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: March 31, 2009


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


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)
            2,603,273
              (Shares
      Outstanding as of May 8, 2009)














DNB
FINANCIAL CORPORATION AND SUBSIDIARY








INDEX








PART  I
      - FINANCIAL INFORMATION
            PAGE
      NO.ITEM
      1.
            
            FINANCIAL
      STATEMENTS (Unaudited):CONSOLIDATED
      STATEMENTS OF FINANCIAL CONDITIONMarch
      31, 2009 and December 31, 2008
            3CONSOLIDATED
      STATEMENTS OF OPERATIONSThree
      Months Ended March 31, 2009 and 2008
            4CONSOLIDATED
      STATEMENTS OF CASH FLOWSThree
      Months Ended March 31, 2009 and 2008
            5NOTES
      TO CONSOLIDATED FINANCIAL STATEMENTS
            6ITEM
      2.
            
            MANAGEMENT'S
      DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF
      OPERATIONS
            13ITEM
      3.
            
            QUANTITATIVE
      AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
            24ITEM
      4.T.
            
            CONTROLS
      AND PROCEDURES
            24PART
      II - OTHER INFORMATIONITEM
      1.
            
            LEGAL
      PROCEEDINGS
            25ITEM
      1A.
            
            RISK
      FACTORS
            25ITEM
      2.
            
            UNREGISTERED
      SALES OF EQUITY  SECURITIES AND USE OF PROCEEDS
            25ITEM
      3.
            
            DEFAULTS
      UPON SENIOR SECURITIES
            25ITEM
      4.
            
            SUBMISSION
      OF MATTERS TO A VOTE OF SECURITY HOLDERS
            25ITEM
      5.
            
            OTHER
      INFORMATION
            25ITEM
      6.
            
            EXHIBITS
            25SIGNATURES
            26EXHIBIT
      INDEX








2







PART
I – FINANCIAL INFORMATION


ITEM 1 – FINANCIAL
STATEMENTS




DNB
Financial Corporation and Subsidiary


Consolidated
Statements of Financial Condition (Unaudited)





March
      31
              
              December
      31(Dollars
      in thousands except share data)
              2009
              
              2008AssetsCash
      and due from banks
              $   11,469
              
              $   9,780Federal
      funds sold
              43,621
              
              38,338Cash
      and cash equivalents
              55,090
              
              48,118AFS
      investment securities, at fair value (amortized cost of
      $73,904
                and
      $61,265)
              71,967
              
              60,666HTM
      investment securities (fair value of $55,837 and $58,525)
              56,743
              
              59,395Other
      investment securities
              4,065
              
              4,065Total
      investment securities
              132,775
              
              124,126Loans
      and leases
              331,514
              
              336,454Allowance
      for credit losses
              (4,641)
              
              (4,586)Net
      loans and leases
              326,873
              
              331,868Office
      property and equipment, net
              9,572
              
              9,665Accrued
      interest receivable
              2,509
              
              2,127Other
      real estate owned
              4,630
              
              4,997Bank
      owned life insurance
              7,643
              
              7,580Core
      deposit intangible
              247
              
              259Net
      deferred taxes
              3,864
              
              3,496Other
      assets
              23,918
              
              1,211Total
      assets
              $567,121
              
              $533,447Liabilities
      and Stockholders’ EquityLiabilitiesNon-interest-bearing
      deposits
              $
      43,620
              
              $45,503Interest-bearing
      deposits:NOW
              138,836
              
              106,623Money market
              82,710
              
              81,742Savings
              33,683
              
              32,895Time
              131,099
              
              141,707Total
      deposits
              429,948
              
              408,470FHLB
      advances
              60,000
              
              60,000Repurchase
      agreements
              21,813
              
              20,185Junior
      subordinated debentures
              9,279
              
              9,279Other
      borrowings
              655
              
              659Total
      borrowings
              91,747
              
              90,123Accrued
      interest payable
              1,000
              
              1,154Other
      liabilities
              3,274
              
              3,642Total
      liabilities
              525,969
              
              503,389Stockholders’
      EquityPreferred
      stock, $10.00 par value;1,000,000
      shares authorized; $1,000 liquidation preference per share;
                11,750
      issued at March 31, 2009 and none issued at December 31,
    2008
              11,604
              
              —Common
      stock, $1.00 par value;10,000,000
      shares authorized; 2,861,619 and 2,863,024 issued
    respectively
              2,869
              
              2,867Stock
      warrants
              151
              
              —Treasury
      stock, at cost; 258,775 and 256,420 shares, respectively
              (4,832)
              
              (4,811)Surplus
              35,105
              
              35,082Accumulated
      deficit
              (855)
              
              (1,062)Accumulated
      other comprehensive income, net
              (2,890)
              
              (2,018)Total stockholders’
      equity
              41,152
              
              30,058Total liabilities and
      stockholders’ equity
              $567,121
              
              $533,447See accompanying notes to
      consolidated financial statements.






3




DNB
Financial Corporation and Subsidiary


Consolidated
Statements of Operations (Unaudited)





(Dollars
      in thousands except share data)
              
              Three
      Months Ended March 31,2009
              
              2008Interest
      Income:Interest
      and fees on loans and leases
              
              $
      4,716
              
              $
      4,916Interest
      and dividends on investment securities:Taxable
              
              1,330
              
              2,168Exempt
      from federal taxes
              
              49
              
              44Interest
      on cash and cash equivalents
              
              19
              
              144Total
      interest income
              
              6,114
              
              7,272Interest
      Expense:Interest
      on NOW, money market and savings
              
              539
              
              1,056Interest
      on time deposits
              
              1,120
              
              1,623Interest
      on FHLB advances
              
              729
              
              676Interest
      on repurchase agreements
              
              69
              
              169Interest
      on junior subordinated debentures
              
              138
              
              162Interest
      on other borrowings
              
              22
              
              23Total
      interest expense
              
              2,617
              
              3,709Net
      interest income
              
              3,497
              
              3,563Provision
      for credit losses
              
              100
              
              60Net
      interest income after provision for credit losses
              
              3,397
              
              3,503Non-interest
      Income:Service
      charges on deposits
              
              387
              
              385Wealth
      management fees
              
              174
              
              285Increase
      in cash surrender value of BOLI
              
              63
              
              66Gain
      on sale of securities
              
              502
              
              256Other
      fees
              
              152
              
              208Total
      non-interest income
              
              1,278
              
              1,200Non-interest
      Expense:Salaries
      and employee benefits
              
              2,123
              
              2,349Furniture
      and equipment
              
              398
              
              421Occupancy
              
              443
              
              398Professional
      and consulting
              
              357
              
              326Advertising
      and marketing
              
              70
              
              83Printing
      and supplies
              
              39
              
              51Other
      expenses
              
              676
              
              566Total
      non-interest expense
              
              4,106
              
              4,194Income
      before income taxes
              
              569
              
              509Income
      tax expense
              
              89
              
              100Net
      Income
              
              $    480
              
              $    409Preferred
      stock dividends and accretion of discount
              
              98
              
              —Net
      Income available to Common Shareholders
              
              $    382
              
              $    409Earnings
      per common share:Basic
              
              $0.14
              
              $0.16Diluted
              
              $0.14
              
              $0.16Cash
      dividends per common share
              
              $0.07
              
              $0.13Weighted
      average common shares outstanding:Basic
              
              2,603,006
              
              2,596,501Diluted
              
              2,603,006
              
              2,600,575See accompanying notes to
      consolidated financial statements.








4





DNB
Financial Corporation and Subsidiary


Consolidated
Statements of Cash Flows (Unaudited)





Three
      Months Ended March 31,(Dollars
      in thousands)
            
            2009
            
            2008Cash
      Flows From Operating Activities:Net
      income
            
            $       480
            
            $       409Adjustments
      to reconcile net income to net cash (used)provided
      by operating activities:Depreciation, amortization and
      accretion
            
            430
            
            353Provision for credit
      losses
            
            100
            
            60Unvested
      stock amortization
            
            25
            
            49Net gain on sale of
      securities
            
            (502)
            
            (256)Net loss on sale of OREO and
      other repossessed property
            
            69
            
            —Decrease (increase) in accrued
      interest receivable
            
            (382)
            
            75Decrease in other
      assets
            
            (666)
            
            (140)Increase in investment in
      BOLI
            
            (63)
            
            (66)Decrease in interest
      payable
            
            (154)
            
            (181)Deferred tax benefit
      (expense)
            
            93
            
            (91)Decrease in other
      liabilities
            
            (466)
            
            (715)Net
      Cash Used By Operating Activities
            
            (1,036)
            
            (503)Cash
      Flows From Investing Activities:Activity
      in available-for-sale securities:Sales
            
            12,411
            
            12,812Maturities,
      repayments and calls
            
            5,572
            
            6,244Purchases
            
            (52,245)
            
            (15,809)Activity
      in held-to-maturity securities:Maturities,
      repayments and calls
            
            4,681
            
            4,025Purchases
            
            (2,023)
            
            (6,027)Net
      (increase) decrease in other investments
            
            —
            
            (352)Net
      decrease (increase) in loans and leases
            
            4,851
            
            2,962Proceeds
      from sale of OREO and other repossessed property
            
            342
            
            —Purchase
      of office property and equipment
            
            (243)
            
            (56)Net
      Cash (Used) Provided By Investing Activities
            
            (26,654)
            
            3,799Cash
      Flows From Financing Activities:Net
      increase (decrease) in deposits
            
            21,478
            
            (16,512)Increase
      (decrease) in FHLB advances
            
            —
            
            10,000Increase
      (decrease) in short term repurchase agreements
            
            1,628
            
            (8,745)Decrease
      in lease obligations
            
            (4)
            
            (4)Dividends
      paid
            
            (169)
            
            (338)Issuance
      of preferred stock and warrants
            
            11,750
            
            —Purchase
      of treasury stock
            
            (21)
            
            (107)Net
      Cash Provided (Used) By Financing Activities
            
            34,662
            
            (15,706)Net
      Change in Cash and Cash Equivalents
            
            6,972
            
            (12,410)Cash
      and Cash Equivalents at Beginning of Period
            
            48,118
            
            45,331Cash and Cash Equivalents at
      End of Period
            
            $55,090
            
            $32,921Supplemental
      Disclosure of Cash Flow Information:Cash
      paid during the period for:Interest
            
            $  2,771
            
            $
      3,890Income
      taxes
            
            352
            
            351Supplemental
      Disclosure of Non-cash Flow Information:Change
      in unrealized losses on investment securities
            
            $  (1,333)
            
            $    1,805Change
      in deferred taxes due to change in unrealizedlosses
      on AFS securities
            
            461
            
            (614)Change
      in unsettled securities purchased included in otherliabilities
            
            —
            
            10,275Change
      in unsettled securities sold included in other assets
            
            (22,041)
            
            (4,526)Transfers
      from loans and leases to other real estate owned
            
            44
            
            451See
      accompanying notes to consolidated financial statements.






5





DNB
FINANCIAL 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 three-month period ended March 31, 2009, 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, 2008.





NOTE
2: EARNINGS PER SHARE





Basic
earnings per share (“EPS”) is 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 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.  At March 31, 2009, there were 191,247 anti-dilutive
stock options outstanding, 24,101 anti-dilutive stock awards and 186,311
anti-dilutive stock warrants.  The dilutive effect of stock options
and unvested shares on basic earnings per share is presented below.


Three
      Months Ended
            
            Three
      Months EndedMarch
      31, 2009
            
            March
      31, 2008(In
      thousands, except per-share data)
            Income
            
            Shares
            
            Amount
            
            Income
            
            Shares
            
            AmountBasic
      EPSIncome
      available to common stockholders
            $   382
            
            2,603
            
            $0.14
            
            $   409
            
            2,597
            
            $0.16Effect
      of dilutive common stock equivalents – stock
              options,
      restricted shares and warrants
            —
            
            —
            
            —
            
            —
            
            4
            
            —Diluted
      EPSIncome
      available to common stockholders after
              assumed
      conversions
            $   382
            
            2,603
            
            $0.14
            
            $   409
            
            2,601
            
            $0.16








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 EndedMarch
      31, 2009
            March
      31, 2008(Dollars
      in thousands)
            
            Net-of-Tax
      Amount
            Net-of-Tax
      AmountNet
      Income
            
            $        480
            
            $        409Other
      Comprehensive Income:Unrealized
      holding (losses) gains arising during the period
            
            (541)
            
            1,360Reclassification
      for gains included in net income
            
            (331)
            
            (169)Unrealized
      actuarial losses-pension
            
            —
            
            (169)Total
      Comprehensive (Loss) Income
            
            $     (392)
            
            $     1,431








6




DNB
FINANCIAL CORPORATION AND SUBSIDIARY


NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS


(Unaudited)








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.





March
      31,
            
            December
      31,(Dollars
      in thousands)
            2009
            
            2008Commercial
      mortgage
            $   139,051
            
            $138,897Commercial
      term and lines of credit
            82,084
            
            83,185Consumer
            61,057
            
            63,400Residential
      mortgage
            43,428
            
            44,053Commercial
      leases
            5,894
            
            6,919Gross
      loans and leases
            331,514
            
            $336,454Allowance
      for credit losses
            (4,641)
            
            (4,586)Net
      loans and leases
            $
      326,873
            
            $331,868








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 $5.2 million 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.














7











DNB
FINANCIAL CORPORATION AND SUBSIDIARY


NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS


(Unaudited)





NOTE
6: RECENT ACCOUNTING PRONOUNCEMENTS







FASB Statement
No. 157In
September 2006, the FASB issued FASB Statement No. 157 — “Fair Value
Measurements” (“Statement 157”). Statement 157 establishes a single
authoritative definition of fair value, sets out a framework for measuring fair
value, and requires additional disclosures about fair-value measurements. The
Statement applies only to fair-value measurements that are already required or
permitted by other accounting standards. Statement 157 is effective for
fair-value measures already required or permitted by other standards for
financial statements issued for fiscal years beginning after November 15,
2007 and interim periods within those fiscal years. DNB did not early adopt FASB
Statement No. 157. The adoption of SFAS No. 157 did not have a
material impact on DNB’s consolidated financial statements.




FSP FAS
No. 157-1 and FSP FAS No. 157-2 In February 2008, the FASB
issued two Staff Positions (FSPs) on Statement No. 157: FSP 157-1
“Application of FASB Statement No. 157 to FASB Statement No. 13 and
Other Accounting Pronouncements That Address Fair Value Measurements for
Purposes of Lease Classification or Measurement Under Statement 13,” and FSP
157-2, “Effective Date of FASB Statement No. 157.” FSP 157-1 excludes fair
value measurements related to leases from the disclosure requirements of
Statement No. 157. FSP 157-2 delayed the effective date of Statement
No. 157 for all non-recurring fair value measurements of non-financial
assets and non-financial liabilities until fiscal years beginning after
November 15, 2008. In 2009 DNB became subject to measurement and disclosure
requirements applicable to non-financial assets and non-financial liabilities
valued at fair value on a non-recurring basis, but those requirements did not
have a material impact on DNB’s consolidated financial statements when they
became applicable.




FSP FAS
No. 157-3In
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 was effective
upon issuance, and was therefore 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 DNB’s consolidated financial statements.




FASB Statement
No. 160In
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. Statement 160 became effective January 1,
2009 and did not have a material impact on DNB’s consolidated financial
statements upon adoption.




FASB Statement
No. 161In
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.




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 became effective with the fiscal year that began on
January 1, 2009, and will change DNB’s accounting treatment for business
combinations on a prospective basis.







8




DNB
FINANCIAL CORPORATION AND SUBSIDIARY


NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS


(Unaudited)







FSP
FAS 132(R)-1In December 2008, the FASB issued FASB Staff Position No. 132(R)-1,
“Employers’ Disclosures about Postretirement Benefit Plan Assets” (“FSP
132(R)-1”). This FSP amends FASB Statement No. 132(R), “Employer’s
Disclosures about Pensions and Other Postretirement Benefits”
(“FAS 132(R)”), to require additional disclosures about assets held in an
employer’s defined benefit pension or other postretirement plan. This FSP is
applicable to an employer that is subject to the disclosure requirements of
FAS 132(R) and is generally effective for fiscal years ending after
December 15, 2009. FSP FAS 132(R)-1 will not change the accounting for
postretirement plan assets. FSP FAS 132(R)-1 will be effective for DNB for
the fiscal year ending December 31, 2009.




On
April 9, 2009, the FASB finalized three FSPs regarding the accounting
treatment for investments including mortgage-backed securities. These FSPs
changed the method for determining if an Other-than-temporary impairment
(“OTTI”) exists and the amount of OTTI to be recorded through an entity’s income
statement. The changes brought about by the FSPs provide greater clarity and
reflect a more accurate representation of the credit and noncredit components of
an OTTI event. The three FSPs are as follows:




·


FSP FAS
157-4 Determining Fair Value When the Volume and Level of Activity for
the Assets or Liability Have Significantly Decreased and Identifying
Transactions That Are Not Orderly” provides guidelines for making fair value
measurements more consistent with the principles presented in SFAS 157, “Fair
Value Measurements.”




·


FSP FAS 115-2 and
FAS 124-2, Recognition and Presentation of Other-than-temporary
impairments” provides additional guidance designed to create greater clarity and
consistency in accounting for and presenting impairment losses on
securities.




·


FSP FAS 107-1 and
APB 28-1, Interim Disclosures about Fair Value of Financial Instruments”
enhances consistency in financial reporting by increasing the frequency of fair
value disclosures.




These
staff positions are effective for financial statements issued for periods ending
after June 15, 2009, with early application possible for the first quarter
of 2009. DNB did not adopt any of the above positions early. DNB has not
completed its evaluation of the impact of these FSPs on its results of
operations and financial position.








9





DNB
FINANCIAL CORPORATION AND SUBSIDIARY


NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS


(Unaudited)









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 201,335 options available for grant at both March 31, 2009 and
December 31, 2008.





Stock
option activity for the three-month period ended March 31, 2009 is indicated
below.


Number
            Weighted
      AverageOutstanding
            Exercise
      PriceOutstanding
      January 1, 2009
            191,247
            
            $19.03Granted
            –
            
            –Exercised
            –
            
            –Expired
            –
            
            –Forfeited
            –
            
            –Outstanding
      March 31, 2009
            191,247
            
            $19.03











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.





March
      31, 2009Range
      of
            Number
            Weighted AverageExercise
      Prices
            Outstanding
            Exercise
      Price
            Remaining
      Contractual Life$
      9.23-10.99
            9,419
            $9.23
            1.25
      years11.00-13.99
            9,414
            11.16
            2.25
      years14.00-19.99
            103,246
            17.43
            4.72
      years20.00-22.99
            21,127
            22.78
            5.73
      years23.00-24.27
            48,041
            24.27
            6.05
      yearsTotal
            191,247
            $19.03
            4.87
      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
three-month period ended March 31, 2009. 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 one
year, during which the shares may not be sold, pledged or otherwise disposed of.
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.











10











DNB
FINANCIAL CORPORATION AND SUBSIDIARY


NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS


(Unaudited)




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-month period
ended March 31, 2009, $25,000 was amortized to expense compared to $49,000
during the same period in 2008.  At March 31, 2009, 205,913 shares
were reserved for future grants under the plan.  Stock grant activity
is indicated below.





SharesOutstanding
      - January 1, 2009
            24,574Granted
            –Forfeited
            (473)Outstanding
      – March 31, 2009
            24,101





NOTE 8:  INCOME
TAXES





As of
March 31, 2009, 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 2005 through 2008 were open
for examination as of March 31, 2009. Income tax expense for the three month
period ended March 31, 2009 was $89,000 compared to $100,000 for the same period
in 2008. The effective tax rate for the three month periods ended March 31, 2009
was 15.7%, compared to 19.6% for the same period in 2008. Although 2009
pre-tax income was $60,000 higher during the first quarter of 2009, income
tax expense and the effective tax rate for the current period were lower than
the same period in 2008.





NOTE
9:  FAIR VALUE MEASUREMENT





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.






11




DNB
FINANCIAL CORPORATION AND SUBSIDIARY


NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS


(Unaudited)





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
March 31, 2009 that are recognized on DNB’s balance sheet using fair value
measurement determined based on the differing levels of input.




March 31,
      2009(Dollars
      in thousands)
            Level 1
            Level 2
            Level 3
            Assets
      at
              Fair
      ValueAssets
      Measured at Fair Value on a Recurring BasisSecurities
      available for sale
            $13
            $71,954
            $—
            $71,967Total
      assets measured at fair value on a recurring basis
            $13
            $71,
      954
            $—
            $71,967Assets
      Measured at Fair Value on a Nonrecurring BasisImpaired
      loans
            $—
            $1,163
            $—
            $1,163OREO &
      other repossessed property
            —
            4,630
            —
            4,630Total
      assets measured at fair value on a nonrecurring basis
            $—
            $5,793
            $—
            $5,793







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 $1.2 million at March 31, 2009. The valuation allowance on
impaired loans was $120,000 as of March 31, 2009. During the three months
ended March 31, 2009, we did not recognize any impairment charges related
to 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
$4.6 million of such assets at March 31, 2009. This consisted of
$4.5 million in OREO and $107,000 in other repossessed property. Subsequent
to the repossession of these assets, DNB did not write down their carrying
values during the three month period ending March 31, 2009, based on
appraisals.










NOTE
10:  STOCKHOLDERS’ EQUITY







Stockholders'
equity was $41.2 million at March 31, 2009 compared to $30.1 million at December
31, 2008.  The increase in stockholders’ equity was primarily a result
of participation in the U.S. Treasury Capital Purchase program as described
below, coupled with year-to-date earnings of $480,000. These additions to
stockholders equity were partially offset by $169,000 of dividends paid on DNB’s
common stock, $98,000 of dividends accrued on DNB’sFixed Rate Cumulative
Perpetual Preferred Stock coupled with an $872,000, net-of-tax SFAS 115
adjustment on the securities portfolio.









12




DNB
FINANCIAL CORPORATION AND SUBSIDIARY


NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS


(Unaudited)




On
January 30, 2009, as part of the Capital Purchase Program administered by
the United States Department of the Treasury, DNB entered into a Letter
Agreement and a Securities Purchase Agreement — Standard Terms with the U.S.
Treasury, pursuant to which DNB issued and sold on January 30, 2009, and
the U.S. Treasury purchased for cash on that date (i) 11,750 shares of the
DNB's Fixed Rate Cumulative Perpetual Preferred Stock, Series 2008A, par
value $10.00 per share, having a liquidation preference of $1,000 per share, and
(ii) a ten-year warrant to purchase up to 186,311 shares of the DNB's
common stock, $1.00 par value, at an exercise price of $9.46 per share, for an
aggregate purchase price of $11,750,000 in cash (this is called the
transaction). This transaction closed on January 30, 2009. The issuance and
sale of these securities was a private placement exempt from registration
pursuant to Section 4(2) of the Securities Act of 1933.  DNB will
pay the Treasury Department a five percent dividend annually for each of the
first five years of the investment and a nine percent dividend thereafter until
the shares are redeemed. The cumulative dividend for the preferred stock is
accrued for and payable on February 15th, May 15th, August 15th and November
15th of each year.




DNB
allocated total proceeds of $11,750,000 based on the relative fair value of
preferred stock and common stock warrants, to preferred stock for $11,599,000
and common stock warrants for $151,000.  The preferred stock discount
will be accreted, on an effective yield method, to preferred stock over five
years.







ITEM 2 - 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 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 second quarter of 2008, 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 endeavor 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. A
discussion of DNB's Key Strategies follows below:





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






13





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





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





·
            Grow
      loans and diversify the mix





·
            Reduce
      long-term borrowings





·
            Focus
      on profitable customer segments





·
            Grow
      and diversify non-interest income





·
            Focus
      on reducing DNB’s cost of funds by changing DNB’s mix of
      deposits





·
            Focus
      on cost containment and improving operational
  efficiencies







Strategic
Plan Update.During the first quarter of 2009, management focused on expense control
as well as strengthening DNB's capital and liquidity positions. Non-interest
expenses decreased $88,000 or 2.10% year over year and Total Risk Based Capital
stood at 14.12% at March 31, 2009.  Cash and cash equivalents
increased to $55.1 million, from $48.1 million at December 31, 2008. In
addition, management was able to reduce DNB’s composite cost of funds to 2.14%
for the three month period ended March 31, 2009 from 3.07% during the same
period in 2008.




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 material challenges, risks and opportunities DNB has
faced during the three-month period ended March 31, 2009.





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.





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.





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.






14




Liquidity and
Market Risk ManagementLiquidity 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 a stable 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 part of its liquidity
management, DNB maintains assets, which comprise its primary liquidity (Federal
funds sold, investments and interest-bearing cash balances, less pledged
securities).




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.




Deposit Insurance
Assessments; FICO Assessments.DNB
pays deposit insurance premiums to the FDIC based on an assessment rate
established by the FDIC. In 2006, the FDIC enacted various rules to implement
the provisions of the Federal Deposit Insurance Reform Act of 2005 (the "FDI
Reform Act"). Pursuant to the FDI Reform Act, in 2006 the FDIC merged the Bank
Insurance Fund with the Savings Association Insurance Fund to create a newly
named Deposit Insurance Fund (the "DIF") that covers both banks and savings
associations. Effective January 1, 2007, the FDIC revised the risk-based
premium system under which the FDIC classifies institutions based on the factors
described below and generally assesses higher rates on those institutions that
tend to pose greater risks to the DIF.






For
most banks and savings associations, including DNB, FDIC rates will depend upon
a combination of CAMELS component ratings and financial ratios. CAMELS ratings
reflect the applicable bank regulatory agency's evaluation of the financial
institution's capital, asset quality, management, earnings, liquidity and
sensitivity to risk. For large banks and savings associations that have
long-term debt issuer ratings, assessment rates will depend upon such ratings
and CAMELS component ratings.






On
February 27, 2009, the FDIC adopted changes to its base and risk-based
deposit insurance assessment rates. Effective for the second quarter of 2009, a
bank's annual assessment base rates will be as follows, depending on the bank's
risk category:




Risk
      CategoryIMinimum
            
            Maximum
            
            II
            
            III
            
            IVAnnual
      rates (in basis points)
            
            
            12
            
            
            16
            
            
            22
            
            
            32
            
            
            45






15




The
base assessment rate can be adjusted downward based on a bank's unsecured debt
and level of excess capital above the well capitalized threshold, or upward
based on a bank's secured liabilities including Federal Home Loan Bank advances
and repurchase agreements, so that the total risk-based assessment rates will
range as follows depending on a bank's risk category:




Risk
      CategoryI
            
            II
            
            III
            
            IVInitial
      base assessment rate
            
            12
      to 16
            
            22
            
            32
            
            45Unsecured
      debt adjustment
            
            –5
      to 0
            
            –5
      to 0
            
            –5
      to 0
            
            –5
      to 0Secured
      liability adjustment
            
            0
      to 8
            
            0
      to 11
            
            0
      to 16
            
            0
      to 22.5Brokered
      deposit adjustment
            
            —
            
            0
      to 10
            
            0
      to 10
            
            0
      to 10Total
      base assessment rate
            
            7
      to 24
            
            17
      to 43
            
            27
      to 58
            
            40
      to 77.5




On February 27, 2009, the FDIC adopted an
interim rule that imposes a special assessment of 20 basis points as of
June 30, 2009, which is to be collected on September 30, 2009. Then,
on March 5, 2009, FDIC Chairman Sheila Bair announced that if Congress
adopts legislation expanding the FDIC's line of credit with Treasury from
$30 billion to $100 billion, the FDIC might have the flexibility to
reduce the special emergency assessment, possibly from 20 to 10 basis points.
Assuming that deposit levels remain constant, we anticipate that the special
assessment for the Bank would total approximately $818,000 at the 20 basis
points level, but if the FDIC is able to reduce the special assessment to 10
basis points, the Bank's assessment would total approximately
$409,000.




Because
the rule has just been issued and is subject to some interpretation, management
has not yet determined what the Bank's final risk-based assessment rate will be
for periods after the first quarter of 2009.




The
FDIA, as amended by the FDI Reform Act, requires the FDIC to set a ratio of
deposit insurance reserves to estimated insured deposits, the designated reserve
ratio (the "DRR"), for a particular year within a range of 1.15% to 1.50%. For
2009, the FDIC has set the DRR at 1.25%, which is unchanged from 2008 levels.
Under the FDI Reform Act and the FDIC's revised premium assessment program,
every FDIC-insured institution will pay some level of deposit insurance
assessments regardless of the level of the DRR. We cannot predict whether, as a
result of an adverse change in economic conditions or other reasons, the FDIC
will be required in the future to increase deposit insurance assessments above
current levels. The FDIC also adopted rules providing for a one-time credit
assessment to each eligible insured depository institution based on the
assessment base of the institution on December 31, 1996. The credit may be
applied against the institution's 2007 assessment, and for the three years
thereafter the institution may apply the credit against up to 90% of its
assessment. DNB qualified for a credit of approximately $245,000, of which
$170,000 was applied in 2007 and the remaining balance of $75,000 was applied in
2008, thereby exhausting the credit.




In
addition, the Deposit Insurance Funds Act of 1996 authorized the Financing
Corporation ("FICO") to impose assessments on DIF applicable deposits in order
to service the interest on FICO's bond obligations from deposit insurance fund
assessments. The amount assessed on individual institutions by FICO will be in
addition to the amount, if any, paid for deposit insurance according to the
FDIC's risk-related assessment rate schedules. FICO assessment rates may be
adjusted quarterly to reflect a change in assessment base. 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 first quarter of 2009 was at an annual rate of 1.04 basis
points (1.04 cents per $100 of assessable deposits).  Under the FDIA,
insurance of deposits may be terminated by the FDIC upon a finding that the
institution has engaged in unsafe and unsound practices, is in an unsafe or
unsound condition to continue operations, or has violated any applicable law,
regulation, rule, order or condition imposed by the FDIC.




Material Trends
and Uncertainties.The global and U.S. economies are experiencing
significantly reduced business activity as a result of disruptions in the
financial system. Dramatic declines in the housing market, 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. As a
result of the recession, retail customers may delay borrowing from DNB as
unemployment increases and the value of existing homes decline and the
availability to borrow against equity diminishes. As the U.S. economy moves
through a period of recession, delinquencies will rise as the value of homes
decline and DNB’s borrowers experience financial difficulty due to corporate
downsizing, reduced sales, or other negative events which may impact their
ability to meet their contractual loan payments. As a result of these negative
trends in the economy and their impact on our borrowers’ ability to repay their
loans, DNB made a $100,000 provision during the three months ending March 31,
2009 in response to DNB’s increased level of non-performing assets which grew to
$10.8 million from $7.7 million at December 31, 2008 along with
other changes in our loan and lease portfolio. In addition, during the first
quarter of 2009, management strengthened DNB's capital and liquidity
positions.  Total Risk Based Capital stood at 14.12% at March 31,
2009. Cash and cash equivalents increased to $55.1 million, from $48.1 million
at December 31, 2008.









16


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.  As mentioned above in Material Trends
and Uncertainties, the economic downturn, increased unemployment, and other
events  negatively impact household and/or corporate incomes and 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 war in Afghanistan and 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
principals. 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 the year ended December 31,
2008.





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.





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 March 31,
2009.  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, 2008.






17




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 $567.1 million at March 31, 2009 compared to $533.4 million at
December 31, 2008.  The increase in total assets was primarily
attributable to an $8.6 million increase in total investment securities, a $7.0
million increase in cash and cash equivalents and a $21.7 million increase in
other assets due to receivables for the sales of investments which were settled
in April 2009 as discussed below.





Investment Securities.
Investment securities at March 31, 2009 were $132.8 million (after $21.7 million
of trade date sales) compared to $124.1 million at December 31, 2008. The $8.6
million increase in investment securities was primarily due to $34.1 million in
sales and $10.3 million in principal pay-downs and maturities offset by the
purchase of $54.2 million in investment securities. Included in the $34.1
million of investment securities sales was $21.7 million for securities which
had a trade date in March 2009, and a settlement date in April 2009. 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).





Gross Loans and Leases. DNB’s
loans and leases decreased $5.0 million to $331.5 million at March 31, 2009
compared to $336.5 million at December 31, 2008, due to decreased loan demand in
DNB’s marketplace. Total commercial loans and commercial leases declined
$948,000 and $1.0 million, respectively, while residential and consumer loans
declined $625,000 and $2.3 million, respectively.





Deposits. Deposits were
$429.9 million at March 31, 2009 compared to $408.5 million at December 31,
2008.  Deposits increased $21.5 million or 5.3% during the three-month
period ended March 31, 2009, primarily due to a seasonal increase in municipal
deposits.  Time deposits, primarily accounts greater than $100,000,
declined $10.6 million, while the aggregate of demand, NOW, money markets and
savings accounts increased $32.1 million.





Borrowings.Borrowings were $91.7
million at March 31, 2009 compared to $90.1 million at December 31,
2008.  The slight increase of $1.6 million or 1.8% was primarily due
to a $1.6 million increase in repurchase agreements.





RESULTS
OF OPERATIONS




SUMMARY





Net
income for the three month period ended March 31, 2009 was $480,000 compared to
$409,000 for the same period in 2008.  Diluted earnings per common
share for the three month period ended March 31, 2009 was $0.14 compared to
$0.16 for the same period in 2008.  The $71,000 increase during the
most recent three-month period was attributable to an $88,000 decrease in
non-interest expense, a $78,000 increase in non-interest income and an $11,000
decline in income tax expense. This was offset by a $106,000 decrease in net
interest income after provision for credit losses. EPS has been reduced by the
dividends on preferred stock and the accretion of the discount on the preferred
stock.





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 month period
ended March 31, 2009 was $3.4 million, compared to $3.5 million for the same
period in 2008.  Interest income for the three month period ended
March 31, 2009 was $6.1 million compared to $7.3 million for the same period in
2008.  The decrease in interest income during the three month period
was primarily attributable to a decrease of interest on loans and leases, which
was a result of lower yields on the loan and lease portfolio, which was caused
by lower market rates.  In addition, interest and dividends on
investment securities declined due to a decrease in the average balance and
yield.  The yield on interest-earning assets for the three month
period ended March 31, 2009 was 4.82%, compared to 5.83% for the same period in
2008.  Interest expense for the three month period ended March 31,
2009 was $2.6 million compared to $3.7 million for the same period in 2008. The
decrease in interest expense during the period was primarily attributable to
lower rates on interest-bearing liabilities. The composite cost of funds for the
three month period ended March 31, 2009 was 2.14% compared to 3.07% for the same
period in 2008.   The net interest margin for the three month
period ended March 31, 2009 was 2.75%, compared to 2.86% for the same period in
2008.






18





Interest
on loans and leases was $4.7 million for the three-month period ended March 31,
2009, compared to $4.9 million for the same period in 2008. The average balance
of loans and leases was $332.4 million with an average yield of 5.73% for the
three-month period ended March 31, 2009 compared to an average balance of $307.2
million with an average yield of 6.42% for the same period in 2008. The increase
in the average balance was primarily due to originations by our loan officers,
coupled with strategic purchases of Small Business Administration and United
States Department of Agriculture guaranteed loans, as well as 2 pools of
consumer loans.  The decrease in yield was primarily the result of
lower yields on prime-rate based loans which were lower in 2009 as a result of
the Federal Reserve’s rate cuts.





Interest
and dividends on investment securities was $1.4 million for the three month
period ended March 31, 2009, compared to $2.2 million for the same period in
2008.  The average balance of investment securities was $137.7 million
with an average yield of 4.08% for the current quarter compared to $172.6
million with an average yield of 5.18% for the same period in
2008.  The decrease in the average balance of investment securities
during the period was the result of management’s decision, in light of
disruptions in the financial system during the fourth quarter of 2008, to
bolster its normal liquidity position. The decrease in the yield during the most
recent three month period was primarily due to a decline in general market rates
as well as the sale of higher yielding securities.  Average cash and
cash equivalents were $42.9 million for the three month period ended March 31,
2009, compared to $21.6 million for the same period in 2008.





Interest
on deposits was $1.7 million for the three month period ended March 31, 2009,
compared to $2.7 million for the same period in 2008.  The average
balance of deposits was $405.4 million with an average rate of 1.66% for the
current quarter compared to $403.8 million with an average rate of 2.67% for the
same period in 2008.  The decrease in rate during the period 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 $958,000 for the three month period ended March 31, 2009,
compared to $1.0 million for the same period in 2008. The average balance of
borrowings was $91.2 million with an average rate of 4.26% for the current
quarter compared to $82.7 million with an average rate of 5.01% for the same
period in 2008.  The increase in the average balance during the
three-months ended March 31, 2009 compared to the same period in 2008 was
attributable to an average $9.6 million increase in FHLB advances, offset by an
average $1.0 million decline in repurchase agreements. The decrease in rate
during the period 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.






19





DNB’s
percentage of allowance for credit losses to total loans and leases was 1.40% at
March 31, 2009 compared to 1.36% and 1.28% at December 31, 2008 and
March 31, 2008, respectively. The percentage of net charge-offs to total average
loans and leases were .01% during the three months ending March 31, 2009, .41%
during the year ended December 31, 2008 and 0.01% during the three months ending
March 31, 2008




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





Three
      Months
              Ended
      March 31,
              2009
            
            Year
      Ended
              December
      31,
              2008
            
            Three
      Months
              Ended
      March 31,
              2008






(Dollars
      in thousands)Beginning
      balance
            $4,586
            
            $3,891
            
            $3,891Provisions
            100
            
            2,018
            
            60Charge-offs
            (57)
            
            (1,401)
            
            (42)Recoveries
            12
            
            78
            
            17Ending
      balance
            $4,641
            
            $4,586
            
            $3,926





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 month period ended March 31, 2009 was $1.3 million,
compared to $1.2 million for the same period in 2008.  The $78,000
increase during the three months ended March 31, 2009 was mainly attributable to
a $246,000 increase in gains on sales of securities, offset by a $111,000
decline in wealth management fees.





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 month period ended March
31, 2009 was $4.1 million compared to $4.2 million for the same period in
2008.  There was a $239,000 decrease in salary & employee benefits
due to a lower level of full time equivalent employees, coupled with lower
benefit costs. DNB’s non-interest expense to average assets ratio for the three
month period ended March 31, 2009 was 3.10%, compared to 3.20% for the same
period in 2008.  The level of non-interest expenses declined during
the period as a result of management’s focus on expense control.





INCOME
TAXES





Income
tax expense for the three month period ended March 31, 2009 was $89,000 compared
to $100,000 for the same period in 2008. The effective tax rate for the three
month periods ended March 31, 2009 was 15.7%, compared to 19.6% for the same
period in 2008. Although 2009 pre-tax income was $60,000 higher during the
first quarter of 2009, income tax expense and the effective tax rate for
the current period were lower than the same period in 2008.  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.





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")and Other Real Estate Owned
("OREO").  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.  OREO is 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.






20





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, which totaled $10.8 million at March 31, 2009, increased $3.1 million
when compared to December 31, 2008. The increase in non-performing assets is
attributed largely to one commercial credit secured by land, totaling $2.8
million.








Non-Performing
      Assets(Dollars
      in thousands)
            
            March
      31,
              2009
            December
      31,
              2008
            March
      31,
              2008Loans
      and leases:Non-accrual
            
            $   5,870
            
            $   1,825
            
            $   5,61290
      days past due and still accruing
            
            330
            
            900
            
            710Troubled
      debt restructurings
            
            —
            
            —
            
            —Total
      non-performing loans and leases
            
            6,200
            
            2,725
            
            6,322OREO
      & other repossessed property
            
            4,630
            
            4,997
            
            451Total
      non-performing assets
            
            $  10,830
            
            $    7,722
            
            $  6,773











The
following table sets forth DNB's asset quality and allowance coverage ratios at
the dates indicated:





March
      31,
              2009
            December
      31,
              2008
            March
      31,
              2008Asset
      quality ratios:Non-performing loans to total
      loans
            
            1.87
            %
            0.8
            %
            2.1
            %Non-performing assets to total
      assets
            
            1.91
            
            1.45
            
            1.3Allowance
      for credit losses to:Total loans and
      leases
            
            1.40
            
            1.36
            
            1.3Non-performing loans and
      leases
            
            74.9
            
            168.3
            
            62.1








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:





Three
      Months Ended
            Year
      Ended
            Three
      Months Ended(Dollars
      in thousands)
            March
      31,
              2009
            December
      31,
              2008
            March
      31,
              2008Interest
      income which would have beenrecorded under original
      terms
            $   81
            
            $  121
            
            $   106Interest
      income recorded during the period
            (13)
            
            (58)
            
            (1)Net
      impact on interest income
            $   67
            
            $   63
            
            $   105





Impaired
loans--Impaired
loans are measured for impairment using the fair value of the collateral for
collateral dependent loans.At December 31, 2008 the average recorded
investment is higher than the total recorded investment in the table below due
primarily to the transfer of loans to OREO totaling approximately
$5.0 million during 2008, the majority being moved during the fourth
quarter. Information regarding impaired loans is presented as
follows:











21











Three
      Months Ended
            Year
      Ended
            Three
      Months Ended(Dollars
      in thousands)
            March
      31,
              2009
            December
      31,
              2008
            March
      31,
              2008Total
      recorded investment
            $  5,870
            
            $1,163
            
            $  10,257Average
      recorded investment
            5,870
            
            6,236
            
            10,257Specific
      allowance allocation
            120
            
            120
            
            480Total
      cash collected
            —
            
            313
            
            81Interest
      income recorded
            —
            
            108
            
            69








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 $53.5 million at March 31,
2009.  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 $128.9 million.  Management believes that DNB
has adequate resources to meet its short-term and long-term funding
requirements.





At March
31, 2009, DNB had $54.2 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 March 31, 2009
totaled $58.0 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.





On
January 30, 2009, as part of the CPP administered by the United States
Department of the Treasury, DNB Financial Corporation entered into a Letter
Agreement and a Securities Purchase Agreement with the U.S. Treasury, pursuant
to which the DNB issued and sold on January 30, 2009, and the U.S. Treasury
purchased for cash on that date (i) 11,750 shares of the company’s Fixed
Rate Cumulative Perpetual Preferred Stock, Series 2008A, par value $10.00
per share, having a liquidation preference of $1,000 per share, and (ii) a
ten-year warrant to purchase up to 186,311 shares of the DNB’s common stock,
$1.00 par value, at an exercise price of $9.46 per share, for an aggregate
purchase price of $11,750,000 in cash. This transaction closed on
January 30, 2009. The issuance and sale of these securities was a private
placement exempt from registration pursuant to Section 4(2) of the
Securities Act of 1933. During 2009 the Bank will need to provide dividends to
the Corporation in connection with the $11,750,000 of Fixed Rate Cumulative
Perpetual Preferred Stock sold on January 30, 2009 as part of the CPP
administered by the United States Department of the Treasury.





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.





Management
believes that the Corporation and the Bank have each met the definition of “well
capitalized” for regulatory purposes on March 31, 2009.  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.








22





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 CorporationMarch
      31, 2009:Total risk-based
      capital
            $57,538
            
            14.12
            %
            $32,606
            
            8.00
            %
            $40,757
            
            10.00
            %Tier 1 capital
            52,770
            
            12.95
            
            16,303
            
            4.00
            
            24,454
            
            6.00Tier 1 (leverage)
      capital
            52,770
            
            9.82
            
            21,495
            
            4.00
            
            26,869
            
            5.00December
      31, 2008:Total risk-based
      capital
            $45,516
            
            12.02
            %
            $30,306
            
            8.00
            %
            $37,883
            
            10.00
            %Tier 1 capital
            40,802
            
            10.77
            
            15,153
            
            4.00
            
            22,730
            
            6.00Tier 1 (leverage)
      capital
            40,802
            
            7.46
            
            21,882
            
            4.00
            
            27,353
            
            5.00DNB
      First, N.A.March
      31, 2009:Total risk-based
      capital
            $55,732
            
            13.75
            %
            $32,415
            
            8.00
            %
            $40,518
            
            10.00
            %Tier 1 capital
            50,964
            
            12.58
            
            16,207
            
            4.00
            
            24,311
            
            6.00Tier 1 (leverage)
      capital
            50,964
            
            9.52
            
            21,422
            
            4.00
            
            26,778
            
            5.00December
      31, 2008:Total risk-based
      capital
            $45,378
            
            12.00
            %
            $30,257
            
            8.00
            %
            $37,822
            
            10.00
            %Tier 1 capital
            40,654
            
            10.75
            
            15,129
            
            4.00
            
            22,693
            
            6.00Tier 1 (leverage)
      capital
            40,654
            
            7.44
            
            21,862
            
            4.00
            
            27,328
            
            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 and 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.






23





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 this Form 10-Q, as well as any changes in
risk factors that we may identify in our quarterly or other reports filed with
the SEC.








ITEM 3 - 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 ranges require action by
management.  At March 31, 2009 and December 31, 2008, 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 March 31, 2009
and December 31, 2008, was within DNB's negative 25% guideline.





March
      31, 2009
            
            December
      31, 2008Change
      in rates
            Flat
            
            -200bp
            
            +200bp
            
            Flat
            
            -200bp
            
            +200bpEVE
            $54,180
            
            $58,553
            
            $47,301
            
            $29,196
            
            $30,554
            
            $25,831Change
            
            
            $4,373
            
            ($6,879
            )
            
            
            1,358
            
            (3,365
            )Change
      as a % of assets
            
            
            .8%
            
            (1.2%)
            
            
            
            .3%
            
            (0.6%
            )Change
      as a % of PV equity
            
            
            8.1%
            
            (12.7%
            )
            
            
            4.7%
            
            (11.5%
            )








ITEM 4 - 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 March 31, 2009, 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 March 31, 2009, that has materially affected, or is reasonably likely to
materially affect, DNB’s internal control over financial reporting.






24





PART II - OTHER INFORMATION





ITEM 1. LEGAL
PROCEEDINGS





Not
Applicable





ITEM 1A. RISK
FACTORS





There
have been no material changes to the Risk Factors previously disclosed in
Registrant's Annual Report on Form 10-K for its fiscal year ended December 31,
2008, filed with the Commission on March 31, 2009 (File No.
000-16667).





ITEM 2. UNREGISTERED SALES
OF EQUITY  SECURITIES AND USE OF PROCEEDS





There
were no Unregistered Sales of Equity Securities during the quarter ended March
31, 2009 other than DNB’s issuance of its fixed rate Cumulative Perpetual
Preferred Stock, Series 2008A and warrant to purchase common stock to the U.S.
Treasury. For more information on this issuance, see DNB’s Form 8-K filed with
the SEC on January 30, 2009.  The following table provides information
on repurchases by DNB of its common stock in each month of the quarter ended
March 31, 2009:




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)January
      1, 2009 – January 31, 2009
            
            2,354
            
            $9.03
            
            2,354
            
            63,216February
      1, 2009 – February 28, 2009
            
            —
            
            —
            
            —
            
            63,216March
      1, 2009 – March 31, 2009
            
            —
            
            —
            
            —
            
            63,216Total
            
            2,354
            
            $9.03
            
            2,354







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.





ITEM 3. DEFAULTS UPON SENIOR
SECURITIES





Not
Applicable





ITEM 4. SUBMISSION OF
MATTERS TO A VOTE OF SECURITY HOLDERS





Not Applicable





ITEM 5. OTHER
INFORMATION





Not
Applicable





ITEM 6.
EXHIBITS





Exhibits
required by Item 601 of Regulation S-K.





The
exhibits listed on the Index to Exhibits on pages 27-29 of this report are
incorporated by reference or filed or furnished herewith in response to this
Item.








25


SIGNATURES











Pursuant
to 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 CORPORATIONMay
      15, 2009
            BY:
            /s/
      William S. LatoffWilliam
      S. Latoff, Chairman of the
              Board
      and Chief Executive OfficerMay
      15, 2009
            BY:
            /s/
      Gerald F. SoppGerald
      F. Sopp, Chief Financial Officer and Executive Vice
    President










































































26













Index to
Exhibits




Exhibit
      No.
                Under
      Item 601
                of
      Regulation S-K3
            (i)
            Amended
      and Restated Articles of Incorporation, as amended effective
      December 8, 2008, filed March 31, 2009 as item 3(i) to
      Form 10-K for the fiscal year-ended December 31, 2008
      (No. 0-16667) and incorporated herein by
reference.(ii)
            Bylaws
      of the Registrant as amended December 8, 2008, filed March 31,
      2009 as item 3(ii) to Form 10-K for the fiscal year-ended
      December 31, 2008 (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. On April 17, 2009, the
      Registrant approved agreements with each non-employee director to
      terminate his or her Change of Control Agreement.(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 17, 2008,
      filed March 31, 2009 as item 10(g) to Form 10-K for the
      fiscal year-ended December 31, 2008 (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.(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.








27






(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, as further amended by Amendment dated
      December 8, 2008, filed March 31, 2009 as item 3(r) to
      Form 10-K for the fiscal year-ended December 31, 2008
      (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.(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 in footnote
      2.31.1
            
            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.






28






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.