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: September 30, 2008


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: 0-16667


DNB
Financial Corporation


(Exact
name of registrant as specified in its charter)





Pennsylvania
              (State
      or other jurisdiction of
              incorporation
      or organization)
            23-2222567
              (I.R.S.
      Employer Identification No.)





4
Brandywine Avenue - Downingtown, PA 19335


(Address
of principal executive offices and Zip Code)





(610)
269-1040


(Registrant's
telephone number, including area code)





Not
Applicable


(Former
name, former address and former fiscal year, if changed since last
report)





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 subject to such filing requirements for
the past 90 days


Yes
      x
            
            No
      o




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




Large
      accelerated filer    o
            
            Accelerated
      filer                  oNon-accelerated
      filer     o
            
            Smaller
      reporting company x




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


Yeso
            
            No
      x





Indicate
the number of shares outstanding of each of the issuer's classes of common
stock, as of the latest practicable date.




Common
      Stock ($1.00 Par Value)
              (Class)
            2,606,678
              (Shares
      Outstanding as of November 10,
2008)





1


DNB
FINANCIAL CORPORATION AND SUBSIDIARY




INDEX




PART  I
      - FINANCIAL INFORMATION
            PAGE
      NO.ITEM
      1.
            
            FINANCIAL
      STATEMENTS:CONSOLIDATED
      STATEMENTS OF FINANCIAL CONDITIONSeptember
      30, 2008 and December 31, 2007
            3CONSOLIDATED
      STATEMENTS OF OPERATIONSThree
      and Nine Months Ended September 30, 2008 and 2007
            4CONSOLIDATED
      STATEMENTS OF CASH FLOWSNine
      Months Ended September 30, 2008 and 2007
            5NOTES
      TO CONSOLIDATED FINANCIAL STATEMENTS
            6ITEM
      2.
            
            MANAGEMENT'S
      DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF
      OPERATIONS
            15ITEM
      3.
            
            QUANTITATIVE
      AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
            27ITEM
      4T.
            
            CONTROLS
      AND PROCEDURES
            27PART
      II - OTHER INFORMATIONITEM
      1.
            
            LEGAL
      PROCEEDINGS
            27ITEM
      1A.
            
            RISK
      FACTORS
            28ITEM
      2.
            
            UNREGISTERED
      SALES OF EQUITY  SECURITIES AND USE OF PROCEEDS
            29ITEM
      3.
            
            DEFAULTS
      UPON SENIOR SECURITIES
            29ITEM
      4.
            
            SUBMISSION
      OF MATTERS TO A VOTE OF SECURITY HOLDERS
            29ITEM
      5.
            
            OTHER
      INFORMATION
            29ITEM
      6.
            
            EXHIBITS
            29SIGNATURES
            30EXHIBIT INDEX








2







PART
I – FINANCIAL INFORMATION


ITEM 1 – FINANCIAL
STATEMENTS




DNBFinancial Corporation and Subsidiary


Consolidated
Statements of Financial Condition (Unaudited)





September
      30
            
            
            December
      31(Dollars
      in thousands except share data)
            
            2008
            
            
            2007AssetsCash
      and due from banks
            
            $
            12,857
            
            
            $
            12,858Federal
      funds sold
            
            
            361
            
            
            
            32,473Cash
      and cash equivalents
            
            
            13,218
            
            
            
            45,331AFS
      investment securities, at fair value (amortized cost of
      $109,985and
      $151,848)
            
            
            108,914
            
            
            
            152,570HTM
      investment securities (fair value of $61,282 and $14,593)
            
            
            61,585
            
            
            
            14,921Other
      investment securities
            
            
            4,032
            
            
            
            3,418Total
      investment securities
            
            
            174,531
            
            
            
            170,909Loans
      and leases
            
            
            342,898
            
            
            
            309,342Allowance
      for credit losses
            
            
            (4,791
            )
            
            
            (3,891
            )Net
      loans and leases
            
            
            338,107
            
            
            
            305,451Office
      property and equipment, net
            
            
            9,551
            
            
            
            9,908Accrued
      interest receivable
            
            
            2,465
            
            
            
            2,610OREO
      & other repossessed property
            
            
            527
            
            
            
            —Bank
      owned life insurance
            
            
            7,513
            
            
            
            7,321Core
      deposit intangible
            
            
            271
            
            
            
            308Net
      deferred taxes
            
            
            3,127
            
            
            
            2,163Other
      assets
            
            
            1,801
            
            
            
            1,839Total
      assets
            
            $
            551,111
            
            
            $
            545,840Liabilities
      and Stockholders’ EquityLiabilitiesNon-interest-bearing
      deposits
            
            $
            46,913
            
            
            $
            48,741Interest-bearing
      deposits:NOW
            
            
            129,390
            
            
            
            82,912Money market
            
            
            88,000
            
            
            
            93,029Savings
            
            
            33,734
            
            
            
            38,362Time
            
            
            124,407
            
            
            
            149,876Total
      deposits
            
            
            422,444
            
            
            
            412,920FHLB
      advances
            
            
            60,000
            
            
            
            50,000Repurchase
      agreements
            
            
            18,917
            
            
            
            29,923Junior
      subordinated debentures
            
            
            9,279
            
            
            
            9,279Other
      borrowings
            
            
            664
            
            
            
            675Total
      borrowings
            
            
            88,860
            
            
            
            89,877Accrued
      interest payable
            
            
            848
            
            
            
            1,498Other
      liabilities
            
            
            8,010
            
            
            
            8,910Total
      liabilities
            
            
            520,162
            
            
            
            513,205Stockholders’
      EquityPreferred
      stock, $10.00 par value;1,000,000 shares authorized;
      none issued
            
            
            —
            
            
            
            —Common
      stock, $1.00 par value;10,000,000
      shares authorized; 2,865,242 and 2,850,799 issued
    respectively
            
            
            2,866
            
            
            
            2,860Treasury
      stock, at cost; 258,537 and 249,859 shares, respectively
            
            
            (4,810
            )
            
            
            (4,757
            )Surplus
            
            
            35,029
            
            
            
            34,888Accumulated
      deficit
            
            
            (743
            )
            
            
            (771
            )Accumulated
      other comprehensive (loss) income, net
            
            
            (1,393
            )
            
            
            415Total stockholders’
      equity
            
            
            30,949
            
            
            
            32,635Total liabilities and
      stockholders’ equity
            
            $
            551,111
            
            
            $
            545,840See accompanying notes to
      consolidated financial statements.





3





DNBFinancial Corporation and Subsidiary


Consolidated
Statements of Operations (Unaudited)








Three
      Months Ended
              September
      30,
            
            
            Nine
      Months Ended
              September
      30,(Dollars
      in thousands except share data)
            
            2008
            
            
            2007
            
            
            2008
            
            
            2007Interest
      Income:Interest
      and fees on loans and leases
            
            $
            5,051
            
            
            $
            5,714
            
            
            $
            14,604
            
            
            $
            17,199Interest
      and dividends on investment securities:Taxable
            
            
            1,938
            
            
            
            1,520
            
            
            
            6,199
            
            
            
            4,152Exempt
      from federal taxes
            
            
            44
            
            
            
            121
            
            
            
            131
            
            
            
            556Interest
      on cash and cash equivalents
            
            
            161
            
            
            
            178
            
            
            
            415
            
            
            
            584Total
      interest income
            
            
            7,194
            
            
            
            7,533
            
            
            
            21,349
            
            
            
            22,491Interest
      Expense:Interest
      on NOW, money market and savings
            
            
            1,203
            
            
            
            1,390
            
            
            
            3,233
            
            
            
            3,544Interest
      on time deposits
            
            
            956
            
            
            
            1,441
            
            
            
            3,622
            
            
            
            4,362Interest
      on FHLB advances
            
            
            744
            
            
            
            530
            
            
            
            2,157
            
            
            
            1,689Interest
      on repurchase agreements
            
            
            123
            
            
            
            277
            
            
            
            410
            
            
            
            1,031Interest
      on junior subordinated debentures
            
            
            156
            
            
            
            183
            
            
            
            472
            
            
            
            548Interest
      on other borrowings
            
            
            23
            
            
            
            24
            
            
            
            68
            
            
            
            84Total
      interest expense
            
            
            3,205
            
            
            
            3,845
            
            
            
            9,962
            
            
            
            11,258Net
      interest income
            
            
            3,989
            
            
            
            3,688
            
            
            
            11,387
            
            
            
            11,233Provision
      for credit losses
            
            
            727
            
            
            
            —
            
            
            
            1,241
            
            
            
            —Net
      interest income after provision for credit losses
            
            
            3,262
            
            
            
            3,688
            
            
            
            10,146
            
            
            
            11,233Non-interest
      Income:Service
      charges on deposits
            
            
            406
            
            
            
            401
            
            
            
            1,184
            
            
            
            1,212Wealth
      management fees
            
            
            182
            
            
            
            185
            
            
            
            703
            
            
            
            631Increase
      in cash surrender value of BOLI
            
            
            63
            
            
            
            57
            
            
            
            192
            
            
            
            171Gain
      on sale of securities
            
            
            27
            
            
            
            178
            
            
            
            764
            
            
            
            281Other
      fees
            
            
            225
            
            
            
            239
            
            
            
            646
            
            
            
            637Total
      non-interest income
            
            
            903
            
            
            
            1,060
            
            
            
            3,489
            
            
            
            2,932Non-interest
      Expense:Salaries
      and employee benefits
            
            
            2,151
            
            
            
            2,322
            
            
            
            6,756
            
            
            
            7,047Furniture
      and equipment
            
            
            426
            
            
            
            409
            
            
            
            1,308
            
            
            
            1,171Occupancy
            
            
            400
            
            
            
            396
            
            
            
            1,166
            
            
            
            1,124Professional
      and consulting
            
            
            263
            
            
            
            284
            
            
            
            904
            
            
            
            894Advertising
      and marketing
            
            
            122
            
            
            
            84
            
            
            
            395
            
            
            
            303Printing
      and supplies
            
            
            44
            
            
            
            56
            
            
            
            188
            
            
            
            255Other
      expenses
            
            
            625
            
            
            
            603
            
            
            
            1,739
            
            
            
            1,715Total
      non-interest expense
            
            
            4,031
            
            
            
            4,154
            
            
            
            12,456
            
            
            
            12,509Income
      before income taxes
            
            
            134
            
            
            
            594
            
            
            
            1,179
            
            
            
            1,656Income
      tax expense
            
            
            (65
            )
            
            
            120
            
            
            
            140
            
            
            
            269Net
      Income
            
            $
            199
            
            
            $
            474
            
            
            $
            1,039
            
            
            $
            1,387Earnings
      per share:Basic
            
            $
            0.08
            
            
            $
            0.18
            
            
            $
            0.40
            
            
            $
            0.53Diluted
            
            $
            0.08
            
            
            $
            0.18
            
            
            $
            0.40
            
            
            $
            0.53Cash
      dividends per share
            
            $
            0.13
            
            
            $
            0.12
            
            
            $
            0.39
            
            
            $
            0.37Weighted
      average common shares outstanding:Basic
            
            
            2,608,051
            
            
            
            2,605,774
            
            
            
            2,601,638
            
            
            
            2,618,605Diluted
            
            
            2,610,515
            
            
            
            2,615,973
            
            
            
            2,604,993
            
            
            
            2,632,667(Share
      data adjusted for 2007 5% stock dividend)See
      accompanying notes to consolidated financial statements.





4




DNBFinancial Corporation and Subsidiary


Consolidated
Statements of Cash Flows (Unaudited)





Nine
      Months Ended
              September
      30,(Dollars
      in thousands)
            
            2008
            
            
            2007Cash
      Flows From Operating Activities:Net
      income
            
            $
            1,039
            
            
            $
            1,387Adjustments
      to reconcile net income to net cashprovided
      by operating activities:Depreciation, amortization and
      accretion
            
            
            1,004
            
            
            
            948Provision for credit
      losses
            
            
            1,241
            
            
            
            —Unvested
      stock amortization
            
            
            99
            
            
            
            84Net gain on sale of
      securities
            
            
            (764
            )
            
            
            (281
            )Increase (decrease) in interest
      receivable
            
            
            145
            
            
            
            (184
            )Decrease in other
      assets
            
            
            38
            
            
            
            135Increase in investment in
      BOLI
            
            
            (192
            )
            
            
            (171
            )Decrease in interest
      payable
            
            
            (650
            )
            
            
            (15
            )Increase in deferred tax
      benefit
            
            
            (186
            )
            
            
            (136
            )(Decrease) increase in other
      liabilities
            
            
            (960
            )
            
            
            5,709Net
      Cash Provided By Operating Activities
            
            
            814
            
            
            
            7,476Cash
      Flows From Investing Activities:Activity
      in available-for-sale securities:Sales
            
            
            108,486
            
            
            
            32,830Maturities,
      repayments and calls
            
            
            18,386
            
            
            
            30,263Purchases
            
            
            (106,806
            )
            
            
            (60,547
            )Activity
      in held-to-maturity securities:Maturities,
      repayments and calls
            
            
            5,945
            
            
            
            3,675Purchases
            
            
            (30,661
            )
            
            
            —Net
      (increase) decrease in other investments
            
            
            (614
            )
            
            
            584Net
      (increase) decrease in loans and leases
            
            
            (34,424
            )
            
            
            8,997Purchase
      of bank property and equipment
            
            
            (628
            )
            
            
            (3,108
            )Net
      Cash (Used) Provided By Investing Activities
            
            
            (40,316
            )
            
            
            12,694Cash
      Flows From Financing Activities:Net
      Increase in deposits
            
            
            9,524
            
            
            
            16,102Increase
      (decrease) in FHLB advances
            
            
            10,000
            
            
            
            (15,000
            )Decrease
      in short term repurchase agreements
            
            
            (11,006
            )
            
            
            (19,172
            )Decrease
      in lease obligations
            
            
            (11
            )
            
            
            (10
            )Dividends
      paid
            
            
            (1,011
            )
            
            
            (973
            )Proceeds
      from issuance of stock under stock option plan
            
            
            —
            
            
            
            117Purchase
      of treasury stock
            
            
            (107
            )
            
            
            (619
            )Net
      Cash Provided (Used) By Financing Activities
            
            
            7,389
            
            
            
            (19,555
            )Net
      Change in Cash and Cash Equivalents
            
            
            (32,113
            )
            
            
            615Cash
      and Cash Equivalents at Beginning of Period
            
            
            45,331
            
            
            
            24,227Cash and Cash Equivalents at
      End of Period
            
            $
            13,218
            
            
            $
            24,842Supplemental
      Disclosure of Cash Flow Information:Cash
      paid during the period for:Interest
            
            $
            10,613
            
            
            $
            11,273Income
      taxes
            
            
            678
            
            
            
            411Supplemental
      Disclosure of Non-cash Flow Information:Change
      in unrealized losses on securities
            
            $
            (2,484
            )
            
            $
            309Change
      in deferred taxes due to change in unrealized losses on
      securities
            
            
            845
            
            
            
            (105
            )Transfer  securities
      from AFS to HTM, at fair value (amortized cost of $22,670)
            
            
            21,987
            
            
            
            —Unsettled
      securities purchased  included in other
    liabilities
            
            
            6,000
            
            
            
            —Transfers
      from loans and leases to real estate owned and other repossessed
      assets
            
            
            527
            
            
            
            —See
      accompanying notes to consolidated financial statements.




5


DNBFINANCIAL CORPORATION AND SUBSIDIARY


NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS


(Unaudited)





NOTE
1: BASIS OF PRESENTATION





The
accompanying unaudited consolidated financial statements of DNB Financial
Corporation (referred to herein as the "Corporation" or "DNB") and its
subsidiary, DNB First, National Association (the "Bank") have been prepared in
accordance with the instructions for Form 10-Q and therefore do not include
certain information or footnotes necessary for the presentation of financial
condition, statement of operations and statement of cash flows required by
generally accepted accounting principles. However, in the opinion of management,
the consolidated financial statements reflect all adjustments (which consist of
normal recurring adjustments) necessary for a fair presentation of the results
for the unaudited periods. Prior amounts not affecting net income are
reclassified when necessary to conform to current period classifications. The
results of operations for the nine-month period ended September 30, 2008, are
not necessarily indicative of the results, which may be expected for the entire
year.  The consolidated financial statements should be read in
conjunction with the Annual Report and report on Form 10-K for the year ended
December 31, 2007.





NOTE
2: EARNINGS PER SHARE





Basic
earnings per share (“EPS”) are computed based on the weighted average number of
common shares outstanding during the period.  Diluted
EPS  is computed using the treasury stock method and reflects the
potential dilution that could occur from the exercise of stock options and the
amortized portion of unvested stock awards.   Stock options and
unvested stock awards for which the exercise or the grant price exceeds the
average market price over the period have an anti-dilutive effect on EPS and,
accordingly, are excluded from the calculation.  There were 187,590
anti-dilutive stock options outstanding and 14,674 anti-dilutive stock awards at
September 30, 2008. There were 116,860 anti-dilutive stock options outstanding
and 14,204 anti-dilutive stock awards at September 30, 2007. EPS, dividends
per share, and weighted average shares outstanding have been adjusted to reflect
the effect of the 5% stock dividend paid in December 2007.  The
dilutive effect of stock options on basic earnings per share is presented
below.





Three
      Months Ended
            
            
            Nine
      Months EndedSeptember
      30, 2008
            
            
            September
      30, 2008(In
      thousands, except per-share data)
            
            Income
            
            
            Shares
            
            
            Amount
            
            
            Income
            
            
            Shares
            
            
            AmountBasic
      EPSIncome
      available to common stockholders
            
            $
            199
            
            
            
            2,608
            
            
            $
            0.08
            
            
            $
            1,039
            
            
            
            2,602
            
            
            $
            0.40Effect
      of potential dilutive common stock– stock options and unvested
      shares
            
            
            —
            
            
            
            3
            
            
            
            —
            
            
            
            —
            
            
            
            3
            
            
            
            —Diluted
      EPSIncome
      available to common stockholders
            
            $
            199
            
            
            
            2,611
            
            
            $
            0.08
            
            
            $
            1,039
            
            
            
            2,605
            
            
            $
            0.40








Three
      Months Ended
            
            
            Nine
      Months EndedSeptember
      30, 2007
            
            
            September
      30, 2007(In
      thousands, except per-share data)
            
            Income
            
            
            Shares
            
            
            Amount
            
            
            Income
            
            
            Shares
            
            
            AmountBasic
      EPSIncome
      available to common stockholders
            
            $
            474
            
            
            
            2,606
            
            
            $
            0.18
            
            
            $
            1,387
            
            
            
            2,619
            
            
            $
            0.53Effect
      of potential dilutive common stock – stock options and unvested
      shares
            
            
            —
            
            
            
            10
            
            
            
            —
            
            
            
            —
            
            
            
            14
            
            
            
            —Diluted
      EPSIncome
      available to common stockholders
            
            $
            474
            
            
            
            2,616
            
            
            $
            0.18
            
            
            $
            1,387
            
            
            
            2,633
            
            
            $
            0.53








6




DNB
FINANCIAL CORPORATION AND SUBSIDIARY


NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS


(Unaudited)








NOTE
3: COMPREHENSIVE INCOME (LOSS)





Comprehensive
income includes all changes in stockholders' equity during the period, except
those resulting from investments by owners and distributions to
owners.  Comprehensive income for all periods consisted of net income
and other comprehensive income relating to the change in unrealized losses on
investment securities available for sale.  Comprehensive income
(loss), net of tax, is disclosed in the following table.





Three
      Months Ended
            Three
      Months EndedSeptember
      30, 2008
            September
      30, 2007(Dollars
      in thousands)
            
            Net-of-Tax
      Amount
            Net-of-Tax
      AmountNet
      Income
            
            $        199
            
            $        474Other
      Comprehensive Income:Unrealized
      holding gains arising during the period
            
            507
            
            1,173Reclassification
      for gains included in net income
            
            (18)
            
            (118)Unrealized
      actuarial losses- pension
            
            —
            
            —Total
      Comprehensive Income
            
            $     688
            
            $     1,529Nine
      Months Ended
            Nine
      Months EndedSeptember
      30, 2008
            September
      30, 2007(Dollars
      in thousands)
            
            Net-of-Tax
      Amount
            Net-of-Tax
      AmountNet
      Income
            
            $      1,039
            
            $      1,387Other
      Comprehensive Income:Unrealized
      holding (losses) gains arising during the period
            
            (1,134)
            
            390Reclassification
      for gains included in net income
            
            (505)
            
            (186)Unrealized
      actuarial losses- pension
            
            (169)
            
            —Total
      Comprehensive (Loss) Income
            
            $       (769)
            
            $       1,591








NOTE
4: COMPOSITION OF LOAN AND LEASE PORTFOLIO





The
following table sets forth information concerning the composition of total loans
and leases outstanding, as of the dates indicated.








September
      30,
            
            
            December
      31,(Dollars
      in thousands)
            
            2008
            
            
            2007Commercial
      mortgage
            
            $
            143,501
            
            
            $
            111,727Commercial
      term and lines of credit
            
            
            79,986
            
            
            
            81,021Consumer
            
            
            65,829
            
            
            
            56,553Residential
      mortgage
            
            
            45,281
            
            
            
            46,448Commercial
      leases
            
            
            8,301
            
            
            
            13,593Gross
      loans and leases
            
            
            342,898
            
            
            
            309,342Allowance
      for credit losses
            
            
            (4,791
            )
            
            
            (3,891
            )Net
      loans and leases
            
            $
            338,107
            
            
            $
            305,451








7




DNB
FINANCIAL CORPORATION AND SUBSIDIARY


NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS


(Unaudited)





NOTE
5: JUNIOR SUBORDINATED DEBENTURES





DNB has
two issuances of junior subordinated debentures (the "debentures") as
follows:





DNB Capital Trust
I





DNB’s
first issuance of junior subordinated debentures was on July 20, 2001. This
issuance of debentures are floating rate and were issued to DNB Capital Trust I,
a Delaware business trust in which DNB owns all of the common equity. DNB
Capital Trust I issued $5 million of floating rate (6 month Libor plus 3.75%,
with a cap of 12%) capital preferred securities to a qualified institutional
buyer. The proceeds of these securities were used by the Trust, along with DNB's
capital contribution, to purchase $5,155,000 principal amount of DNB's floating
rate junior subordinated debentures.  The preferred securities have
been redeemable since July 25, 2006 and must be redeemed upon maturity of the
debentures on July 25, 2031.





DNB Capital Trust
II





DNB’s
second issuance of junior subordinated debentures was on March 30, 2005. This
issuance of debentures are floating rate and were issued to DNB Capital Trust
II, a Delaware business trust in which DNB owns all of the common equity. DNB
Capital Trust II issued $4.0 million of floating rate (the rate is fixed at
6.56% for the first 5 years and will adjust at a rate of 3-month LIBOR plus
1.77% thereafter) capital preferred securities. The proceeds of these securities
were used by the Trust, along with DNB's capital contribution, to purchase $4.1
million principal amount of DNB's floating rate junior subordinated debentures.
The preferred securities are redeemable by DNB on or after May 23, 2010, or
earlier in the event of certain adverse tax or bank regulatory developments. The
preferred securities must be redeemed upon maturity of the debentures on May 23,
2035.





The
majority of the proceeds of each issuance were invested in DNB’s subsidiary, DNB
First, National Association, to increase the Bank's capital levels. The junior
subordinated debentures issued in each case qualify as a component of capital
for regulatory purposes.





NOTE
6: RECENT ACCOUNTING PRONOUNCEMENTS







FASB Statement
No. 159 In February 2007, the FASB issued FASB Statement
No. 159 — “The Fair Value Option for Financial Assets and
Liabilities — Including an Amendment of FASB Statement No. 115”
(“Statement 159”). Statement 159 permits entities to measure many financial
instruments and certain other items at fair value. The objective is to improve
financial reporting by providing entities with the opportunity to mitigate
volatility in reported earnings without having to apply complex hedge accounting
provisions. Statement 159 became effective January 1, 2008 and did not have a
material impact on DNB’s consolidated financial statements upon
adoption.




FASB Statement
No. 160 In December 2007, the FASB issued FASB Statement
No. 160 — “Noncontrolling Interest in Consolidated Financial
Statements — Including an Amendment of ARB No. 51” (“Statement
160”). Statement 160 improves the relevance, comparability, and transparency of
the financial information that a reporting entity provides in its consolidated
financial statements by establishing accounting and reporting standards for the
noncontrolling interest in a subsidiary and for the de-consolidation of a
subsidiary. Statement 160 is effective as of the beginning of an entity’s first
fiscal year that begins on or after December 15, 2008. Early adoption is
prohibited. DNB has not yet determined whether this statement will have a
material impact on DNB’s consolidated financial statements upon
adoption.




FASB Statement
No. 161 In March 2008, the FASB issued FASB Statement
No. 161 — “Disclosures about Derivative Instruments and Hedging
Activities—an amendment of FASB Statement No. 133” (“Statement
161”).  Statement 161 amends Statement No. 133 and its related
guidance by requiring expanded disclosures about derivative instruments and
hedging activities.  This Statement will require DNB to provide
additional disclosure about a) how and why we use derivative instruments; b) how
we account for derivative instruments and related hedged items under SFAS No.
133 and its related interpretations; and c) how derivative instruments and
related hedged items effect our financial condition, financial performance, and
cash flows.  Statement 161 does not change the accounting for
derivatives under SFAS No. 133. DNB does not currently engage in derivative
instruments and hedging activities.




8


DNB
FINANCIAL CORPORATION AND SUBSIDIARY


NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS


(Unaudited)







FASB Statement
No. 141 (revised) In December 2007, FASB issued FASB Statement
No. 141 (revised 2007), “Business Combinations” (“Statement 141R).
Statement 141R retains the fundamental requirement of FASB Statement
No. 141 that the acquisition method of accounting be used for all business
combinations. However, Statement 141R does make significant changes to the
accounting for a business combination achieved in stages, the treatment of
contingent consideration, transaction and restructuring costs, and other aspects
of business combination accounting. Statement 141R will be effective with the
fiscal year that begins on January 1, 2009, and will change DNB’s
accounting treatment for business combinations on a prospective
basis.




FIN 48 In
July 2006, the FASB issued FASB Interpretation No. 48, “Accounting for
Uncertainty in Income Taxes”—an interpretation of FASB Statement No. 109
(FIN 48). This interpretation of FASB Statement 109 prescribes a recognition
threshold and measurement attribute for the financial statement recognition and
measurement of a tax position taken or expected to be taken in a tax return.
This interpretation also provides guidance on de-recognition, classification,
interest and penalties, accounting in interim periods, disclosure and
transition. The interpretation was effective on January 1, 2007. The
adoption of FIN 48 did not have a significant impact on DNB’s consolidated
financial statements.




SAB No. 109In November 2007, the SEC issued SAB No. 109, “Written Loan
Commitments Recorded at Fair Value Through Earnings” (“SAB 109”).
SAB 109 supersedes SAB No. 105, “Loan Commitments Accounted for as
Derivative Instruments,” and expresses the view that expected net future cash
flows related to the servicing of loans should be included in the fair value
measurement of all written loan commitments that are accounted for at fair value
through earnings. SAB 109 retains the views in SAB No. 105 that
internally developed intangible assets (such as client relationship intangible
assets) should not be included in the fair value measurement of derivative loan
commitments. SAB 109 was effective on January 1, 2008. DNB concluded
that SAB 109 did not have a material effect on its consolidated financial
statements upon adoption.




SAB
No. 110  In December 2007, the SEC issued SAB
No. 110, and extended, under certain circumstances, the availability of a
“simplified” method for estimating the expected term of “plain vanilla” share
options in accordance with FASB Statement No. 123 (revised). DNB determined
SAB 110 did not affect DNB’s consolidated financial statements upon
adoption.




FSP FAS
No. 157-3 In October 2008, the FASB issued FSP FAS
No. 157-3, Determining the Fair Value of a Financial Asset When the Market
for That Asset Is Not Active. FSP FAS No. 157-3 clarifies the application
of SFAS No. 157, Fair Value Measurements, in a market that is not active
and provides an example to illustrate key considerations in determining the fair
value of a financial asset when the market for that financial asset is not
active. This FSP is effective upon issuance, including prior periods for which
financial statements have not been issued. Therefore, FSP FAS No. 157-3 is
effective for the consolidated financial statements included in the Company’s
quarterly report for the period ended September 30, 2008. The adoption of
FSP FAS No. 157-3 did not have a material impact on the Company’s
consolidated financial statements.







NOTE
7: STOCK-BASED COMPENSATION





Stock Option
Plan





DNB has a
Stock Option Plan for employees and directors.  Under the plan,
options (both qualified and non-qualified) to purchase a maximum of 643,368
shares of DNB’s common stock could be issued to employees and
directors.





Under the
plan, option exercise prices must equal the fair market value of the shares on
the date of option grant and the option exercise period may not exceed ten
years.  The Plan Committee determines vesting of options under the
plan.  There were 186,159 and 149,263 options available for grant at
September 30, 2008 and December 31, 2007, respectively.





9




DNB
FINANCIAL CORPORATION AND SUBSIDIARY


NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS


(Unaudited)







Stock
option activity for the nine-month period ended September 30, 2008 is indicated
below.





Number
            
            
            Weighted
      AverageOutstanding
            
            
            Exercise
      PriceOutstanding
      January 1, 2008
            
            
            243,320
            
            
            $
            19.36Granted
            
            
            –
            
            
            
            –Exercised
            
            
            –
            
            
            
            –Expired
            
            
            (29,221
            )
            
            
            (21.64
            )Forfeited
            
            
            (7,676
            )
            
            
            (20.95
            )Outstanding
      September 30, 2008
            
            
            206,423
            
            
            $
            18.98





The
weighted-average price and weighted average remaining contractual life for the
outstanding options are listed below for the dates indicated.  All
outstanding options are exercisable.





September
      30, 2008


Range
      of
            Number
            Weighted
      AverageExercise
      Prices
            Outstanding
            Exercise
      Price
            Remaining
      Contractual Life$
      9.23-10.99
            9,419
            
            $9.23
            1.75
      years11.00-13.99
            9,414
            
            11.16
            2.75
      years14.00-16.99
            22,985
            
            16.83
            3.75
      years17.00-19.99
            92,543
            
            17.56
            5.45
      years20.00-22.99
            24,021
            
            22.78
            6.23
      years23.00-24.27
            48,041
            
            24.27
            6.55
      yearsTotal
            206,423
            
            $18.98
            5.31
      years





Restricted Stock
Awards





DNB
maintains an Incentive Equity and Deferred Compensation Plan. The plan provides
that up to 243,101 (as adjusted for subsequent stock dividends) shares of common
stock may be granted, at the discretion of the Board, to individuals of the
Company.  DNB did not grant any shares of restricted stock during the
nine-month period ended September 30, 2008. Shares already granted are issuable
on the earlier of three years after the date of the grant or a change in control
of DNB if the recipients are then employed by DNB (“Vest Date”).  Upon
issuance of the shares, resale of the shares is restricted for an additional
period of time, during which the shares may not be sold, pledged or otherwise
disposed of. The 2005 grant is restricted for 2 years and the 2007 grant is
restricted for 1 year. Prior to the Vest Date and in the event the
recipient terminates association with DNB for reasons other than death,
disability or change in control, the recipient forfeits all rights to the shares
that would otherwise be issued under the grant.




Share
awards granted by the plan were recorded at the date of award based on the
market value of shares.  Awards are being amortized to expense over
the three-year cliff-vesting period. DNB records compensation expense equal to
the value of the shares being amortized.  For the three and nine-month
periods ended September 30, 2008, $17,000 and $100,000 was amortized to
expense.  At September 30, 2008, 215,341 shares were reserved for
future grants under the plan.





Unvested
Stock grant activity is indicated below. The shares have been adjusted for the
5% stock dividend in December 2007.





SharesOutstanding
      - January 1, 2008
            30,103Granted
            –Vested
      shares
            (13,087)Forfeited
            (2,342)Outstanding
      – September 30, 2008
            14,674








10


DNB
FINANCIAL CORPORATION AND SUBSIDIARY


NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS


(Unaudited)








NOTE 8:  INCOME
TAXES





As of
September 30, 2008, the Company had no material unrecognized tax benefits or
accrued interest and penalties. It is the Company’s policy to account for
interest and penalties accrued relative to unrecognized tax benefits as a
component of income tax expense.  Federal and state tax years 2004
through 2007 were open for examination as of September 30, 2008. Income tax
(benefit) expense for the three and nine-month periods ended September 30, 2008
was ($65,000) and $140,000 compared to $120,000 and $269,000 for the same
periods in 2007. The effective tax rate for the three and nine-month periods
ended September 30, 2008 was (48.5%) and 11.9%, compared to 20.2% and 16.2% for
the same period in 2007.  Income tax expense varies during 2008 versus
2007 primarily as a result of the decrease in pre-tax income
year-over-year.





NOTE
9:  FAIR VALUE MEASUREMENT





The
following disclosures are made in conjunction with FASB Statement No. 157 (“FAS
157”), Fair Value Measurement, which became effective January 1,
2008.





FAS 157
establishes a fair value hierarchy based on the nature of data inputs for fair
value determinations, under which DNB is required to value each asset within its
scope using assumptions that market participations would utilize to value that
asset.  When DNB uses its own assumptions, it is required to disclose
additional information about the assumptions used and the effect of the
measurement on earnings or the net change in assets for the period.





DNB’s
available-for-sale investment securities, which generally include state and
municipal securities, U.S. government agencies and mortgage backed securities,
are reported at fair value.  These securities are valued by an
independent third party (“preparer”).  The preparer’s evaluations are
based on market data.  They utilize evaluated pricing models that vary
by asset and incorporate available trade, bid and other market
information.  For securities that do not trade on a daily basis, their
evaluated pricing applications apply available information such as benchmarking
and matrix pricing.  The market inputs normally sought in the
evaluation of securities include benchmark yields, reported trades,
broker/dealer quotes (only obtained from market makers or broker/dealers
recognized as market participants), issuer spreads, two-sided markets, benchmark
securities, bid, offers and reference data.  For certain securities
additional inputs may be used or some market inputs may not be
applicable.  Inputs are prioritized differently on any given day based
on market conditions.





U.S.
Government agencies are evaluated and priced using multi-dimensional relational
models and option adjusted spreads.  State and municipal securities
are evaluated on a series of matrices including reported trades and material
event notices.  Mortgage backed securities are evaluated using matrix
correlation to treasury or floating index benchmarks, prepayment speeds, monthly
payment information and other benchmarks.  Other investments are
evaluated using a broker-quote based application, including quotes from
issuers.





These
investment securities are classified as available for sale.





The value
of the investment portfolio is determined using three broad levels of
input:





Level 1 –
Quoted prices in active markets for identical securities.





Level 2 –
Quoted prices for similar instruments in active markets; quoted prices for
identical or similar instruments in markets that are not active and model
derived valuations whose inputs are observable or whose significant value drives
are observable.





Level 3 –
Instruments whose significant value drivers are unobservable.





These
levels are not necessarily an indication of the risks or liquidity associated
with these investments.  The following table summarizes the assets at
September 30, 2008 that are recognized on DNB’s balance sheet using fair value
measurement determined based on the differing levels of input.





11








DNB
FINANCIAL CORPORATION AND SUBSIDIARY


NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS


(Unaudited)





September
      30, 2008Level
      1
            
            
            Level
      2
            
            
            Level
      3
            
            
            Assets
      at Fair Value(Dollars
      in thousands)Assets
      Measured at Fair Value on a Recurring BasisSecurities
      available for sale
            
            $
            24
            
            
            $
            108,890
            
            
            $
            -
            
            
            $
            108,914Total
      assets measured at fair value on a recurring basis
            
            $
            24
            
            
            $
            108,890
            
            
            $
            -
            
            
            $
            108,914Assets
      Measured at Fair Value on a Nonrecurring BasisImpaired
      loans
            
            $
            -
            
            
            $
            5,821
            
            
            $
            -
            
            
            $
            5,821OREO
      & other repossessed property
            
            
            
            
            
            
            527
            
            
            
            
            
            
            
            527Total
      assets measured at fair value on a nonrecurring basis
            
            $
            -
            
            
            $
            6,348
            
            
            $
            -
            
            
            $
            6,348




Impaired loans. Impaired
loans, which are measured for impairment using the fair value of the collateral
for collateral dependent loans, had a carrying amount of $5.8 million at
September 30, 2008. The valuation allowance on impaired loans was $485,000
as of September 30, 2008. During the nine months ended September 30,
2008, we recognized no impairment charges related to approximately $5.8 million
in loans.





Other Real Estate Owned & other
repossessed property.Other real estate owned (“OREO”) consists of properties acquired as a
result of, or in-lieu-of, foreclosure. Properties or other assets (primarily
repossessed assets formerly leased) are classified as OREO and other repossessed
property and are reported at the lower of carrying value or fair value, less
estimated costs to sell. Costs relating to the development or improvement of the
assets are capitalized and costs relating to holding the assets are charged to
expense. DNB had $527,000 of such assets at September 30, 2008. This
consisted of $438,867 in OREO and $ 88,000 in other repossessed property.
Subsequent to the repossession of these assets, DNB wrote down their carrying
values by $12,000, based on appraisals.




The
provisions of FAS 157 related to disclosures surrounding non-financial assets
and non-financial liabilities have not been applied because in February 2008,
the FASB deferred the required implementation of these disclosures until
2009.







NOTE
10:  STOCKHOLDERS’ EQUITY





Stockholders'
equity was $30.9 million at September 30, 2008 compared to $32.6 million at
December 31, 2007.  The decrease in stockholders’ equity was primarily
the result of a $1.6 million, net-of-tax adjustment on the available for sale
investment securities portfolio and dividends paid on DNB’s common stock
totaling $1.0 million. These decreases were partially offset by year-to-date
earnings totaling $1.0 million.











NOTE
11:  INVESTMENT SECURITIES





DNB’s
investment securities portfolio consists of fixed income instruments, including
mortgage-backed securities, U.S.  Government agency bonds, taxable and
tax-free municipal bonds and corporate bonds. DNB maintains its investment
portfolio to generate cash flow, manage interest rate risk, and to provide
collateral for deposits, repurchase agreements and other
liabilities.




12




DNB
FINANCIAL CORPORATION AND SUBSIDIARY


NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS


(Unaudited)


Investment
securities are classified and accounted for as follows:




Held-To-Maturity (“HTM”)
includes debt and non-readily marketable equity securities that DNB has the
positive intent and ability to hold to maturity. Debt securities are reported at
cost, adjusted for amortization of premiums and accretion of
discounts.





Trading Account (“TA”)
includes securities that are generally held for a short term in anticipation of
market gains. Such securities would be carried at fair value with realized and
unrealized gains and losses on trading account securities included in the
statement of operations. DNB does not have a Trading Account.




Available-For-Sale(“AFS”)includes
debt and equity securities not classified as HTM or TA securities. Securities
classified as AFS are securities that DNB intends to hold for an indefinite
period of time, but not necessarily to maturity. Such securities are reported at
fair value, with unrealized holding gains and losses excluded from earnings and
reported, net of tax (if applicable), as a separate component of stockholders’
equity. Realized gains and losses on the sale of AFS securities are computed on
the basis of specific identification of the adjusted cost of each
security.




Other Investment Securities
includes investments in Federal Home Loan Bank (FHLB), Federal Reserve Bank
(FRB) and Atlantic Central Bankers Bank (ACBB) stock which are carried at cost
and are redeemable at par with certain restrictions. Investments in these stocks
are necessary to participate in FHLB, FRB and ACBB programs.





Amortization
of premiums and accretion of discounts for all types of securities are computed
using a method approximating a level-yield basis.





As of
September 30, 2008, DNB reclassified its taxable municipal securities with a
book value (net carrying amount) of $22.7 million from available-for-sale (AFS)
to held-to-maturity (HTM). Reclassifying the taxable municipal securities to HTM
will reduce the volatility and future negative effect on DNB’s capital ratios,
because HTM securities are not marked-to-market through other comprehensive
income, but carried at their amortized cost basis. The fair value of our taxable
municipal securities was $22.0 million at September 30, 2008, the date of
their reclassification. The $683,000 difference between their book value and
their fair value will be treated like a discount and accreted into interest
income over the remaining life of the security. The unrealized loss on these
securities, which is in accumulated other comprehensive income, will be
amortized as an adjustment of yield in a manner consistent with the discount,
thus offsetting or mitigating the effect on interest income of the amortization
of the discount.





The
amortized cost and estimated fair values of investment securities, as of the
dates indicated, are summarized as follows:




September 30,
      2008(Dollars
      in thousands)
            Amortized
              Cost
            Unrealized
              Gains
            Unrealized
              Losses
            Estimated
              Fair
      ValueHeld
      To MaturityCollateralized
      mortgage obligations
            5,106
            —
            (345)
            4,761US
      agency mortgage-backed securities
            29,972
            134
            (96)
            30,010State
      and municipal tax-exempt
            4,520
            30
            (26)
            4,524State
      and municipal taxable
            21,987
            —
            —
            21,987Total
            $61,585
            $164
            $(467)
            $61,282Available
      For SaleUS
      Government agency obligations
            $14,479
            $34
            $(38)
            $14,475Collateralized
      mortgage obligations
            5,011
            18
            —
            5,029Corporate
      Bonds
            20,364
            13
            (909)
            19,468US
      agency mortgage-backed securities
            70,099
            138
            (319)
            69,918Equity
      securities
            32
            —
            (8)
            24Total
            $109,985
            $203
            $(1,274)
            $108,914








13




DNB
FINANCIAL CORPORATION AND SUBSIDIARY


NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS


(Unaudited)








December 31,
      2007(Dollars
      in thousands)
            
            Amortized
              Cost
            
            
            Unrealized
              Gains
            
            
            Unrealized
              Losses
            
            
            Estimated
              Fair
      ValueHeld
      To MaturityUS
      Government agency obligations
            
            $
            3,731
            
            
            $
            —
            
            
            $
            (19
            )
            
            $
            3,712US
      agency mortgage-backed securities
            
            
            842
            
            
            
            9
            
            
            
            (1
            )
            
            
            850Collateralized
      mortgage obligations
            
            
            5,808
            
            
            
            —
            
            
            
            (340
            )
            
            
            5,468State
      and municipal tax-exempt
            
            
            4,540
            
            
            
            25
            
            
            
            (2
            )
            
            
            4,563Total
            
            $
            14,921
            
            
            $
            34
            
            
            $
            (362
            )
            
            $
            14,593Available
      For SaleUS
      Government agency obligations
            
            $
            33,943
            
            
            $
            326
            
            
            $
            —
            
            
            $
            34,269US
      agency mortgage-backed securities
            
            
            82,608
            
            
            
            518
            
            
            
            (161
            )
            
            
            82,965Collateralized
      mortgage obligations
            
            
            7,213
            
            
            
            48
            
            
            
            —
            
            
            
            7,261State
      and municipal taxable
            
            
            28,047
            
            
            
            106
            
            
            
            (107
            )
            
            
            28,046Equity
      securities
            
            
            37
            
            
            
            —
            
            
            
            (8
            )
            
            
            29Total
            
            $
            151,848
            
            
            $
            998
            
            
            $
            (276
            )
            
            $
            152,570







The
following tables set forth information regarding the composition and stated
maturity of DNB’s investment security portfolio as of the dates indicated. The
table does not include amortization or anticipated prepayments on
mortgage-backed securities. Callable securities are included at their stated
maturity dates




September 30,
      2008Held to
      Maturity(Dollars in thousands)
            
            Less
      than
              1
      Year
            
            
            1-5
              Years
            
            
            5-10
              Years
            
            
            Over
              10
      Years
            
            
            No
              Stated
              Maturity
            
            
            TotalCollateralized
      mortgage obligations
            
            $
            —
            
            
            $
            —
            
            
            $
            375
            
            
            $
            4,731
            
            
            $
            —
            
            
            $
            5,106US
      agency mortgage-backed securities
            
            
            3,751
            
            
            
            17,699
            
            
            
            307
            
            
            
            8,215
            
            
            
            —
            
            
            
            29,972State
      and municipal tax-exempt
            
            
            —
            
            
            
            1,491
            
            
            
            —
            
            
            
            3,029
            
            
            
            —
            
            
            
            4,520State
      and municipal taxable
            
            
            —
            
            
            
            —
            
            
            
            10,668
            
            
            
            11,319
            
            
            
            —
            
            
            
            21,987Total
            
            $
            3,751
            
            
            $
            19,190
            
            
            $
            11,350
            
            
            $
            27,294
            
            
            $
            —
            
            
            $
            61,585Percent
      of portfolio
            
            
            6
            %
            
            
            31
            %
            
            
            19
            %
            
            
            44
            %
            
            
            —
            %
            
            
            100
            %







Available
      for Sale
            
            Less
      than
              1
      Year
            
            
            1-5
              Years
            
            
            5-10
              Years
            
            
            Over
              10
      Years
            
            
            No
              Stated
              Maturity
            
            
            TotalUS
      Government agency obligations
            
            $
            7,410
            
            
            $
            7,065
            
            
            
            —
            
            
            
            —
            
            
            $
            —
            
            
            $
            14,475Collateralized
      mortgage obligations
            
            
            —
            
            
            
            —
            
            
            
            —
            
            
            
            5,029
            
            
            
            —
            
            
            
            5,029Corporate
      Bonds
            
            
            1,892
            
            
            
            9,905
            
            
            
            7,671
            
            
            
            —
            
            
            
            —
            
            
            
            19,468US
      agency mortgage-backed securities
            
            
            9
            
            
            
            14,995
            
            
            
            2,863
            
            
            
            52,051
            
            
            
            —
            
            
            
            69,918Equity
      securities
            
            
            —
            
            
            
            —
            
            
            
            —
            
            
            
            —
            
            
            
            24
            
            
            
            24Total
            
            $
            9,311
            
            
            $
            31,965
            
            
            $
            10,534
            
            
            $
            57,080
            
            
            $
            24
            
            
            $
            108,914Percent
      of portfolio
            
            
            9
            %
            
            
            29
            %
            
            
            10
            %
            
            
            52
            %
            
            
            —
            %
            
            
            100
            %





December
      31, 2008Held
      to Maturity
            
            Less
      than
              1
      Year
            
            
            1-5
              Years
            
            
            5-10
              Years
            
            
            Over
              10
      Years
            
            
            No
              Stated
              Maturity
            
            
            TotalUS
      Government agency obligations
            
            $
            3,731
            
            
            $
            —
            
            
            $
            —
            
            
            $
            —
            
            
            $
            —
            
            
            $
            3,731US
      agency mortgage-backed securities
            
            
            255
            
            
            
            217
            
            
            
            230
            
            
            
            140
            
            
            
            —
            
            
            
            842Collateralized
      mortgage obligations
            
            
            —
            
            
            
            —
            
            
            
            444
            
            
            
            5,364
            
            
            
            —
            
            
            
            5,808State
      and municipal tax-exempt
            
            
            —
            
            
            
            791
            
            
            
            700
            
            
            
            3,049
            
            
            
            —
            
            
            
            4,540Total
            
            $
            3,986
            
            
            $
            1,008
            
            
            $
            1,374
            
            
            $
            8,553
            
            
            $
            —
            
            
            $
            14,921Percent
      of portfolio
            
            
            27
            %
            
            
            7
            %
            
            
            9
            %
            
            
            57
            %
            
            
            —
            %
            
            
            100
            %







14


Available
      for Sale
            
            Less
      than
              1
      Year
            
            
            1-5
              Years
            
            
            5-10
              Years
            
            
            Over
              10
      Years
            
            
            No
              Stated
              Maturity
            
            
            TotalUS
      Government agency obligations
            
            $
            6,012
            
            
            $
            4,422
            
            
            $
            15,039
            
            
            $
            8,796
            
            
            $
            —
            
            
            $
            34,269US
      agency mortgage-backed securities
            
            
            40
            
            
            
            —
            
            
            
            3,970
            
            
            
            78,955
            
            
            
            —
            
            
            
            82,965Collateralized
      mortgage obligations
            
            
            —
            
            
            
            —
            
            
            
            —
            
            
            
            7,261
            
            
            
            
            
            
            
            7,261State
      and municipal taxable
            
            
            —
            
            
            
            —
            
            
            
            3,050
            
            
            
            24,996
            
            
            
            —
            
            
            
            28,046Equity
      securities
            
            
            —
            
            
            
            —
            
            
            
            —
            
            
            
            —
            
            
            
            29
            
            
            
            29Total
            
            $
            6,052
            
            
            $
            4,422
            
            
            $
            22,059
            
            
            $
            120,008
            
            
            $
            29
            
            
            $
            152,570Percent
      of portfolio
            
            
            4
            %
            
            
            3
            %
            
            
            14
            %
            
            
            79
            %
            
            
            —
            %
            
            
            100
            %







ITEM2 -
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF
OPERATIONS





DESCRIPTION
OF DNB'S BUSINESS AND BUSINESS STRATEGY





DNB
Financial Corporation is a bank holding company whose bank subsidiary, DNB
First, National Association (the “Bank”) is a nationally chartered commercial
bank with trust powers, and a member of the Federal Reserve System. The FDIC
insures DNB’s deposits. DNB provides a broad range of banking services to
individual and corporate customers through its thirteen community offices
located throughout Chester and Delaware Counties, Pennsylvania. DNB is a
community banking organization that focuses its lending and other services on
businesses and consumers in the local market area. DNB funds all of these
activities with retail and business deposits and borrowings.  Through
its DNB Advisors division, the Bank provides wealth management and trust
services to individuals and businesses.  The Bank and its subsidiary,
DNB Financial Services, Inc., make available certain non-depository products and
services, such as securities brokerage, mutual funds, life insurance and
annuities.





DNB earns
revenues and generates cash flows by lending funds to commercial and consumer
customers in its marketplace. DNB generates its largest source of interest
income through its lending function.  Another source of interest
income is derived from DNB’s investment portfolio, which provides liquidity and
cash flows for future lending needs.





In
addition to interest earned on loans and investments, DNB earns revenues from
fees it charges customers for non-lending services. These services include
wealth management and trust services; brokerage and investment services; cash
management services; banking and ATM services; as well as safekeeping and other
depository services.





To
implement the culture changes necessary at DNB First to become an innovative
community bank capable of meeting challenges of the 21st century, we embarked on
a strategy called "Loyalty, Bank On It."  In recognizing the
importance of loyalty in our everyday lives, we have embraced this concept as
the cornerstone of DNB First's new culture.  To that end, DNB
continues to make appropriate investments in all areas of our business,
including people, technology, facilities and marketing.





Comprehensive
5-Year Plan.During
the third quarter of 2007, management updated the 5-year strategic plan that was
designed to reposition its balance sheet and improve core earnings. Through the
Plan, which covers years 2008 through 2012, management will continue to expand
its loan portfolio through new originations, increased loan participations, as
well as strategic loan and lease receivable purchases.  Management
also plans to reduce the absolute level of borrowings with cash flows from
existing loans and investments as well as from new deposit
growth.  DNB’s Key Strategies include:





·
            Focus
      on penetrating markets and allowing existing locations to maximize
      profitability





·
            Improve
      earnings by allowing revenues to catch up to the investments made over the
      past five years in people, infrastructure and branch
    expansion





·
            Emphasize
      Private Banking, with the objective of promoting loan growth and fee based
      income by providing high net worth individuals with banking and wealth
      management services





·
            Implement
      a formal training program that will emphasize product knowledge, sales
      skills, people skills and technical knowledge to promote customer
      satisfaction





15


·
            Maintain
      sound asset quality by continuing to apply prudent underwriting
      standards





·
            Grow
      loans and diversify the mix





·
            Reduce
      long-term borrowings





·
            Focus
      on profitable customer segments





·
            Grow
      and diversify non-interest income




Strategic
Plan Update.During the first nine months of 2008, DNB focused on expense control as
non-interest expenses have decreased $53,000 or 0.4% over the first nine months
of 2007. DNB’s loans and leases increased $33.6 million to $342.9 million at
September 30, 2008 compared to $309.3 million at December 31,
2007.   During the first nine months of 2008, DNB’s total
deposits increased $9.5 million. Time deposits, primarily accounts greater than
$100,000 declined $25.5 million, while the aggregate of demand, NOW, money
markets and savings accounts increased $35.0 million.  Consistent with
prudent balance sheet management, DNB has been balancing deposit pricing with
liquidity needs and has been able to lower the cost of funds while growing the
loan portfolio. Composite cost of funds during the first nine months of 2008 was
2.66% compared to 3.22% during the first nine months of 2007.




Management's
strategies are designed to direct DNB's tactical investment decisions and
support financial objectives. DNB's most significant revenue source continues to
be net interest income, defined as total interest income less interest expense,
which accounted for 76.5% of total revenue during the first nine months of 2008.
To produce net interest income and consistent earnings growth over the
long-term, DNB must generate loan and deposit growth at acceptable economic
spreads within its market area. To generate and grow loans and deposits, DNB
must focus on a number of areas including, but not limited to, the economy,
branch expansion, sales practices, customer satisfaction and retention,
competition, customer behavior, technology, product innovation and credit
performance of its customers.




Management
has made a concerted effort to improve the measurement and tracking of business
lines and overall corporate performance levels. Improved information systems
have increased DNB's ability to track key indicators and enhance corporate
performance levels. Better measurement against goals and objectives and
increased accountability will be integral in attaining desired loan, deposit and
fee income production.




MATERIAL
CHALLENGES, RISKS AND OPPORTUNITIES





The
following is a summary of changes to material challenges, risks and
opportunities DNB has faced during the three and nine-month periods ended
September 30, 2008.





Interest Rate
Risk Management. Interest rate risk is the exposure to adverse changes in
net interest income due to changes in interest rates. DNB considers interest
rate risk the predominant risk in terms of its potential impact on
earnings.  Interest rate risk can occur for any one or more of the
following reasons: (a) assets and liabilities may mature or re-price at
different times; (b) short-term or long-term market rates may change by
different amounts; or (c) the remaining maturity of various assets or
liabilities may shorten or lengthen as interest rates change. DNB’s margin was
affected by the Federal Reserve’s 225 basis point reductions during the nine
months ended September 30, 2008, coupled with DNB’s asset sensitivity. Since
most of DNB’s floating rate loans reprice within 30 days of a rate change,
downward loan pricing adjustments began in the fourth quarter of 2007 and
continued during the first nine months of 2008. Funding costs typically take 90
to 120 days to reprice. Consequently, most of the corresponding decreases in
funding costs did not begin until the first quarter of 2008 and continued to lag
the repricing in the loan portfolio. This put pressure on DNB’s net interest
margin which was 2.98% for the nine months ended September 30, 2008 compared to
3.17% for the prior year.





The
principal objective of the Bank’s interest rate risk management is to evaluate
the interest rate risk included in certain on and off-balance sheet accounts,
determine the level of risk appropriate given the Bank’s business strategy,
operating environment, capital and liquidity requirements and performance
objectives, and manage the risk consistent with approved guidelines. Through
such management, DNB seeks to reduce the vulnerability of its operations to
changes in interest rates. The Bank’s Asset Liability Committee (the “ALCO”) is
responsible for reviewing the Bank’s asset/liability policies and interest rate
risk position and making decisions involving asset liability considerations. The
ALCO meets on a monthly basis and reports trends and the Bank’s interest rate
risk position to the Board of Directors.  The extent of the movement
of interest rates is an uncertainty that could have a negative impact on the
earnings of the Bank.





16


The
largest component of DNB’s total income is net interest income, and the majority
of DNB’s financial instruments are comprised of interest rate-sensitive assets
and liabilities with various terms and maturities.  The primary
objective of management is to maximize net interest income while minimizing
interest rate risk.  Interest rate risk is derived from timing
differences in the re-pricing of assets and liabilities, loan prepayments,
deposit withdrawals, and differences in lending and funding
rates.  The ALCO actively seeks to monitor and control the mix of
in­terest rate-sensitive assets and interest rate-sensitive
­liabilities. One measure of interest rate risk is net interest income
simulation analysis.  The ALCO utilizes simulation analysis, whereby
the model estimates the variance in net interest income with a change in
interest rates of plus or minus 200 basis points in addition to four yield curve
twists over a twelve-month period.





Liquidity and
Market Risk Management.Liquidity is the ability to meet current and
future financial obligations. The Bank further defines liquidity as the ability
to respond to deposit outflows as well as maintain flexibility to take advantage
of lending and investment opportunities.  The Bank’s primary sources
of funds are operating earnings, deposits, repurchase agreements, principal and
interest payments on loans, proceeds from loan sales, sales and maturities of
mortgage-backed and investment securities, and FHLB advances.  The
Bank uses the funds generated to support its lending and investment activities
as well as any other demands for liquidity such as deposit
outflows.  While maturities and scheduled amortization of loans and
securities are predictable sources of funds, deposit flows, mortgage
prepayments, loan and security sales and the exercise of call features are
greatly influenced by general interest rates, economic conditions and
competition.





The
objective of DNB’s asset/liability management function is to maintain consistent
growth in net interest income within DNB’s policy limits.  This
objective is accomplished through the management of liquidity and interest rate
risk, as well as customer offerings of various loan and deposit
products.  DNB maintains adequate liquidity to meet daily funding
requirements, anticipated deposit withdrawals, or asset opportunities in a
timely manner.  Liquidity is also necessary to meet obligations during
unusual, extraordinary or adverse operating circumstances, while avoiding a
significant loss or cost.  DNB’s foundation for liquidity is its
deposit base as well as a marketable investment portfolio that provides cash
flow through regular maturities or that can be used for collateral to secure
funding in an emergency. As of September 30, 2008, DNB had $13.2 million in
cash and cash equivalents to meet its funding requirements.  This has
decreased from $45.3 million at December 31, 2007, primarily due to a $34.4
million increase in loans.





Credit Risk
Management.DNB defines credit risk as the risk of default by a customer
or counter-party.  The objective of DNB’s credit risk management
strategy is to quantify and manage credit risk on an aggregate portfolio basis
as well as to limit the risk of loss resulting from an individual customer
default.  Credit risk is managed through a combination of
underwriting, documentation and collection standards.  DNB’s credit
risk management strategy calls for regular credit examinations and quarterly
management reviews of large credit exposures and credits that are experiencing
credit quality deterioration.  DNB’s loan review procedures provide
assessments of the quality of underwriting, documentation, risk grading and
charge-off procedures, as well as an assessment of the allowance for credit loss
reserve analysis process.





Competition.In addition to the challenges related to the interest rate environment,
community banks in Chester and Delaware Counties have been experiencing
increased competition from large regional and international banks entering DNB’s
marketplace through mergers and acquisitions.  Competition for loans
and deposits has negatively affected DNB’s net interest margin.  To
compensate for the increased competition, DNB, along with other area community
banks, has aggressively sought and marketed customers who have been
disenfranchised by these mergers.  To attract these customers, DNB has
introduced new deposit products and services, such as Rewards Checking and
Executive and employee packages. In addition, DNB has introduced Remote Capture
to our commercial customers to expedite their collection of funds.





Bank Secrecy
Act/OFAC/Patriot Act Implementation.It is management’s goal to maintain
a BSA compliance program that will address its compliance needs to a level
commensurate with BSA, OFAC and Patriot Act related risks to which the Bank is
exposed in order to establish the Bank as an institution that will not pose a
target to those who would use the U.S. financial system to further criminal or
terrorist ends.  However, there is no assurance that the Bank’s
compliance plan will eliminate all risks related to BSA, OFAC and Patriot Act
because those regulatory requirements are dynamic and complex and must be
continually reassessed in light of the changing environment in which they
operate. During the first nine months of 2008, DNB continued its efforts to
strengthen its BSA policies, procedures and systems to ensure compliance with
OFAC regulations.





Deposit Insurance
Assessments; FICO Assessments.All Federally insured
depository institutions are liable to pay periodic premiums, or assessments, to
a deposit insurance fund organized by the Federal government to insure bank and
savings association deposits.  The Emergency Economic Stabilization
Act of 2008 increased the insurance amount per owner from $100,000 to $250,000
until December 31, 2009.  On January 1, 2010, the insurance amount
will revert to $100,000 per owner (except for certain retirement accounts which
will continue to be insured at $250,000).  In addition, pursuant to
the FDIC’s Temporary Liquidity Guarantee Program announced October 14, 2008, the
FDIC temporarily increased deposit insurance to an unlimited amount for
non-interest-bearing demand deposit accounts.




17


Banks
must pay assessments to the FDIC to maintain reserves in its Deposit Insurance
Fund (“DIF”), which is the fund from which the FDIC pays the costs relating to
failed institutions.  The FDIC assesses higher rates on those
institutions that pose greater risks to the insurance fund. Banks are divided
into risk categories and are subject to deposit insurance assessments according
to the risk category into which they fall.  The following table sets
forth the rates that applied to banks during the period covered by this
report:




Capital
      Category
            Supervisory
      GroupA
            B
            CWell
      Capitalized
            I
              5-7
      bps
            II
              10
      bps
            III
              28
      bpsAdequately
      CapitalizedUndercapitalized
            III
              28
      bps
            IV
              43
      bps





In the
above table, assessments are calculated at the indicated number of basis points
on the dollar amount of an institution’s assessable deposits. Supervisory Group
“A” generally includes those institutions that pose the least risk to the DIF;
Supervisory Group “B” generally includes institutions that pose moderate risk to
the DIF; and Supervisory Group “C” generally includes institutions posing the
highest risks to the DIF.  Rates for institutions that do not pay the
minimum or maximum rate will vary between these rates.  Basis points
are cents per $100 of assessable deposits (annual rate).





DNB is
well capitalized and was assessed an annual rate of 6.61 bps during the period
covered by this report.





The FDIC
has authority to raise or lower the rates.  Given present economic
uncertainties, it is possible the FDIC will raise assessment rates
further.  If it does so, DNB’s costs for deposit insurance will
increase.  On October 7, 2008, the FDIC proposed to raise assessment
rates for all banks by 7 basis points for the first quarter 2009 assessment
period and, beginning April 1, 2009, again raise assessment rates and alter the
way in which the assessment system differentiates for risk.  Because
the proposed rule is complicated and not yet final, there is no certainty what
assessment rates will apply to DNB in 2009, but if the rule is adopted as
proposed, DNB’s assessment rate could increase to a rate between 12 and 14 basis
points in the first quarter of 2009.





A recent
law provided assessment credits to certain institutions that paid high premiums
in the past.  DNB used $170,000 of its $245,000 assessment credit in
2007. Of the remaining $75,000, $61,000 was used in the first quarter of 2008
and the remaining $14,000 was used in the second quarter. If DNB had not
benefited from the assessment credit, management estimates that its deposit
insurance assessment for the 9 months ended September 30, 2008 would have been
$192,000.  DNB will have no further credit to apply against future
deposit insurance assessments.





Banks
must also pay assessments to help repay bonds issued by the Financing
Corporation (FICO), established by the Competitive Equality Banking Act of
1987.  The FICO assessment rate is adjusted quarterly to reflect
changes in the assessment bases of the fund based on quarterly Call Report and
Thrift Financial Report submissions. The FICO rate for the third quarter of 2008
is an annual rate of 1.10 basis points (1.10 cents per $100 of assessable
deposits).





Material
Trends and Uncertainties.


The
global and U.S. economies are experiencing significantly reduced business
activity as a result of, among other factors, disruptions in the financial
system during the past year. Dramatic declines in the national housing market
during the past year, with falling home prices and increasing foreclosures and
unemployment, have resulted in significant write-downs of asset values by
financial institutions, including government-sponsored entities and major
commercial and investment banks. These write-downs, initially of mortgage-backed
securities but spreading to credit default swaps and other derivative
securities, have caused many financial institutions to seek additional capital,
to merge with larger and stronger institutions and, in some cases, to
fail.





Reflecting
concern about the stability of the financial markets generally and the strength
of counterparties, many lenders and institutional investors have reduced, and in
some cases, ceased to provide funding to borrowers, including other financial
institutions. The availability of credit, confidence in the financial sector,
and level of volatility in the financial markets have been adversely affected.
These events prompted the Federal Reserve to lower the borrowing rate at the
Discount Window which increased market stability and liquidity.





18


On
October 3, 2008, in response to the financial crises affecting the
banking system and financial markets and going concern threats to investment
banks and other financial institutions, the Emergency Economic Stabilization Act
of 2008, or EESA, was signed into law. Pursuant to the EESA, the U.S. Treasury
will have the authority to, among other things, purchase up to $700 billion
of mortgages, mortgage-backed securities and certain other financial instruments
from financial institutions for the purpose of stabilizing and providing
liquidity to the U.S. financial markets.




On
October 14, 2008, Secretary Paulson, after consulting with the Federal
Reserve and the FDIC, announced that the U.S. Treasury will purchase stakes in a
wide variety of U.S. banks and thrifts to encourage these institutions to build
capital to increase the flow of financing to U.S. businesses and consumers and
to support the U.S. economy. Under this program, known as the Troubled Asset
Relief Program Capital Purchase Program (the TARP Capital Purchase Program), the
Treasury will make $250 billion of capital available to qualifying U.S.
financial institutions in the form of preferred stock. In conjunction with the
purchase of preferred stock, the Treasury will receive warrants to purchase
common stock with an aggregate market price equal to 15% of the preferred
investment. Participating financial institutions will be required to adopt the
U.S. Treasury’s standards for executive compensation and corporate governance
for the period during which the U.S. Treasury holds equity issued under the TARP
Capital Purchase Program. These standards generally apply to the chief executive
officer, chief financial officer, plus the next three most highly compensated
executive officers.




Also on
October 14, 2008, after receiving a recommendation from the boards of the
FDIC and the Federal Reserve, and consulting with the President, Secretary
Paulson signed the systemic risk exception to the FDIC Act, enabling the FDIC to
temporarily provide a 100% guarantee of the senior debt of all FDIC-insured
institutions and their holding companies, as well as deposits in non-interest
bearing transaction deposit accounts under a Temporary Liquidity Guarantee
Program. Coverage under the Temporary Liquidity Guarantee Program is available
for 30 days without charge and thereafter at a cost of 75 basis points per
annum for senior unsecured debt and 10 basis points per annum for non-interest
bearing transaction deposits.




It cannot
be determined whether these recent steps taken by the federal government will
result in significant improvement in financial and economic conditions affecting
the banking industry. Despite the federal government's recent fiscal and
monetary measures, if the U.S. economy were to remain in a recessionary
condition for an extended period, this would present additional significant
challenges for the U.S. banking and financial services industry, and inevitably,
DNB.




Other
Material Challenges, Risks and Opportunities. As a financial institution,
DNB's earnings are significantly affected by general business and economic
conditions.  These conditions include short-term and long-term
interest rates, inflation, monetary supply, fluctuations in both debt and equity
capital markets, and the strength of the United States economy and local
economics in which we operate.  For example, an economic downturn,
increase in unemployment, or other events that negatively impact household
and/or corporate incomes could decrease the demand for DNB's loan and non-loan
products and services and increase the number of customers who fail to pay
interest or principal on their loans.  Geopolitical conditions can
also affect DNB's earnings.  Acts or threats of terrorism, actions
taken by the United States or other governments in response to acts or threats
of terrorism and our military conflicts including the aftermath of the war with
Iraq, could impact business conditions in the United States.




CRITICAL
ACCOUNTING POLICIES




The
following discussion and analysis of financial condition and results of
operations is based upon our consolidated financial statements, which have been
prepared in accordance with United States generally accepted accounting
principles. Generally accepted accounting principles are complex and require
management to apply significant judgment to various accounting, reporting and
disclosure matters. Management must use assumptions and estimates to apply these
principles where actual measurement is not possible or practical. Actual results
may differ from these estimates under different assumptions or
conditions.




In management's opinion,
the most critical accounting policies and estimates impacting DNB's consolidated
financial statements are listed below.  These policies are critical
because they are highly dependent upon subjective or complex judgments,
assumptions and estimates.  Changes in such estimates may have a
significant impact on the financial statements.  For a complete
discussion of DNB's significant accounting policies, see the footnotes to the
Consolidated Financial Statements included in DNB's 10-K for theyear
ended December 31, 2007.




Determination
of the allowance for credit losses.
Credit loss allowance policies involve significant judgments, estimates and
assumptions by management which may have a material impact on the carrying value
of net loans and leases and, potentially, on the net income recognized by DNB
from period to period.  The allowance for credit losses is based on
management’s ongoing evaluation of the loan and lease portfolio and reflects an
amount considered by management to be its best estimate of the amount necessary
to absorb known and inherent losses in the portfolio.  Management
considers a variety of factors when establishing the allowance, such as the
impact of current economic conditions, diversification of the portfolios,
delinquency statistics, results of loan review and related classifications, and
historic loss rates.  In addition, certain individual loans which
management has identified as problematic are specifically provided for, based
upon an evaluation of the borrower’s perceived ability to pay, the estimated
adequacy of the underlying collateral and other relevant factors.  In
addition, regulatory authorities, as an integral part of their examinations,
periodically review the allowance for credit losses.  They may require
additions to the allowance based upon their judgments about information
available to them at the time of examination.  Although provisions
have been established and segmented by type of loan, based upon management’s
assessment of their differing inherent loss characteristics, the entire
allowance for credit losses is available to absorb further losses in any
category.





19





Management
uses significant estimates to determine the allowance for credit
losses.  Because the allowance for credit losses is dependent, to a
great extent, on conditions that may be beyond DNB’s control, management’s
estimate of the amount necessary to absorb credit losses and actual credit
losses could differ.  DNB’s current judgment is that the valuation of
the allowance for credit losses remains adequate at September 30,
2008.  For a description of DNB’s accounting policies in connection
with its allowance for credit losses, see, “Allowance for Credit Losses”, in
Management’s Discussion and Analysis.




Realization
of deferred income tax items.Estimates
of deferred tax assets and deferred tax liabilities make up the asset category
titled “net deferred taxes”.  These estimates involve significant
judgments and assumptions by management, which may have a material impact on the
carrying value of net deferred tax assets for financial reporting
purposes.  Deferred tax assets and liabilities are recognized for the
future tax consequences attributable to differences between the financial
statement carrying amounts of existing assets and liabilities and their
respective tax basis, as well as operating loss carry
forwards.  Deferred tax assets and liabilities are measured using
enacted tax rates expected to apply to taxable income in the years in which
those temporary differences are expected to be recovered or
settled.  The effect on deferred tax assets and liabilities of a
change in tax rates is recognized in income in the period that includes the
enactment date.  A valuation allowance would be established against
deferred tax assets when in the judgment of management, it is more likely than
not that such deferred tax assets will not become available.  For a
more detailed description of these items, refer to Footnote 11 (Federal Income
Taxes) to DNB’s consolidated financial statements for the year ended December
31, 2007.




Unrealized
Gains and Losses on Securities Available for Sale: DNB receives estimated
fair values of debt securities from independent valuation services and brokers.
In developing these fair values, the valuation services and brokers use
estimates of cash flows based on historical performance of similar instruments
in similar rate environments. Debt securities available for sale are mostly
comprised of mortgage-backed securities as well U.S. government agency
securities. DNB uses various indicators in determining whether a security is
other-than-temporarily impaired. Debt securities are monitored for changes in
credit ratings. Adverse changes in credit ratings would affect the estimated
cash flows of the underlying collateral or issuer. The unrealized losses
associated with the securities portfolio, that management has the ability and
intent to hold, are not considered to be other-than temporary as of September
30, 2008 because the unrealized losses are primarily related to changes in
interest rates and current market conditions, however, we do not see any
negative effect on the expected cash flows of the underlying collateral or
issuer.






The
Footnotes to DNB's most recent Consolidated Financial Statements as set forth in
DNB's Annual Report 10-K identify other significant accounting policies used in
the development and presentation of its financial statements.  This
discussion and analysis, the significant accounting policies, and other
financial statement disclosures identify and address key variables and other
qualitative and quantitative factors that are necessary for an understanding and
evaluation of DNB and its results of operations.




FINANCIAL
CONDITION




DNB's
total assets were $551.1 million at September 30, 2008 compared to $545.8
million at December 31, 2007.  The increase in total assets was
primarily attributable to a $9.5 million increase in total deposits as discussed
below.




Investment
Securities. Investment securities at September 30, 2008 were $174.5
million (including $6.0 million of trade date purchases) compared to $170.9
million (including $5.9 million of trade date purchases) at December 31, 2007.
The slight increase in investment securities was primarily due to $132.2 million
in sales, principal pay-downs and maturities offset by the purchase of $138.3
million in investment securities. Included in the $138.3 million of investment
securities purchased were $6.0 million for securities which had a trade date in
September 2008, and a settlement date in October 2008. Trade Date accounting is
a method used to record transactions that take place on the date at
which an agreement has been entered (the trade date), and not on
the date the transaction has been finalized (the settlement
date).




As of
September 30, 2008, DNB reclassified its taxable municipal securities with an
amortized cost of $22.7 million from available-for-sale (AFS) to
held-to-maturity (HTM). Reclassifying the taxable municipal securities to HTM
will reduce the volatility and future negative effect on DNB’s capital ratios,
because HTM securities are not marked-to-market through other comprehensive
income, but carried at their amortized cost basis. The fair value of our taxable
municipal securities was $22.0 million at September 30, 2008, the date of
their reclassification. The $683,000 difference between their book value and
their fair value will be treated like a discount and accreted into interest
income over the remaining life of the security. The unrealized loss on these
securities, which is in accumulated other comprehensive income, will be
amortized as an adjustment of yield in a manner consistent with the discount,
thus offsetting or mitigating the effect on interest income of the amortization
of the discount.





20


Gross
Loans and Leases.
DNB’s loans and leases increased $33.6 million to $342.9 million at September
30, 2008 compared to $309.3 million at December 31, 2007.  Total
commercial loans grew $30.7 million and consumer loans grew $9.3 million while
residential real estate loans and commercial leases declined $1.2 million and
$5.3 million respectively.




Deposits.
Deposits were $422.4 million at September 30, 2008 compared to $412.9 million at
December 31, 2007.  Deposits increased $9.5 million or 2.3% during the
nine-month period ended September 30, 2008.  Time deposits, primarily
accounts greater than $100,000, declined $25.5 million, while the aggregate of
demand, NOW, money markets and savings accounts increased $35.0
million.  Consistent with prudent balance sheet management, DNB has
been balancing deposit pricing with liquidity needs and has been able to lower
the cost of funds while growing the loan portfolio.




Borrowings.
Borrowings
were $88.9 million at September 30, 2008 compared to $89.9 million at December
31, 2007.  The slight decrease of $1.0 million or 1.1% was primarily
due to a $10.0 million increase in FHLB borrowings coupled with an $11.0 million
decline in repurchase agreements.




RESULTS
OF OPERATIONS


SUMMARY




Net
income for the three and nine-month periods ended September 30, 2008 was
$199,000 and $1.0 million compared to $474,000 and $1.4 million for the same
periods in 2007.  Diluted earnings per share for the three and
nine-month period ended September 30, 2008 were $0.08 and $0.40 compared to
$0.18 and $0.53 for the same periods in 2007.  Earnings per share in
2007 have been adjusted to reflect the effect of the 5% stock dividend paid in
December 2007.  The $275,000 decrease during the most recent
three-month period was attributable to a $157,000 decrease in non-interest
income and a $426,000 decline in net interest income after provision for credit
losses, offset by a $123,000 decrease in non-interest expense and a $185,000
decrease in income tax expense. The decreases in non-interest income and
non-interest expense are discussed in detail below.




NET
INTEREST INCOME




DNB's
earnings performance is primarily dependent upon its level of net interest
income, which is the excess of interest income over interest
expense.  Interest income includes interest earned on loans,
investments and federal funds sold and interest-earning cash, as well as loan
fees and dividend income earned on investment securities.  Interest
expense includes interest on deposits, FHLB advances, repurchase agreements,
Federal funds purchased and other borrowings.




Net
interest income after provision for credit losses for the three and nine-month
periods ended September 30, 2008 was $3.3 million and $10.1
million, compared to $3.7 million and $11.2 million for the same periods in
2007.  Interest income for the three and nine-month periods ended
September 30, 2008 was $7.2 million and $21.3 million compared to $7.5 million
and $22.5 million for the same periods in 2007.  The decrease in
interest income during the nine month period was primarily attributable to a
decrease of interest on loans and leases, which was a result of lower average
balances and lower yields on the loan and lease portfolio.  In
addition, interest and dividends on investment securities increased during both
periods due to an increase in taxable securities and a decrease in tax-exempt
securities year over year.  The yield on interest-earning assets for
the three and nine-month periods ended September 30, 2008 was 5.37% and 5.56%,
compared to 6.28% and 6.29% for the same periods in 2007.  Interest
expense for the three and nine-month periods ended September 30, 2008 was $3.2
million and $10.0 million compared to $3.8 million and $11.3 million for the
same periods in 2007. The decrease in interest expense during both periods was
primarily attributable to lower rates on interest-bearing liabilities. The
composite cost of funds for the three and nine-month periods ended September 30,
2008 was 2.45% and 2.66%, compared to 3.27% and 3.22% for the same periods in
2007. The net interest margin for the three and nine-month periods ended
September 30, 2008 was 2.99% and 2.98%, compared to 3.10% and 3.17% for the same
periods in 2007.




Interest
on loans and leases was $5.1 million and $14.6 million for the three and
nine-month periods ended September 30, 2008, compared to $5.7 million and $17.2
million for the same periods in 2007. The average balance of loans and leases
was $330.4 million with an average yield of 6.06% for the current quarter
compared to $321.8 million with an average yield of 7.05% for the same period in
2007.  The average balance of loans and leases was $314.8 million with
an average yield of 6.18% for the current nine months compared to $325.1 million
with an average yield of 7.06% for the same period in 2007.  The
decrease in yield during both periods was primarily the result of a declining
interest rate environment.





21





Interest
and dividends on investment securities was $2.0 million and $6.3 million for the
three and nine-month periods ended September 30, 2008, compared to $1.6 million
and $4.7 million for the same periods in 2007.  The average balance of
investment securities was $166.0 million with an average yield of 4.83% for the
current quarter compared to $137.8 million with an average yield of 4.92% for
the same period in 2007.  The average balance of investment securities
was $169.7 million with an average yield of 5.03% for the current nine months
compared to $136.4 million with an average yield of 4.87% for the same period in
2007. The increase in the average balance during both periods was the result of
increased cash flows from net new deposits and lower levels of average loans
outstanding during both periods.  The increase in the yield during the
most recent nine month period was primarily due to an increase in the amount of
taxable securities in the portfolio and a decrease in the amount of tax-exempt
securities.





Interest
on deposits was $2.2 million and $6.9 million for the three and nine-month
periods ended September 30, 2008, compared to $2.8 million and $7.9 million for
the same periods in 2007.   The average balance of deposits was
$429.8 million with an average rate of 1.99% for the current quarter compared to
$390.9 million with an average rate of 2.87% for the same period in
2007.    The average balance of deposits was $411.2 million
with an average rate of 2.22% for the nine months ended September 30, 2008
compared to $382.1 million with an average rate of 2.77% for the same period in
2007. The increase in the average balance during both periods was primarily the
result of year-over-year increased deposit relationships through aggressive
marketing efforts.  The decrease in rate during both periods was
primarily attributable to lower rates being paid on maturing time deposits and
certain money market accounts, stimulated by a lower interest rate
environment.





Interest
on borrowings was $1.0 million and $3.1 million for the three and nine-month
periods ended September 30, 2008, compared to $1.0 million and $3.4 million for
the same periods in 2007. The average balance of borrowings was $89.9 million
with an average rate of 4.62% for the current quarter compared to $75.3 million
with an average rate of 5.35% for the same period in 2007.  The
average balance of borrowings was $87.2 million with an average rate of 4.75%
for the nine months ended September 30, 2008 compared to $85.5 million with an
average rate of 5.24% for the same period in 2007. The increase in the average
balance during the nine-months ended September 30, 2008 compared to the same
period in 2007 was attributable to an average $18.3 million increase in FHLB
advances, offset by an average $16.2 million decline in repurchase agreements.
The decrease in average balance of repurchase agreements was due to a fewer
number of commercial customers using this product during both periods as
compared to the prior year.  The decrease in rate during both periods
was attributable to a decrease in market rates resulting from the Federal
Reserve’s tightening actions over the last twelve months.








ALLOWANCE
FOR CREDIT LOSSES





To
provide for known and inherent losses in the loan and lease portfolios, DNB
maintains an allowance for credit losses. Provisions for credit losses are
charged against income to increase the allowance when necessary. Loan and lease
losses are charged directly against the allowance and recoveries on previously
charged-off loans and leases are added to the allowance. In establishing its
allowance for credit losses, management considers the size and risk exposure of
each segment of the loan and lease portfolio, past loss experience, present
indicators of risk such as delinquency rates, levels of non-accruals, the
potential for losses in future periods, and other relevant factors. Management’s
evaluation of the loan and lease portfolio generally includes reviews of problem
borrowers of $100,000 or greater. Consideration is also given to examinations
performed by regulatory agencies, primarily the Office of the Comptroller of the
Currency (“OCC”).





In
establishing and reviewing the allowance for adequacy, management establishes
the allowance for credit losses in accordance with generally accepted accounting
principles in the United States and the guidance provided in the Securities and
Exchange Commission’s Staff Accounting Bulletin 102 (SAB 102).  Its
methodology for assessing the appropriateness of the allowance consists of
several key elements which include: specific allowances for identified problem
loans; formula based allowances for commercial and commercial real estate loans;
and allowances for pooled, homogenous loans.  As a result, management
has taken into consideration factors and variables which may influence the risk
of loss within the loan portfolio, including: (i) trends in delinquency and
non-accrual loans; (ii) changes in the nature and volume of the loan portfolio;
(iii) effects of any changes in lending policies; (iv) experience, ability, and
depth of management; (v) quality of loan review; (vi) national and local
economic trends and conditions; (vii) concentrations of credit; and (viii)
effect of external factors on estimated credit losses.  In addition,
DNB reviews historical loss experience for the commercial real estate,
commercial, residential real estate, home equity and consumer installment loan
pools to determine a historical loss factor. The historical loss factors are
then applied to the current portfolio balances to determine the required reserve
percentage for each loan pool based on risk rating.





DNB’s
percentage of allowance for credit losses to total loans and leases was
1.40% at September 30, 2008 compared to 1.26% at December 31,
2007.  Management believes that the allowance for credit losses was
adequate and reflects known and inherent credit losses. During the nine months
ended September 30, 2008, DNB made a $1.2 million provision for credit losses as
a result of a $33.6 million net increase in loans and leases, coupled with a
$5.5 million increase in non-performing loans.





22


The
following table summarizes the changes in the allowance for credit losses for
the periods indicated.





(Dollars
      in thousands)
            
            Nine
      Months Ended September 30,
              2008
            
            
            Year Ended
              December
      31,
              2007
            
            
            Nine
      Months Ended September 30,
              2007Beginning
      balance
            
            
            3,891
            
            
            $
            4,226
            
            
            
            4,226Provisions
            
            
            1,241
            
            
            
            60
            
            
            
            3⁄4Charge-offs
            
            
            (405
            )
            
            
            (486
            )
            
            
            (396
            )Recoveries
            
            
            64
            
            
            
            91
            
            
            
            87Ending
      balance
            
            $
            4,791
            
            
            $
            3,891
            
            
            $
            3,917








NON-INTEREST
INCOME





Total
non-interest income includes service charges on deposit products; fees received
in connection with the sale of non-depository products and services, including
fiduciary and investment advisory services offered through DNB Advisors;
securities brokerage products and services and insurance brokerage products and
services offered through DNB Financial Services; and other sources of income
such as increases in the cash surrender value of bank owned life insurance
("BOLI"), net gains on sales of investment securities and other real estate
owned ("OREO") properties. In addition, DNB receives fees for cash management,
merchant services, debit cards, safe deposit box rentals, lockbox services and
similar activities.





Non-interest
income for the three and nine-month periods ended September 30, 2008 was
$903,000 and $3.5 million, compared to $1.06 million and $2.9 million for the
same periods in 2007.  The $157,000 decrease during the three months
ended September 30, 2008 was mainly attributable to a $151,000 decrease in gains
on sales of securities. The $558,000 increase during the nine months ended
September 30, 2008 was mainly attributable to a $483,000 increase in gains on
sales of securities, a $129,000 increase in income from DNB Financial Services,
offset by a $57,000 decline in fees from DNB Advisors and a $27,000 decrease in
service charges on deposits.





NON-INTEREST
EXPENSE





Non-interest
expense includes salaries & employee benefits, furniture & equipment,
occupancy, professional & consulting fees as well as printing &
supplies, marketing and other less significant expense
items.  Non-interest expense for the three and nine-month periods
ended September 30, 2008 was $4.0 million and $12.5 million compared to $4.2
million and $12.5 million for the same periods in 2007.  The level of
non-interest expenses during both periods has remained flat as a result of
management’s focus on expense control. There were increases in occupancy costs
as well as furniture and equipment expenses as a result of a new office in
Chadds Ford and branch renovations in West Goshen and Little Washington. In
addition, advertising and marketing expenditures were higher during both periods
as a result of increased target marketing during 2008. DNB’s non-interest
expense to average assets ratio for the three and nine-month periods ended
September 30, 2008 was 2.89% and 3.10%, compared to 3.30% and 3.34% for the same
periods in 2007.





INCOME
TAXES





DNB’s
income tax (benefit) expense for the three and nine-month periods ended
September 30, 2008 was ($65,000) and $140,000 compared to $120,000 and $269,000
for the same periods in 2007. The effective tax rate for the three and
nine-month periods ended September 30, 2008 was (48.5%) and 11.9% respectively,
compared to 20.2% and 16.2% for the same periods in 2007. DNB recorded a
tax benefit during the most recent three month period as a result of lower
earnings due to an increase in the provision for credit losses. This resulted in
a lower anticipated annual effective tax rate.





The
effective tax rates for both current periods were lower than the same periods in
2007 due to lower taxable income during both periods.  Income tax expense
for each period differs from the amount determined at the statutory rate of 34%
due to tax-exempt income on loans and investment securities, DNB's ownership of
BOLI policies, and tax credits recognized on a low-income housing limited
partnership.








23




ASSET
QUALITY





Non-performing
assets are comprised of non-accrual loans and leases, loans and leases
delinquent over ninety days and still accruing, troubled debt restructurings
(TDRs”) as well as Other Real Estate Owned ("OREO") and other repossessed
assets.  Non-accrual loans and leases are loans and leases for which
the accrual of interest ceases when the collection of principal or interest
payments is determined to be doubtful by management.  It is the policy
of DNB to discontinue the accrual of interest when principal or interest
payments are delinquent 90 days or more (unless the loan principal and interest
are determined by management to be fully secured and in the process of
collection), or earlier if considered prudent. Interest received on such loans
is applied to the principal balance, or may, in some instances, be recognized as
income on a cash basis.  A non-accrual loan or lease may be restored
to accrual status when management expects to collect all contractual principal
and interest due and the borrower has demonstrated a sustained period of
repayment performance in accordance with the contractual terms.  OREO
consists of real estate acquired by foreclosure. Other repossessed assets are
primarily assets from DNB’s commercial lease portfolio that were
repossessed.  OREO and other repossessed assets are carried at the
lower of cost or estimated fair value, less estimated disposition
costs.  Any significant change in the level of non-performing assets
is dependent, to a large extent, on the economic climate within DNB's market
area.





The
following table sets forth those assets that are: (i) placed on non-accrual
status, (ii) contractually delinquent by 90 days or more and still accruing,
(iii) troubled debt restructurings other than those included in items (i) and
(ii), and (iv) OREO as a result of foreclosure or voluntary transfer to DNB as
well as other repossessed assets.





Non-Performing
      Assets(Dollars
      in thousands)
            
            September
      30,
              2008
            
            
            December
      31, 2007
            
            
            September
      30,
              2007Loans
      and leases:Non-accrual
            
            $
            6,963
            
            
            $
            1,521
            
            
            $
            88390
      days past due and still accruing
            
            
            391
            
            
            
            345
            
            
            
            113Troubled
      debt restructurings
            
            
            —
            
            
            
            —
            
            
            
            —Total
      non-performing loans and leases
            
            
            7,354
            
            
            
            1,866
            
            
            
            996OREO
      and other repossessed property
            
            
            527
            
            
            
            —
            
            
            
            —Total
      non-performing assets
            
            $
            7,881
            
            
            $
            1,866
            
            
            $
            996





The
increase in non-performing assets can be attributed largely to three commercial
credits totaling $5.8 million that are secured by commercial real estate. The
first commercial credit totaling $4.2 million became impaired and was placed on
non-accrual status during the first quarter. The second commercial credit was
for land development (2 loans-$1.2 million) and the third commercial credit was
a land development loan for $392,000, which was placed on non-accrual status
during the first quarter. As a result of this increase in non-performing assets,
DNB’s ratio of its allowance to non-performing loans & leases has declined
from 208.52% at December 31, 2007 to 65.14% at September 30,
2008.  The following table sets forth DNB's asset quality and
allowance coverage ratios at the dates indicated:





September
      30,
              2008
            
            December
      31, 2007
            
            September
      30,
              2007Asset
      quality ratios:Non-performing loans to total
      loans
            
            2.14
            %
            0.60
            %
            0.31
            %Non-performing assets to total
      assets
            
            1.43
            
            0.34
            
            0.19Allowance
      for credit losses to:Total loans and
      leases
            
            1.40
            
            1.26
            
            1.22Non-performing loans and
      leases
            
            65.14
            
            208.52
            
            393.32





Included
in the loan and lease portfolio are loans for which DNB has ceased the accrual
of interest.  If contractual interest income had been recorded on
non-accrual loans, interest would have been increased as shown in the following
table:





Nine
      Months Ended
            
            
            Year
      Ended
            
            
            Nine
      Months Ended(Dollars
      in thousands)
            
            September
      30,
              2008
            
            
            December
      31, 2007
            
            
            September
      30,
              2007Interest
      income which would have beenrecorded under original
      terms
            
            $
            354
            
            
            $
            109
            
            
            $
            41Interest
      income recorded during the period
            
            
            (31
            )
            
            
            (70
            )
            
            
            (19
            )Net
      impact on interest income
            
            $
            323
            
            
            $
            39
            
            
            $
            22





24


Impaired
loans are those for which the Company has recorded a specific reserve.
Information regarding impaired loans is presented as follows:





Nine
      Months Ended
            
            
            Year
      Ended
            
            
            Nine
      Months Ended(Dollars
      in thousands)
            
            September
      30,
              2008
            
            
            December
      31, 2007
            
            
            September
      30,
              2007Total
      recorded investment
            
            $
            5,821
            
            
            $
            2,274
            
            
            $
            733Average
      recorded investment
            
            
            7,926
            
            
            
            1,095
            
            
            
            702Specific
      allowance allocation
            
            
            485
            
            
            
            485
            
            
            
            50Total
      cash collected
            
            
            313
            
            
            $
            344
            
            
            
            281Interest
      income recorded
            
            
            108
            
            
            
            27
            
            
            
            18











LIQUIDITY
AND CAPITAL RESOURCES





Management
maintains liquidity to meet depositors’ needs for funds, to satisfy or fund loan
commitments, and for other operating purposes.  DNB’s foundation for
liquidity is a stable and loyal customer deposit base, cash and cash
equivalents, and a marketable investment portfolio that provides periodic cash
flow through regular maturities and amortization, or that can be used as
collateral to secure funding.  As part of its liquidity management,
DNB maintains assets that comprise its primary liquidity, which totaled $33.3
million at September 30, 2008.  Primary liquidity includes
investments, Federal funds sold, and interest-bearing cash balances, less
pledged securities.  DNB also anticipates scheduled payments and
prepayments on its loan and mortgage-backed securities portfolios.  In
addition, DNB maintains borrowing arrangements with various correspondent banks,
the Federal Home Loan Bank of Pittsburgh and the Federal Reserve Bank of
Philadelphia to meet short-term liquidity needs.  Through these
relationships, DNB has available credit of approximately $173.7
million.  Management believes that DNB has adequate resources to meet
its short-term and long-term funding requirements.





At
September 30, 2008, DNB had $65.6 million in un-funded loan
commitments.  Management anticipates these commitments will be funded
by means of normal cash flows.  Certificates of deposit greater than
or equal to $100,000 scheduled to mature in one year or less from September 30,
2008 totaled $55.2 million.  Management believes that the majority of
such deposits will be reinvested with DNB and that certificates that are not
renewed will be funded by a reduction in Federal funds sold or by pay-downs and
maturities of loans and investments.





In March
of 2005, DNB completed a private offering of $4 million Trust Preferred
Securities, and in November 2005, DNB completed a private offering of 265,730
shares of its common stock to 53 accredited investors at a price of $21.00 per
share, realizing total offering proceeds of $5.6 million.  DNB
invested the majority of the proceeds of each of these securities issuances into
the Bank to increase the Bank’s capital levels and legal lending
limit.





The
Corporation and the Bank have each met the definition of “well capitalized” for
regulatory purposes on September 30, 2008.  The Bank’s capital
category is determined for the purposes of applying the bank regulators’ “prompt
corrective action” regulations and for determining levels of deposit insurance
assessments and may not constitute an accurate representation of the
Corporation’s or the Bank’s overall financial condition or prospects. The
Corporation’s capital exceeds the FRB’s minimum lever­age ratio requirements
for bank holding companies (see additional discussion included in Footnote
17 of DNB’s 10-K).





Under
federal banking laws and regulations, DNB and the Bank are required to maintain
minimum capital as determined by certain regulatory ratios. Capital adequacy for
regulatory purposes, and the capital category assigned to an institution by its
regulators, may be determinative of an institution’s overall financial
condition.








25




The
following table summarizes data and ratios pertaining to the Corporation and the
Bank's capital structure.





For
      Capital
            
            
            To
      Be Well Capitalized Under Prompt CorrectiveActual
            
            
            Adequacy
      Purposes
            
            
            Action
      Provisions(Dollars
      in thousands)
            
            Amount
            
            
            Ratio
            
            
            Amount
            
            
            Ratio
            
            
            Amount
            
            
            RatioDNB
      Financial CorporationSeptember
      30, 2008:Total risk-based
      capital
            
            $
            45,951
            
            
            
            11.70
            %
            
            $
            31,419
            
            
            
            8.00
            %
            
            $
            39,273
            
            
            
            10.00
            %Tier 1 capital
            
            
            41,062
            
            
            
            10.46
            
            
            
            15,709
            
            
            
            4.00
            
            
            
            23,564
            
            
            
            6.00Tier 1 (leverage)
      capital
            
            
            41,062
            
            
            
            7.42
            
            
            
            22,137
            
            
            
            4.00
            
            
            
            27,672
            
            
            
            5.00December
      31, 2007:Total risk-based
      capital
            
            $
            44,859
            
            
            
            13.08
            %
            
            $
            27,437
            
            
            
            8.00
            %
            
            $
            34,296
            
            
            
            10.00
            %Tier 1 capital
            
            
            40,901
            
            
            
            11.93
            
            
            
            13,719
            
            
            
            4.00
            
            
            
            20,578
            
            
            
            6.00Tier 1 (leverage)
      capital
            
            
            40,901
            
            
            
            7.77
            
            
            
            21,061
            
            
            
            4.00
            
            
            
            26,326
            
            
            
            5.00DNB
      First, N.A.September
      30, 2008:Total risk-based
      capital
            
            $
            45,774
            
            
            
            11.67
            %
            
            $
            31,380
            
            
            
            8.00
            %
            
            $
            39,225
            
            
            
            10.00
            %Tier 1 capital
            
            
            40,885
            
            
            
            10.42
            
            
            
            15,690
            
            
            
            4.00
            
            
            
            23,535
            
            
            
            6.00Tier 1 (leverage)
      capital
            
            
            40,885
            
            
            
            7.39
            
            
            
            22,118
            
            
            
            4.00
            
            
            
            27,648
            
            
            
            5.00December
      31, 2007:Total risk-based
      capital
            
            $
            44,581
            
            
            
            13.02
            %
            
            $
            27,385
            
            
            
            8.00
            %
            
            $
            34,231
            
            
            
            10.00
            %Tier 1 capital
            
            
            40,624
            
            
            
            11.87
            
            
            
            13,692
            
            
            
            4.00
            
            
            
            20,539
            
            
            
            6.00Tier 1 (leverage)
      capital
            
            
            40,624
            
            
            
            7.72
            
            
            
            21,036
            
            
            
            4.00
            
            
            
            26,295
            
            
            
            5.00





In
addition, the Federal Reserve Bank (the "FRB") leverage ratio rules require bank
holding companies to maintain a minimum level of "primary capital" to total
assets of 5.5% and a minimum level of "total capital" to total assets of
6%.  For this purpose, (i) "primary capital" includes, among other
items, common stock, certain perpetual debt instruments such as eligible Trust
preferred securities, contingency and other capital reserves, and the allowance
for loan losses, (ii) "total capital" includes, among other things, certain
subordinated debt, and "total assets" is increased by the allowance for loan
losses.  DNB's primary capital ratio and its total capital ratio are
both well in excess of FRB requirements.





REGULATORY
MATTERS





Dividends
payable to the Corporation by the Bank are subject to certain regulatory
limitations. Under normal circumstances, the payment of dividends in any year
without regulatory permission is limited to the net profits (as defined for
regulatory purposes) for that year, plus the retained net profits for the
preceding two calendar years.





FORWARD-LOOKING
STATEMENTS





This
report contains statements which, to the extent that they are not recitations of
historical fact may constitute forward-looking statements within the meaning of
the United States Private Securities Litigation Reform Act of 1995. Such
forward-looking statements may include financial and other projections as well
as statements regarding DNB’s future plans, objectives, performance, revenues,
growth, profits, operating expenses or DNB’s underlying assumptions. The words
“may”, “would”, “could”, “will”, “likely”, “expect,” “anticipate,” “intend”,
“estimate”, “plan”, “forecast”, “project” and “believe” or other similar words
and phrases may identify forward-looking statements. Persons reading this report
are cautioned that such statements are only predictions, and that DNB’s actual
future results or performance may be materially different.





Such
forward-looking statements involve known and unknown risks,
uncertainties.   A number of factors, many of which are beyond
DNB's control, could cause our actual results, events or developments, or
industry results, to be materially different from any future results, events or
developments expressed, implied or anticipated by such forward-looking
statements, and so our business and financial condition and results of
operations could be materially and adversely affected. Such factors include,
among others, our need for capital; the impact of economic conditions on our
business; changes in banking regulation and the possibility that any banking
agency approvals we might require for certain activities will not be obtained in
a timely manner or at all or will be conditioned in a manner that would impair
our ability to implement our business plans; our ability to attract and retain
key personnel; competition in our marketplace; and other factors as described in
our securities filings.  All forward-looking statements and
information made herein are based on our current expectations as of the date
hereof and speak only as of the date they are made.  DNB does not
undertake to update forward-looking statements.





26


For a
complete discussion of the assumptions, risks and uncertainties related to our
business, you are encouraged to review our filings with the Securities and
Exchange Commission, including our most recent annual report on Form 10-K, as
well as any changes in risk factors that we may identify in our quarterly or
other reports filed with the SEC.





ITEM3 -
QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK





To
measure the impacts of longer-term asset and liability mismatches beyond two
years, DNB utilizes an Economic Value of Equity ("EVE") model.  The
EVE model measures the potential price risk of equity to changes in interest
rates and factors in the optionality included on the balance
sheet.  EVE analysis is used to dynamically model the present value of
asset and liability cash flows, with rates ranging up or down 200 basis
points.  The EVE is likely to be different if rates
change.  Results falling outside prescribed policy ranges require
action by management.  At September 30, 2008 and December 31, 2007,
DNB's variance in the EVE as a percentage of assets with an instantaneous and
sustained parallel shift of 200 basis points was within its negative 3%
guideline, as shown in the table below.  The change as a percentage of
the present value of equity with a 200 basis point increase or decrease at
September 30, 2008 and December 31, 2007, was within DNB's negative 25%
guideline.





(Dollars
      in thousands)
            September
      30, 2008
            
            December
      31, 2007Change
      in rates
            Flat
            
            -200bp
            
            +200bp
            
            Flat
            
            -200bp
            
            +200bpEVE
            $32,555
            
            $29,745
            
            $28,443
            
            $40,466
            
            $36,234
            
            $36,672Change
            
            
            ($2,810
            )
            $(4,112
            )
            
            
            (4,232
            )
            (3,793
            )Change
      as a % of assets
            
            
            (.5%
            )
            (.8%
            )
            
            
            (0.8%)
            
            (0.7%
            )Change
      as a % of PV equity
            
            
            (8.6%
            )
            (12.6%
            )
            
            
            (10.5%
            )
            (9.4%
            )








ITEM4T-
CONTROLS AND PROCEDURES





DNB’s
Chief Executive Officer and Chief Financial Officer have reviewed and evaluated
the effectiveness of our disclosure controls and procedures (as defined in
Exchange Act Rule 13a-15(e)) as of September 30, 2008, the end of the period
covered by this report, in accordance with the requirements of Exchange Act Rule
240.13a-15(b). Based on that evaluation, the Chief Executive Officer and the
Chief Financial Officer have concluded that DNB’s current disclosure controls
and procedures are effective and timely, providing them with material
information relating to DNB and its subsidiaries required to be disclosed in the
report DNB files under the Exchange Act.





Management
of DNB is responsible for establishing and maintaining adequate internal control
over financial reporting for DNB, as such term is defined in Rule 13a-15(f)
under the Securities Exchange Act of 1934.  There was no change in the
DNB’s “internal control over financial reporting” (as such term is defined in
Rule 13a-15(f) under the Exchange Act) that occurred during the fiscal quarter
ended September 30, 2008, that has materially affected, or is reasonably likely
to materially affect, DNB’s internal control over financial
reporting.





PART
II - OTHER INFORMATION





ITEM1.
LEGAL PROCEEDINGS





Not
Applicable





27







ITEM1A. RISK
FACTORS




In
addition to the risk factors previously disclosed in DNB’s Annual Report on Form
10-K for the year ended December 31, 2007 filed with the Commission on
March 28, 2008 (File No. 000-16667), the following additional risks and
uncertainties should also be considered:




The
current economic environment poses significant challenges for many financial
institutions and DNB and could adversely affect our financial condition and
results of operations.   The continued decline in real
estate values, home sales volumes and financial stress on borrowers as a result
of the uncertain economic environment, including job losses, could have an
adverse effect on our borrowers or their customers, which could adversely affect
our financial condition and results of operations. Delinquencies, foreclosures
and losses generally increase during economic slow growth and we expect that our
servicing costs and credit losses will increase during periods such as the one
we are currently experiencing. While we are taking steps to decrease and limit
our exposure to residential mortgage loans, home equity loans and line of credit
and construction and land loans, we nonetheless retain direct exposure to these
products and will be affected by these events.




The
soundness of other financial institutions could adversely affect us.Financial
services institutions are interrelated as a result of trading, clearing,
counterparty, or other relationships. We have exposure to many different
industries and counterparties, and we routinely execute transactions with
counterparties in the financial services industry. Many of these transactions
expose us to credit risk in the event of default of our counterparty or client.
In addition, our credit risk may be exacerbated when the collateral held by us
cannot be realized upon or is liquidated at prices not sufficient to recover the
full amount of the loan or derivative exposure due us. Losses related to these
credit risks could materially and adversely affect our results of operations or
earnings.




Current
levels of market volatility are unprecedented.The
capital and credit markets have been experiencing volatility and disruption for
more than 12 months. In recent weeks, the volatility and disruption has reached
unprecedented levels. In some cases, the markets have produced downward pressure
on stock prices and credit availability for certain issuers without regard to
those issuers’ underlying financial strength. If current levels of market
disruption and volatility continue or worsen, there can be no assurance that DNB
will not experience an adverse effect, which may be material, on its ability to
access capital and on its business, financial condition and results of
operations.




There
can be no assurance that recently enacted legislation will stabilize the U.S.
financial system. On October 3, 2008, President Bush signed into law
the Emergency Economic Stabilization Act of 2008 (the “EESA”). The legislation
was the result of a proposal by Treasury Secretary Henry Paulson to the U.S.
Congress in response to the financial crises affecting the banking system and
financial markets and threats to investment banks and other financial
institutions. Pursuant to the EESA, the U.S. Treasury will have the authority
to, among other things, purchase up to $700 billion of mortgages,
mortgage-backed securities and certain other financial instruments from
financial institutions for the purpose of stabilizing and providing liquidity to
the U.S. financial markets. On October 14, 2008, the U.S. Department of
Treasury announced a program under the EESA pursuant to which it would make
senior preferred stock investments in participating financial institutions (the
“TARP Capital Purchase Program”). On October 14, 2008, the Federal Deposit
Insurance Corporation announced the development of a guarantee program under the
systemic risk exception to the Federal Deposit Act (“FDA”) pursuant to which the
FDIC would offer a guarantee of certain financial institution indebtedness in
exchange for an insurance premium to be paid to the FDIC by issuing financial
institutions (the “FDIC Temporary Liquidity Guarantee Program”). There can be no
assurance, however, as to the actual impact that the EESA and its implementing
regulations, the FDIC programs, or any other governmental program will have on
the financial markets. The failure of the EESA, the FDIC, or the U.S. Government
to stabilize the financial markets and a continuation or worsening of current
financial market conditions could materially and adversely affect our business,
financial condition, results of operations, and access to credit or the trading
price of our common stock.





28







ITEM2.
UNREGISTERED SALES OF EQUITY SECURITIES AND USE OF PROCEEDS





There
were no Unregistered Sales of Equity Securities during the quarter ended
September 30, 2008.  The following table provides information on
repurchases by DNB of its common stock in each month of the quarter ended
September 30, 2008:


Period
            
            Total Number
              Of
      Shares Purchased
            
            Average
              Price
      Paid
              Per
      Share
            
            Total Number of
              Shares Purchased
              as Part of Publicly
              Announced Plans
              or Programs
            
            Maximum Number
              of Shares that May
              Yet Be Purchased
              Under the Plans or
              Programs (a)July
      1, 2008 – July 31, 2008
            
            —
            
            —
            —
            —
            
            68,270August
      1, 2008 – August 31, 2008
            
            1,000
            
            12.74
            
            1,000
            
            67,270September
      1, 2008 – September 30, 2008
            
            1,000
            
            12.40
            
            1,000
            
            66,270Total
            
            2,000
            
            $12.57
            
            2,000







On July 25, 2001, DNB authorized the
buyback of up to 175,000 shares of its common stock over an indefinite period.
On August 27, 2004, DNB increased the buyback from 175,000 to 325,000 shares of
its common stock over an indefinite period.







ITEM3.
DEFAULTS UPON SENIOR SECURITIES





Not
Applicable





ITEM4.
SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS





Not
Applicable





ITEM5.
OTHER INFORMATION





Not
Applicable





ITEM6.
EXHIBITS





Exhibits
required by Item 601 of Regulation S-K.





The
exhibits listed on the Index to Exhibits on the pages immediately following the
Signature Page of this report are incorporated by reference or filed or
furnished herewith in response to this Item.





29





Pursuantto the requirements of Section 13 or 15(d) 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.





DNB
      FINANCIAL CORPORATIONNovember
      14, 2008
            BY:
            /s/
      William S. LatoffWilliam
      S. Latoff, Chairman of the
              Board
      and Chief Executive OfficerNovember
      14, 2008
            BY:
            /s/
      Gerald F. SoppGerald
      F. Sopp, Chief Financial Officer and Executive Vice
    President








30





Indexto
Exhibits




Exhibit
      No.
                Under
      Item 601
                of
      Regulation S-K
            Description
      of Exhibit and Filing Information3
            (i)
            Amended
      and Restated Articles of Incorporation, as amended effective June 15,
      2001, filed on August 14, 2001, as Item 6(a) to Form 10-Q
      (No. 0-16667) and incorporated herein by reference.(ii)
            Bylaws
      of the Registrant as amended December 19, 2007, filed March 28,
      2008 as item 3(ii) to Form 10-K for the fiscal year-ended
      December 31, 2007 (No. 0-16667) and incorporated herein by
      reference.4
            
            Registrant
      has certain debt obligations outstanding, for none of which do the
      instruments defining holders rights authorize an amount of securities in
      excess of 10% of the total assets of the Registrant and its subsidiaries
      on a consolidated basis. Registrant agrees to furnish copies of such
      agreements to the Commission on request.10
            (a)*
            Amended
      and Restated Change of Control Agreements dated December 20, 2006
      between DNB Financial Corporation and DNB First, N.A. and the following
      executive officers, each in the form filed March 26, 2007 as
      item 10(a) to Form 10-K for the fiscal year-ended
      December 31, 2006 (No. 0-16667) and incorporated herein by
      reference: Bruce E. Moroney, C. Tomlinson Kline III, and
      Richard J. Hartmann.(b)**
            1995
      Stock Option Plan of DNB Financial Corporation (as amended and restated,
      effective as of April 27, 2004), filed on March 29, 2004 as
      Appendix A to Registrant’s Proxy Statement for its Annual Meeting of
      Stockholders held April 27, 2004, and incorporated herein by
      reference.(c)*
            Form
      of Change of Control Agreements, as amended November 10, 2003, filed
      on November 14, 2003 as Item 10(e) to Form 8-K
      (No. 0-16667) and incorporated herein by reference between DNB
      Financial Corporation and DNB First, N.A. and each of the following
      Directors: (i) dated November 10, 2005 with James H.
      Thornton, James J. Koegel and Eli Silberman, and (ii) dated
      February 23, 2005 with Mildred C. Joyner, and dated
      February 22, 2006 with Thomas A. Fillippo.(d)***
            DNB
      Financial Corporation Incentive Equity and Deferred Compensation Plan
      filed March 10, 2005 as item 10(i) to Form 10-K for the
      fiscal year-ended December 31, 2004 (No. 0-16667) and
      incorporated herein by reference.(e)*
            Amended
      and Restated Change of Control Agreement among DNB Financial Corporation,
      DNB First, N.A. and William S. Latoff, dated December 20, 2006, filed
      March 26, 2007 as item 10(e) to Form 10-K for the fiscal
      year-ended December 31, 2006 (No. 0-16667) and incorporated
      herein by reference.(f)*
            Agreement
      of Lease dated February 10, 2005 between Headwaters Associates, a
      Pennsylvania general partnership, as Lessor, and DNB First, National
      Association as Lessee for a portion of premises at 2 North Church Street,
      West Chester, Pennsylvania, filed March 10, 2005 as Item 10(l)
      to Form 10-K for the fiscal year ended December 31, 2004
      (No. 0-16667) and incorporated herein by reference, as amended by
      Addendum to Agreement of Lease dated as of November 15, 2005, filed
      March 23, 2006 as Item 10(l) to Form 10-K for the fiscal
      year ended December 31, 2005 (No. 0-16667) and incorporated
      herein by reference, and as further amended by Second Addendum to
      Agreement of Lease dated as of May 25, 2006, filed August 14,
      2006 as Item 10(l) to Form 10-Q for the fiscal quarter ended
      June 30, 2006 (No. 0-16667) and incorporated herein by
      reference.(g)
            Marketing
      Services Agreement between TSG, Inc., a Pennsylvania business
      corporation (the “Service Provider”) for which Eli Silberman, a Director
      of Registrant, is the President and owner dated December 19, 2007,
      filed March 28, 2008 as item 10(g) to Form 10-K for the
      fiscal year-ended December 31, 2007 (No. 0-16667) and
      incorporated herein by reference.(h)**
            Form
      of Stock Option Agreement for grants prior to 2005 under the Registrant’s
      Stock Option Plan, filed May 11, 2005 as Item 10(n) to
      Form 10-Q for the fiscal quarter ended March 31, 2005
      (No. 0-16667) and incorporated herein by reference.




31


(i)**
            Form
      of Nonqualified Stock Option Agreement for April 18, 2005 and
      subsequent grants under the Stock Option Plan, filed May 11, 2005 as
      Item 10(o) to Form 10-Q for the fiscal quarter ended
      March 31, 2005 (No. 0-16667) and incorporated herein by
      reference.(j)
            Agreement
      of Sale dated June 1, 2005 between DNB First, National Association
      (the “Bank”), as seller, and Papermill Brandywine Company, LLC, a
      Pennsylvania limited liability company, as buyer (“Buyer”) with respect to
      the sale of the Bank’s operations center and an adjunct administrative
      office (the “Property”) and accompanying (i) Agreement of Lease
      between the Buyer as landlord and the Bank as tenant, pursuant to which
      the Property will be leased back to the Bank, and (ii) Parking
      Easement Agreement to provide cross easements with respect to the
      Property, the Buyer’s other adjoining property and the Bank’s other
      adjoining property, filed August 15, 2005 as Item 10(p) to
      Form 10-Q for the fiscal quarter ended June 30, 2005
      (No. 0-16667) and incorporated herein by reference.(k)
            Agreement
      of Lease dated November 18, 2005 between Papermill Brandywine
      Company, LLC, a Pennsylvania limited liability company (“Papermill”),
      as Lessor, and DNB First, National Association as Lessee for the banks
      operations center and adjunct administrative office, filed March 23,
      2006 as Item 10(q) to Form 10-K for the fiscal year ended
      December 31, 2005 (No. 0-16667) and incorporated herein by
      reference.(l)*
            Amended
      and Restated Change of Control Agreement among DNB Financial Corporation,
      DNB First, N.A. and William J. Hieb, filed May 15, 2007 as
      Item 10(l) to Form 10-Q for the fiscal quarter ended
      March 31, 2007 (No. 0-16667) and incorporated herein by
      reference.(m)**
            Form
      of Nonqualified Stock Option Agreement for grants on and after
      December 22, 2005 under the Stock Option Plan, filed March 23,
      2006 as Item 10(s) to Form 10-K for the fiscal year ended
      December 31, 2005 (No. 0-16667) and incorporated herein by
      reference.(n)***
            Deferred
      Compensation Plan For Directors of DNB Financial Corporation (adopted
      effective October 1, 2006), filed November 14, 2006 as
      Item 10(s) to Form 10-Q for the fiscal quarter ended
      September 30, 2006 (No. 0-16667) and incorporated herein by
      reference.(o)***
            DNB
      Financial Corporation Deferred Compensation Plan (adopted effective
      October 1, 2006), filed November 14, 2006 as Item 10(t) to
      Form 10-Q for the fiscal quarter ended September 30, 2006
      (No. 0-16667) and incorporated herein by reference.(p)***
            Trust
      Agreement, effective as of October 1, 2006, between DNB Financial
      Corporation and DNB First, National Association (Deferred Compensation
      Plan), filed November 14, 2006 as Item 10(u) to Form 10-Q
      for the fiscal quarter ended September 30, 2006 (No. 0-16667)
      and incorporated herein by reference.(q)*
            Change
      of Control Agreements among DNB Financial Corporation, DNB First, N.A. and
      each of the following executive officers, each in the form filed
      March 26, 2007 as item 10(q) to Form 10-K for the fiscal
      year-ended December 31, 2006 (No. 0-16667) and incorporated
      herein by reference: Albert J. Melfi, Jr. and Gerald F. Sopp.(r)*
            DNB
      Financial Corporation Supplemental Executive Retirement Plan for William
      S. Latoff as amended and restated effective April 1, 2007, filed
      May 15, 2007 as Item 10(r) to Form 10-Q for the fiscal
      quarter ended March 31, 2007 (No. 0-16667) and incorporated
      herein by reference.(s)*
            Trust
      Agreement effective as of December 20, 2006 between DNB Financial
      Corporation and DNB First, N.A. (William S. Latoff SERP), filed
      March 26, 2007 as item 10(s) to Form 10-K for the fiscal
      year-ended December 31, 2006 (No. 0-16667) and incorporated
      herein by reference, as modified by Agreement to Terminate Trust dated as
      of April 1, 2007, filed May 15, 2007 as Item 10(s) to
      Form 10-Q for the fiscal quarter ended March 31, 2007
      (No. 0-16667) and incorporated herein by reference.(t)*
            DNB
      Offer Letter to Albert J. Melfi, Jr., dated November 10, 2006,
      filed March 26, 2005 as item 10(t) to Form 10-K for the
      fiscal year-ended December 31, 2006 (No. 0-16667) and
      incorporated herein by reference.(u)*
            DNB
      Offer Letter to Gerald F. Sopp, dated December 20, 2006, filed
      March 26, 2007 as item 10(u) to Form 10-K for the fiscal
      year-ended December 31, 2006 (No. 0-16667) and incorporated
      herein by reference.




32


(v)***
            Form
      of Restricted Stock Award Agreement dated November, 28, 2007, filed
      March 28, 2008 as item 10(v) to Form 10-K for the fiscal
      year-ended December 31, 2007 (No. 0-16667) and incorporated
      herein by reference.11
            
            Registrant’s
      Statement of Computation of Earnings Per Share is incorporated herein by
      reference to page 6 of this Form 10Q.14
            
            Code
      of Ethics as amended and restated effective February 23, 2005, filed
      March 10, 2005 as Item 10(m) to Form 10-K for the fiscal
      year ended December 31, 2004 (No. 0-16667) and incorporated
      herein by reference.31.1
            
            Rule 13a-14(a)/15d-14 (a) Certification of
      Chief Executive Officer, filed herewith.31.2
            
            Rule 13a-14(a)/15d-14 (a) Certification of
      Chief Financial Officer, filed herewith.32.1
            
            Section 1350 Certification of Chief Executive
      Officer, filed herewith.32.2
            
            Section 1350 Certification of Chief Financial
      Officer, filed herewith.*
            Management
      contract or compensatory plan arrangement.**
            Shareholder
      approved compensatory plan pursuant to which the Registrant’s Common Stock
      may be issued to employees of the Corporation.***
            Non-shareholder
      approved compensatory plan pursuant to which the Registrant’s Common Stock
      may be issued to employees of the
Corporation.





33