999 and as amended on April 6, 2000.                                                                                | *** *** | *******  |
|        |         |                                                                                                                                                                                                                                                                                                                                                                                              |         |     |
| ***10.2***  | *** *** | ***1998 Stock Incentive Plan of The Fidelity Deposit and Discount Bank,  as assumed by Registrant.***Incorporated by reference to Exhibit 10.2 of  Registrant’s Registration Statement No. 333-90273 on Form S-4, filed with the  SEC on Nov. 3, 1999 and as amended on April 6, 2000.                                                                                                       | *** *** | *******  |
|        |         |                                                                                                                                                                                                                                                                                                                                                                                              |         |     |
| ***10.3***  | *** *** | ***Form of Deferred Compensation Plan of The Fidelity Deposit and  Discount Bank.***Incorporated  by reference to Exhibit 10.3 to Registrant’s Registration Statement No.  333-45668 on Form S-1, filed with the SEC on September 12, 2000 and as  amended on October 11, 2000.                                                                                                              | *** *** | *******  |
|        |         |                                                                                                                                                                                                                                                                                                                                                                                              |         |     |
| ***10.4***  | *** *** | ***Registrant’s 2000 Dividend Reinvestment Plan****.*Incorporated by reference to Exhibit 4 to  Registrant’s Registration Statement No. 333-45668 on Form S-1, filed with the  SEC on September 12, 2000 and as amended by Pre-Effective Amendment No. 1 on  October 11, 2000, by Post-Effective Amendment No. 1 on May 30, 2001 and by  Post-Effective Amendment No 2 on July 7, 2005. | *** *** | *******  |
|        |         |                                                                                                                                                                                                                                                                                                                                                                                              |         |     |
| ***10.5***  | *** *** | ***Registrant’s 2000 Independent Directors Stock Option Plan.***Incorporated by reference to Exhibit 4.3 to  Registrant’s Registration Statement No. 333-64356 on Form S-8 filed with the  SEC on July 2, 2001.                                                                                                                                                                         | *** *** | *******  |
|        |         |                                                                                                                                                                                                                                                                                                                                                                                              |         |     |
| ***10.6***  | *** *** | ***Registrant’s 2000 Stock Incentive Plan.***Incorporated by reference to Exhibit 4.4 to  Registrant’s Registration Statement No. 333-64356 on Form S-8 filed with the  SEC on July 2, 2001.                                                                                                                                                                                            | *** *** | *******  |

 

 

34

----

 

 
|        |         |                                                                                                                                                                                                                                                                                                 |         |     |
|-------------|--------------|------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|--------------|----------|
| ***10.7***  | *** *** | ***Registrant’s 2002 Employee Stock Purchase Plan.***Incorporated by reference to Appendix A to  Registrant’s Definitive Proxy Statement filed with the SEC on March 28, 2002.                                                                                                             |         | *        |
|        |         |                                                                                                                                                                                                                                                                                                 |         |     |
| ***10.8***  | *** *** | ***Employment Agreement between Registrant, The Fidelity Deposit and  Discount Bank and Steven C. Ackmann, dated June 21, 2004****.*Incorporated by reference to Exhibit 99.1 to  Registrant’s Current Report on Form 8-K filed with the SEC on June 24, 2004***.***                            |         | *        |
|        |         |                                                                                                                                                                                                                                                                                                 |         |     |
| ***10.9***  | *** *** | ***Complete Settlement Agreement and General Release between Michael F.  Marranca, Registrant and The Fidelity Deposit and Discount Bank, dated July  30, 2004. Incorporated by reference to Exhibit 99.1 to Registrant’s Current  Report on Form 8-K filed with the SEC on August 10, 2004.*** | *** *** | *******  |
|        |         |                                                                                                                                                                                                                                                                                                 |         |     |
| ***10.10*** | *** *** | ***Change of Control and Severance Agreement between James T. Gorman,  Registrant and the Fidelity Deposit and Discount Bank, dated September 19,  2005. Incorporated by reference to Exhibit 99.1 to Registrant’s Current  Report on Form 8-K filed with the SEC on September 22, 2005.***     | *** *** | *******  |
|        |         |                                                                                                                                                                                                                                                                                                 |         |     |
| ***11***    | *** *** | ***Statement regarding computation of earnings per share***. Included herein.                                                                                                                                                                                                                        | *** *** | ***8***  |
|        |         |                                                                                                                                                                                                                                                                                                 |         |     |
| ***31.1***  | *** *** | ***Rule 13a-14(a) Certification of Principal Executive Officer.***                                                                                                                                                                                                                                   | *** *** | ***36*** |
|        |         |                                                                                                                                                                                                                                                                                                 |         |     |
| ***31.2***  | *** *** | ***Rule 13a-14(a) Certification of Principal Financial Officer.***                                                                                                                                                                                                                                   | *** *** | ***37*** |
|        |         |                                                                                                                                                                                                                                                                                                 |         |     |
| ***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.***                                                                                                                                       | *** *** | ***38*** |
|        |         |                                                                                                                                                                                                                                                                                                 |         |     |
| ***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.***                                                                                                                                       | *** *** | ***39*** |

 

----

*******- Incorporated by Reference

 

 

35

----