UNITED
STATES


SECURITIES
AND EXCHANGE COMMISSION


Washington,
D.C. 20549





FORM
10-Q





x QUARTERLY REPORT
PURSUANT TO SECTION 13 OR 15(d) OF THE


SECURITIES
EXCHANGE ACT OF 1934





For
the quarterly period ended June 30, 2010





OR





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


SECURITIES
EXCHANGE ACT OF 1934





For the
transition period from ______________to______________________





Commission
file number: 333-90273





FIDELITY
D & D BANCORP, INC.





STATE OF
INCORPORATION:  IRS EMPLOYER IDENTIFICATION NO:


PENNSYLVANIA                                     23-3017653





Address
of principal executive offices:


BLAKELY
& DRINKER ST.


DUNMORE,
PENNSYLVANIA 18512





TELEPHONE:


570-342-8281





Indicate
by check mark whether the registrant (1) has filed all reports required to be
filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the
preceding 12 months (or for such shorter period that the registrant was required
to file such reports), and (2) has been subjected to such filing requirements
for the past 90 days.  x YES  ̈ NO





Indicate
by check mark whether the registrant has submitted electronically and posted on
its corporate Web site, if any, every Interactive Data File required to be
submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this
chapter) during the preceding 12 months (or for such shorter period that the
registrant was required to submit and post such files).   ̈ YES  ̈ NO





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





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





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


 ̈ YES x NO





The
number of outstanding shares of Common Stock of Fidelity D & D Bancorp, Inc.
on July 30, 2010, the latest practicable date, was 2,148,408
shares.








FIDELITY
D & D BANCORP, INC.





Form 10-Q June 30,
2010





Index


PagePart I.  Financial
      InformationItem
      1.
                                      Financial
      Statements (unaudited):Consolidated
      Balance Sheets as of June 30, 2010and
      December 31, 2009
                                      
                                      3Consolidated
      Statements of Income for the three and six monthsended
      June 30, 2010 and 2009
                                      
                                      4Consolidated
      Statements of Changes in Shareholders’ Equityfor
      the six months ended June 30, 2010 and 2009
                                      
                                      5Consolidated
      Statements of Cash Flows for the six monthsended
      June 30, 2010 and 2009
                                      
                                      6Notes
      to Consolidated Financial Statements
                                      
                                      7Item
      2.
                                      Management’s
      Discussion and Analysis of Financial Conditionand
      Results of Operations
                                      
                                      17Item
      3.
                                      Quantitative
      and Qualitative Disclosure about Market Risk
                                      
                                      31Item
      4T.
                                      Controls
      and Procedures
                                      
                                      36Part II.  Other
      InformationItem
      1.
                                      Legal
      Proceedings
                                      
                                      36Item
      1A.
                                      Risk
      Factors
                                      
                                      36Item
      2.
                                      Unregistered
      Sales of Equity Securities and Use of Proceeds
                                      
                                      36Item
      3.
                                      Defaults
      upon Senior Securities
                                      
                                      36Item
      4.
                                      (Removed
      and Reserved)
                                      
                                      37Item
      5.
                                      Other
      Information
                                      
                                      37Item
      6.
                                      Exhibits
                                      
                                      37Signatures
                                      
                                      39Exhibit
      index
                                      
                                      40




- 2
-





PART
I – Financial Information


Item
1: Financial Statements





FIDELITY
D & D BANCORP, INC. AND SUBSIDIARY


Consolidated
Balance Sheets


(Unaudited)





June 30, 2010
                
                
                December 31, 2009Assets:Cash
      and due from banks
                
                $
                13,734,046
                
                
                $
                8,173,199Interest-bearing
      deposits with financial institutions
                
                
                22,994,829
                
                
                
                154,755Total
      cash and cash equivalents
                
                
                36,728,875
                
                
                
                8,327,954Available-for-sale
      securities
                
                
                75,370,473
                
                
                
                75,821,292Held-to-maturity
      securities (fair value $636,015 in 2010; $765,195 in 2009)
                
                
                577,591
                
                
                
                708,706Federal
      Home Loan Bank Stock
                
                
                4,781,100
                
                
                
                4,781,100Loans
      and leases, net (allowance for loan losses of $7,523,250 in 2010;
      $7,573,603 in 2009)
                
                
                420,215,504
                
                
                
                423,124,054Loans
      available-for-sale (fair value $388,709 in 2010; $1,233,345 in
      2009)
                
                
                384,000
                
                
                
                1,221,365Bank
      premises and equipment, net
                
                
                14,936,387
                
                
                
                15,361,810Cash
      surrender value of bank owned life insurance
                
                
                9,269,973
                
                
                
                9,117,156Accrued
      interest receivable
                
                
                2,149,434
                
                
                
                2,250,855Foreclosed
      assets held-for-sale
                
                
                1,084,007
                
                
                
                887,397Other
      assets
                
                
                13,772,939
                
                
                
                14,415,582Total
      assets
                
                $
                579,270,283
                
                
                $
                556,017,271Liabilities:Deposits:Interest-bearing
                
                $
                403,090,854
                
                
                $
                388,103,880Non-interest-bearing
                
                
                77,836,050
                
                
                
                70,890,578Total
      deposits
                
                
                480,926,904
                
                
                
                458,994,458Accrued
      interest payable and other liabilities
                
                
                2,922,545
                
                
                
                2,815,159Short-term
      borrowings
                
                
                15,577,694
                
                
                
                16,533,107Long-term
      debt
                
                
                32,000,000
                
                
                
                32,000,000Total
      liabilities
                
                
                531,427,143
                
                
                
                510,342,724Shareholders'
      equity:Preferred
      stock authorized 5,000,000 shares with no par value; none
      issued
                
                
                -
                
                
                
                -Capital
      stock, no par value (10,000,000 shares authorized; shares issued and
      outstanding; 2,148,408 in 2010; and 2,105,860 in 2009)
                
                
                20,553,888
                
                
                
                19,982,677Retained
      earnings
                
                
                35,101,386
                
                
                
                34,886,265Accumulated
      other comprehensive loss
                
                
                (7,812,134
                )
                
                
                (9,194,395
                )Total
      shareholders' equity
                
                
                47,843,140
                
                
                
                45,674,547Total
      liabilities and shareholders' equity
                
                $
                579,270,283
                
                
                $
                556,017,271





See notes
to consolidated financial statements


- 3
-





FIDELITY
D & D BANCORP, INC. AND SUBSIDIARY


Consolidated
Statements of Income


(Unaudited)





Three months ended
                        
                        
                        Six months endedJune 30, 2010
                        
                        
                        June 30, 2009
                        
                        
                        June 30, 2010
                        
                        
                        June 30, 2009Interest
      income:Loans
      and leases:Taxable
                        
                        $
                        6,004,167
                        
                        
                        $
                        6,356,864
                        
                        
                        $
                        12,084,184
                        
                        
                        $
                        12,917,612Nontaxable
                        
                        
                        153,855
                        
                        
                        
                        113,488
                        
                        
                        
                        300,151
                        
                        
                        
                        228,262Interest-bearing
      deposits with financial institutions
                        
                        
                        7,890
                        
                        
                        
                        337
                        
                        
                        
                        16,318
                        
                        
                        
                        448Investment
      securities:U.S.
      government agency and corporations
                        
                        
                        478,691
                        
                        
                        
                        550,457
                        
                        
                        
                        959,010
                        
                        
                        
                        1,317,828States
      and political subdivisions (non-taxable)
                        
                        
                        256,083
                        
                        
                        
                        270,334
                        
                        
                        
                        509,410
                        
                        
                        
                        468,909Other
      securities
                        
                        
                        63,060
                        
                        
                        
                        157,458
                        
                        
                        
                        128,971
                        
                        
                        
                        342,508Federal
      funds sold
                        
                        
                        6,447
                        
                        
                        
                        6,575
                        
                        
                        
                        13,440
                        
                        
                        
                        7,359Total
      interest income
                        
                        
                        6,970,193
                        
                        
                        
                        7,455,513
                        
                        
                        
                        14,011,484
                        
                        
                        
                        15,282,926Interest
      expense:Deposits
                        
                        
                        1,299,716
                        
                        
                        
                        2,138,133
                        
                        
                        
                        2,713,777
                        
                        
                        
                        4,329,905Securities
      sold under repurchase agreements
                        
                        
                        25,298
                        
                        
                        
                        8,081
                        
                        
                        
                        70,190
                        
                        
                        
                        16,555Other
      short-term borrowings and other
                        
                        
                        2
                        
                        
                        
                        405
                        
                        
                        
                        633
                        
                        
                        
                        26,545Long-term
      debt
                        
                        
                        427,896
                        
                        
                        
                        568,325
                        
                        
                        
                        850,669
                        
                        
                        
                        1,344,532Total
      interest expense
                        
                        
                        1,752,912
                        
                        
                        
                        2,714,944
                        
                        
                        
                        3,635,269
                        
                        
                        
                        5,717,537Net
      interest income
                        
                        
                        5,217,281
                        
                        
                        
                        4,740,569
                        
                        
                        
                        10,376,215
                        
                        
                        
                        9,565,389Provision
      for loan losses
                        
                        
                        300,000
                        
                        
                        
                        300,000
                        
                        
                        
                        875,000
                        
                        
                        
                        725,000Net
      interest income after provision for loan losses
                        
                        
                        4,917,281
                        
                        
                        
                        4,440,569
                        
                        
                        
                        9,501,215
                        
                        
                        
                        8,840,389Other
      income:Service
      charges on deposit accounts
                        
                        
                        671,890
                        
                        
                        
                        648,228
                        
                        
                        
                        1,288,914
                        
                        
                        
                        1,280,648Fees
      and other service charges
                        
                        
                        514,550
                        
                        
                        
                        472,313
                        
                        
                        
                        1,018,009
                        
                        
                        
                        979,489Gain
      (loss) on sale or disposal of:Loans
                        
                        
                        129,386
                        
                        
                        
                        327,785
                        
                        
                        
                        228,716
                        
                        
                        
                        818,326Premises
      and equipment
                        
                        
                        -
                        
                        
                        
                        (4,378
                        )
                        
                        
                        (16,171
                        )
                        
                        
                        (6,624
                        )Foreclosed
      assets held-for-sale
                        
                        
                        405
                        
                        
                        
                        14,891
                        
                        
                        
                        21,415
                        
                        
                        
                        25,887Impairment
      losses on investment securities:Other-than-temporary
      impairment on investment securities
                        
                        
                        (828,601
                        )
                        
                        
                        (570
                        )
                        
                        
                        (2,265,237
                        )
                        
                        
                        (326,095
                        )Non-credit
      related losses on investment securities not expectedto
      be sold (recognized in other comprehensive income/(loss))
                        
                        
                        152,729
                        
                        
                        
                        -
                        
                        
                        
                        1,510,315
                        
                        
                        
                        -Net
      impairment losses on investment securities recognized in
      earnings
                        
                        
                        (675,872
                        )
                        
                        
                        (570
                        )
                        
                        
                        (754,922
                        )
                        
                        
                        (326,095
                        )Total
      other income
                        
                        
                        640,359
                        
                        
                        
                        1,458,269
                        
                        
                        
                        1,785,961
                        
                        
                        
                        2,771,631Other
      expenses:Salaries
      and employee benefits
                        
                        
                        2,232,842
                        
                        
                        
                        2,422,656
                        
                        
                        
                        5,001,932
                        
                        
                        
                        4,992,349Premises
      and equipment
                        
                        
                        846,443
                        
                        
                        
                        904,893
                        
                        
                        
                        1,741,262
                        
                        
                        
                        1,811,315Advertising
                        
                        
                        182,471
                        
                        
                        
                        135,992
                        
                        
                        
                        307,803
                        
                        
                        
                        278,393Other
                        
                        
                        1,432,399
                        
                        
                        
                        1,275,293
                        
                        
                        
                        2,747,607
                        
                        
                        
                        2,318,719Total
      other expenses
                        
                        
                        4,694,155
                        
                        
                        
                        4,738,834
                        
                        
                        
                        9,798,604
                        
                        
                        
                        9,400,776Income
      before income taxes
                        
                        
                        863,485
                        
                        
                        
                        1,160,004
                        
                        
                        
                        1,488,572
                        
                        
                        
                        2,211,244Provision
      for income taxes
                        
                        
                        144,513
                        
                        
                        
                        247,851
                        
                        
                        
                        213,720
                        
                        
                        
                        474,033Net
      income
                        
                        $
                        718,972
                        
                        
                        $
                        912,153
                        
                        
                        $
                        1,274,852
                        
                        
                        $
                        1,737,211Per
      share data:Net
      income - basic
                        
                        $
                        0.34
                        
                        
                        $
                        0.44
                        
                        
                        $
                        0.60
                        
                        
                        $
                        0.84Net
      income - diluted
                        
                        $
                        0.34
                        
                        
                        $
                        0.44
                        
                        
                        $
                        0.60
                        
                        
                        $
                        0.84Dividends
                        
                        $
                        0.25
                        
                        
                        $
                        0.25
                        
                        
                        $
                        0.50
                        
                        
                        $
                        0.50





See notes
to consolidated financial statements


- 4
-


FIDELITY
D & D BANCORP, INC. AND SUBSIDIARY


Consolidated
Statements of Changes in Shareholders' Equity


For the
six months ended June 30, 2010 and 2009


(Unaudited)





AccumulatedotherCapital stock
                                
                                
                                Treasury stock
                                
                                
                                Retained
                                
                                
                                comprehensiveShares
                                
                                
                                Amount
                                
                                
                                Shares
                                
                                
                                Amount
                                
                                
                                earnings
                                
                                
                                income (loss)
                                
                                
                                TotalBalance,
      December 31, 2008
                                
                                
                                2,075,182
                                
                                
                                $
                                19,410,306
                                
                                
                                
                                (12,255
                                )
                                
                                $
                                (351,665
                                )
                                
                                $
                                38,126,250
                                
                                
                                $
                                (8,224,240
                                )
                                
                                $
                                48,960,651Cumulative
      effect of change in accounting principle
                                
                                
                                
                                
                                
                                
                                
                                
                                
                                
                                
                                
                                
                                
                                
                                
                                
                                
                                350,720
                                
                                
                                
                                (350,720
                                )
                                
                                
                                -Total
      comprehensive income:Net
      income
                                
                                
                                
                                
                                
                                
                                
                                
                                
                                
                                
                                
                                
                                
                                
                                
                                
                                
                                1,737,211
                                
                                
                                
                                
                                
                                
                                
                                1,737,211Change
      in net unrealized holding losses on available-for-sale securities, net of
      reclassification adjustment and net of tax adjustments of
      $310,796
                                
                                
                                
                                
                                
                                
                                
                                
                                
                                
                                
                                
                                
                                
                                
                                
                                
                                
                                
                                
                                
                                
                                (603,309
                                )
                                
                                
                                (603,309
                                )Change
      in cash flow hedge intrinsic value
                                
                                
                                
                                
                                
                                
                                
                                
                                
                                
                                
                                
                                
                                
                                
                                
                                
                                
                                
                                
                                
                                
                                (334,716
                                )
                                
                                
                                (334,716
                                )Comprehensive
      income
                                
                                
                                
                                
                                
                                
                                
                                
                                
                                
                                
                                
                                
                                
                                
                                
                                
                                
                                
                                
                                
                                
                                
                                
                                
                                
                                799,186Issuance
      of common stock through Employee Stock Purchase Plan
                                
                                
                                1,701
                                
                                
                                
                                40,569
                                
                                
                                
                                
                                
                                
                                
                                
                                
                                
                                
                                
                                
                                
                                
                                
                                
                                
                                
                                40,569Dividends
      reinvested through DividendReinvestment
      Plan
                                
                                
                                5,774
                                
                                
                                
                                112,477
                                
                                
                                
                                14,755
                                
                                
                                
                                408,170
                                
                                
                                
                                (112,329
                                )
                                
                                
                                
                                
                                
                                
                                408,318Stock-based
      compensation expense
                                
                                
                                
                                
                                
                                
                                4,508
                                
                                
                                
                                
                                
                                
                                
                                
                                
                                
                                
                                
                                
                                
                                
                                
                                
                                
                                
                                4,508Purchase
      of treasury stock
                                
                                
                                
                                
                                
                                
                                
                                
                                
                                
                                (2,500
                                )
                                
                                
                                (56,505
                                )
                                
                                
                                
                                
                                
                                
                                
                                
                                
                                
                                (56,505
                                )Cash
      dividends declared
                                
                                
                                
                                
                                
                                
                                
                                
                                
                                
                                
                                
                                
                                
                                
                                
                                
                                
                                (1,034,178
                                )
                                
                                
                                
                                
                                
                                
                                (1,034,178
                                )Balance,
      June 30, 2009
                                
                                
                                2,082,657
                                
                                
                                $
                                19,567,860
                                
                                
                                
                                -
                                
                                
                                $
                                -
                                
                                
                                $
                                39,067,674
                                
                                
                                $
                                (9,512,985
                                )
                                
                                $
                                49,122,549Balance,
      December 31, 2009
                                
                                
                                2,105,860
                                
                                
                                $
                                19,982,677
                                
                                
                                
                                -
                                
                                
                                $
                                -
                                
                                
                                $
                                34,886,265
                                
                                
                                $
                                (9,194,395
                                )
                                
                                $
                                45,674,547Total
      comprehensive income:Net
      income
                                
                                
                                
                                
                                
                                
                                
                                
                                
                                
                                
                                
                                
                                
                                
                                
                                
                                
                                1,274,852
                                
                                
                                
                                
                                
                                
                                
                                1,274,852Change
      in net unrealized holding losses on available-for-sale securities, net of
      reclassification adjustment and net of tax adjustments of
      $1,225,581
                                
                                
                                
                                
                                
                                
                                
                                
                                
                                
                                
                                
                                
                                
                                
                                
                                
                                
                                
                                
                                
                                
                                2,379,069
                                
                                
                                
                                2,379,069Non-credit
      related impairment losses on investment securities not expected to be
      sold, net of tax adjustments of $513,507
                                
                                
                                
                                
                                
                                
                                
                                
                                
                                
                                
                                
                                
                                
                                
                                
                                
                                
                                
                                
                                
                                
                                (996,808
                                )
                                
                                
                                (996,808
                                )Comprehensive
      income
                                
                                
                                
                                
                                
                                
                                
                                
                                
                                
                                
                                
                                
                                
                                
                                
                                
                                
                                
                                
                                
                                
                                
                                
                                
                                
                                2,657,113Issuance
      of common stock through Employee Stock Purchase Plan
                                
                                
                                4,754
                                
                                
                                
                                67,367
                                
                                
                                
                                
                                
                                
                                
                                
                                
                                
                                
                                
                                
                                
                                
                                
                                
                                
                                
                                67,367Issuance
      of common stock through Dividend Reinvestment Plan
                                
                                
                                37,794
                                
                                
                                
                                496,359
                                
                                
                                
                                
                                
                                
                                
                                
                                
                                
                                
                                
                                
                                
                                
                                
                                
                                
                                
                                496,359Stock-based
      compensation expense
                                
                                
                                
                                
                                
                                
                                7,485
                                
                                
                                
                                
                                
                                
                                
                                
                                
                                
                                
                                
                                
                                
                                
                                
                                
                                
                                
                                7,485Cash
      dividends declared
                                
                                
                                
                                
                                
                                
                                
                                
                                
                                
                                
                                
                                
                                
                                
                                
                                
                                
                                (1,059,731
                                )
                                
                                
                                
                                
                                
                                
                                (1,059,731
                                )Balance,
      June 30, 2010
                                
                                
                                2,148,408
                                
                                
                                $
                                20,553,888
                                
                                
                                
                                -
                                
                                
                                $
                                -
                                
                                
                                $
                                35,101,386
                                
                                
                                $
                                (7,812,134
                                )
                                
                                $
                                47,843,140





See notes
to consolidated financial statements


- 5
-





FIDELITY DEPOSIT & DISCOUNT BANCORP, INC. AND
SUBSIDIARY


Consolidated
Statements of Cash Flows


(Unaudited)





Six months ended June 30,2010
                
                
                2009Cash
      flows from operating activities:Net
      income
                
                $
                1,274,852
                
                
                $
                1,737,211Adjustments
      to reconcile net income to net cash provided by operating
      activities:Depreciation,
      amortization and accretion
                
                
                929,446
                
                
                
                609,143Provision
      for loan losses
                
                
                875,000
                
                
                
                725,000Deferred
      income tax (benefit) expense
                
                
                (432,600
                )
                
                
                133,518Stock-based
      compensation expense
                
                
                7,485
                
                
                
                4,508Loss
      from investment in limited partnership
                
                
                -
                
                
                
                40,200Proceeds
      from sale of loans available-for-sale
                
                
                18,964,669
                
                
                
                74,147,662Originations
      of loans available-for-sale
                
                
                (15,970,697
                )
                
                
                (64,393,533
                )Increase
      in cash surrender value of life insurance
                
                
                (152,817
                )
                
                
                (154,297
                )Net
      gain on sale of loans
                
                
                (228,716
                )
                
                
                (818,326
                )Net
      gain on sale of foreclosed assets held-for-sale
                
                
                (21,415
                )
                
                
                (25,887
                )Loss
      on disposal of equipment
                
                
                16,171
                
                
                
                6,624Other-than-temporary
      impairment on securities
                
                
                754,922
                
                
                
                326,095Change
      in:Accrued
      interest receivable
                
                
                44,988
                
                
                
                74,687Other
      assets
                
                
                357,217
                
                
                
                (1,339,119
                )Accrued
      interest payable and other liabilities
                
                
                108,196
                
                
                
                629,634Net
      cash provided by operating activities
                
                
                6,526,701
                
                
                
                11,703,120Cash
      flows from investing activities:Held-to-maturity
      securities:Proceeds
      from maturities, calls and principal pay-downs
                
                
                131,113
                
                
                
                66,727Available-for-sale
      securities:Proceeds
      from maturities, calls and principal pay-downs
                
                
                20,636,090
                
                
                
                29,835,486Purchases
                
                
                (18,726,036
                )
                
                
                (23,752,046
                )Net
      (increase) decrease in loans and leases
                
                
                (805,707
                )
                
                
                4,282,109Acquisition
      of bank premises and equipment
                
                
                (412,873
                )
                
                
                (415,925
                )Proceeds
      from sale of foreclosed assets held-for-sale
                
                
                570,605
                
                
                
                408,680Net
      cash provided by investing activities
                
                
                1,393,192
                
                
                
                10,425,031Cash
      flows from financing activities:Net
      increase in deposits
                
                
                21,932,446
                
                
                
                20,561,432Net
      decrease in short-term borrowings
                
                
                (955,413
                )
                
                
                (29,249,361
                )Repayments
      of long-term debt
                
                
                -
                
                
                
                (10,000,000
                )Purchase
      of treasury stock
                
                
                -
                
                
                
                (56,505
                )Proceeds
      from Employee Stock Purchase Plan participants
                
                
                67,367
                
                
                
                40,569Dividends
      paid, net of dividends reinvested
                
                
                (702,600
                )
                
                
                (625,860
                )Proceeds
      from Dividend Reinvestment Plan participants
                
                
                139,228
                
                
                
                -Net
      cash provided by (used in) financing  activities
                
                
                20,481,028
                
                
                
                (19,329,725
                )Net
      increase in cash and cash equivalents
                
                
                28,400,921
                
                
                
                2,798,426Cash
      and cash equivalents, beginning
                
                
                8,327,954
                
                
                
                12,771,147Cash
      and cash equivalents, ending
                
                $
                36,728,875
                
                
                $
                15,569,573





See notes
to consolidated financial statements


- 6
-





FIDELITY
D & D BANCORP, INC.





Notes
to Consolidated Financial Statements


(Unaudited)




1.   Nature
of operations and critical accounting policies





Nature of
operations




Fidelity
Deposit and Discount Bank (the Bank) is a commercial bank chartered in the
Commonwealth of Pennsylvania and a wholly-owned subsidiary of Fidelity D & D
Bancorp, Inc. (the Company or collectively, the Company).  Having
commenced operations in 1903, the Bank is committed to provide superior customer
service, while offering a full range of banking products and financial and trust
services to both our consumer and commercial customers from our main office
located in Dunmore and other branches located throughout Lackawanna and Luzerne
counties.




Principles of
consolidation




The
accompanying unaudited consolidated financial statements of the Company and the
Bank have been prepared in accordance with accounting principles generally
accepted in the United States of America (GAAP) for interim financial
information and with the instructions to this Form 10-Q and Rule 10-01 of
Regulation S-X.  Accordingly, they do not include all of the
information and footnote disclosures required by GAAP for complete financial
statements.  In the opinion of management, all normal recurring
adjustments necessary for a fair presentation of the financial condition and
results of operations for the periods have been included.  All
significant inter-company balances and transactions have been eliminated in
consolidation.




The
preparation of financial statements in conformity with GAAP requires management
to make estimates and assumptions that affect the reported amounts of assets and
liabilities and disclosure of contingent assets and liabilities at the date of
the financial statements and the reported amounts of revenues and expenses
during the reported periods.  Actual results could differ from those
estimates.  For additional information and disclosures required under
GAAP, refer to the Company’s Annual Report on Form 10-K for the year ended
December 31, 2009.




Management
is responsible for the fairness, integrity and objectivity of the unaudited
financial statements included in this report.  Management prepared the
unaudited financial statements in accordance with GAAP.  In meeting
its responsibility for the financial statements, management depends on the
Company's accounting systems and related internal controls.  These
systems and controls are designed to provide reasonable but not absolute
assurance that the financial records accurately reflect the transactions of the
Company, the Company’s assets are safeguarded and that the financial statements
present fairly the financial condition and results of operations of the
Company.




In the
opinion of management, the consolidated balance sheets as of June 30, 2010 and
December 31, 2009 and the related consolidated statements of income for the
three- and six-month periods ended June 30, 2010 and 2009 and changes in
shareholders’ equity and cash flows for the six months ended June 30, 2010 and
2009 present fairly the financial condition and results of operations of the
Company.  All material adjustments required for a fair presentation
have been made.  These adjustments are of a normal recurring
nature.




This
Quarterly Report on Form 10-Q should be read in conjunction with the Company’s
audited financial statements for the year ended December 31, 2009, and the notes
included therein, included within the Company’s Annual Report filed on Form
10-K.




Critical accounting
policies




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




A
material estimate that is particularly susceptible to significant change relates
to the determination of the allowance for loan losses.  Management
believes that the allowance for loan losses at June 30, 2010 is adequate and
reasonable.  Given the subjective nature of identifying and valuing
loan losses, it is likely that well-informed individuals could make different
assumptions, and could, therefore calculate a materially different allowance
value.  While management uses available information to recognize
losses on loans, changes in economic conditions may necessitate revisions in the
future.  In addition, various regulatory agencies, as an integral part
of their examination process, periodically review the Company’s allowance for
loan losses.  Such agencies may require the Company to recognize
adjustments to the allowance based on their judgment of information available to
them at the time of their examination.


- 7
-


Another
material estimate is the calculation of fair values of the Company’s investment
securities.  Except for the Company’s investment in corporate bonds,
consisting of pooled trust preferred securities, fair values of the other
investment securities are determined by prices provided by a third-party vendor
who is a provider of financial market data, analytics and related services to
financial institutions.  For the pooled trust preferred securities,
management is unable to obtain readily attainable and realistic pricing from
market traders due to lack of active market participants and therefore
management has determined the market for these securities to be
inactive.  In order to determine the fair value of the pooled trust
preferred securities, management relied on the use of an income valuation
approach (present value technique) that maximizes the use of observable inputs
and minimizes the use of unobservable inputs, the results of which are more
representative of fair value than the market approach valuation technique used
for the other investment securities.




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




The fair
value of residential mortgage loans, classified as AFS, is obtained from the
Federal National Mortgage Association (FNMA) or the Federal Home Loan Bank
(FHLB).  Generally, the market to which the Company sells mortgages it
originates for sale is restricted and price quotes from other sources are not
typically obtained.  On occasion, the Company may transfer loans from
the loan and lease portfolio to loans AFS.  Under these rare
circumstances, pricing may be obtained from other entities and the loans are
transferred at the lower of cost or market value and simultaneously
sold.  For a further discussion on the accounting treatment of AFS
loans, see the section entitled “Loans available-for-sale,” contained within
management’s discussion and analysis.




For
purposes of reporting cash flows, cash and cash equivalents includes cash on
hand, amounts due from banks and interest-bearing deposits with financial
institutions.  For the six months ended June 30, 2010 and 2009, the
Company paid interest of $3,674,000 and $5,623,000, respectively.  The
Company paid income taxes during the first six months of 2010 of $375,000, and
$400,000 for the six months ended June 30, 2009.  Transfers from loans
to foreclosed assets held-for-sale amounted to $747,000 and $132,000 during the
first six months of 2010 and 2009, respectively.  Transfers from loans
to loans available-for-sale amounted to $2,093,000 and $11,140,000 during the
first six months of 2010 and 2009, respectively.  Expenditures for
construction in process, a component of other assets in the consolidated balance
sheets, are included in acquisition of bank premises and equipment.




2.  New
Accounting Pronouncements




During
the first quarter of 2010, the Company adopted the new accounting guidance
related to the transfers and servicing of financial assets.  The
standard eliminates the concept of qualifying special purpose entities, provides
guidance as to when a portion of a transferred financial asset should be
evaluated for sale accounting, provides additional guidance with regard to
accounting for transfers of financial assets and requires additional
disclosures.  The adoption of the new accounting guidance did not have
a material impact on the Company’s consolidated financial
statements.




During
the first quarter of 2010, the Company adopted the amended accounting guidance
related to fair value measurements which entails new disclosures and clarifies
disclosure requirements about fair value measurement as set forth in previous
guidance.  The objective is to improve these disclosures and, thus,
increase the transparency in financial reporting.  Specifically, an
entity is required to disclose separately the amounts of significant transfers
in and out of Level 1 and Level 2 fair value measurements and describe the
reasons for the transfers; and in the reconciliation for fair value measurements
using significant unobservable inputs, a reporting entity should present
separately information about purchases, sales, issuances, and
settlements.  The amended guidance also clarifies the requirements of
the following disclosures: for purposes of reporting fair value measurement for
each class of assets and liabilities, a reporting entity needs to use judgment
in determining the appropriate classes of assets and liabilities; and a
reporting entity should provide disclosures about the valuation techniques and
inputs used to measure fair value for both recurring and non-recurring fair
value measurements.  The new guidance became effective for interim and
annual reporting periods beginning after December 15, 2009, except for the
disclosures about purchases, sales, issuances, and settlements in the roll
forward of activity in Level 3 fair value measurements.  Those
disclosures will become effective for fiscal years beginning after December 15,
2010, and for interim periods within those fiscal years.




In
July 2010, the FASB issued new guidance on disclosures about the credit quality
of financing receivables and the allowance for credit losses.  The new
disclosure guidance will significantly expand the existing requirements for
greater transparency into a company's exposure to credit losses from lending
type arrangements.  The objectives of the expanded disclosures are to
provide information that will enable readers of financial statements to
understand the nature of credit risk in a company's financing receivables, how
that risk is analyzed in determining the related allowance for credit losses and
changes to the allowance during the reporting period.  The new
guidance applies to all companies.  The extensive new disclosures of
information as of the end of a reporting period will become effective for both
interim and annual reporting periods ending after December 15, 2010 for public
companies.  Specific items regarding activity that occurred before the
issuance of the new guidance, such as the allowance roll forward and
modification disclosures will be required for periods beginning after December
15, 2010 for public companies.


- 8
-




3.
Investment securities




The
amortized cost and fair value of investment securities at June 30, 2010 and
December 31, 2009 are summarized as follows (dollars in thousands):




June 30, 2010Amortized
                          
                          
                          Gross unrealized
                          
                          
                          Gross unrealized
                          
                          
                          Faircost
                          
                          
                          gains
                          
                          
                          losses
                          
                          
                          valueHeld-to-maturity
securities:MBS
      - GSE residential
                          
                          $
                          578
                          
                          
                          $
                          58
                          
                          
                          $
                          -
                          
                          
                          $
                          636Available-for-sale
    securities:Agency
      - GSE
                          
                          $
                          24,273
                          
                          
                          $
                          243
                          
                          
                          $
                          206
                          
                          
                          $
                          24,310Obligations
      of states andpolitical
      subdivisions
                          
                          
                          22,743
                          
                          
                          
                          531
                          
                          
                          
                          114
                          
                          
                          
                          23,160Corporate
      bonds:Pooled
      trust preferred securities
                          
                          
                          18,109
                          
                          
                          
                          -
                          
                          
                          
                          13,189
                          
                          
                          
                          4,920MBS
      - GSE residential
                          
                          
                          21,759
                          
                          
                          
                          806
                          
                          
                          
                          -
                          
                          
                          
                          22,565Total
      debt securities
                          
                          
                          86,884
                          
                          
                          
                          1,580
                          
                          
                          
                          13,509
                          
                          
                          
                          74,955Equity
      securities - financial services
                          
                          
                          322
                          
                          
                          
                          104
                          
                          
                          
                          11
                          
                          
                          
                          415Total
      available-for-sale securities
                          
                          $
                          87,206
                          
                          
                          $
                          1,684
                          
                          
                          $
                          13,520
                          
                          
                          $
                          75,370




December 31, 2009Amortized
                            
                            
                            Gross unrealized
                            
                            
                            Gross unrealized
                            
                            
                            Faircost
                            
                            
                            gains
                            
                            
                            losses
                            
                            
                            valueHeld-to-maturity
securities:MBS
      - GSE residential
                            
                            $
                            709
                            
                            
                            $
                            56
                            
                            
                            $
                            -
                            
                            
                            $
                            765Available-for-sale
    securities:Agency
      - GSE
                            
                            $
                            34,205
                            
                            
                            $
                            4
                            
                            
                            $
                            1,077
                            
                            
                            $
                            33,132Obligations
      of states andpolitical
      subdivisions
                            
                            
                            23,013
                            
                            
                            
                            394
                            
                            
                            
                            137
                            
                            
                            
                            23,270Corporate
      bonds:Pooled
      trust preferred securities
                            
                            
                            18,794
                            
                            
                            
                            -
                            
                            
                            
                            13,552
                            
                            
                            
                            5,242MBS
      - GSE residential
                            
                            
                            13,418
                            
                            
                            
                            401
                            
                            
                            
                            71
                            
                            
                            
                            13,748Total
      debt securities
                            
                            
                            89,430
                            
                            
                            
                            799
                            
                            
                            
                            14,837
                            
                            
                            
                            75,392Equity
      securities - financial services
                            
                            
                            322
                            
                            
                            
                            121
                            
                            
                            
                            14
                            
                            
                            
                            429Total
      available-for-sale securities
                            
                            $
                            89,752
                            
                            
                            $
                            920
                            
                            
                            $
                            14,851
                            
                            
                            $
                            75,821




- 9
-


The
amortized cost and fair value of debt securities at June 30, 2010 by contractual
maturity are summarized below (dollars in thousands):




Amortized
                          
                          
                          Marketcost
                          
                          
                          valueHeld-to-maturity
securities:MBS
      - GSE residential
                          
                          $
                          578
                          
                          
                          $
                          636Available-for-sale
    securities:Debt
      securities:Due
      in one year or less
                          
                          $
                          -
                          
                          
                          $
                          -Due
      after one year through five years
                          
                          
                          1,000
                          
                          
                          
                          1,005Due
      after five years through ten years
                          
                          
                          10,153
                          
                          
                          
                          10,259Due
      after ten years
                          
                          
                          53,972
                          
                          
                          
                          41,126Total
      debt securities
                          
                          
                          65,125
                          
                          
                          
                          52,390MBS
      - GSE residential
                          
                          
                          21,759
                          
                          
                          
                          22,565Total
      available-for-sale debt securities
                          
                          $
                          86,884
                          
                          
                          $
                          74,955




Expected
maturities will differ from contractual maturities because issuers and borrowers
may have the right to call or repay obligations with or without call or
prepayment penalty.  Federal agency and municipal securities are
included based on their original stated maturity.  Mortgage-backed
securities, which are based on weighted-average lives and subject to monthly
principal pay-downs, are listed in total.




The
following tables present the fair value and gross unrealized losses of
investment securities aggregated by investment type, the length of time and the
number of securities that have been in a continuous unrealized loss position as
of June 30, 2010 and December 31, 2009 (dollars in thousands):




June 30, 2010Less than 12 months
                      
                      
                      More than 12 months
                      
                      
                      TotalFair
                      
                      
                      Unrealized
                      
                      
                      Fair
                      
                      
                      Unrealized
                      
                      
                      Fair
                      
                      
                      Unrealizedvalue
                      
                      
                      losses
                      
                      
                      value
                      
                      
                      losses
                      
                      
                      value
                      
                      
                      lossesAgency
      - GSE
                      
                      $
                      -
                      
                      
                      $
                      -
                      
                      
                      $
                      5,790
                      
                      
                      $
                      206
                      
                      
                      $
                      5,790
                      
                      
                      $
                      206Obligations
      of states andpolitical
      subdivisions
                      
                      
                      3,575
                      
                      
                      
                      102
                      
                      
                      
                      2,605
                      
                      
                      
                      12
                      
                      
                      
                      6,180
                      
                      
                      
                      114Corporate
      bonds:Pooled
      trust preferred securities
                      
                      
                      -
                      
                      
                      
                      -
                      
                      
                      
                      4,920
                      
                      
                      
                      13,189
                      
                      
                      
                      4,920
                      
                      
                      
                      13,189MBS
      - GSE residential
                      
                      
                      -
                      
                      
                      
                      -
                      
                      
                      
                      -
                      
                      
                      
                      -
                      
                      
                      
                      -
                      
                      
                      
                      -Total
      debt securities
                      
                      
                      3,575
                      
                      
                      
                      102
                      
                      
                      
                      13,315
                      
                      
                      
                      13,407
                      
                      
                      
                      16,890
                      
                      
                      
                      13,509Equity
      securities - financial services
                      
                      
                      49
                      
                      
                      
                      1
                      
                      
                      
                      114
                      
                      
                      
                      10
                      
                      
                      
                      163
                      
                      
                      
                      11Total
      temporarily impaired securities
                      
                      $
                      3,624
                      
                      
                      $
                      103
                      
                      
                      $
                      13,429
                      
                      
                      $
                      13,417
                      
                      
                      $
                      17,053
                      
                      
                      $
                      13,520Number
      of securities
                      
                      
                      8
                      
                      
                      
                      
                      
                      
                      
                      18
                      
                      
                      
                      
                      
                      
                      
                      26




- 10
-




December 31, 2009Less than 12 months
                      
                      
                      More than 12 months
                      
                      
                      TotalFair
                      
                      
                      Unrealized
                      
                      
                      Fair
                      
                      
                      Unrealized
                      
                      
                      Fair
                      
                      
                      Unrealizedvalue
                      
                      
                      losses
                      
                      
                      value
                      
                      
                      losses
                      
                      
                      value
                      
                      
                      lossesAgency
      - GSE
                      
                      $
                      21,090
                      
                      
                      $
                      291
                      
                      
                      $
                      5,038
                      
                      
                      $
                      786
                      
                      
                      $
                      26,128
                      
                      
                      $
                      1,077Obligations
      of states andpolitical
      subdivisions
                      
                      
                      3,534
                      
                      
                      
                      115
                      
                      
                      
                      2,600
                      
                      
                      
                      22
                      
                      
                      
                      6,134
                      
                      
                      
                      137Corporate
      bonds:Pooled
      trust preferred securities
                      
                      
                      -
                      
                      
                      
                      -
                      
                      
                      
                      5,242
                      
                      
                      
                      13,552
                      
                      
                      
                      5,242
                      
                      
                      
                      13,552MBS
      - GSE residential
                      
                      
                      5,055
                      
                      
                      
                      71
                      
                      
                      
                      -
                      
                      
                      
                      -
                      
                      
                      
                      5,055
                      
                      
                      
                      71Total
      debt securities
                      
                      
                      29,679
                      
                      
                      
                      477
                      
                      
                      
                      12,880
                      
                      
                      
                      14,360
                      
                      
                      
                      42,559
                      
                      
                      
                      14,837Equity
      securities - financial services
                      
                      
                      114
                      
                      
                      
                      10
                      
                      
                      
                      46
                      
                      
                      
                      4
                      
                      
                      
                      160
                      
                      
                      
                      14Total
      temporarily impaired securities
                      
                      $
                      29,793
                      
                      
                      $
                      487
                      
                      
                      $
                      12,926
                      
                      
                      $
                      14,364
                      
                      
                      $
                      42,719
                      
                      
                      $
                      14,851Number
      of securities
                      
                      
                      23
                      
                      
                      
                      
                      
                      
                      
                      17
                      
                      
                      
                      
                      
                      
                      
                      40




Management
conducts a formal review of investment securities on a quarterly basis for the
presence of other-than-temporary impairment (OTTI).  The accounting
guidance related to OTTI requires the Company to assess whether OTTI is present
when the fair value of a debt security is less than its amortized cost as of the
balance sheet date.  Under these circumstances, OTTI is considered to
have occurred if: (1) the entity has intent to sell the security;
(2) more likely than not the entity will be required to sell the security
before recovery of its amortized cost basis; or (3) the present value of
expected cash flows is not sufficient to recover the entire amortized
cost.




The
accounting guidance requires that credit-related OTTI be recognized in earnings
while non-credit-related OTTI on securities not expected to be sold be
recognized in other comprehensive income (OCI).  Non-credit-related
OTTI is based on other factors effecting market conditions, including
illiquidity.  The presentation of OTTI is made in the consolidated
statements of income on a gross basis with an offset for the amount of
non-credit-related OTTI recognized in OCI.




The
Company’s OTTI evaluation process also follows the guidance set forth in topics
related to debt and equity securities.  The guidance set forth in
these pronouncements requires the Company to take into consideration current
market conditions, fair value in relationship to cost, extent and nature of
changes in fair value, issuer rating changes and trends, volatility of earnings,
current analysts’ evaluations, all available information relevant to the
collectability of debt securities, the ability and intent to hold investments
until a recovery of fair value, which may be maturity, and other factors when
evaluating for the existence of OTTI.  This guidance also eliminates
the requirement that a holder’s best estimate of cash flows is based upon those
that a market participant would use.  Instead, the guidance requires
that OTTI be recognized as a realized loss through earnings when there has been
an adverse change in the holder’s expected cash flows such that the full amount
(principal and interest) will probably not be received.  This
requirement is consistent with the impairment model in the guidance for
accounting for debt and equity securities.




For all
security types discussed below, at June 30, 2010 the Company applied the
criteria provided in the recognition and presentation of OTTI
guidance.  That is, management has no intent to sell the securities
and no conditions were identified by management that more likely than not would
require the Company to sell the securities before recovery of their amortized
cost basis.  The results indicated there was no presence of OTTI for
the Company’s portfolios of Agency – Government Sponsored Enterprise (GSE),
Mortgage-backed securities (MBS) – GSE residential and Obligations of states and
political subdivisions.




Agency - GSE and MBS - GSE
residential


Agency –
GSE and MBS – GSE residential securities consist of medium and long-term notes
issued by Federal Home Loan Mortgage Corporation (FHLMC), Federal National
Mortgage Association (FNMA), Federal Home Loan Bank (FHLB) and Government
National Mortgage Association (GNMA).  These securities have interest
rates that are largely fixed-rate issues, have varying mid- to long-term
maturity dates and have contractual cash flows guaranteed by the U.S. government
or agencies of the U.S. government.




Obligations of states and
political subdivisions


The
municipal securities are bank qualified, general obligation bonds rated as
investment grade by various credit rating agencies and have fixed rates of
interest with mid- to long-term maturities.  Fair values of these
securities are highly driven by interest rates.  Management performs
ongoing credit quality reviews on these issues.




In all of
the above security types, the decline in fair value is attributable to changes
in interest rates and not credit quality.  Consequently, no OTTI is
considered necessary for these securities at June 30, 2010.


- 11
-


Pooled trust preferred
securities


A Pooled
Trust Preferred Collateralized Debt Obligation (CDO) is a type of investment
security collateralized by trust preferred securities (TPS) issued by banks,
insurance companies and real estate investment trusts (REITs).  The
primary collateral type is a TPS issued by a bank.  A TPS is a
hybrid security with both debt and equity characteristics such as the ability to
voluntarily defer interest payments for up to 20 consecutive
quarters.  A TPS is considered a junior security in the capital
structure of the issuer.




There are
various tranches or investment classes issued by
the CDO with the most senior tranche having the lowest yield but
the most protection from credit losses compared to other tranches
that are subordinate.  Losses are generally allocated from the lowest
tranche with the equity component holding the most risk and then subordinate
tranches in reverse order up to the senior tranche.  The allocation of
losses is defined in the indenture when the CDO was formed.




Unrealized
losses in the pooled trust preferred securities (PreTSLs) are caused mainly by
the following factors: (1) collateral deterioration due to bank failures
and credit concerns across the banking sector; (2) widening of credit
spreads and (3) illiquidity in the market.  The Company’s review
of these securities, in accordance with the previous discussion, determined that
in 2010, credit-related OTTI be recorded on three holdings of these securities
all of which are in the AFS securities portfolio.




The
following table summarizes the amount of credit-related OTTI recognized in
earnings for 2010 and the amount of credit- and non-credit-related OTTI
recognized in earnings for 2009, by security during the periods indicated
(dollars in thousands):




Three months ended
                              
                              
                              Six months endedJune 30,
                              
                              
                              June 30,2010
                              
                              
                              2009
                              
                              
                              2010
                              
                              
                              2009Pooled
      trust preferred securities:PreTSL
      VII, Mezzanine
                              
                              $
                              67
                              
                              
                              $
                              1
                              
                              
                              $
                              86
                              
                              
                              $
                              326PreTSL
      XI, B3
                              
                              
                              -
                              
                              
                              
                              -
                              
                              
                              
                              60
                              
                              
                              
                              -PreTSL
      XVI, C
                              
                              
                              609
                              
                              
                              
                              -
                              
                              
                              
                              609
                              
                              
                              
                              -Total
                              
                              $
                              676
                              
                              
                              $
                              1
                              
                              
                              $
                              755
                              
                              
                              $
                              326




The
following table is a tabular roll-forward of the cumulative amount of
credit-related OTTI recognized in earnings (dollars in thousands):




Inception toJune 30, 2010HTM
                            
                            
                            AFS
                            
                            
                            TotalBeginning
      balance of credit-related OTTI
                            
                            $
                            -
                            
                            
                            $
                            (3,198
                            )
                            
                            $
                            (3,198
                            )Additions
      for credit-related OTTInot
      previously recognized
                            
                            
                            -
                            
                            
                            
                            (669
                            )
                            
                            
                            (669
                            )Additional
      credit-related OTTIpreviously
      recognized when thereis
      no intent to sell before recoveryof
      amortized cost basis
                            
                            
                            -
                            
                            
                            
                            (86
                            )
                            
                            
                            (86
                            )Ending
      balance of credit-related OTTI
                            
                            $
                            -
                            
                            
                            $
                            (3,953
                            )
                            
                            $
                            (3,953
                            )




To
determine the ending balance of credit-related OTTI, the Company uses discounted
present value cash flow analysis and compares the results with the bond’s face
value.  The analysis considered the following assumptions: the
discount rate which equated to the discount margin for each tranche (credit
spread) at the time of purchase which was then added to the appropriate
three-month Libor forward rate obtained from the forward Libor curve; historical
average default rates obtained from the FDIC for U.S. Banks and Thrifts for the
period spanning 1988 to 1991 increased by a factor of three and rolled forward
to project a rate of default of approximately one-third; the default rate was
reduced by the actual deferrals / defaults experienced in all preferred term
securities from 2008 through 2009; the remaining estimated default rate was then
stratified with higher default rates occurring in the beginning of 2010
regressing to normal in 2011, with an estimated 15% recovery by way of a two
year lag; and no prepayments of principal.




Two of
the Company’s initial mezzanine holdings (PreTSLs IV and V) are now senior
tranches and the remaining holdings are mezzanine tranches.  As of
June 30, 2010, none of the pooled trust preferred securities were investment
grade.  At the time of initial issue, the subordination in the
Company’s tranches ranged in size from approximately 8.0% to 25.2% of the total
principal amount of the respective securities and no more than 5% of any pooled
trust preferred security consisted of a security issued by any one bank and 4%
for insurance companies.  As of June 30, 2010, management estimates
the subordination in the Company’s tranches ranging from 0% to 19.1% of the
current performing collateral.  During the first six months of 2010,
PreTSL IX with a book value of $2.8 million and corresponding fair value of $1.2
million was placed on non-accrual status.


- 12
-


The
following table is the composition of the Company’s non-accrual PreTSL
securities as of the period indicated (dollars in thousands):




June 30, 2010
                    
                    
                    December 31, 2009Book
                    
                    
                    Fair
                    
                    
                    Book
                    
                    
                    FairDeal
                    
                    Class
                    
                    
                    value
                    
                    
                    value
                    
                    
                    value
                    
                    
                    valuePreTSL
      VII
                    
                    Mezzanine
                    
                    
                    $
                    340
                    
                    
                    $
                    163
                    
                    
                    $
                    432
                    
                    
                    $
                    219PreTSL  IX
                    
                    B-1,B-3
                    
                    
                    
                    2,804
                    
                    
                    
                    1,207
                    
                    
                    
                    -
                    
                    
                    
                    -PreTSL  XV
                    
                    B-1
                    
                    
                    
                    1,359
                    
                    
                    
                    265
                    
                    
                    
                    1,359
                    
                    
                    
                    297PreTSL
      XVI
                    
                    C
                    
                    
                    
                    681
                    
                    
                    
                    51
                    
                    
                    
                    1,290
                    
                    
                    
                    65PreTSL
      XXV
                    
                    C-1
                    
                    
                    
                    507
                    
                    
                    
                    20
                    
                    
                    
                    507
                    
                    
                    
                    2$
                    5,691
                    
                    
                    $
                    1,706
                    
                    
                    $
                    3,588
                    
                    
                    $
                    583




The
securities included in the above table, have experienced impairment of
principal, and interest was “paid-in-kind”.  On a quarterly basis,
each of the other issues will be evaluated for the presence of these two
conditions and placed on non-accrual status if necessary.




The
following table provides additional information with respect to the Company’s
pooled trust preferred securities as of June 30, 2010:




Current
                        
                        
                        
                        
                        
                        Actual
                        
                        
                        
                        
                        
                        Excess
                        
                        
                        Effectivenumber
                        
                        
                        
                        
                        
                        deferrals
                        
                        
                        
                        
                        
                        subordination *
                        
                        
                        subordination **of
                        
                        
                        Actual
                        
                        
                        and defaults
                        
                        
                        
                        
                        
                        as a % of
                        
                        
                        as a % ofMoody's /
                        
                        banks /
                        
                        
                        deferrals
                        
                        
                        as a % of
                        
                        
                        Excess
                        
                        
                        current
                        
                        
                        currentBook
                        
                        
                        Fair
                        
                        
                        Unrealized
                        
                        Fitch
                        
                        insurance
                        
                        
                        and defaults
                        
                        
                        current
                        
                        
                        subordination
                        
                        
                        performing
                        
                        
                        performingDeal
                        
                        Class
                        
                        
                        value
                        
                        
                        value
                        
                        
                        loss
                        
                        ratings
                        
                        companies
                        
                        
                        $(000)
                        
                        
                        collateral
                        
                        
                        $(000)
                        
                        
                        collateral
                        
                        
                        collateralPreTSL  IV
                        
                        Mezzanine
                        
                        
                        $
                        609,971
                        
                        
                        $
                        450,280
                        
                        
                        $
                        (159,691
                        )
                        Ca /
      CCC
                        
                        6 /
      -
                        
                        
                        
                        18,000
                        
                        
                        
                        27.1
                        
                        
                        
                        9,846
                        
                        
                        
                        19.1
                        
                        
                        
                        34.0PreTSL  V
                        
                        Mezzanine
                        
                        
                        
                        275,162
                        
                        
                        
                        188,771
                        
                        
                        
                        (86,391
                        )
                        Ba3
      / C
                        
                        4 /
      -
                        
                        
                        
                        18,950
                        
                        
                        
                        43.1
                        
                        
                        None
                        
                        
                        
                        N/A
                        
                        
                        
                        N/APreTSL VII
                        
                        Mezzanine
                        
                        
                        
                        339,758
                        
                        
                        
                        162,639
                        
                        
                        
                        (177,119
                        )
                        Ca /
      C
                        
                        19 /
      -
                        
                        
                        
                        160,000
                        
                        
                        
                        70.5
                        
                        
                        None
                        
                        
                        
                        N/A
                        
                        
                        
                        N/APreTSL  IX
                        
                        B-1,B-3
                        
                        
                        
                        2,804,129
                        
                        
                        
                        1,206,389
                        
                        
                        
                        (1,597,740
                        )
                        Ca /
      C
                        
                        49 /
      -
                        
                        
                        
                        131,510
                        
                        
                        
                        29.2
                        
                        
                        None
                        
                        
                        
                        N/A
                        
                        
                        
                        N/APreTSL XI
                        
                        B-3
                        
                        
                        
                        2,339,462
                        
                        
                        
                        912,500
                        
                        
                        
                        (1,426,962
                        )
                        Ca /
      C
                        
                        65 /
      -
                        
                        
                        
                        142,780
                        
                        
                        
                        23.7
                        
                        
                        None
                        
                        
                        
                        N/A
                        
                        
                        
                        5.0PreTSL  XV
                        
                        B-1
                        
                        
                        
                        1,359,562
                        
                        
                        
                        265,285
                        
                        
                        
                        (1,094,277
                        )
                        Ca /
      C
                        
                        63 /
      9
                        
                        
                        
                        159,050
                        
                        
                        
                        26.6
                        
                        
                        None
                        
                        
                        
                        N/A
                        
                        
                        
                        N/APreTSL XVI
                        
                        C
                        
                        
                        
                        680,552
                        
                        
                        
                        51,182
                        
                        
                        
                        (629,370
                        )
                        Ca /
      C
                        
                        49 /
      7
                        
                        
                        
                        212,890
                        
                        
                        
                        37.0
                        
                        
                        None
                        
                        
                        
                        N/A
                        
                        
                        
                        N/APreTSL XVII
                        
                        C
                        
                        
                        
                        1,009,600
                        
                        
                        
                        41,354
                        
                        
                        
                        (968,246
                        )
                        Ca /
      C
                        
                        51 /
      6
                        
                        
                        
                        113,720
                        
                        
                        
                        24.0
                        
                        
                        None
                        
                        
                        
                        N/A
                        
                        
                        
                        3.4PreTSL XVIII
                        
                        C
                        
                        
                        
                        1,012,049
                        
                        
                        
                        108,997
                        
                        
                        
                        (903,052
                        )
                        Ca /
      C
                        
                        66 /
      14
                        
                        
                        
                        150,140
                        
                        
                        
                        22.2
                        
                        
                        None
                        
                        
                        
                        N/A
                        
                        
                        
                        5.5PreTSL XIX
                        
                        C
                        
                        
                        
                        2,555,406
                        
                        
                        
                        280,042
                        
                        
                        
                        (2,275,364
                        )
                        Ca /
      C
                        
                        60 /
      14
                        
                        
                        
                        162,400
                        
                        
                        
                        23.2
                        
                        
                        None
                        
                        
                        
                        N/A
                        
                        
                        
                        4.5PreTSL XXIV
                        
                        B-1
                        
                        
                        
                        2,228,209
                        
                        
                        
                        379,065
                        
                        
                        
                        (1,849,144
                        )
                        Caa3
      /  CC
                        
                        80 /
      13
                        
                        
                        
                        349,800
                        
                        
                        
                        33.3
                        
                        
                        None
                        
                        
                        
                        N/A
                        
                        
                        
                        11.5PreTSL XXV
                        
                        C-1
                        
                        
                        
                        506,673
                        
                        
                        
                        20,442
                        
                        
                        
                        (486,231
                        )
                        C /
      C
                        
                        64 /
      9
                        
                        
                        
                        271,600
                        
                        
                        
                        31.0
                        
                        
                        None
                        
                        
                        
                        N/A
                        
                        
                        
                        0.2PreTSL XXVII
                        
                        B
                        
                        
                        
                        2,388,930
                        
                        
                        
                        853,095
                        
                        
                        
                        (1,535,835
                        )
                        Caa3
      / B
                        
                        42 /
      7
                        
                        
                        
                        90,800
                        
                        
                        
                        27.8
                        
                        
                        None
                        
                        
                        
                        N/A
                        
                        
                        
                        19.9$
                        18,109,463
                        
                        
                        $
                        4,920,041
                        
                        
                        $
                        (13,189,422
                        )




* Excess
subordination represents the excess (if any) of the amount of performing
collateral over the given class of bonds.


**Effective
subordination represents the estimated percentage of the performing collateral
that would need to defer or default at the next payment in order to trigger a
loss of principal or interest.  This differs from excess subordination
in that it considers the effect of excess interest earned on the performing
collateral.




For a
further discussion on the fair value determination of the Company’s investment
in pooled trust preferred securities, see “Investment securities” under the
caption “Comparison of financial condition at June 30, 2010 and December 31,
2009” of Part 1, Item 2, “Management’s Discussion and Analysis of Financial
Condition and Results of Operations”; below.




4.  Earnings
per share




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


- 13
-


In the
computation of diluted EPS, the Company uses the treasury stock method to
determine the dilutive effect of its granted but unexercised stock
options.  Under the treasury stock method, the assumed proceeds
received from shares issued, in a hypothetical stock option exercise, are
assumed to be used to purchase treasury stock.  There were no
potentially dilutive shares outstanding in either period because the average
share price of the Company’s common stock during the six months ended June 30,
2010 and 2009 was below the strike prices of all options granted.  For
a further discussion on the Company’s stock option plans, see note 5, “Stock
plans,” below.




The
following table illustrates the data used in computing basic EPS and a
reconciliation to derive at the components of diluted EPS for the periods
indicated:




2010
                                    
                                    
                                    2009Six months ended June 30,Net
      income available to common shareholders
                                    
                                    $
                                    1,274,852
                                    
                                    
                                    $
                                    1,737,211Weighted-average
      common shares outstanding
                                    
                                    
                                    2,123,364
                                    
                                    
                                    
                                    2,070,144Basic
      EPS
                                    
                                    $
                                    0.60
                                    
                                    
                                    $
                                    0.84Diluted EPS:Net
      income available to common shareholders
                                    
                                    $
                                    1,274,852
                                    
                                    
                                    $
                                    1,737,211Weighted-average
      common shares outstanding
                                    
                                    
                                    2,123,364
                                    
                                    
                                    
                                    2,070,144Potentially
      dilutive common shares
                                    
                                    
                                    -
                                    
                                    
                                    
                                    -Weighted-average
      common shares and dilutive potential shares
                                    
                                    
                                    2,123,364
                                    
                                    
                                    
                                    2,070,144Diluted
      EPS
                                    
                                    $
                                    0.60
                                    
                                    
                                    $
                                    0.84




5.  Stock
plans




The
Company has two stock-based compensation plans (the stock option plans) and
applies the fair value method of accounting for stock-based compensation
provided under the current accounting guidance.  The guidelines
require the cost of share-based payment transactions (including those with
employees and non-employees) be recognized in the financial
statements.  The stock option plans were shareholder-approved and
permit the grant of share-based compensation awards to its directors, key
officers and certain other employees.  The Company believes that the
stock option plans better align the interest of its directors, key officers and
employees with the interest of its shareholders.  The Company further
believes that the granting of share-based awards is necessary to retain the
knowledge base, continuity and expertise of its directors, key officers and
employees.  In the stock option plans, directors, key officers and
certain other employees are eligible to be awarded stock options to purchase the
Company’s common stock at the fair market value on the date of
grant.




The
Company established the 2000 Independent Directors Stock Option Plan and has
reserved 55,000 shares of its un-issued capital stock for issuance under the
plan.  No stock options were awarded during the six months ended June
30, 2010 and 2009.  As of June 30, 2010, there were 21,050 unexercised
stock options outstanding under this plan.




The
Company also established the 2000 Stock Incentive Plan and has reserved 55,000
shares of its un-issued capital stock for issuance under the
plan.  There were no options awarded during the six months ended June
30, 2010 and 2009.  As of June 30, 2010, there were 6,810 unexercised
stock options outstanding under this plan.




Since no
awards were vested in either of the stock option plans during the six months
ended June 30, 2010 and 2009, there was no stock-based compensation expense
recognized related to either of the stock option plans.




In
addition to the two stock option plans, the Company established the 2002
Employee Stock Purchase Plan (the ESPP) and reserved 110,000 shares of its
un-issued capital stock for issuance.  The plan was designed to
promote broad-based employee ownership of the Company’s stock and to motivate
employees to improve job performance and enhance the financial results of the
Company.  Under the ESPP, employees use automatic payroll withholdings
to purchase the Company’s capital stock at a discounted price based on the fair
market value of the capital stock as measured on either the commencement date or
termination date.  As of June 30, 2010, 17,025 shares have been issued
under the ESPP.  The ESPP is considered a compensatory plan and as
such, is required to comply with the provisions of authoritative accounting
guidance.  The Company recognizes compensation expense on its ESPP on
the date the shares are purchased.  For the six months ended June 30,
2010 and 2009, compensation expense related to the ESPP approximated $7,000 and
$5,000, respectively, and is included as a component of salaries and employee
benefits in the consolidated statements of income.


- 14
-


6.  Fair value
measurements




The
accounting guidelines established a framework for measuring fair value and
enhancing disclosures about fair value measurements.  The guidelines
of fair value reporting instituted a valuation hierarchy for disclosure of the
inputs used to measure fair value.  This hierarchy prioritizes the
inputs into three broad levels as follows:




Level 1
inputs are quoted prices (unadjusted) in active markets for identical assets or
liabilities;




Level 2
inputs are quoted prices for similar assets and liabilities in active markets;
quoted prices for identical or similar assets or liabilities in markets that are
not active; or inputs that are observable for the asset or liability, either
directly or indirectly through market corroboration, for substantially the full
term of the financial instrument;




Level 3
inputs are unobservable inputs based on our own assumptions to measure assets
and liabilities at fair value.  Level 3 pricing for securities may
also include unobservable inputs based upon broker-traded
transactions.  A financial asset or liability’s classification within
the hierarchy is determined based on the lowest level input that is significant
to the fair value measurement.




The
Company uses fair value to measure certain assets and, if necessary, liabilities
on a recurring basis when fair value is the primary measure for
accounting.  Thus, the Company uses fair value for AFS
securities.  Fair value is used on a non-recurring basis to measure
certain assets when adjusting carrying values to market values, such as impaired
loans.




The
following table illustrates the financial instruments measured at fair value on
a recurring basis segregated by hierarchy fair value levels as of June 30, 2010
and December 31, 2009 (dollars in thousands):




Fair value measurements at June 30, 2010:Total carrying
                  
                  
                  Quoted prices
                  
                  
                  Significant other
                  
                  
                  Significantvalue at
                  
                  
                  in active markets
                  
                  
                  observable inputs
                  
                  
                  unobservable inputsAssets:
                  
                  June 30, 2010
                  
                  
                  (Level 1)
                  
                  
                  (Level 2)
                  
                  
                  (Level 3)Available-for-sale
      securities:Agency
      - GSE
                  
                  $
                  24,310
                  
                  
                  $
                  -
                  
                  
                  $
                  24,310
                  
                  
                  $
                  -Obligations
      of states andpolitical
      subdivisions
                  
                  
                  23,160
                  
                  
                  
                  -
                  
                  
                  
                  23,160
                  
                  
                  
                  -Corporate
      bonds:Pooled
      trust preferred securities
                  
                  
                  4,920
                  
                  
                  
                  -
                  
                  
                  
                  -
                  
                  
                  
                  4,920MBS
      - GSE residential
                  
                  
                  22,565
                  
                  
                  
                  -
                  
                  
                  
                  22,565
                  
                  
                  
                  -Equity
      securities - financial services
                  
                  
                  415
                  
                  
                  
                  415
                  
                  
                  
                  -
                  
                  
                  
                  -Total
      available-for-sale securities
                  
                  $
                  75,370
                  
                  
                  $
                  415
                  
                  
                  $
                  70,035
                  
                  
                  $
                  4,920





Fair value measurements at December 31, 2009:Total carrying
                  
                  
                  Quoted prices
                  
                  
                  Significant other
                  
                  
                  Significantvalue at
                  
                  
                  in active markets
                  
                  
                  observable inputs
                  
                  
                  unobservable inputsAssets:
                  
                  December 31, 2009
                  
                  
                  (Level 1)
                  
                  
                  (Level 2)
                  
                  
                  (Level 3)Available-for-sale
      securities:Agency
      - GSE
                  
                  $
                  33,132
                  
                  
                  $
                  -
                  
                  
                  $
                  33,132
                  
                  
                  $
                  -Obligations
      of states andpolitical
      subdivisions
                  
                  
                  23,270
                  
                  
                  
                  -
                  
                  
                  
                  23,270
                  
                  
                  
                  -Corporate
      bonds:Pooled
      trust preferred securities
                  
                  
                  5,242
                  
                  
                  
                  -
                  
                  
                  
                  -
                  
                  
                  
                  5,242MBS
      - GSE residential
                  
                  
                  13,748
                  
                  
                  
                  -
                  
                  
                  
                  13,748
                  
                  
                  
                  -Equity
      securities - financial services
                  
                  
                  429
                  
                  
                  
                  429
                  
                  
                  
                  -
                  
                  
                  
                  -Total
      available-for-sale securities
                  
                  $
                  75,821
                  
                  
                  $
                  429
                  
                  
                  $
                  70,150
                  
                  
                  $
                  5,242




Equity
securities in the AFS portfolio are measured at fair value using quoted market
prices for identical assets and are classified within Level 1 of the valuation
hierarchy.  Other than the Company’s investment in corporate bonds,
consisting of pooled
trust preferred securities, all other debt securities in the AFS portfolio are
measured at fair value using prices provided by a third-party vendor, who is a
provider of financial market data, analytics and related services to financial
institutions.  Assets classified as Level 2 use valuation techniques
that are common to bond valuations.  That is, in active markets
whereby bonds of similar characteristics frequently trade, quotes for similar
assets are obtained.  For the six months ended June 30, 2010, there
were no transfers to and from Level 1 and Level 2 fair value measurements for
financial assets measured on a recurring basis.


- 15
-


The
Company’s pooled trust preferred securities include both observable and
unobservable inputs to determine fair value and, therefore, are classified as
Level 3 inputs. For a discussion on the fair value determination of the
Company’s investment in pooled trust preferred securities, see “Investment
securities” under the caption “Comparison of Financial Condition at June 30,
2010 and December 31, 2009” in “Management’s Discussion and Analysis of
Financial Condition and Results of Operations,” below.




The
following table illustrates the changes in Level 3 financial instruments,
consisting of the Company’s investment in pooled trust preferred securities,
measured at fair value on a recurring basis for the periods indicated (dollars
in thousands):




As of and for the
                      
                      
                      As of and for thesix months ended
                      
                      
                      six months endedJune 30, 2010
                      
                      
                      June 30, 2009Assets:Balance
      at beginning of period
                      
                      $
                      5,242
                      
                      
                      $
                      10,260Realized
      / unrealized (losses) gains:in
      earnings
                      
                      
                      (755
                      )
                      
                      
                      (326
                      )in
      comprehensive income (loss)
                      
                      
                      363
                      
                      
                      
                      (2,311
                      )Purchases,
      sales, issuances and settlements,amortization
      and accretion, net
                      
                      
                      70
                      
                      
                      
                      640Balance
      at end of period
                      
                      $
                      4,920
                      
                      
                      $
                      8,263




The
following table illustrates the financial instruments measured at fair value on
a non-recurring basis segregated by hierarchy fair value levels as of June 30,
2010 and December 31, 2009 (dollars in thousands):




Fair value measurements at June 30, 2010 using:Total carrying
                          
                          
                          Quoted prices
                          
                          
                          Significant other
                          
                          
                          Significantvalue at
                          
                          
                          in active markets
                          
                          
                          observable inputs
                          
                          
                          unobservable inputsJune 30, 2010
                          
                          
                          (Level 1)
                          
                          
                          (Level 2)
                          
                          
                          (Level 3)Assets:Impaired
      loans
                          
                          $
                          2,741
                          
                          
                          $
                          -
                          
                          
                          $
                          2,360
                          
                          
                          $
                          381





Fair value measurements at December 31, 2009 using:Total carrying
                                  
                                  
                                  Quoted prices
                                  
                                  
                                  Significant other
                                  
                                  
                                  Significantvalue at
                                  
                                  
                                  in active markets
                                  
                                  
                                  observable inputs
                                  
                                  
                                  unobservable inputsDecember 31, 2009
                                  
                                  
                                  (Level 1)
                                  
                                  
                                  (Level 2)
                                  
                                  
                                  (Level 3)Assets:Impaired
      loans
                                  
                                  $
                                  4,842
                                  
                                  
                                  $
                                  15
                                  
                                  
                                  $
                                  4,447
                                  
                                  
                                  $
                                  380




Impaired
loans that are collateral dependent are written down to fair value through the
establishment of specific reserves. Techniques used to value the collateral that
secures the impaired loan include: quoted market prices for identical assets
classified as Level 1 inputs; for Level 2, observable inputs, employed by
certified appraisers for similar assets are utilized if the loan is collateral
dependent and then discounted based upon the type and/or age of the appraisal,
the costs to sell and maintain the underlying collateral. If the loan is not
considered to be collateral dependent, any impairment may be determined based
upon the present value of the reported cash flows discounted at the loan’s
effective interest rate. In cases where valuation techniques included inputs
that are unobservable, the valuations are based on commonly used and generally
accepted industry liquidation advance rates or estimates and assumptions
developed by management, with significant adjustments applied to the best
information available under each circumstance. These asset valuations are
classified as Level 3 inputs. A net reduction or transfer out of the
impaired loans with Level 2 inputs occurred during the six month period ended
June 30, 2010 based upon payments received. There were no significant transfers
during the quarter in the Level 1 and Level 3 impaired loans.


- 16
-


A summary
of the carrying amounts and estimated fair values of certain financial
instruments follows as of the periods indicated (dollars in
thousands):




June 30, 2010
                
                
                December 31, 2009Carrying
                
                
                Estimated
                
                
                Carrying
                
                
                Estimatedamount
                
                
                fair value
                
                
                amount
                
                
                fair valueFinancial
      assets:Cash
      and cash equivalents
                
                $
                36,729
                
                
                $
                36,729
                
                
                $
                8,328
                
                
                $
                8,328Held-to-maturity
      securities
                
                
                578
                
                
                
                636
                
                
                
                709
                
                
                
                765Available-for-sale
      securities
                
                
                75,370
                
                
                
                75,370
                
                
                
                75,821
                
                
                
                75,821FHLB
      stock
                
                
                4,781
                
                
                
                4,781
                
                
                
                4,781
                
                
                
                4,781Loans
      and leases
                
                
                420,216
                
                
                
                416,717
                
                
                
                423,124
                
                
                
                420,908Loans
      available-for-sale
                
                
                384
                
                
                
                389
                
                
                
                1,221
                
                
                
                1,233Accrued
      interest
                
                
                2,149
                
                
                
                2,149
                
                
                
                2,251
                
                
                
                2,251Financial
      liabilities:Deposit
      liabilities
                
                
                480,927
                
                
                
                479,690
                
                
                
                458,994
                
                
                
                453,264Short-term
      borrowings
                
                
                15,578
                
                
                
                15,578
                
                
                
                16,533
                
                
                
                16,533Long-term
      debt
                
                
                32,000
                
                
                
                35,444
                
                
                
                32,000
                
                
                
                35,017Accrued
      interest
                
                
                625
                
                
                
                625
                
                
                
                665
                
                
                
                665




The
following summarizes the methodology used to determine estimated fair values in
the above table:




The
carrying value of short-term financial instruments, as listed below,
approximates their fair value. These instruments generally have limited credit
exposure, no stated or short-term maturities and carry interest rates that
approximate market.




·
            Cash
      and cash equivalents




·
            Non-interest
      bearing deposit accounts




·
            Savings,
      NOW and money market accounts




·
            Short-term
      borrowings




·
            Accrued
      interest




Securities:
Except for corporate bonds consisting of preferred term securities, fair values
on the other investment securities are determined by prices provided by a
third-party vendor, who is a provider of financial market data, analytics and
related services to financial institutions. The fair values of pooled trust
preferred securities is determined based on a present value technique (income
valuation) as described under the caption “Investment securities” of the
comparison of financial condition at June 30, 2010 and December 31, 2009,
below.




FHLB
stock, or restricted regulatory equity, is carried at cost, which approximates
fair value.




Loans and
leases: The fair value of all loans is estimated by the net present value of the
future expected cash flows discounted at current market rates.




Loans
available-for-sale: For loans available-for-sale, the fair value is estimated
using rates currently offered for similar loans and are obtained from the FNMA
or the FHLB.




Certificates
of deposit: The fair values of certificate of deposit accounts are based on
discounted cash flows using rates which approximate market rates of deposits
with similar maturities.




Long-term
debt: The fair value is estimated using market rates currently offered for
similar borrowings.




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




The
following is management's discussion and analysis of the significant changes in
the consolidated financial condition of the Company as of June 30, 2010 compared
to December 31, 2009 and a comparison of the results of operations for the
three- and six-months ended June 30, 2010 and 2009. Current performance may not
be indicative of future results. This discussion should be read in conjunction
with the Company’s 2009 Annual Report filed on Form 10-K.


- 17
-




Forward-looking
statements




Certain
of the matters discussed in this Interim Report on Form 10-Q may constitute
forward-looking statements for purposes of the Securities Act of 1933, as
amended, and the Securities Exchange Act of 1934, as amended, and as such may
involve known and unknown risks, uncertainties and other factors which may cause
the actual results, performance or achievements of the Company to be materially
different from future results, performance or achievements expressed or implied
by such forward-looking statements. The words “expect,” “anticipate,” “intend,”
“plan,” “believe,” “estimate,” and similar expressions are intended to identify
such forward-looking statements.




The
Company’s actual results may differ materially from the results anticipated in
these forward-looking statements due to a variety of factors, including, without
limitation:




§
            the
      effects of economic deterioration on current customers, specifically the
      effect of the economy on loan customers’ ability to repay
      loans;


§
            the
      costs and effects of litigation and of unexpected or adverse outcomes in
      such litigation;


§
            governmental
      monetary and fiscal policies, as well as legislative and regulatory
      changes, in particular the effects of the Dodd-Frank Wall Street Reform
      and Consumer Protection Act;


§
            the
      effect of changes in accounting policies and practices, as may be adopted
      by the regulatory agencies, as well as the Financial Accounting Standards
      Board and other accounting standard
setters;


§
            the
      risks of changes in interest rates on the level and composition of
      deposits, loan demand, and the values of loan collateral, securities and
      interest rate protection agreements, as well as interest rate
      risks;


§
            the
      effects of competition from other commercial banks, thrifts, mortgage
      banking firms, consumer finance companies, credit unions, securities
      brokerage firms, insurance companies, money market and other mutual funds
      and other financial institutions operating in our market area and
      elsewhere, including institutions operating locally, regionally,
      nationally and internationally, together with such competitors offering
      banking products and services by mail, telephone, computer and the
      internet;


§
            technological
      changes;


§
            acquisitions
      and integration of acquired
businesses;


§
            the
      failure of assumptions underlying the establishment of reserves for loan
      and lease losses and estimations of values of collateral and various
      financial assets and liabilities;


§
            volatilities
      in the securities markets;


§
            deteriorating
      economic conditions;


§
            acts
      of war or terrorism; and


§
            disruption
      of credit and equity markets.




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




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




General




The
Company’s results of operations depend primarily on net interest income. Net
interest income is the difference between interest income and interest expense.
Interest income is generated from yields on interest-earning assets, which
consist principally of loans and investment securities. Interest expense is
incurred from rates paid on interest-bearing liabilities, which consist of
deposits and borrowings. Net interest income is determined by the Company’s
interest rate spread (the difference between the yields earned on its
interest-earning assets and the rates paid on its interest-bearing liabilities)
and the relative amounts of interest-earning assets and interest-bearing
liabilities. Interest rate spread is significantly impacted by: changes in
interest rates and market yield curves and their related impact on cash flows;
the composition and characteristics of interest-earning assets and
interest-bearing liabilities; differences in the maturity and re-pricing
characteristics of assets compared to the maturity and re-pricing
characteristics of the liabilities that fund them and by the competition in our
marketplace.




The
Company’s profitability is also affected by the level of its non-interest income
and expenses, provision for loan losses and provision for income taxes.
Non-interest income consists of service charges on the Bank’s loan and deposit
products, trust and asset management service fees, increases in the cash
surrender value of the bank owned life insurance (BOLI), net gains or losses
from sales of loans, securities and foreclosed properties held-for-sale and from
credit-related other-than-temporary impairment (OTTI) charges on investment
securities. Non-interest expense consists of compensation and related employee
benefit expenses, occupancy, equipment, data processing, advertising, marketing,
professional fees, insurance and other operating overhead.


- 18
-




The
Company’s profitability is significantly affected by general economic and
competitive conditions, changes in market interest rates, government policies
and actions of regulatory authorities. The Company’s loan portfolio is comprised
principally of commercial and commercial real estate loans. The properties
underlying the Company’s mortgages are concentrated in Northeastern
Pennsylvania. Credit risk, which represents the possibility of the Company not
recovering amounts due from its borrowers, is significantly related to local
economic conditions in the areas the properties are located as well as the
Company’s underwriting standards. Economic conditions affect the market value of
the underlying collateral as well as the levels of adequate cash flow and
revenue generation from income-producing commercial properties.




Comparison of the results of
operations


Three and six months ended
June 30, 2010 and 2009




Overview




Net
income for the second quarter of 2010 was $719,000, or $0.34 per diluted share,
compared to $912,000, or $0.44, recorded in the same quarter of 2009. For the
six months ended June 30, 2010, net income was $1,275,000, or $0.60 per diluted
share, compared to $1,737,000, or $0.84 recorded for the six months ended June
30, 2009. The decrease in net income in the quarter and year-to-date comparisons
was due to: a decline in non-interest income, largely from higher non-cash,
other-than-temporary impairment (OTTI) charges related to the Company’s
investment portfolio and lower levels of gains from the sales of mortgage loans;
and in the year-to-date comparison, higher operating overhead and an increase in
the provision for loan losses. These items were partially offset by higher net
interest income and in the quarter-to-quarter comparison, lower salary and
employee benefits.




Return on
average assets (ROA) and return on average shareholders’ equity (ROE) were 0.49%
and 6.10%, respectively, for the three months ended June 30, 2010 compared to
0.65% and 7.63%, respectively, for the three months ended June 30, 2009. For the
six months ended June 30, 2010, ROA and ROE were 0.44% and 5.48%, respectively,
compared to 0.62% and 7.33% for the same period in 2009. The decreases in both
ROA and ROE are attributable to lower net income.




Net interest income and
interest sensitive assets / liabilities




Net
interest income increased $477,000, or 10%, to $5,217,000 in the second quarter
of 2010, from $4,740,000 recorded in the same quarter of 2009. The improvement
was principally from lower interest expense of $962,000 due to a 93 basis point
reduction in rates paid on interest-bearing liabilities, where a 92 basis point
reduction in deposit rates more than offset the effect of a $17,300,000 increase
in average balances. Conversely, though average interest-earning assets
increased $19,800,000, interest income was negatively impacted by a 55 basis
point decline in yields earned resulting in a net decline in interest income of
$485,000 in the second quarter of 2010 compared to the second quarter of
2009.




During
the second quarter of 2010, the Company’s tax-equivalent margin and spread were
3.92% and 3.66%, compared to 3.70% and 3.28%, respectively, during the second
quarter of 2009. The improvement in spread was caused by a greater reduction in
rates paid on interest-bearing liabilities than the reduction in yields earned
on interest-earning assets. The improvement in margin was from higher net
interest income.




For the
six months ended June 30, 2010, net interest income improved 8%, or $811,000,
compared to the six months ended June 30, 2009. Similar to the second quarter
comparison, the improvement was principally from lower interest expense of
$2,082,000 due to a 99 basis point reduction in rates paid on interest-bearing
liabilities including a 92 basis point reduction in rates paid on deposits. The
decrease in interest income of $1,271,000 was from lower yields on earning
assets.




The
Company’s tax-equivalent margin and spread improved to 3.91% and 3.64%,
respectively, in the first half of 2010 from 3.71% and 3.27% during the same
period of 2009. The improvements stem from deposit rates declining more rapidly
than yields from earning from assets and higher net interest
income.




The
prolonged low interest rate environment continued into the first half of
2010. As the Company continues to operate in this environment, earning
assets will continue to price and re-price to lower levels thereby causing
downward pressure on yields. The Company’s Asset Liability Management (ALM) team
meets regularly to discuss among other things, interest rate risk and when
deemed necessary adjusts interest rates on deposits and repurchase agreements in
order to maintain acceptable interest rate margins. However, the Company’s
deposit offering rates are at historical lows and whether the Company can retain
and grow its deposit base will largely depend on customers’ sentiment to
maintain low-earning deposits. Nonetheless, the Company’s ALM team will continue
to address interest rate issues in this difficult financial environment and is
poised to create and offer products that are fair for its customers and
equitable for the Company.




- 19
-




The table
that follows sets forth a comparison of average balances and their corresponding
fully tax-equivalent (FTE) interest income and expense and annualized
tax-equivalent yield and cost for the periods indicated (dollars in
thousands):




Three months ended:June 30, 2010
                            
                            
                            June 30, 2009Average
                            
                            
                            
                            
                            
                            Yield /
                            
                            
                            Average
                            
                            
                            
                            
                            
                            Yield /balance
                            
                            
                            Interest
                            
                            
                            rate
                            
                            
                            balance
                            
                            
                            Interest
                            
                            
                            rateAssetsInterest-earning
      assets:Loans
      and leases
                            
                            $
                            432,214
                            
                            
                            $
                            6,237
                            
                            
                            
                            5.79
                            %
                            
                            $
                            428,079
                            
                            
                            $
                            6,529
                            
                            
                            
                            6.12
                            %Investments
                            
                            
                            99,663
                            
                            
                            
                            925
                            
                            
                            
                            3.72
                            
                            
                            
                            94,535
                            
                            
                            
                            1,113
                            
                            
                            
                            4.72Federal
      funds sold
                            
                            
                            10,210
                            
                            
                            
                            6
                            
                            
                            
                            0.25
                            
                            
                            
                            10,793
                            
                            
                            
                            7
                            
                            
                            
                            0.24Interest-bearing
      deposits
                            
                            
                            12,482
                            
                            
                            
                            8
                            
                            
                            
                            0.25
                            
                            
                            
                            1,419
                            
                            
                            
                            -
                            
                            
                            
                            0.10Total
      interest-earning assets
                            
                            
                            554,569
                            
                            
                            
                            7,176
                            
                            
                            
                            5.19
                            
                            
                            
                            534,826
                            
                            
                            
                            7,649
                            
                            
                            
                            5.74Non-interest-earning
      assets
                            
                            
                            30,880
                            
                            
                            
                            
                            
                            
                            
                            
                            
                            
                            
                            28,615Total
      assets
                            
                            $
                            585,449
                            
                            
                            
                            
                            
                            
                            
                            
                            
                            
                            $
                            563,441Liabilities and shareholders'
      equityInterest-bearing
      liabilities:Other
      interest-bearing deposits
                            
                            $
                            263,717
                            
                            
                            $
                            473
                            
                            
                            
                            0.72
                            %
                            
                            $
                            217,249
                            
                            
                            $
                            550
                            
                            
                            
                            1.02
                            %Certificates
      of deposit
                            
                            
                            143,416
                            
                            
                            
                            827
                            
                            
                            
                            2.31
                            
                            
                            
                            172,573
                            
                            
                            
                            1,588
                            
                            
                            
                            3.69Borrowed
      funds
                            
                            
                            42,014
                            
                            
                            
                            428
                            
                            
                            
                            4.09
                            
                            
                            
                            42,578
                            
                            
                            
                            569
                            
                            
                            
                            5.36Repurchase
      agreements
                            
                            
                            11,309
                            
                            
                            
                            25
                            
                            
                            
                            0.90
                            
                            
                            
                            9,837
                            
                            
                            
                            8
                            
                            
                            
                            0.33Total
      interest-bearing liabilities
                            
                            
                            460,456
                            
                            
                            
                            1,753
                            
                            
                            
                            1.53
                            
                            
                            
                            442,237
                            
                            
                            
                            2,715
                            
                            
                            
                            2.46Non-interest-bearing
      deposits
                            
                            
                            74,101
                            
                            
                            
                            
                            
                            
                            
                            
                            
                            
                            
                            68,909Other
      non-interest-bearing liabilities
                            
                            
                            3,618
                            
                            
                            
                            
                            
                            
                            
                            
                            
                            
                            
                            4,373Shareholders'
      equity
                            
                            
                            47,274
                            
                            
                            
                            
                            
                            
                            
                            
                            
                            
                            
                            47,922Total
      liabilities and shareholders' equity
                            
                            $
                            585,449
                            
                            
                            
                            
                            
                            
                            
                            
                            
                            
                            $
                            563,441Net
      interest income / interest rate spread
                            
                            
                            
                            
                            
                            $
                            5,423
                            
                            
                            
                            3.66
                            %
                            
                            
                            
                            
                            
                            $
                            4,934
                            
                            
                            
                            3.28
                            %Net
      interest margin
                            
                            
                            
                            
                            
                            
                            
                            
                            
                            
                            3.92
                            %
                            
                            
                            
                            
                            
                            
                            
                            
                            
                            
                            3.70
                            %
  Six months ended:June 30, 2010
                                
                                
                                June 30, 2009Average
                                
                                
                                
                                
                                
                                Yield /
                                
                                
                                Average
                                
                                
                                
                                
                                
                                Yield /balance
                                
                                
                                Interest
                                
                                
                                rate
                                
                                
                                balance
                                
                                
                                Interest
                                
                                
                                rateAssetsInterest-earning
      assets:Loans
      and leases
                                
                                $
                                434,693
                                
                                
                                $
                                12,540
                                
                                
                                
                                5.82
                                %
                                
                                $
                                433,412
                                
                                
                                $
                                13,263
                                
                                
                                
                                6.17
                                %Investments
                                
                                
                                96,316
                                
                                
                                
                                1,848
                                
                                
                                
                                3.87
                                
                                
                                
                                98,488
                                
                                
                                
                                2,372
                                
                                
                                
                                4.86Federal
      funds sold
                                
                                
                                11,540
                                
                                
                                
                                13
                                
                                
                                
                                0.23
                                
                                
                                
                                6,145
                                
                                
                                
                                7
                                
                                
                                
                                0.24Interest-bearing
      deposits
                                
                                
                                12,942
                                
                                
                                
                                16
                                
                                
                                
                                0.25
                                
                                
                                
                                773
                                
                                
                                
                                -
                                
                                
                                
                                0.12Total
      interest-earning assets
                                
                                
                                555,491
                                
                                
                                
                                14,417
                                
                                
                                
                                5.23
                                
                                
                                
                                538,818
                                
                                
                                
                                15,642
                                
                                
                                
                                5.85Non-interest-earning
      assets
                                
                                
                                31,406
                                
                                
                                
                                
                                
                                
                                
                                
                                
                                
                                
                                29,027Total
      assets
                                
                                $
                                586,897
                                
                                
                                
                                
                                
                                
                                
                                
                                
                                
                                $
                                567,845Liabilities and shareholders'
      equityInterest-bearing
      liabilities:Other
      interest-bearing deposits
                                
                                $
                                260,481
                                
                                
                                $
                                979
                                
                                
                                
                                0.76
                                %
                                
                                $
                                212,270
                                
                                
                                $
                                1,119
                                
                                
                                
                                1.06
                                %Certificates
      of deposit
                                
                                
                                144,892
                                
                                
                                
                                1,735
                                
                                
                                
                                2.41
                                
                                
                                
                                172,922
                                
                                
                                
                                3,210
                                
                                
                                
                                3.74Borrowed
      funds
                                
                                
                                42,028
                                
                                
                                
                                851
                                
                                
                                
                                4.08
                                
                                
                                
                                52,387
                                
                                
                                
                                1,371
                                
                                
                                
                                5.28Repurchase
      agreements
                                
                                
                                14,642
                                
                                
                                
                                70
                                
                                
                                
                                0.97
                                
                                
                                
                                10,098
                                
                                
                                
                                17
                                
                                
                                
                                0.33Total
      interest-bearing liabilities
                                
                                
                                462,043
                                
                                
                                
                                3,635
                                
                                
                                
                                1.59
                                
                                
                                
                                447,677
                                
                                
                                
                                5,717
                                
                                
                                
                                2.58Non-interest-bearing
      deposits
                                
                                
                                74,452
                                
                                
                                
                                
                                
                                
                                
                                
                                
                                
                                
                                68,498Other
      non-interest-bearing liabilities
                                
                                
                                3,499
                                
                                
                                
                                
                                
                                
                                
                                
                                
                                
                                
                                3,873Shareholders'
      equity
                                
                                
                                46,903
                                
                                
                                
                                
                                
                                
                                
                                
                                
                                
                                
                                47,797Total
      liabilities and shareholders' equity
                                
                                $
                                586,897
                                
                                
                                
                                
                                
                                
                                
                                
                                
                                
                                $
                                567,845Net
      interest income / interest rate spread
                                
                                
                                
                                
                                
                                $
                                10,782
                                
                                
                                
                                3.64
                                %
                                
                                
                                
                                
                                
                                $
                                9,925
                                
                                
                                
                                3.27
                                %Net
      interest margin
                                
                                
                                
                                
                                
                                
                                
                                
                                
                                
                                3.91
                                %
                                
                                
                                
                                
                                
                                
                                
                                
                                
                                
                                3.71
                                %





In the
preceding table, interest income was adjusted to a tax-equivalent basis, using
the corporate federal tax rate of 34%, to recognize the income from tax-exempt
interest-earning assets as if the interest was taxable. This treatment allows a
uniform comparison between yields on interest-earning assets. Loans include
loans AFS and non-accrual loans but exclude the allowance for loan losses.
Securities include non-accrual securities. Average balances are based on
amortized cost and do not reflect net unrealized gains or losses. Net interest
margin is calculated by dividing net interest income by total average
interest-earning assets.


- 20
-


Provision for loan
losses




The
provision for loan losses represents the necessary amount to charge against
current earnings, the purpose of which is to increase the allowance for loan
losses to a level that represents management’s best estimate of known and
inherent losses in the Company’s loan portfolio. Loans and leases determined to
be uncollectible are charged off against the allowance for loan losses. The
required amount of the provision for loan losses, based upon the adequate level
of the allowance for loan losses, is subject to ongoing analysis of the loan
portfolio. The Company’s Special Assets Committee meets periodically to review
problem loans and leases. The committee is comprised of management, including
the senior loan officer, the chief risk officer, loan officers, loan workout
officers and collection personnel. The committee reports quarterly to the Credit
Administration Committee of the Board of Directors.




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




•
            specific
      loans that could have loss
potential;


•
            levels
      of and trends in delinquencies and non-accrual
  loans;


•
            levels
      of and trends in charge-offs and
recoveries;


•
            trends
      in volume and terms of loans;


•
            changes
      in risk selection and underwriting
standards;


•
            changes
      in lending policies, procedures and
practices;


•
            experience,
      ability and depth of lending
management;


•
            national
      and local economic trends and conditions;
and


•
            changes
      in credit concentrations.




The
provision for loan losses was $300,000 for the three months ending June 30, 2010
and also $300,000 for the three month period ending June 30, 2009. Total
provisions for the six months ended June 30, 2010 were $875,000 and $725,000 for
the same six months of 2009. The $300,000 provision for the current quarter was
recorded to provide for increased allocations for residential mortgages and
consumer loans resulting from locally weakened economic conditions and to
reserve for a decline in real estate values. For a further discussion on
non-performing loans, see “Non-performing assets” under the caption “Comparison
of financial condition at June 30, 2010 and December 31, 2009”,
below.




The
allowance for loan losses was $7,523,000 at June 30, 2010 compared to $7,574,000
at December 31, 2009. For a further discussion on the allowance for loan losses,
see “Allowance for loan losses” under the caption “Comparison of financial
condition at June 30, 2010 and December 31, 2009” below.




Other
income




In the
second quarter of 2010, other (non-interest) income decreased $818,000, or 56%,
to $640,000 from $1,458,000 recorded in second quarter of 2009. The decline was
primarily from non-cash OTTI charges of $676,000 recorded in the current year
quarter. The OTTI is related to credit impairment in the Company’s investments
in pooled trust preferred securities that is discussed more fully in Note 3,
“Investment securities”. Contributing further to the decline in non-interest
income in the current year quarter was a $198,000, or 61%, decline in gains from
mortgage banking services. These declines stem from the expected slow-down in
mortgage refinance and origination activity and therefore lower volumes of sales
of fixed-rate mortgage loans into the secondary market. The historical low
interest rate environment caused a surge and peak in mortgage origination
activity in 2009 and currently the Company does not expect that level of
activity to recur.




For the
six months ended June 30, 2010, other income declined $986,000, or 36%, compared
to the six months ended June 30, 2009. In the current year, the Company
recognized $229,000 in gains from mortgage banking services compared to $818,000
recognized during the first half of 2009. The 2009 gain included sales of
$10,838,000 of loans transferred from the loan and lease portfolio to loans AFS
and simultaneously sold. Further negatively impacting the non-interest income
during the first half of 2010 was an increase of $429,000 in OTTI credit charges
related to the pooled trust preferred securities, noted above.




Other operating
expenses




For the
quarter ended June 30, 2010, other (non-interest) expenses declined $45,000, or
1%, compared to the quarter ended June 30, 2009. Salary and employee benefits
decreased $190,000, or 8%, due to employee downsizing in conjunction with the
planned reorganization of the Company during the latter half of 2009 and first
quarter of 2010. The number of full-time equivalent (FTE) employees was 163 at
June 30, 2010 compared to 196 at June 30, 2009. The $58,000, or 6%, savings in
premises and equipment is from lower property insurance. The $46,000 increase in
advertising expenses was due to costs for the development of a new Company
website and an integrated marketing campaign that includes the usage of
multi-media advertising. The other category of other operating expense increased
by $157,000, or 12%, from higher credit collection expense recognized in our
efforts to resolve problematic loans and the effect of less deferral of mortgage
origination costs on lower volume of mortgage originations during the current
year second quarter compared to the second quarter of 2009. In addition, the
Company established a contingent liability of $64,000 associated with potential
off-balance sheet loan commitments. These items were partially offset by savings
from less sold loan charges due to lower loan sales volume, less ORE expense,
travel related costs, PA shares tax and greater efficiencies in branch
operations.


- 21
-


For the
six months ended June 30, 2010, non-interest related expenses increased
$398,000, or 4%, compared to the six months ended June 30, 2009. Salary and
employee benefits increased $10,000 but included approximately $400,000 of
severance and voluntary termination payout from the aforementioned planned,
structured reorganization of the Company. This event was offset by lower
expenses related to employee group insurance, commission, bonus, overtime and
costs related to Company contributions to the employee retirement plan. Savings
in property insurance and facility maintenance resulted in a decrease of
$70,000, or 4%, in premises and equipment costs. Advertising expenses increased
$29,000, or 11%, due to the website re-construction project, usage of
multi-media advertising and sundry promotional campaigns. The other category of
non-interest expenses increased by $429,000, or 18% in the current year’s first
half, compared to the first half of 2009. The increase stems from higher legal
and professional services including consulting for company-wide training, higher
collection expense, less deferral of mortgage origination costs and the
establishment of the loss contingency reserve for off-balance sheet loan
commitments. Partially offsetting these items were lower: ORE costs, travel
related expenses and sold loan charges on lower origination and sales
volume.




Provision for income
taxes




The
Company’s effective tax rates for the six months ended June 30, 2010 and 2009
were 14.4% and 21.4%, respectively, and for the quarters ended June 30, 2010 and
2009 were 16.7% and 21.4%, respectively. The decrease in the effective tax rates
in the 2010 periods compared to the same periods in 2009 reflects a combination
of lower pre-tax income and an increase in non-taxable items (permanent
differences), net that had the effect of lowering taxable income.




Comparison of financial
condition at


June 30, 2010 and December
31, 2009




Overview




Consolidated
assets increased to $579,270,000 or 4%, as of June 30, 2010 from $556,017,000 at
December 31, 2009. The increase was primarily from $21,932,000 growth in
deposits and a $2,169,000 increase in shareholders’ equity.




Investment
securities




At the
time of purchase, management classifies investment securities into one of three
categories: trading, AFS or held-to- maturity (HTM). To date, management has not
purchased any securities for trading purposes. Most of the securities purchased
are classified as AFS even though there is no immediate intent to sell them. The
AFS designation affords management the flexibility to sell securities and
position the balance sheet in response to capital levels, liquidity needs or
changes in market conditions. Securities AFS are carried at fair value in the
consolidated balance sheet with an adjustment to shareholders’ equity, net of
tax, presented under the caption “Accumulated other comprehensive income
(loss).” Securities designated as HTM are carried at amortized cost and
represent debt securities that the Company has the ability and intent to hold
until maturity.




As of
June 30, 2010, the carrying value of investment securities amounted to
$75,948,000, or 13% of total assets, compared to $76,530,000, or 14% of total
assets, at December 31, 2009. At June 30, 2010, approximately 30% of the
carrying value of the investment portfolio was comprised of mortgage-backed
securities that amortize and provide monthly cash flow.




Investment
securities are comprised of HTM and AFS securities with carrying values of
$578,000 and $75,370,000, respectively. As of June 30, 2010, the AFS debt
securities were recorded with a net unrealized loss in the amount of $11,929,000
and equity securities were recorded with an unrealized net gain of $93,000.
During the six months ended June 30, 2010, carrying value of total investments
declined modestly; approximately $600,000. However, the decline is net of
$2,100,000 in net market value appreciation in the AFS
portfolio.


- 22
-




A
comparison of investment securities at June 30, 2010 and December 31, 2009 is as
follows (dollars in thousands):




June 30, 2010
                  
                  
                  December 31, 2009Amount
                  
                  
                  %
                  
                  
                  Amount
                  
                  
                  %Agency
      - GSE
                  
                  $
                  24,310
                  
                  
                  
                  32.0
                  
                  
                  $
                  33,132
                  
                  
                  
                  43.3MBS
      - GSE residential
                  
                  
                  23,143
                  
                  
                  
                  30.5
                  
                  
                  
                  14,457
                  
                  
                  
                  18.9State
      & municipal subdivisions
                  
                  
                  23,160
                  
                  
                  
                  30.5
                  
                  
                  
                  23,270
                  
                  
                  
                  30.4Pooled
      trust preferred securities
                  
                  
                  4,920
                  
                  
                  
                  6.5
                  
                  
                  
                  5,242
                  
                  
                  
                  6.8Equity
      securities - financial services
                  
                  
                  415
                  
                  
                  
                  0.5
                  
                  
                  
                  429
                  
                  
                  
                  0.6Total
      investments
                  
                  $
                  75,948
                  
                  
                  
                  100.0
                  
                  
                  $
                  76,530
                  
                  
                  
                  100.0





Quarterly,
management performs a review of the investment portfolio to determine the cause
of declines in the fair value of each security. The Company uses inputs provided
by independent third parties to determine the fair value of its investment
securities portfolio. The inputs provided are reviewed and corroborated by
management. Evaluations of the causes of the unrealized losses are performed to
determine whether impairment is temporary or other-than-temporary.
Considerations such as the Company’s intent to sell the security, more likely
than not the Company will be required to sell the security before recovery of
its amortized cost basis, the present value of expected cash flows is not
sufficient to recover the entire amortized cost basis, recoverability of the
invested amounts over the intended holding period, the length of time and the
severity in pricing decline below cost, the interest rate environment, receipts
of amounts contractually due and whether or not there is an active market for
the security, for example, are applied, along with the financial condition of
the issuer for management to make a realistic judgment of the probability that
the Company will be unable to collect all amounts (principal and interest) due
in determining whether a security is other-than-temporarily impaired. If a
decline in value is deemed to be other-than-temporary, the amortized cost of the
security is reduced by the credit impairment amount and a corresponding charge
to earnings is recognized. If at the time of sale, call or maturity the proceeds
exceed the security’s amortized cost, the impairment charge may be fully or
partially recovered.




Under
these circumstances, OTTI is considered to have occurred if: (1) the
entity has intent to sell the security; (2) more likely than not the
entity will be required to sell the security before recovery of its amortized
cost basis; or (3) the present value of expected cash flows is not
sufficient to recover the entire amortized cost.




The
uncertainty in the financial markets continues to foster volatility in fair
value estimates for the securities in the Company’s investment portfolio. Fair
values of the Company’s investment securities have improved since year-end 2009,
but remain well below their amortized cost - $11.8 million, or 14% as of June
30, 2010 and $13.9 million, or 16% as of December 31, 2009. Management believes
fair values and their changes are due mainly to a combination of the interest
rate environment, instability in the capital markets, limited trading activity
and illiquid conditions in the financial markets, not deterioration in the
creditworthiness of the issuers. Nearly all of the securities in the portfolio
have fixed rates or have predetermined scheduled rate changes, and many have
call features that allow the issuer to call the security at par before its
stated maturity without penalty. The most significant component of the $11.8
million net unrealized loss in the AFS securities portfolio, as of June 30,
2010, was $13.2 million from the Company’s investments in corporate bonds
consisting of collateralized debt obligation (CDO) securities that are backed by
pooled trust preferred securities issued by banks, thrifts and insurance
companies.




Management
is unable to obtain readily attainable and realistic pricing from market traders
for the pooled trust preferred securities portfolio because there continues to
be a lack of active market participants who deal in these
securities.




As of
June 30, 2010, the Company owned 13 tranches of pooled trust preferred
securities (PreTSLs). Management has determined the market for these securities
and other issues of PreTSLs at June 30, 2010 is inactive. The inactivity was
evidenced first by a significant widening of the bid-ask spread in the brokered
markets in which PreTSLs trade, then by a significant decrease in the volume of
trades relative to historical levels and the lack of a new-issue market since
2007. There are currently very few market participants who are willing and/or
able to transact for these securities. Given the conditions in the debt markets
today and the absence of observable transactions in the secondary and new issue
markets, management has made the following observations and has
determined:




·
            The
      few observable transactions and market quotations that were available were
      not reliable for purposes of determining fair value at June 30,
      2010,




·
            An
      income valuation approach (present value technique) that maximizes the use
      of relevant observable inputs and minimizes the use of unobservable inputs
      are equally or more representative of fair value than the market approach
      valuation technique, and




·
            The
      PreTSL securities are classified within “Level 3” in the fair value
      hierarchy (as defined in current accounting guidance and explained in Note
      6, “Fair Value Measurements” of the consolidated financial statements)
      because significant adjustments are required to determine fair value at
      the measurement date. The valuations of the Company’s PreTSLs were
      prepared by an independent third party and corroborated by management. The
      approach to determine fair value involved the
  following:




- 23
-


o
            Data
      about the issue structure as defined in the indenture and the underlying
      collateral were collected,




o
            The
      credit quality of the collateral is estimated using issuer-specific
      probability of default values,




o
            The
      default probabilities also considered the potential for 50% correlation
      among issuers within the same industry (e.g. banks with other banks) and
      30% correlation between industries (e.g. banks vs.
    insurance),




o
            The
      loss given default, or amount of cash lost to the investor when a debt
      asset defaults, was assumed to be 100% (no recovery). This replicates the
      historically high default loss levels on trust preferred
      instruments,




o
            The
      cash flows were forecast for the underlying collateral and applied to each
      tranche to determine the resulting distribution among the securities. This
      ascertains which investors are paid and which investors incur losses.
      Thus, these cash flow projections capture the credit
  risk,




o
            The
      expected cash flows utilize no prepayments and were discounted utilizing
      three-month LIBOR as the risk-free rate for the base case and then added a
      300bp liquidity premium as the discount rate to calculate the present
      value of the security,




o
            The
      effective discount rates on an overall basis range from 8.9% to 343.9% and
      are highly dependent upon the credit quality of the collateral, the
      relative position of the tranche within the capital structure of the
      security and the prepayment assumptions,
and




o
            The
      calculations were modeled in several thousand scenarios using a Monte
      Carlo engine to establish a distribution of intrinsic values and the
      average was used for valuation
purposes.




Based on
the technique described, the Company determined that as of June 30, 2010, the
fair value of three PreTSL securities: VII, XI and XVI had declined $2,988,000
in total below their amortized cost basis and since the present value of the
security’s expected cash flows were insufficient to recover the entire amortized
cost basis, the securities are deemed to have experienced credit related
other-than-temporary impairment in the amount of $755,000 which was charged to
current earnings as a component of other income in the consolidated statement of
income for the six months ended June 30, 2010. This compares to $326,000 of
impairment charges recorded for the first half of 2009. The Company closely
monitors the pooled trust preferred securities market and performs collateral
sufficiency and cash flow analyses on a quarterly basis. Future analyses could
yield results that may indicate further impairment has occurred and would
therefore require additional write-downs and corresponding other-than-temporary
impairment charges to current earnings.




Federal Home Loan Bank
Stock




Investment
in FHLB stock is required for membership in the organization and is carried at
cost since there is no market value available. The amount the Company is
required to invest is dependent upon the relative size of outstanding borrowings
the Company has with the FHLB. Excess stock is typically repurchased from the
Company at par if the level of borrowings declines to a predetermined level. In
addition, the Company normally earns a return or dividend on the amount
invested. In order to preserve its capital level, in December 2008 the FHLB
announced that it had suspended the payment of dividends and excess capital
stock repurchasing and as of June 30, 2010, that position has not changed. That
decision was based on the FHLB’s analysis and consideration of certain negative
market trends and the impact those trends will have on their financial
condition. Based on the financial results of the FHLB for the six months ended
June 30, 2010 and for the year-ended December 31, 2009, management believes that
the suspension of both the dividend payments and excess capital stock repurchase
is temporary in nature. Management further believes that the FHLB will continue
to be a primary source of wholesale liquidity for both short- and long-term
funding and has concluded that its investment in FHLB stock is not
other-than-temporarily impaired. There can be no assurance, however, that future
negative changes to the financial condition of the FHLB may not require the
Company to recognize an impairment charge with respect to such holdings. The
Company will continue to monitor the financial condition of the FHLB and assess
its future ability to resume normal dividend payments and stock redemption
activities.




Loans available-for-sale
(AFS)




Generally,
upon origination, certain residential mortgages are classified as AFS. In the
event of market rate increases, fixed-rate loans and loans not immediately
scheduled to re-price would no longer produce yields consistent with the current
market. In a declining interest rate environment, the Company would be exposed
to prepayment risk and, as rates decrease, interest income could be negatively
affected. Consideration is given to the Company’s current liquidity position and
projected future liquidity needs. To better manage prepayment and interest rate
risk, loans that meet these conditions may be classified as AFS. The carrying
value of loans AFS is at the lower of cost or estimated fair value. If the fair
values of these loans fall below their original cost, the difference is written
down and charged to current earnings. Subsequent appreciation in the portfolio
is credited to current earnings but only to the extent of previous
write-downs.


- 24
-


Loans AFS
at June 30, 2010 amounted to $384,000 with a corresponding fair value of
approximately $389,000, compared to $1,221,000 and $1,233,000, respectively, at
December 31, 2009. During the six months ended June 30, 2010, residential
mortgage loans with principal balances of $18,902,000 were sold into the
secondary market with net gains of approximately $229,000 recognized, compared
to $73,329,000 and $818,000, respectively, during the six months ended June 30,
2009. Included in the 2009 sales was $10,838,000 of residential mortgage loans
transferred from the loan and lease portfolio during the first quarter of 2009.
The Company expects loan originations and the related sales to diminish in 2010
as the refinance activity in 2009, caused by low interest rates, has ebbed with
originations returning to normal volumes.




Loans and
leases




The
Company originates commercial and industrial (commercial) and commercial real
estate (CRE) loans, residential mortgages, consumer, home equity and
construction loans. The relative volume of originations is dependent upon
customer demand, current interest rates and the perception and duration of
future interest rate levels. As part of the overall strategy to serve the
business community in which it operates, the Company is focused on developing
and implementing products and services to the broad spectrum of businesses that
operate in our marketplace. The Company’s goals center on building relationships
by providing credit and non-credit products and services, continuing to
diversify its loan portfolio and utilizing participations to reduce risk in
larger credit transactions. Especially in the current economic climate, the
Company, in providing credit to existing and new customers, has implemented
policies and procedures to reduce the associated risk. The risks associated with
interest rates are being managed by utilizing floating versus long-term fixed
rates and exploring programs where we can match our cost of funds.




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




The
composition of the loan portfolio at June 30, 2010 and December 31, 2009, is
summarized as follows (dollars in thousands):





June 30, 2010
                  
                  
                  December 31, 2009Amount
                  
                  
                  %
                  
                  
                  Amount
                  
                  
                  %Real
      estate:Commercial
                  
                  $
                  174,437
                  
                  
                  
                  40.8
                  
                  
                  $
                  186,727
                  
                  
                  
                  43.3Residential
                  
                  
                  68,586
                  
                  
                  
                  16.0
                  
                  
                  
                  71,001
                  
                  
                  
                  16.5Construction
                  
                  
                  11,017
                  
                  
                  
                  2.6
                  
                  
                  
                  10,125
                  
                  
                  
                  2.4Commercial
      and industrial
                  
                  
                  87,332
                  
                  
                  
                  20.4
                  
                  
                  
                  76,788
                  
                  
                  
                  17.8Consumer
                  
                  
                  86,036
                  
                  
                  
                  20.1
                  
                  
                  
                  85,690
                  
                  
                  
                  19.9Direct
      financing leases
                  
                  
                  331
                  
                  
                  
                  0.1
                  
                  
                  
                  367
                  
                  
                  
                  0.1Gross
      loans
                  
                  
                  427,739
                  
                  
                  
                  100.0
                  
                  
                  
                  430,698
                  
                  
                  
                  100.0Allowance
      for loan losses
                  
                  
                  (7,523
                  )
                  
                  
                  
                  
                  
                  
                  (7,574
                  )Net
      loans
                  
                  $
                  420,216
                  
                  
                  
                  
                  
                  
                  $
                  423,124




The $3.0
million net decline in gross loans during the first half of 2010 was
predominantly from the payoff of some sizeable commercial real estate (CRE)
credits that the Company aggressively sought for settlement. The growth in
commercial and industrial (C&I) is attributable to a short-term, match
funded loan with a municipal customer. This loan matures during the fourth
quarter of 2010.


- 25
-




Allowance for loan
losses




Management
continually evaluates the credit quality of the Company’s loan portfolio and
performs a formal review of the adequacy of the allowance for loan losses (the
allowance) on a quarterly basis. The allowance reflects management’s best
estimate of the amount of credit losses in the loan portfolio. Management’s
judgment is based on the evaluation of individual loans, past experience, the
assessment of current economic conditions and other relevant factors including
the amounts and timing of cash flows expected to be received on impaired loans.
Those estimates may be susceptible to significant change. The provision for loan
losses represents the amount necessary to maintain an appropriate allowance.
Loan losses are charged directly against the allowance when loans are deemed to
be uncollectible. Recoveries from previously charged-off loans are added to the
allowance when received.




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




•
            identification
      of specific impaired loans by loan
category;


•
            calculation
      of specific allowances where required for the impaired loans based on
      collateral and other objective and quantifiable
  evidence;


•
            determination
      of homogenous pools by loan category and eliminating the impaired
      loans;


•
            application
      of historical loss percentages (three-year average) to pools to determine
      the allowance allocation; and


•
            application
      of qualitative factor adjustment percentages to historical losses for
      trends or changes in the loan portfolio, and /or current economic
      conditions.




Allocation
of the allowance for different categories of loans is based on the methodology
as explained above. A key element of the methodology to determine the allowance
is the Company’s credit risk evaluation process, which includes credit risk
grading of individual commercial loans. Commercial loans are assigned credit
risk grades based on the Company’s assessment of conditions that affect the
borrower’s ability to meet its contractual obligations under the loan agreement.
That process includes reviewing borrowers’ current financial information,
historical payment experience, credit documentation, public information and
other information specific to each individual borrower. Upon review, the
commercial loan credit risk grade is revised or reaffirmed. The credit risk
grades may be changed at any time management feels an upgrade or downgrade may
be warranted. The credit risk grades for the commercial loan portfolio are taken
into account in the reserve methodology and loss factors are applied based upon
the credit risk grades. The loss factors applied are based upon the company’s
historical experience as well as what management believes to be best practices
and within common industry standards. Historical experience reveals there is a
direct correlation between the credit risk grades and loan charge-offs. The
changes in allocations in the commercial loan portfolio from period-to-period
are based upon the credit risk grading system and from periodic reviews of the
loan and lease portfolios.




Each
quarter, management performs an assessment of the allowance and the provision
for loan losses. The Company’s Special Assets Committee meets quarterly and the
applicable lenders discuss each relationship under review and reach a consensus
on the appropriate estimated loss amount based on current accounting guidelines.
The Special Assets Committee’s focus is on ensuring the pertinent facts are
considered and the reserve amounts pursuant to the accounting principles are
reasonable. The assessment process includes the review of all loans on a
non-accruing basis as well as a review of certain loans to which the lenders or
the Company’s Credit Administration function have assigned a criticized or
classified risk rating.




Total
charge-offs net of recoveries for the six months ending June 30, 2010, were
$925,000, compared to $254,000 in the first six months of 2009. The higher level
of charge-offs recorded in the current year primarily resulted from the
write-down of impaired commercial real estate loans to current fair value as
well as the charge-off of both consumer and commercial and industrial loans.
Commercial real estate loan net charge-offs of $454,000 were recorded during the
six month period ending June 30, 2010 versus $9,000 at June 30, 2009.
Residential real estate loan net charge-offs totaled $63,000 for the six month
period ending June 30, 2010, and were $3,000 in the like period of 2009.
Commercial and industrial loan net charge-offs were $262,000 for the six months
ending June 30, 2010 compared to net charge-offs of $116,000 in the same period
of 2009. Consumer loan net charge-offs of $146,000 were recorded during the six
months ending June 30, 2010 versus $126,000 at the June 30, 2009 like period
end. For a discussion on the provision for loan losses, see the “Provision for
loan losses,” located in the results of operations section of management’s
discussion and analysis contained herein.




The
allowance for loan losses was $7,523,000 at June 30, 2010 and $7,574,000 at
December 31, 2009. Management believes that the current balance in the allowance
for loan losses of $7,523,000 is sufficient to withstand the identified
potential credit quality issues that may arise and others unidentified but
inherent to the portfolio as of this time. Potential problem loans are those
where there is known information that leads management to believe repayment of
principal and/or interest is in jeopardy and the loans are currently neither on
non-accrual status or past due 90 days or more. Given continuing pressure on
property values and the generally uncertain economic backdrop, there could be
additional instances which become identified in future periods that may require
additional charge-offs and/or increases to the allowance. The ratio of allowance
for loan losses to total loans was 1.76% at June 30, 2010 compared to 1.22% at
June 30, 2009.


- 26
-


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




As of and for the
                      
                      
                      As of and for the
                      
                      
                      As of and for thesix months ended
                      
                      
                      twelve months ended
                      
                      
                      six months endedJune 30, 2010
                      
                      
                      December 31, 2009
                      
                      
                      June 30, 2009Balance
      at beginning of period
                      
                      $
                      7,573,603
                      
                      
                      $
                      4,745,234
                      
                      
                      $
                      4,745,234Provision
      charged to operations
                      
                      
                      875,000
                      
                      
                      
                      5,050,000
                      
                      
                      
                      725,000Charge-offs:Real
      estate:Commercial
                      
                      
                      455,755
                      
                      
                      
                      843,527
                      
                      
                      
                      24,932Residential
                      
                      
                      63,214
                      
                      
                      
                      9,158
                      
                      
                      
                      3,158Commercial
      and industrial
                      
                      
                      265,154
                      
                      
                      
                      983,490
                      
                      
                      
                      118,520Consumer
                      
                      
                      169,776
                      
                      
                      
                      432,951
                      
                      
                      
                      133,617Total
                      
                      
                      953,899
                      
                      
                      
                      2,269,126
                      
                      
                      
                      280,227Recoveries:Real
      estate:Commercial
                      
                      
                      1,449
                      
                      
                      
                      2,075
                      
                      
                      
                      15,808Residential
                      
                      
                      -
                      
                      
                      
                      -
                      
                      
                      
                      -Commercial
      and industrial
                      
                      
                      2,949
                      
                      
                      
                      34,735
                      
                      
                      
                      2,075Consumer
                      
                      
                      24,148
                      
                      
                      
                      10,685
                      
                      
                      
                      7,846Total
                      
                      
                      28,546
                      
                      
                      
                      47,495
                      
                      
                      
                      25,729Net
      charge-offs
                      
                      
                      925,353
                      
                      
                      
                      2,221,631
                      
                      
                      
                      254,498Balance
      at end of period
                      
                      $
                      7,523,250
                      
                      
                      $
                      7,573,603
                      
                      
                      $
                      5,215,736Total
      loans, end of period
                      
                      $
                      428,122,754
                      
                      
                      $
                      431,919,023
                      
                      
                      $
                      427,432,128





As of and for the
                            
                            
                            As of and for the
                            
                            
                            As of and for thesix months ended
                            
                            
                            twelve months ended
                            
                            
                            six months endedJune 30, 2010
                            
                            
                            December 31, 2009
                            
                            
                            June 30, 2009Net charge-offs to
      (annualized):Average
      loans
                            
                            
                            0.43
                            %
                            
                            
                            0.51
                            %
                            
                            
                            0.12
                            %Allowance
      for loan losses
                            
                            
                            24.60
                            %
                            
                            
                            29.33
                            %
                            
                            
                            9.76
                            %Provision
      for loan losses
                            
                            
                            1.06
                            x
                            
                            
                            0.44
                            x
                            
                            
                            0.35
                            xAllowance for loan losses
    to:Total
      loans
                            
                            
                            1.76
                            %
                            
                            
                            1.75
                            %
                            
                            
                            1.22
                            %Non-accrual
      loans
                            
                            
                            0.84
                            x
                            
                            
                            0.61
                            x
                            
                            
                            0.70
                            xNon-performing
      loans
                            
                            
                            0.81
                            x
                            
                            
                            0.59
                            x
                            
                            
                            0.69
                            xNet
      charge-offs (annualized)
                            
                            
                            4.07
                            x
                            
                            
                            3.41
                            x
                            
                            
                            10.25
                            xLoans
      30-89 days past due and still accruing
                            
                            $
                            3,295,675
                            
                            
                            $
                            5,173,394
                            
                            
                            $
                            2,360,786Loans
      90 days past due and accruing
                            
                            $
                            319,828
                            
                            
                            $
                            554,806
                            
                            
                            $
                            180,800Non-accrual
      loans
                            
                            $
                            8,918,932
                            
                            
                            $
                            12,329,338
                            
                            
                            $
                            7,398,505Allowance
      for loan losses to loans 90days
      or more past due and accruing
                            
                            
                            23.52
                            x
                            
                            
                            13.65
                            x
                            
                            
                            28.85
                            x




- 27
-




Non-performing
assets




The
Company defines non-performing assets as accruing loans past due 90 days or
more, non-accrual loans, restructured loans, other real estate owned (ORE),
non-accrual securities and repossessed assets. As of June 30, 2010,
non-performing assets represented 2.21% of total assets compared to 2.58% at
December 31, 2009. The decline at June 30, 2010 was driven by reductions in both
the loans past due more than 90 days as well as the reduced non-accrual
levels.




In the
review of loans for both delinquency and collateral sufficiency, management
concluded that there were a number of loans that lacked the ability to repay in
accordance with contractual terms. The decision to place loans or leases on a
non-accrual status is made on an individual basis after considering factors
pertaining to each specific loan. The commercial loans are placed on non-accrual
status when management has determined that payment of all contractual principal
and interest is in doubt or the loan is past due 90 days or more as to principal
and interest, unless well-secured and in the process of collection. Consumer
loans secured by real estate are placed on non-accrual status at 120 days past
due as to principal and interest, and unsecured consumer loans are charged-off
when the loan is 90 days or more past due as to principal and interest.
Uncollected interest income accrued on all non-accrual loans is reversed and
charged to interest income.




The
majority of the non-performing assets for the period were comprised of
non-accruing commercial business loans, non-accruing real estate loans,
non-accrual securities and ORE. Most of the loans are collateralized, thereby
mitigating the Company’s potential for loss. During the first six months of
2010, $1,706,000 of corporate bonds consisting of pooled trust preferred
securities were on non-accrual status. There were no non-accrual securities
prior to 2009. For a further discussion on the Company’s securities portfolio,
see Note 3, “Investments Securities”, within the notes to the consolidated
financial statements and the section entitled “Investments”, contained within
this management discussion and analysis section.




Non-performing
loans were reduced from $12,884,000 on December 31, 2009 to $9,239,000 on June
30, 2010. At December 31, 2009, the over 90 day past due portion was comprised
of nine loans ranging from $1,000 to $294,000, and the non-accrual loan portion
numbered 58 loans ranging from $2,600 to $2,800,000. At June 30, 2010, there
were nine loans ranging from $3,000 to $107,000 in the over 90 days past due
category, and 64 loans ranging from $1,600 to $754,000 in the non-accrual
category. The reduction of $3,645,000 in non-performing loans from December 31,
2009 to June 30, 2010 resulted mainly from non-accrual commercial loan
repayments and the transfer of $747,000 from non-accrual to ORE. Restructured
loans were $791,000 at June 30, 2010. There were no restructured loans at
December 31, 2009. ORE at June 30, 2010 was $1,084,000 and consisted of three
properties. At June 30, 2010, the non-accrual loans aggregated $8,919,000 as
compared to $12,329,000 at December 31, 2009. The net reduction in the level of
non-accrual loans at June 30, 2010 occurred as follows: Additions to the
non-accrual loan component of the non-performing assets totaling $4,850,000 were
made during the first six months of the year. These were partially offset by
reductions or payoffs of $6,597,000, charge-offs of $685,000, transfers to ORE
of $747,000 and $231,000 of loans that returned to performing status. Loans past
due 90 days or more and accruing were $320,000 at June 30, 2010 and $555,000, at
December 31, 2009. Non-accrual securities were $1,706,000 at June 30, 2010 and
$583,000 at December 31, 2009.




Non-performing
loans to total loans were 2.16% at June 30, 2010, down from 2.98% at December
31, 2009. The percentage of non-performing assets to total assets was 2.21% at
June 30, 2010, also down from 2.58% at December 31, 2009, primarily driven by
the aforementioned decline in the non-accrual loans component.




The 30-89
day past due loans at June 30, 2010 were $3,296,000 and $5,173,000 at December
31, 2009. The reduced level occurred as a result of the transfer of some loans
to non-accrual, payments collected on others and the conversion / transfer of a
loan to ORE status.


- 28
-




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




June 30, 2010
                    
                    
                    December 31, 2009
                    
                    
                    June 30, 2009Loans
      past due 90 days or moreand accruing
                    
                    $
                    319,828
                    
                    
                    $
                    554,806
                    
                    
                    $
                    180,800Non-accrual
      loans
                    
                    
                    8,918,931
                    
                    
                    
                    12,329,338
                    
                    
                    
                    7,398,505Total
      non-performing loans
                    
                    
                    9,238,759
                    
                    
                    
                    12,884,144
                    
                    
                    
                    7,579,305Restructured
      loans
                    
                    
                    791,168
                    
                    
                    
                    -
                    
                    
                    
                    -Other
      real estate owned
                    
                    
                    1,084,007
                    
                    
                    
                    887,397
                    
                    
                    
                    1,199,060Non-accrual
      securities
                    
                    
                    1,705,937
                    
                    
                    
                    583,390
                    
                    
                    
                    -Total
      non-performing assets
                    
                    $
                    12,819,871
                    
                    
                    $
                    14,354,931
                    
                    
                    $
                    8,778,365Total
      loans including AFS
                    
                    $
                    428,122,754
                    
                    
                    $
                    431,919,023
                    
                    
                    $
                    427,432,128Total
      assets
                    
                    $
                    579,270,283
                    
                    
                    $
                    556,017,271
                    
                    
                    $
                    560,454,208Non-accrual
      loans to total loans
                    
                    
                    2.08
                    %
                    
                    
                    2.85
                    %
                    
                    
                    1.73
                    %Non-performing
      loans to total loans
                    
                    
                    2.16
                    %
                    
                    
                    2.98
                    %
                    
                    
                    1.77
                    %Non-performing
      assets to total assets
                    
                    
                    2.21
                    %
                    
                    
                    2.58
                    %
                    
                    
                    1.57
                    %




The
composition of gross loans and non-performing loans as of June 30, 2010 (dollars
in thousands):




Gross
                  
                  
                  Past due 90
                  
                  
                  Non-
                  
                  
                  Total non-
                  
                  
                  % ofloan
                  
                  
                  days or more
                  
                  
                  accrual
                  
                  
                  performing
                  
                  
                  grossbalances
                  
                  
                  and still accruing
                  
                  
                  loans
                  
                  
                  loans
                  
                  
                  loansReal
      estate:Commercial
                  
                  $
                  174,437
                  
                  
                  $
                  3
                  
                  
                  $
                  3,629
                  
                  
                  $
                  3,632
                  
                  
                  
                  2.08
                  %Residential
      (1-4 family)
                  
                  
                  68,970
                  
                  
                  
                  278
                  
                  
                  
                  4,114
                  
                  
                  
                  4,392
                  
                  
                  
                  6.37
                  %Construction
                  
                  
                  11,017
                  
                  
                  
                  -
                  
                  
                  
                  -
                  
                  
                  
                  -
                  
                  
                  
                  -Commercial
      and industrial
                  
                  
                  87,332
                  
                  
                  
                  33
                  
                  
                  
                  520
                  
                  
                  
                  553
                  
                  
                  
                  0.63
                  %Consumer
                  
                  
                  86,036
                  
                  
                  
                  6
                  
                  
                  
                  656
                  
                  
                  
                  662
                  
                  
                  
                  0.77
                  %Direct
      financing leases
                  
                  
                  331
                  
                  
                  
                  -
                  
                  
                  
                  -
                  
                  
                  
                  -
                  
                  
                  
                  -Total
                  
                  $
                  428,123
                  
                  
                  $
                  320
                  
                  
                  $
                  8,919
                  
                  
                  $
                  9,239
                  
                  
                  
                  2.16
                  %




Bank premises and equipment,
net




A leased
branch building that contains leasehold improvements with a net book value of
approximately $618,000, as of June 30, 2010 was in the process of foreclosure by
the Company, the lien holder, and was originally scheduled for sheriff’s sale in
June 2010. The sale was delayed to July and the Company was the successful
bidder. The Company has not taken title the property and expects to assign the
bid to a third party for a financial commitment. The Company further expects to
continue to operate the branch, uninterrupted, under a lease agreement with
terms consistent with the prior lease. The Company does not expect the event to
have a material impact on its results of operation or financial
condition.




Foreclosedassets
held-for-sale




Foreclosed
assets held-for-sale, consisting of ORE, was $1,084,000 at June 30, 2010
comprised of three properties which are listed for sale with local realtors. The
$197,000 rise in ORE from December 31, 2009 occurred from the sale of one
commercial property with a book balance of $550,000 and the transfer into ORE of
a commercial property for its fair value of $747,000.




Other
assets




Other
assets at June 30, 2010 declined $643,000, or 4%, from December 31, 2010. A
lower deferred tax asset from appreciation in fair values, from December 31,
2009, in the securities portfolio and the period recognition and associated
reduction of the prepaid FDIC insurance premium were the primary causes of the
decrease.


- 29
-


Deposits




The Bank
is a community-based commercial financial institution, member FDIC, which offers
a variety of deposit products with varying ranges of interest rates and terms.
Deposit products include savings, clubs, interest-bearing checking (NOW), money
market, non-interest-bearing checking (DDAs) and certificates of deposit
accounts. Certificates of deposit accounts, or CDs, are deposits with stated
maturities which can range from seven days to ten years. The flow of deposits is
significantly influenced by general economic conditions, changes in prevailing
interest rates, pricing and competition. To determine deposit product interest
rates, the Company considers local competition, spreads to earning-asset yields,
liquidity position and rates charged for alternative sources of funding such as
borrowings which include repurchase agreements. Though the Company tends to
experience intense competition for deposits, the interest rate setting strategy
also includes consideration of the Company’s balance sheet structure and cost
effective strategies that are mindful of the current economic
landscape.




Compared
to December 31, 2009 total deposits grew $21,900,000, or 5%, during the first
half of 2010. The growth in total deposits was due to increases in DDA, NOW and
savings accounts of $6,946,000, or 10%, $11,991,000, or 19% and $20,400,000, or
24%, respectively, partially offset by lower CD balances. Generally, deposits
are obtained from consumers and businesses within the communities that surround
the Company’s 11 branch offices and all deposits are insured by the FDIC up to
the full extent permitted by law. In an effort to grow and retain core deposits,
the Company introduces innovative options to its variety of deposit products.
The multi-tiered interest rate savings account developed in 2009 continues to
grow while NOW account balances have prospered from the seasonal influx of local
municipal tax deposits and growth in the non-personal, business sector. The
Company will continue to provide superb customer service and bring innovative
ideas to the market in order to continue to grow and retain
deposits.




The
following table represents the components of deposits as of the date
indicated:




June 30, 2010
                
                
                December 31, 2009Amount
                
                
                %
                
                
                Amount
                
                
                %Money
      market
                
                $
                78,184
                
                
                
                16.3
                
                
                $
                91,488
                
                
                
                19.9NOW
                
                
                74,022
                
                
                
                15.4
                
                
                
                62,031
                
                
                
                13.5Savings
      and club
                
                
                106,735
                
                
                
                22.2
                
                
                
                86,335
                
                
                
                18.8Certificates
      of deposit
                
                
                132,352
                
                
                
                27.5
                
                
                
                139,502
                
                
                
                30.5CDARS
                
                
                11,798
                
                
                
                2.4
                
                
                
                8,748
                
                
                
                1.9Total
      interest-bearing
                
                
                403,091
                
                
                
                83.8
                
                
                
                388,104
                
                
                
                84.6Non-interest-bearing
                
                
                77,836
                
                
                
                16.2
                
                
                
                70,890
                
                
                
                15.4Total
      deposits
                
                $
                480,927
                
                
                
                100.0
                
                
                $
                458,994
                
                
                
                100.0




The
Company uses the Certificate of Deposit Account Registry Service (CDARS)
reciprocal program to obtain FDIC insurance protection for customers who have
large deposits that at times may exceed the FDIC maximum amount of $250,000. In
the CDARS program, deposits with varying terms and interest rates, originated in
the Company’s own markets, are exchanged for deposits of other financial
institutions that are members in the CDARS network. By placing these deposits in
other participating institutions, the deposits of our customers are fully
insured by the FDIC. In return for deposits placed with network institutions,
the Company receives from network institutions deposits that are approximately
equal in amount and contain similar terms as those placed for our customers.
Deposits the Company receives, or reciprocal deposits, from other institutions
are considered brokered deposits by regulatory definitions.




Excluding
CDARS, certificates of deposit accounts of $100,000 or more amounted to
$51,089,000 and $54,941,000 at June 30, 2010 and December 31, 2009,
respectively. Certificates of deposit of $250,000 or more amounted to
$18,327,000 and $20,641,000 as of June 30, 2010 and December 31,
2009.




Including
CDARS, approximately 25% of the CDs are scheduled to mature in 2010. Renewing
CDs may re-price to lower or higher market rates depending on the direction of
interest rate movements, the shape of the yield curve, competition, the rate
profile of the maturing accounts and depositor preference for alternative
products. In this current low interest rate environment, customers with maturing
CDs prefer to hold their deposits in readily available transaction products such
as savings accounts.




In July
2010, President Obama signed the Dodd-Frank Wall Street Reform and Consumer
Protection Act, which, in part, permanently raises the current standard maximum
deposit insurance amount to $250,000. The standard maximum insurance amount of
$100,000 had been temporarily raised to $250,000 until December 31, 2013. The
FDIC insurance coverage limit applies per depositor, per insured depository
institution for each account ownership category.


- 30
-


Borrowings




Borrowings
are used as a complement to deposit generation as an alternative funding source
whereby the Bank will borrow under customer repurchase agreements in the local
market, advances from the Federal Home Loan Bank of Pittsburgh (FHLB) and other
correspondent banks for asset growth and liquidity needs.




Repurchase
agreements are non-insured interest-bearing liabilities that have a perfected
security interest in qualified investments of the Company.  The FDIC
Depositor Protection Act of 2009 requires banks to provide a perfected security
interest to the purchasers of uninsured repurchase
agreements.  Repurchase agreements are offered through a sweep
product.  A sweep account is designed to ensure that on a daily basis,
an attached DDA is adequately funded and excess funds are transferred, or swept,
into an interest-bearing overnight repurchase agreement account.  Due
to the constant flow of funds in to and out of the sweep product, their balances
tend to be somewhat volatile mimicking the likes of a DDA deposit account.
Customer liquidity is the typical cause for variances in repurchase agreements,
which for the first six months of 2010 declined $1,945,000 from December 31,
2009.




The
components of borrowings as of June 30, 2010 and December 31, 2009 are as
follows (dollars in thousands):




June 30, 2010
                  
                  
                  December 31, 2009Amount
                  
                  
                  %
                  
                  
                  Amount
                  
                  
                  %Overnight
      borrowings
                  
                  $
                  -
                  
                  
                  
                  -
                  
                  
                  $
                  8,573
                  
                  
                  
                  17.7Repurchase
      agreements
                  
                  
                  5,802
                  
                  
                  
                  12.2
                  
                  
                  
                  7,747
                  
                  
                  
                  16.0Demand
      note, U.S. Treasury
                  
                  
                  276
                  
                  
                  
                  0.5
                  
                  
                  
                  213
                  
                  
                  
                  0.4FHLB
      advances:Short-term
                  
                  
                  9,500
                  
                  
                  
                  20.0
                  
                  
                  
                  -
                  
                  
                  
                  -Long-term
                  
                  
                  32,000
                  
                  
                  
                  67.3
                  
                  
                  
                  32,000
                  
                  
                  
                  65.9Total
      borrowings
                  
                  $
                  47,578
                  
                  
                  
                  100.0
                  
                  
                  $
                  48,533
                  
                  
                  
                  100.0




Total
borrowings have decreased $955,000 or 2%, during the six months ended June 30,
2010.  Growth in deposits has reduced the Company’s frequency for
overnight funding needs.  The short-term FHLB advance was to
accommodate a short-term, match funded commercial loan with a municipal
customer.




Recent
Developments




Dodd-Frank Wall
Street Reform and Consumer Protection Act.   On July 21,
2010, President Obama signed into law the Dodd-Frank Wall Street Reform and
Consumer Protection Act (the “Act”).  The Act will result in sweeping
financial regulatory reform aimed at strengthening the nation’s financial
services sector.




The Act’s
provisions that have received the most public attention generally have been
those applying to larger institutions or institutions that engage in practices
in which we do not engage.  These provisions include growth
restrictions, credit exposure limits, higher prudential standards, prohibitions
on proprietary trading, and prohibitions on sponsoring and investing in hedge
funds and private equity funds.




However,
the Act contains numerous other provisions that likely will directly impact us
and our banking subsidiary.  These include increased fees payable by
banks to regulatory agencies, new capital guidelines for banks and bank holding
companies, permanently increasing the FDIC insurance coverage from $100,000 to
$250,000 per depositor, new liquidation procedures for banks, new regulations
affecting consumer financial products, new corporate governance disclosures and
requirements and the increased cost of supervision and compliance more
generally.  Many aspects of the law are subject to rulemaking by
various government agencies and will take effect over several
years.  This time table, combined with the Act’s significant deference
to future rulemaking by various regulatory agencies, makes it difficult for us
to anticipate the Act’s overall financial, competitive and regulatory impact on
us, our customers, and the financial industry more generally.




Item
3.  Quantitative and 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 its lending, investing
and financing activities.  Fluctuations of interest rates will impact
interest income and interest expense along with affecting market values of all
interest-earning assets and interest-bearing liabilities, except for those
assets or liabilities with a short term remaining to
maturity.  Interest rate risk management is an integral part of the
asset/liability management process.  The Company has instituted
certain procedures and policy guidelines to manage the interest rate risk
position.  Those internal policies enable the Company to react to
changes in market rates to protect net interest income from significant
fluctuations.  The primary objective in managing interest rate risk is
to minimize the adverse impact of changes in interest rates on net interest
income along with creating an asset/liability structure that maximizes
earnings.


- 31
-


Asset/Liability
Management.  One major objective of the Company when managing
the rate sensitivity of its assets and liabilities is to stabilize net interest
income.  The management of and authority to assume interest rate risk
is the responsibility of the Company’s Asset/Liability Committee (ALCO), which
is comprised of senior management and members of the board of
directors.  ALCO meets quarterly to monitor the relationship of
interest-sensitive assets to interest- sensitive liabilities.  The
process to review interest rate risk is a regular part of managing the
Company.  Consistent policies and practices of measuring and reporting
interest rate risk exposure, particularly regarding the treatment of
non-contractual assets and liabilities, are in effect.  In addition,
there is an annual process to review the interest rate risk policy with the
board of directors which includes limits on the impact to earnings from shifts
in interest rates.




Interest Rate Risk Measurement.Interest rate risk is monitored through the use of three complementary
measures: static gap analysis, earnings at risk simulation and economic value at
risk simulation.  While each of the interest rate risk measurements
has limitations, taken together they represent a reasonably comprehensive view
of the magnitude of interest rate risk in the Company and the distribution of
risk along the yield curve, the level of risk through time and the amount of
exposure to changes in certain interest rate relationships.




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




To manage
this interest rate sensitivity gap position, an asset/liability model commonly
known as cumulative gap analysis is used to monitor the difference in the volume
of the Company’s interest-sensitive assets and liabilities that mature or
re-price within given time intervals.  A positive gap (asset
sensitive) indicates that more assets will mature or re-price during a given
period compared to liabilities, while a negative gap (liability sensitive) has
the opposite effect.  The Company employs computerized net interest
income simulation modeling to assist in quantifying interest rate risk
exposure.  This process measures and quantifies the impact on net
interest income through varying interest rate changes and balance sheet
compositions.  The use of this model assists the ALCO to gauge the
effects of the interest rate changes on interest-sensitive assets and
liabilities in order to determine what impact these rate changes will have upon
the net interest spread.  As of June 30, 2010, the Bank maintained a
one-year cumulative gap of positive $45.6 million, or 7.87%, of total
assets.  The effect of this positive gap position provided a mismatch
of assets and liabilities which may expose the Bank to interest rate risk during
periods of falling interest rates.  Conversely, in an increasing
interest rate environment, net interest income could be positively impacted
because more assets than liabilities would re-price upward during the one-year
period.




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


- 32
-


The
following table illustrates the Company’s interest sensitivity gap position at
June 30, 2010 (dollars in thousands):




Three months
                    
                    
                    Three to
                    
                    
                    One to
                    
                    
                    Overor less
                    
                    
                    twelve months
                    
                    
                    three years
                    
                    
                    three years
                    
                    
                    TotalCash
      and cash equivalents
                    
                    $
                    79
                    
                    
                    $
                    -
                    
                    
                    $
                    -
                    
                    
                    $
                    36,650
                    
                    
                    $
                    36,729Investment
      securities(1)(2)
                    
                    
                    11,521
                    
                    
                    
                    19,089
                    
                    
                    
                    18,643
                    
                    
                    
                    26,695
                    
                    
                    
                    75,948Loans
      (2)
                    
                    
                    129,785
                    
                    
                    
                    68,368
                    
                    
                    
                    114,075
                    
                    
                    
                    108,372
                    
                    
                    
                    420,600Fixed
      and other assets
                    
                    
                    -
                    
                    
                    
                    9,270
                    
                    
                    
                    -
                    
                    
                    
                    36,723
                    
                    
                    
                    45,993Total
      assets
                    
                    $
                    141,385
                    
                    
                    $
                    96,727
                    
                    
                    $
                    132,718
                    
                    
                    $
                    208,440
                    
                    
                    $
                    579,270Total
      cumulative assets
                    
                    $
                    141,385
                    
                    
                    $
                    238,112
                    
                    
                    $
                    370,830
                    
                    
                    $
                    579,270Non-interest
      bearing transaction deposits (3)
                    
                    $
                    -
                    
                    
                    $
                    7,784
                    
                    
                    $
                    21,405
                    
                    
                    $
                    48,647
                    
                    
                    $
                    77,836Interest-bearing
      transaction deposits (3)
                    
                    
                    80,358
                    
                    
                    
                    -
                    
                    
                    
                    67,536
                    
                    
                    
                    111,047
                    
                    
                    
                    258,941Time
      deposits
                    
                    
                    16,473
                    
                    
                    
                    61,320
                    
                    
                    
                    52,165
                    
                    
                    
                    14,192
                    
                    
                    
                    144,150Repurchase
      agreements
                    
                    
                    5,802
                    
                    
                    
                    -
                    
                    
                    
                    -
                    
                    
                    
                    -
                    
                    
                    
                    5,802Short-term
      borrowings
                    
                    
                    276
                    
                    
                    
                    9,500
                    
                    
                    
                    -
                    
                    
                    
                    -
                    
                    
                    
                    9,776Long-term
      debt
                    
                    
                    -
                    
                    
                    
                    11,000
                    
                    
                    
                    -
                    
                    
                    
                    21,000
                    
                    
                    
                    32,000Other
      liabilities
                    
                    
                    -
                    
                    
                    
                    -
                    
                    
                    
                    -
                    
                    
                    
                    2,922
                    
                    
                    
                    2,922Total
      liabilities
                    
                    $
                    102,909
                    
                    
                    $
                    89,604
                    
                    
                    $
                    141,106
                    
                    
                    $
                    197,808
                    
                    
                    $
                    531,427Total
      cumulative liabilities
                    
                    $
                    102,909
                    
                    
                    $
                    192,513
                    
                    
                    $
                    333,619
                    
                    
                    $
                    531,427Interest
      sensitivity gap
                    
                    $
                    38,476
                    
                    
                    $
                    7,123
                    
                    
                    $
                    (8,388
                    )
                    
                    $
                    10,632Cumulative
      gap
                    
                    $
                    38,476
                    
                    
                    $
                    45,599
                    
                    
                    $
                    37,211
                    
                    
                    $
                    47,843Cumulative
      gap to total assets
                    
                    
                    6.64
                    %
                    
                    
                    7.87
                    %
                    
                    
                    6.42
                    %
                    
                    
                    8.26
                    %





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


(2)
            Investments
      and loans are included in the earlier of the period in which interest
      rates were next scheduled to adjust or the period in which they are
      due.  In addition, loans are included in the periods in which
      they are scheduled to be repaid based on scheduled
      amortization.  For amortizing loans and MBS – GSE residential,
      annual prepayment rates are assumed reflecting historical experience as
      well as management’s knowledge and experience of its loan
      products.


(3)
            The
      Bank’s demand and savings accounts are generally subject to immediate
      withdrawal.  However, management considers a certain amount of
      such accounts to be core accounts having significantly longer effective
      maturities based on the retention experiences of such deposits in changing
      interest rate environments.  The effective maturities presented
      are the recommended maturity distribution limits for non-maturing deposits
      based on historical deposit
studies.




Earnings at Risk and Economic Value
at Risk Simulations.  The Company recognizes that more
sophisticated tools exist for measuring the interest rate risk in the balance
sheet that extend beyond static re-pricing gap analysis.  Although it
will continue to measure its re-pricing gap position, the Company utilizes
additional modeling for identifying and measuring the interest rate risk in the
overall balance sheet.  The ALCO is responsible for focusing on
“earnings at risk” and “economic value at risk”, and how both relate to the
risk-based capital position when analyzing the interest rate risk.




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




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




The
following table illustrates the simulated impact of 200 basis points upward or
downward movement in interest rates on net interest income, net income and the
change in the economic value (portfolio equity).  This analysis
assumes that interest-earning asset and interest-bearing liability levels at
June 30, 2010 remain constant.  The impact of the rate movements was
developed by simulating the effect of rates changing over a twelve-month period
from the June 30, 2010 levels:


- 33
-




Earnings at risk:
                    
                    Rates +200
                    
                    
                    Rates -200Percent
      change in:Net
      interest income
                    
                    
                    1.8
                    %
                    
                    
                    1.5
                    %Net
      income
                    
                    
                    7.1
                    
                    
                    
                    4.4Economic
      value at risk:Percent
      change in:Economic
      value of equity
                    
                    
                    (30.7
                    )
                    
                    
                    (0.3
                    )Economic
      value of equityas a percent of book assets
                    
                    
                    (2.2
                    )
                    
                    
                    (0.0
                    )




Economic
value has the most meaning when viewed within the context of risk-based
capital.  Therefore, the economic value may normally change beyond the
Company's policy guideline for a short period of time as long as the risk-based
capital ratio (after adjusting for the excess equity exposure) is greater than
10%.  As of June 30, 2010, the Company’s risk-based capital ratio was
12.0%.




The table
below summarizes estimated changes in net interest income over a twelve-month
period beginning July 1, 2010, under alternate interest rate scenarios using the
income simulation model described above (dollars in thousands):




Netinterest
                    
                    
                    $
                    
                    
                    %Change in interest rates
                    
                    income
                    
                    
                    variance
                    
                    
                    variance+200
      basis points
                    
                    $
                    20,859
                    
                    
                    $
                    367
                    
                    
                    1.8
                    %+100
      basis points
                    
                    
                    20,501
                    
                    
                    
                    9
                    
                    
                    0.0Flat
      rate
                    
                    
                    20,492
                    
                    
                    
                    -
                    
                    
                    --100
      basis points
                    
                    
                    20,817
                    
                    
                    
                    325
                    
                    
                    1.6-200
      basis points
                    
                    
                    20,803
                    
                    
                    
                    311
                    
                    
                    1.5




Simulation
models require assumptions about certain categories of assets and
liabilities.  The models schedule existing assets and liabilities by
their contractual maturity, estimated likely call date or earliest re-pricing
opportunity.  MBS – GSE residential securities and amortizing loans
are scheduled based on their anticipated cash flow including estimated
prepayments.  For investment securities, the Bank uses a third-party
service to provide cash flow estimates in the various rate
environments.  Savings, money market and NOW accounts do not have a
stated maturity or re-pricing term and can be withdrawn or re-priced at any
time.  This may impact the margin if more expensive alternative
sources of deposits are required to fund loans or deposit
runoff.  Management projects the re-pricing characteristics of these
accounts based on historical performance and assumptions that it believes
reflect their rate sensitivity.  The model reinvests all maturities,
repayments and prepayments for each type of asset or liability into the same
product for a new like term at current product interest rates.  As a
result, the mix of interest-earning assets and interest bearing-liabilities is
held constant.




Liquidity




Liquidity
management ensures that adequate funds will be available to meet customers’
needs for borrowings, deposit withdrawals and maturities and normal operating
expenses of the Company.  Current sources of liquidity are cash and
cash equivalents, asset maturities and pay-downs within one year, loans and
investments AFS, growth of core deposits, growth of repurchase agreements,
increases of other borrowed funds from correspondent banks and issuance of
capital stock.  Although regularly scheduled investment and loan
payments are a dependable source of daily funds, the sales of both loans and
investments AFS, deposit activity and investment and loan prepayments are
significantly influenced by general economic conditions and the interest rate
environment.  During a declining interest rate environment,
prepayments from interest-sensitive assets tend to accelerate and provide
significant liquidity which can be used to invest in other interest-earning
assets but at lower market rates.  Conversely, in a period of rising
interest rates, prepayments from interest-sensitive assets tend to decelerate
causing cash flow from mortgage loans and the MBS–GSE residential securities
portfolio to decrease.  Rising interest rates may also cause deposit
inflow to accelerate and be invested at higher market interest
rates.  The Company closely monitors activity in the capital markets
and takes appropriate action to ensure that the liquidity levels are adequate
for funding, investing and operating activities.




For the
six months ended June 30, 2010, the Company generated approximately $28.4
million of cash.  During the first half of 2010, the Company’s
financing activities provided $20.5 million, primarily from $21.9 million of
deposit growth.  During the same period, the Company’s operations
provided approximately $6.5 million primarily from the sales of mortgages AFS
net of originations and from increased net income.  $21.0 million of
the proceeds from financing, operations and security pay-offs were used to fund
growth in the loan portfolio, purchase new securities and facility
improvements.


- 34
-


As of
June 30, 2010, the Company maintained $36.7 million in cash and cash equivalents
and $75.8 million of investments and loans AFS and also had approximately $128.7
million available to borrow from the FHLB, $21.0 million available from other
correspondent banks, $23.8 million from the Discount Window of the Federal
Reserve Bank and $29.7 million with CDARS.  This combined total of
$315.7 million represented 54% of total assets at June 30,
2010.  Management believes this level of liquidity to be strong and
adequate to support current operations.




During
April 2010, the FHLB informed the Company of a 50% collateral maintenance
requirement on outstanding obligations and restrictions on utilization above 35%
of the amount available to borrow.  The Company is formulating
strategies to improve its position and have the requirements
lifted.  The requirements only impose more stringent collateral
delivery requirements and utilization subject to prior credit committee
decision-making and does not minimize or reduce the amount the Company may
borrow.  Management does not consider this action to significantly
effect the liquidity position of the Company.




Capital




During
the six months ended June 30, 2010, total shareholders' equity increased
$2,169,000, or 5%.  The increase was generated by: first half net
income of $1,275,000; $67,000 in proceeds from employees enrolled in the
Company’s Employee Stock Purchase Plan; a $1,382,000 (net of $997,000 in
non-credit-related OTTI) after tax improvement in the market value of the AFS
securities portfolio; partially offset by $563,000 of dividends paid to
shareholders, net of dividends reinvested and optional cash payments received
from participants in the Company’s Dividend Reinvestment Plan.




As of
June 30, 2010, the Company reported a net unrealized loss of $7,812,000, net of
tax, from the securities AFS compared to a net unrealized loss of $9,194,000 as
of December 31, 2009.  While the unrealized loss position has
improved, the prolonged economic downturn continues to assert uncertainty and in
certain circumstances illiquidity in the financial and capital markets and has
had a sizable negative impact on the fair value estimates on the securities
inbanks’ investment
portfolios.  Management maintains these changes are due mainly to
liquidity problems in the financial markets and to a lesser extent the
deterioration in the creditworthiness of the issuers.




The
Company (on a consolidated basis) and the Bank are subject to various regulatory
capital requirements administered by the federal banking
agencies.  Failure to meet minimum capital requirements can initiate
certain mandatory and possible additional discretionary actions by regulators
that, if undertaken, could have a direct material effect on the Company’s and
the Bank’s financial statements.  Under capital adequacy guidelines
and the regulatory framework for prompt corrective action, the Company and the
Bank must meet specific capital guidelines that involve quantitative measures of
their assets, liabilities and certain off-balance-sheet items as calculated
under regulatory accounting practices.  The capital amounts and
classification are also subject to qualitative judgments by the regulators about
components, risk-weightings and other factors.  Prompt corrective
action provisions are not applicable to bank holding companies.




Under
these guidelines, assets and certain off-balance sheet items are assigned to
broad risk categories, each with appropriate weights.  The resulting
capital ratios represent capital as a percentage of total risk-weighted assets
and certain off-balance sheet items.  The appropriate risk-weighting,
pursuant to regulatory guidelines, requires an increase in the risk-weighting of
securities that are rated below investment grade, thus significantly inflating
the total risk-weighted assets.  The regulatory guidelines require all
banks and bank holding companies to maintain a minimum ratio of total risk-based
capital to total risk-weighted assets (Total Risk Adjusted Capital) of 8%,
including Tier I capital to total risk-weighted assets (Tier I Capital) of 4%
and Tier I capital to average total assets (Leverage Ratio) of at least
4%.  As of June 30, 2010, the Company and the Bank met all capital
adequacy requirements to which it was subject.




The
Company continues to closely monitor and evaluate alternatives to enhance its
capital ratios as the regulatory and economic environments
change.  The following table depicts the capital amounts and ratios of
the Company and the Bank as of June 30, 2010:


- 35
-




To be well capitalizedFor capital
                                                        
                                                        
                                                        
                                                        under prompt correctiveActual
                                                        
                                                        
                                                        
                                                        
                                                        
                                                        
                                                        adequacy purposes
                                                        
                                                        
                                                        
                                                        action provisionsAmount
                                                        
                                                        
                                                        Ratio
                                                        
                                                        
                                                        
                                                        Amount
                                                        
                                                        Ratio
                                                        
                                                        
                                                        
                                                        Amount
                                                        
                                                        RatioTotal
      capital(to
      risk-weighted assets)Consolidated
                                                        
                                                        $
                                                        62,117,449
                                                        
                                                        
                                                        
                                                        12.0
                                                        %
                                                        
                                                        ≥
                                                        $
                                                        41,542,460
                                                        
                                                        ≥
                                                        8.0
                                                        %
                                                        
                                                        
                                                        
                                                        N/A
                                                        
                                                        
                                                        N/ABank
                                                        
                                                        $
                                                        61,734,704
                                                        
                                                        
                                                        
                                                        11.9
                                                        %
                                                        
                                                        ≥
                                                        $
                                                        41,537,582
                                                        
                                                        ≥
                                                        8.0
                                                        %
                                                        
                                                        ≥
                                                        $
                                                        51,921,978
                                                        
                                                        ≥
                                                        10.0
                                                        %Tier
      I capital(to
      risk-weighted assets)Consolidated
                                                        
                                                        $
                                                        55,571,145
                                                        
                                                        
                                                        
                                                        10.7
                                                        %
                                                        
                                                        ≥
                                                        $
                                                        20,771,230
                                                        
                                                        ≥
                                                        4.0
                                                        %
                                                        
                                                        
                                                        
                                                        N/A
                                                        
                                                        
                                                        N/ABank
                                                        
                                                        $
                                                        55,231,641
                                                        
                                                        
                                                        
                                                        10.6
                                                        %
                                                        
                                                        ≥
                                                        $
                                                        20,768,791
                                                        
                                                        ≥
                                                        4.0
                                                        %
                                                        
                                                        ≥
                                                        $
                                                        31,153,187
                                                        
                                                        ≥
                                                        6.0
                                                        %Tier
      I capital(to
      average assets)Consolidated
                                                        
                                                        $
                                                        55,571,145
                                                        
                                                        
                                                        
                                                        9.5
                                                        %
                                                        
                                                        ≥
                                                        $
                                                        23,408,532
                                                        
                                                        ≥
                                                        4.0
                                                        %
                                                        
                                                        
                                                        
                                                        N/A
                                                        
                                                        
                                                        N/ABank
                                                        
                                                        $
                                                        55,231,641
                                                        
                                                        
                                                        
                                                        9.5
                                                        %
                                                        
                                                        ≥
                                                        $
                                                        23,386,064
                                                        
                                                        ≥
                                                        4.0
                                                        %
                                                        
                                                        ≥
                                                        $
                                                        29,232,579
                                                        
                                                        ≥
                                                        5.0
                                                        %




Item
4T.  Controls and Procedures




As of the
end of the period covered by this Quarterly Report on Form 10-Q, an evaluation
was carried out by the Company’s management, with the participation of its
Interim President and Chief Executive Officer and Chief Financial Officer, of
the effectiveness of the Company’s disclosure controls and procedures, as
defined in Rule 13a-15(e) under the Securities Exchange Act of
1934.  Based on such evaluation, the Interim President and Chief
Executive Officer and Chief Financial Officer concluded that the Company’s
disclosure controls and procedures are designed to ensure that information
required to be disclosed in the reports the Company files or furnishes under the
Securities Exchange Act of 1934 is recorded, processed, summarized and reported
within the time periods specified in the SEC’s rules and regulations, and are
operating in an effective manner.  The Company made no significant
changes in its internal controls over financial reporting or in other factors
that materially affected, or are reasonably likely to materially affect, these
controls during the last fiscal quarter ended June 30, 2010.




In July
2010, President Obama signed into law the Dodd-Frank Wall Street Reform and
Consumer Protection Act, which in part, provides smaller companies and debt-only
issuers with a permanent exemption from the Sarbanes-Oxley internal control
audit requirements.  Without this exemption, these companies would
have been required to comply with the internal control audit requirements for
fiscal years ended on or after June 15, 2010.  The permanent exemption
applies to entities that are commonly referred to as non-accelerated filers and
smaller reporting companies, such as the Company.  Generally speaking,
a non-accelerated filer and a smaller reporting company have public float, or
market capitalization of less than $75.0 million.  The permanent
exemption applies only to the Sarbanes-Oxley internal control audit
requirements.  Non-accelerated filers and smaller reporting companies
are still required to disclose management's assessment of the effectiveness of
internal control over financial reporting.




PART
II - Other Information




Item
1.  Legal Proceedings




The
nature of the Company’s business generates some litigation involving matters
arising in the ordinary course of business.  However, in the opinion
of the Company after consultation with legal counsel, no legal proceedings are
pending, which, if determined adversely to the Company or the Bank, would have a
material effect on the Company’s undivided profits or financial
condition.  No legal proceedings are pending other than ordinary
routine litigation incidental to the business of the Company and the
Bank.  In addition, to management’s knowledge, no governmental
authorities have initiated or contemplated any material legal actions against
the Company or the Bank.




Item
1A.  Risk Factors




Management
of the Company does not believe there have been any material changes in risk
factors that were disclosed in the 2009 Form 10-K filed with the Securities and
Exchange Commission on March 8, 2010.




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




None




Item
3.  Default Upon Senior Securities




None


- 36
-


Item
4.  (Removed and Reserved)




None




Item
5.  Other Information




None




Item
6.  Exhibits




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




3(i) Amended and
Restated Articles of Incorporation of Registrant.Incorporated by
reference to Annex B of the Proxy Statement/Prospectus included in Registrant’s
Amendment 4 to its Registration Statement No. 333-90273 on Form S-4, filed with
the SEC on April 6, 2000.




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




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




*10.2 1998 Stock
Incentive Plan of The Fidelity Deposit and Discount Bank, as assumed by
Registrant.Incorporated by reference to Exhibit 10.2 of Registrant’s
Registration Statement No. 333-90273 on Form S-4, filed with the SEC on November
3, 1999.




*10.3
Registrant’s 2000 Dividend Reinvestment Plan.Incorporated by reference to Exhibit 4
to Registrant’s Registration Statement No. 333-45668 on Form S-1, filed with the
SEC on September 12, 2000 and as amended by Pre-Effective Amendment No. 1 on
October 11, 2000, by Post-Effective Amendment No. 1 on May 30, 2001, by
Post-Effective Amendment No. 2 on July 7, 2005, by Registration Statement No.
333-152806 on Form S-3 filed on August 6, 2008 and by Post-Effective
Amendment No. 1 on January 25, 2010.




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




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




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




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




*10.8 Registrant’s
2002 Employee Stock Purchase Plan.Incorporated by reference
to Exhibit 4.4 to Registrant’s Registration Statement No. 333-113339 on Form S-8
filed with the SEC on March 5, 2004.




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




*10.10 Amended and
Restated Executive Employment Agreement between Fidelity D & D Bancorp,
Inc., The Fidelity Deposit and Discount Bank and Steven C. Ackmann, dated July
11, 2007.Incorporated by
reference to Exhibit 10.1 to Registrant’s Current Report on Form 8-K filed with
the SEC on July 13, 2007.




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




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




*10.13 Release
Agreement between Steven C. Ackmann, Registrant and The Fidelity Deposit and
Discount Bank, dated August 31, 2009.  Incorporated by
reference to Exhibit 99.1 to Registrant’s Current Report on Form 8-K filed with
the SEC on September 8, 2009.


- 37
-


*10.14 Consulting
Agreement between Steven C. Ackmann, former President and Chief Executive
Officer of the Registrant and The Fidelity Deposit and Discount Bank, and The
Fidelity Deposit and Discount Bank, dated September 1, 2009.  Incorporated by
reference to Exhibit 99.2 to Registrant’s Current Report on Form 8-K filed with
the SEC on September 8, 2009.




11Statement
regarding computation of earnings per share.  Included herein
in Note No. 4, “Earnings per share,” contained within the Notes to Consolidated
Financial Statements, and incorporated herein by reference.




31.1
Rule 13a-14(a) Certification of Principal Executive Officer, filed
herewith.




31.2
Rule 13a-14(a) Certification of Principal Financial Officer, filed
herewith.




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




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







*Management
contract or compensatory plan or arrangement.


- 38
-


Signatures





FIDELITY
D & D BANCORP, INC.





Pursuant
to the requirements of the Securities Exchange Act of 1934, the registrant has
duly caused this report to be signed on its behalf by the undersigned thereunto
duly authorized.





FIDELITY
      D & D BANCORP, INC.Date:
      August 10, 2010
                        /s/
      Patrick J. DempseyPatrick J. Dempsey,Interim President and Chief Executive OfficerDate:
      August 10, 2010
                        /s/
      Salvatore R. DeFrancesco, Jr.Salvatore R. DeFrancesco, Jr.,Treasurer and Chief Financial
Officer


- 39
-


EXHIBIT
INDEX


Page3(i)
      Amended and Restated Articles of Incorporation of Registrant.Incorporated by reference to Annex B of the Proxy
      Statement/Prospectus included in Registrant’s Amendment 4 to its
      Registration Statement No. 333-90273 on Form S-4, filed with the SEC on
      April 6, 2000.
            
            *3(ii)
      Amended and Restated Bylaws of Registrant.Incorporated by
      reference to Exhibit 3(ii) to Registrant’s Form 8-K filed with the SEC on
      November 21, 2007.
            
            *10.1 1998
      Independent Directors Stock Option Plan of The Fidelity Deposit and
      Discount Bank, as assumed by Registrant.Incorporated by reference
      to Exhibit 10.1 to Registrant’s Registration Statement No. 333-90273 on
      Form S-4, filed with the SEC on November 3, 1999.
            
            *10.2 1998
      Stock Incentive Plan of The Fidelity Deposit and Discount Bank, as assumed
      by Registrant.Incorporated by reference to Exhibit 10.2 of
      Registrant’s Registration Statement No. 333-90273 on Form S-4, filed with
      the SEC on November 3, 1999.
            
            *10.3
      Registrant’s 2000 Dividend Reinvestment Plan.Incorporated
      by reference to Exhibit 4 to Registrant’s Registration Statement No.
      333-45668 on Form S-1, filed with the SEC on September 12, 2000 and as
      amended by Pre-Effective Amendment No. 1 on October 11, 2000, by
      Post-Effective Amendment No. 1 on May 30, 2001, by Post-Effective
      Amendment No. 2 on July 7, 2005 and by Registration Statement No.
      333-152806 on Form S-3 filed on August 6, 2008 and by Post-Effective
      Amendment No. 1 on January 25, 2010.
            
            *10.4
      Registrant’s 2000 Independent Directors Stock Option
      Plan.Incorporated by reference to Exhibit 4.3 to
      Registrant’s Registration Statement No. 333-64356 on Form S-8 filed with
      the SEC on July 2, 2001.
            
            *10.5
      Amendment, dated October 2, 2007, to the Registrant’s 2000 Independent
      Directors Stock Option Plan.Incorporated by reference
      to Exhibit 10.2 to Registrant’s Form 8-K filed with the SEC on October 4,
      2007.
            
            *10.6
      Registrant’s 2000 Stock Incentive Plan.Incorporated by
      reference to Exhibit 4.4 to Registrant’s Registration Statement No.
      333-64356 on Form S-8 filed with the SEC on July 2, 2001.
            
            *10.7
      Amendment, dated October 2, 2007, to the Registrant’s 2000 Stock Incentive
      Plan.Incorporated by reference to Exhibit 10.1 to
      Registrant’s Form 8-K filed with the SEC on October 4,
    2007.
            
            *10.8
      Registrant’s 2002 Employee Stock Purchase
      Plan.Incorporated by reference to Exhibit 4.4 to
      Registrant’s Registration Statement No. 333-113339 on Form S-8 filed with
      the SEC on March 5, 2004.
            
            *10.9 Change
      of Control Agreements with Salvatore R. DeFrancesco, Registrant and The
      Fidelity Deposit and Discount Bank, dated March 21,
      2006.Incorporated by reference to Exhibit 99.2 to
      Registrant’s Current Report on Form 8-K filed with the SEC on March 27,
      2006.
            
            *10.10
      Amended and Restated Executive Employment Agreement between Fidelity D
      & D Bancorp, Inc., The Fidelity Deposit and Discount Bank and Steven
      C. Ackmann, dated July 11, 2007.Incorporated by
      reference to Exhibit 10.1 to Registrant’s Current Report on Form 8-K filed
      with the SEC on July 13, 2007.
            
            *10.11
      Executive Employment Agreement between Fidelity D & D Bancorp, Inc.,
      The Fidelity Deposit and Discount Bank and Timothy
      P. O’Brien, dated January 3, 2008.Incorporated by
      reference to Exhibit 10.1 to Registrant’s Current Report on Form 8-K filed
      with the SEC on January 10, 2008.
            
            *10.12
      Executive Employment Agreement between Fidelity D & D Bancorp, Inc.,
      The Fidelity Deposit and Discount Bank and Daniel J. Santaniello, dated
      February 28, 2008.Incorporated by reference to Exhibit
      10.1 to Registrant’s Current Report on Form 8-K filed with the SEC on
      March 3, 2008.
            
            *10.13
      Release Agreement between Steven C. Ackmann, Registrant and The Fidelity
      Deposit and Discount Bank, dated August 31,
      2009.Incorporated by reference to Exhibit 99.1 to
      Registrant’s Current Report on Form 8-K filed with the SEC on September 8,
      2009.
            
            *


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10.14
      Consulting Agreement between Steven C. Ackmann, former President and Chief
      Executive Officer of the Registrant and The Fidelity Deposit and Discount
      Bank, and The Fidelity Deposit and Discount Bank, dated September 1,
      2009.  Incorporated by reference to Exhibit 99.2 to
      Registrant’s Current Report on Form 8-K filed with the SEC on September 8,
      2009.
                      
                      *11
      Statement
      regarding computation of earnings per share.
                      
                      1331.1
      Rule 13a-14(a) Certification of Principal Executive
    Officer.
                      
                      4231.2
      Rule 13a-14(a) Certification of Principal Financial
    Officer.
                      
                      4332.1
      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.
                      
                      4432.2
      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.
                      
                      45








*
Incorporated by Reference


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