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, 2010


or


[  ] Transition report pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934.





For the transition period from ________________ to _____________





Commission File Number: 0-16667


DNB Financial Corporation


(Exact name of registrant as specified in its charter)





Pennsylvania

(State or other jurisdiction of

incorporation or organization)
23-2222567

(I.R.S. Employer Identification No.)





4 Brandywine Avenue - Downingtown, PA 19335


(Address of principal executive offices and Zip Code)





(610) 269-1040


(Registrant's telephone number, including area code)





Not Applicable


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





Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports) and (2) has been subject to such filing requirements for the past 90 days





Yes x

No o





Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).








Yes o

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   oAccelerated filer                   o


Non-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)
2,633,985

(Shares Outstanding as of May 13, 2010)














DNB FINANCIAL CORPORATION AND SUBSIDIARY








INDEX








PART  I - FINANCIAL INFORMATION
PAGE NO.ITEM 1.

FINANCIAL STATEMENTS (Unaudited):CONSOLIDATED STATEMENTS OF FINANCIAL CONDITIONMarch 31, 2010 and December 31, 2009
3CONSOLIDATED STATEMENTS OF OPERATIONSThree Months Ended March 31, 2010 and 2009
4CONSOLIDATED STATEMENTS OF STOCKHOLDERS’ EQUITY AND COMPREHENSIVE INCOME (LOSS)Three Months Ended March 31, 2010 and 2009
5CONSOLIDATED STATEMENTS OF CASH FLOWSThree Months Ended March 31, 2010 and 2009
6NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
7ITEM 2.

MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
19ITEM 3.

QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
33ITEM 4T

CONTROLS AND PROCEDURES
33PART II - OTHER INFORMATIONITEM 1.

LEGAL PROCEEDINGS
33ITEM 1A.

RISK FACTORS
33ITEM 2.

UNREGISTERED SALES OF EQUITY  SECURITIES AND USE OF PROCEEDS
34ITEM 3.

DEFAULTS UPON SENIOR SECURITIES
34ITEM 4.

REMOVED AND RESERVED
34ITEM 5.

OTHER INFORMATION
34ITEM 6.

EXHIBITS
34SIGNATURES
35EXHIBIT INDEX




















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)

2010


2009AssetsCash and due from banks

$
11,380


$
35,832Federal funds sold


8,000



8,000Cash and cash equivalents


19,380



43,832AFS investment securities


158,960



155,862HTM investment securities (fair value of $39,562 and $43,742)


39,837



44,166Restricted stock


4,365



4,067Total investment securities


203,162



204,095Loans and leases


363,972



359,427Allowance for credit losses


(5,857
)


(5,477
)Net loans and leases


358,115



353,950Office property and equipment, net


8,555



8,775Accrued interest receivable


2,932



2,703OREO & other repossessed property


3,670



4,489Bank owned life insurance


7,949



7,887Core deposit intangible


197



210Net deferred taxes


3,796



3,866Other assets


6,987



4,441Total assets

$
614,743


$
634,248Liabilities and Stockholders’ EquityLiabilitiesNon-interest-bearing deposits

$
49,576


$
46,236Interest-bearing deposits:NOW


154,074



151,597Money market


100,002



102,427Savings


39,080



35,973Time


157,122



171,114Total deposits


499,854



507,347FHLB advances


30,000



53,000Repurchase agreements


26,414



16,529Junior subordinated debentures


9,279



9,279Other borrowings


637



642Total borrowings


66,330



79,450Accrued interest payable


581



743Other liabilities


4,396



3,832Total liabilities


571,161



591,372Stockholders’ EquityPreferred stock, $10.00 par value;1,000,000 shares authorized; $1,000 liquidation preference per share;

11,750 issued at March 31, 2010 and December 31, 2009


11,518



11,511Common stock, $1.00 par value;10,000,000 shares authorized; 2,861,618 and 2,861,618 issued respectively


2,877



2,875Stock warrants


151



151Treasury stock, at cost; 235,007 and 243,593 shares, respectively


(4,677
)


(4,727
)Surplus


35,203



35,179Accumulated deficit


(224
)


(666
)Accumulated other comprehensive loss, net


(1,266
)


(1,447
)Total stockholders’ equity


43,582



42,876Total liabilities and stockholders’ equity

$
614,743


$
634,248See accompanying notes to unaudited consolidated financial statements.








3








DNB FinancialCorporation and Subsidiary


Consolidated Statements of Operations (Unaudited)





(Dollars in thousands,  except share data)

Three Months Ended March 31,2010

2009Interest Income:Interest and fees on loans and leases

$
5,131

$
4,716Interest and dividends on investment securities:Taxable


1,448


1,330Exempt from federal taxes


45


49Interest on cash and cash equivalents


27


19Total interest income


6,651


6,114Interest Expense:Interest on NOW, money market and savings


630


539Interest on time deposits


888


1,120Interest on FHLB advances


521


729Interest on repurchase agreements


65


69Interest on junior subordinated debentures


120


138Interest on other borrowings


22


22Total interest expense


2,246


2,617Net interest income


4,405


3,497Provision for credit losses


426


100Net interest income after provision for credit losses


3,979


3,397Non-interest Income:Service charges on deposits


343


387Wealth management fees


216


174Increase in cash surrender value of BOLI


62


63Gain on sale of securities


696


502Loss on sale of OREO


—


(66Other fees


252


218Total non-interest income


1,569


1,278Non-interest Expense:Salaries and employee benefits


2,103


2,123Furniture and equipment


359


398Occupancy


456


443Professional and consulting


266


357Advertising and marketing


104


70Printing and supplies


41


39FDIC insurance


211


64FHLB prepayment penalties


560


—Other expenses


502


612Total non-interest expense


4,602


4,106Income before income taxes


946


569Income tax expense


271


89Net Income

$
675

$
480Preferred stock dividends and accretion of discount


154


103Net Income available to Common Shareholders

$
521

$
377Earnings per common share:Basic

$
0.20

$
0.14Diluted

$
0.20

$
0.14Cash dividends per common share

$
0.03

$
0.07Weighted average common shares outstanding:Basic


2,620,314


2,603,006Diluted


2,620,314


2,603,006See accompanying notes to unaudited consolidated financial statements.








4


DNB FINANCIAL CORPORATIONAND Subsidiary


Consolidated Statements of Stockholders’ Equity and Comprehensive Income (Loss) (Unaudited)


(Dollars in thousands)




Preferred

Stock


Common

Stock


Stock

Warrants


Treasury

Stock


Surplus


Accumulated

Deficit


Accumulated

Other

Compre-

hensive

Loss


TotalBalance at January 1, 2010

$
11,511


$
2,875


$
151


$
(4,727
)

$
35,179


$
(666
)

$
(1,447
)

$
42,876Comprehensive income:Net income for three months

ended March 31, 2010


—



—



—



—



—



675



—



675Other comprehensive income, net

of tax:Unrealized gains on AFS

securities, net


—



—



—



—



—



—



181



181Total comprehensive income


—



—



—



—



—



—



—



856Preferred stock discount accretion


7



—



—



—



—



(7
)


—



—Restricted stock compensation


—



2



—



—



24



—



—



26Cash dividends-Common ($.03 per

share)


—



—



—



—



—



(79
)


—



(79
)Cash dividends-Preferred


—



—



—



—



—



(147
)


—



(147
)Sale of treasury shares to 401-

K plan (8,586 shares)


—



—



—



50



—



—



—



50Balance at March 31, 2010

$
11,518


$
2,877


$
151


$
(4,677
)

$
35,203


$
(224
)

$
(1,266
)

$
43,582Preferred Stock


Common

Stock


Stock

Warrants


Treasury

Stock


Surplus


Accumulated

Deficit


Accumulated

Other

Compre-

hensive

Loss


TotalBalance at January 1, 2009

$
—


$
2,867


$
—


$
(4,811
)

$
35,082


$
(1,062
)

$
(2,018
)

$
30,058Comprehensive income:Net income for three months

ended March 31, 2009


—



—



—



—



—



480



—



480Other comprehensive income, net

of tax:Unrealized losses on AFS

securities, net


—



—



—



—



—



—



(872
)


(872
)Total comprehensive income (loss)


—



—



—



—



—



—



—



(392
)Issuance of Preferred Stock


11,599



—



—



—



—



—



—



11,599Stock warrants issued


—



—



151



—



—



—



—



151Purchase of Treasury Stock (2,354

shares)


—



—



—



(21
)


—



—



—



(21
)Preferred stock discount accretion


5



—



—



—



—



(6
)


—



(1
)Restricted stock compensation


—



2



—



—



23



—



—



25Cash dividends-Common ($.07 per

share)


—



—



—



—



—



(169
)


—



(169
)Cash dividends-Preferred


—



—



—



—



—



(98
)


—



(98
)Balance at March 31, 2009

$
11,604


$
2,869


$
151


$
(4,832
)

$
35,105


$
(855
)

$
(2,890
)

$
41,152




See accompanying notes to unaudited consolidated financial statements.




5





DNB Financial Corporation and Subsidiary


Consolidated Statements of Cash Flows (Unaudited)





Three Months Ended March 31,(Dollars in thousands)

2010


2009Cash Flows From Operating Activities:Net income

$
675


$
480Adjustments to reconcile net income to net cashprovided by (used by) operating activities:Depreciation, amortization and accretion


688



430Provision for credit losses


426



100Unvested stock amortization


26



25Net gain on sale of securities


(696
)


(502
)Net loss on sale of OREO and other repossessed property


7



69Increase in accrued interest receivable


(229
)


(382
)Increase (decrease) in other assets


374



(666
)Earnings from investment in BOLI


(62
)


(63
)Decrease in accrued interest payable


(162
)


(154
)Increase in deferred tax (benefit) expense


(17
)


93Decrease in other liabilities


(268
)


(466
)Net Cash Provided (Used) By Operating Activities


762



(1,036
)Cash Flows From Investing Activities:Activity in available-for-sale securities:Sales


59,227



12,411Maturities, repayments and calls


9,983



5,572Purchases


(74,689
)


(52,245
)Activity in held-to-maturity securities:Maturities, repayments and calls


4,363



4,681Purchases


—



(2,023
)Net increase in restricted stock


(298
)


—Net (increase) decrease in loans and leases


(4,212
)


4,851Proceeds from sale of OREO and other repossessed property


1,265



342Purchase of office property and equipment


(64
)


(243
)Net Cash Provided (Used) By Investing Activities


(4,425
)


(26,654
)Cash Flows From Financing Activities:Net (decrease) increase in deposits


(7,493
)


21,478Decrease in FHLB advances


(23,000
)


—Increase in short term repurchase agreements


9,885



1,628Decrease in lease obligations


(5
)


(4
)Dividends paid


(226
)


(169
)Issuance of preferred stock and warrants


—



11,750Sale (purchase) of treasury stock


50



(21
)Net Cash Provided (Used) By Financing Activities


(20,789
)


34,662Net Change in Cash and Cash Equivalents


(24,452
)


6,972Cash and Cash Equivalents at Beginning of Period


43,832



48,118Cash and Cash Equivalents at End of Period

$
19,380


$
55,090Supplemental Disclosure of Cash Flow Information:Cash paid during the period for:Interest

$
2,408


$
2,771Income taxes


461



352Supplemental Disclosure of Non-cash Flow Information:Change in unrealized losses on investment securities

$
256


$
(1,333
)Change in deferred taxes due to change in unrealizedlosses on AFS securities


(87
)


461Change in unsettled securities sold included in other assets


(2,920
)


(22,041
)Change in unsettled loans purchased included in other liabilities


832



—Transfers from loans and leases to other real estate owned


453



44See accompanying notes to unaudited consolidated financial statements.








6





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, 2010, 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, 2009.





Subsequent Events--Management has considered subsequent events through the date of this filing in preparing the March 31, 2010 Consolidated Financial Statements (Unaudited).





NOTE 2: INVESTMENT SECURITIES





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




March 31, 2010(Dollars in thousands)

Amortized

Cost


Unrealized

Gains


Unrealized

Losses


Estimated

Fair ValueHeld To MaturityGovernment Sponsored Entities (GSE) mortgage-backed securities

$
9,933


$
315


$
—


$
10,248Collateralized mortgage obligations (GSE)


3,372



42



(23
)


3,391State and municipal tax-exempt bonds


4,245



95



—



4,340State and municipal taxable bonds


22,287



366



(1,070
)


21,583Total

$
39,837


$
818


$
(1,093
)

$
39,562Available For SaleUS Government agency obligations

$
80,385


$
138


$
(100
)

$
80,423Government Sponsored Entities (GSE) mortgage-backed securities


56,579



54



(409
)


56,224Collateralized mortgage obligations (GSE)


15,081



170



—



15,251Corporate bonds


7,033



56



(42
)


7,047Equity securities


32



—



(17
)


15Total

$
159,110


$
418


$
(568
)

$
158,960





December 31, 2009(Dollars in thousands)

Amortized

Cost


Unrealized

Gains


Unrealized

Losses


Estimated

Fair ValueHeld To MaturityGovernment Sponsored Entities (GSE) mortgage-backed securities

$
12,809


$
348


$
—


$
13,157Collateralized mortgage obligations (GSE)


3,667



29



(24
)


3,672State and municipal tax-exempt bonds


5,454



105



—



5,559State and municipal taxable bonds


22,236



294



(1,176
)


21,354Total

$
44,166


$
776


$
(1,200
)

$
43,742Available For SaleUS Government agency obligations

$
62,168


$
64


$
(172
)

$
62,060Government Sponsored Entities (GSE) mortgage-backed securities


59,593



432



(181
)


59,844Collateralized mortgage obligations (GSE)


11,723



64



(37
)


11,750Corporate bonds


22,752



54



(611
)


22,195Equity securities


32



—



(19
)


13Total

$
156,268


$
614


$
(1,020
)

$
155,862








7





DNB FINANCIAL CORPORATION AND SUBSIDIARY


NOTES TO CONSOLIDATED FINANCIAL STATEMENTS


(Unaudited)







Included in unrealized losses are market losses on securities that have been in a continuous unrealized loss position for twelve months or more and those securities that have been in a continuous unrealized loss position for less than twelve months. The table below details the aggregate unrealized losses and aggregate fair value of the underlying securities whose fair values are below their amortized cost at March 31, 2010 and December 31, 2009.




March 31, 2010(Dollars in thousands)

Total

Fair Value


Total

Unrealized

Loss


Fair value

Impaired

Less Than

12 Months


Unrealized

Loss

Less Than

12 Months


Fair value

Impaired

More Than

12 Months


Unrealized

Loss

More Than

12 MonthsHeld To MaturityCollateralized mortgage obligations (GSE)

$
1,013


$
(23
)

$
—


$
—


$
1,013


$
(23
)State and municipal taxable


11,812



(1,070
)


5,526



(195
)


6,286



(875
)Total

$
12,825


$
(1,093
)

$
5,526


$
(195
)

$
7,299


$
(898
)Available For SaleCorporate bonds

$
3,332


$
(42
)

$
1,581


$
(6
)

$
1,751


$
(36
)US Government agency obligations


34,916



(100
)


34,916



(100
)


—



—GSE mortgage-backed securities


49,025



(409
)


49,025



(409
)


—



—Equity securities


15



(17
)


—



—



15



(17
)Total

$
87,288


$
(568
)

$
85,522


$
(515
)

$
1,766


$
(53
)





December 31, 2009(Dollars in thousands)

Total

Fair Value


Total

Unrealized

Loss


Fair value

Impaired

Less Than

12 Months


Unrealized

Loss

Less Than

12 Months


Fair value

Impaired

More Than

12 Months


Unrealized

Loss

More Than

12 MonthsHeld To MaturityCollateralized mortgage obligations (GSE)

$
2,202


$
(24
)

$
1,123


$
(2
)

$
1,079


$
(22
)State and municipal taxable


12,679



(1,176
)


6,546



(169
)


6,133



(1,007
)Total

$
14,881


$
(1,200
)

$
7,669


$
(171
)

$
7,212


$
(1,029
)Available For SaleCorporate bonds

$
12,239


$
(611
)

$
5,877


$
(308
)

$
6,362


$
(303
)US Government agency obligations


29,863



(172
)


29,863



(172
)


—



—Collateralized mortgage obligations (GSE)


7,134



(37
)


7,134



(37
)


—



—GSE mortgage-backed securities


11,896



(181
)


11,896



(181
)


—



—Equity securities


13



(19
)


—



—



13



(19
)Total

$
61,145


$
(1,020
)

$
54,770


$
(698
)

$
6,375


$
(322
)




As of March 31, 2010, there were 11 mortgage backed securities, 7 municipal obligations, 4 corporate bonds, 11 agency notes, 2 collateralized mortgage obligations and 7 equity securities which were in an unrealized loss position. DNB does not intend to sell these securities and management of DNB does not expect to be required to sell any of these securities prior to a recovery of its cost basis. Management does not believe any individual unrealized loss as of March 31, 2010 represents an other-than-temporary impairment. DNB had $1.8 million in AFS securities and $7.3 million in HTM securities, which have had fair values below amortized cost for more than twelve continuous months at March 31, 2010. The total unrealized loss of these securities was $53,000 and $898,000, respectively. DNB reviews its investment portfolio on a quarterly basis judging each investment for other-than temporary impairment (OTTI). The OTTI analysis focuses on duration and amount a security is below book. As of March 31, 2010, the following securities were reviewed:




GSE Collateralized mortgage obligations.  The unrealized losses on two investments in collateralized mortgage obligations portfolio were caused by interest rate increases and have been impaired for more than twelve months. The contractual terms of those investments do not permit the issuer to settle these securities at a price less than the amortized cost basis of the investments. Because DNB does not intend to sell the investments and it is not more likely than not that DNB will be required to sell the investments before recovery of their amortized cost basis, which may be maturity, DNB does not consider these investments to be other-than-temporarily impaired at March 31, 2010.







8




DNB FINANCIAL CORPORATION AND SUBSIDIARY


NOTES TO CONSOLIDATED FINANCIAL STATEMENTS


(Unaudited)







Corporate bonds.  The unrealized losses on the three investments in the Corporate Bonds portfolio were caused by three factors: an increase in rates since the bonds were purchased, a decline in certain bonds ratings since the bonds were purchased and a widening of corporate spreads over treasury equivalents since the bonds were purchased. At March 31, 2010, all of the bonds were rated as investment grade by one or more of the major rating agencies and were impaired for more than twelve months. The contractual terms of those investments do not permit the issuer to settle the securities at a price less than the amortized cost basis of the investments. Because DNB does not intend to sell the investments and it is not more likely than not that DNB will be required to sell the investments before recovery of their amortized cost basis, which may be maturity, DNB does not consider these investments to be other-than-temporarily impaired at March 31, 2010.




Equity securities.  DNB’s investment in seven marketable equity securities consist primarily of investments in common stock of community banks in Pennsylvania. The unrealized losses on the six investments in the Equity securities portfolio were all impaired for more than twelve months. The severity and duration of the impairment are driven by higher collateral losses, wider credit spreads, and changes in interest rates within the financial services sector. DNB evaluated the prospects of all issuers in relation to the severity and duration of the impairment. Based on this analysis and an evaluation of DNB’s ability and intent to hold these investments for a reasonable period of time sufficient for each security to increase to DNB’s cost, DNB does not intend to sell these investments and it is not more likely than not that DNB will be required to sell the investments before recovery of their cost, DNB does not consider these investments to be other-than-temporarily impaired at March 31, 2010.




State and municipal taxable securities.  The unrealized losses on the seven investments in State and municipal taxable securities portfolio were caused by the fact that some of the insurance companies that were insuring these bonds, were downgraded, and consequently, the overall ratings on the bonds declined (however the underlying ratings on these bonds have not declined). In addition, the Federal government passed legislation promoting Build America Bonds in an effort to stimulate the economy. Build America Bonds are more attractive to potential buyers than bonds issued in prior years in our portfolio, because Build America Bonds are taxable municipal bonds that carry special tax credits and federal subsidies for either the bond issuer or the bondholder. Build America Bonds were created under the American Recovery and Reinvestment Act signed into law on February 17, 2009. There were no changes in the underlying credit of these bonds. Three are impaired for less than twelve months and four are impaired for more than twelve months. The contractual terms of those investments do not permit the issuer to settle the securities at a price less than the amortized cost basis of the investments. Because DNB does not intend to sell the investments and it is not more likely than not that DNB will be required to sell the investments before recovery of their amortized cost basis, which may be maturity, DNB does not consider these investments to be other-than-temporarily impaired at March 31, 2010. A further description of the four securities impaired for more that twelve months is as follows:





DNB holds a zero coupon taxable limited general obligation municipal bonds backed by property taxes. Bonds are insured by AGM. Bonds are rated Aa3 by Moody’s. The issuer, Cook County School District #89, has never deferred or defaulted on interest payments on this issue, so credit risk is acceptable. Taxable municipal bonds trade frequently, so liquidity risk is acceptable. The security matures on 12/1/15 with a modified duration of 5.5 years, so interest rate risk is acceptable. With no embedded options, earnings potential is good. This bond currently has a loss of $83,661 which represents 5.43% of book value.




DNB holds a fixed rate taxable unlimited general obligation municipal bond backed by ad valorem property taxes. Bonds are insured by AMBAC. Bonds are not rated. The issuer, Blount County, TN, has never deferred or defaulted on interest payments on this issue, so credit risk is acceptable. Taxable municipal bonds trade frequently, so liquidity risk is acceptable. The security matures on 6/1/24 with a modified duration of 9.02 years, so interest rate risk is acceptable. With a coupon of 6.00% and a call option on 6/1/17, earnings potential is good. This bond currently has a loss of $376,397 which represents 18.6% of book value.




DNB holds a fixed rate taxable tax allocation municipal bond backed by tax increment allocation revenues. Bonds are insured by AMBAC. Bonds are rated A- by S&P with an A- underlying rating. The issuer, Monrovia, CA, has never deferred or defaulted on interest payments on this issue, so credit risk is acceptable. Taxable municipal bonds trade frequently, so liquidity risk is acceptable. The security matures on 5/1/28 with a modified duration of 10.1 years, so interest rate risk is acceptable. With a coupon of 6.28% and a call option on 5/1/16, earnings potential is good. This bond currently has a loss of $94,711 which represents 13.6% of book value.




DNB holds a fixed rate taxable revenue municipal bond backed by university revenues. Bonds are insured by XLCA. Bonds are rated A1 by Moody’s with an A1 underlying rating. The issuer, Iowa University, has never deferred or defaulted on interest payments on this issue, so credit risk is acceptable. Taxable municipal bonds trade frequently, so liquidity risk is acceptable. The security matures on 7/1/33 with a modified duration of 11.7 years, so interest rate risk is acceptable. With a coupon of 6.10% and a call option on 7/1/18, earnings potential is good. This bond currently has a loss of $320,794 which represents 11.0% of book value.




9





DNB FINANCIAL CORPORATION AND SUBSIDIARY


NOTES TO CONSOLIDATED FINANCIAL STATEMENTS


(Unaudited)












The amortized cost and estimated fair value of investment securities as of March 31, 2010, by contractual maturity, are shown below. Actual maturities may differ from contractual maturities because certain securities may be called or prepaid without penalties.




Held to Maturity


Available for Sale(Dollars in thousands)

Amortized

Cost


Estimated

Fair Value


Amortized

Cost


Estimated

Fair ValueDue in one year or less

$
2,651


$
2,669


$
6,536


$
6,546Due after one year through five years


5,126



5,332



64,559



64,564Due after five years through ten years


19,284



19,572



10,986



10,995Due after ten years


12,776



11,989



76,997



76,840No stated maturity


—



—



32



15Total investment securities

$
39,837


$
39,562


$
159,110


$
158,960











DNB sold $59.2 million and $12.4 million securities from the AFS portfolio during the three months ended March 31, 2010 and 2009, respectively. Gains and losses resulting from investment sales, redemptions or calls were as follows:




Three months ended March 31(Dollars in thousands)

2010


2009Gross realized gains

$
859


$
502Gross realized losses


163



—Net realized gain

$
696


$
502






At March 31, 2010 and December 31, 2009, investment securities with a carrying value of approximately $110 million and $158 million, respectively, were pledged to secure public funds, repurchase agreements, FHLB advances and for other purposes as required by law.




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









NOTE 3: 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, warrants and the amortized portion of unvested stock awards.   Stock options and unvested stock awards for which the exercise or the grant price exceeds the average market price over the period have an anti-dilutive effect on EPS and, accordingly, are excluded from the calculation.  Treasury shares are not deemed outstanding for calculations. There were 186,311 anti-dilutive stock warrants, 169,503 anti-dilutive stock options outstanding and 23,601 anti-dilutive stock awards at March 31, 2010. There were 186,311 anti-dilutive stock warrants, 191,247 anti-dilutive stock options outstanding and 24,101 anti-dilutive stock awards at March 31, 2009.   The dilutive effect of stock options and unvested shares on basic earnings per share is presented below.








10





DNB FINANCIAL CORPORATION AND SUBSIDIARY


NOTES TO CONSOLIDATED FINANCIAL STATEMENTS


(Unaudited)








Three Months Ended


Three Months EndedMarch 31, 2010


March 31, 2009(In thousands, except per-share data)

Income


Shares


Amount


Income


Shares


AmountBasic EPSIncome available to common stockholders

$
521



2,620


$
0.20


$
377



2,603


$
0.14Effect of dilutive common stock equivalents – stock

options, restricted shares and warrants


—



—



—



—



—



—Diluted EPSIncome available to common stockholders after

assumed conversions

$
521



2,620


$
0.20


$
377



2,603


$
0.14











NOTE 4: COMPREHENSIVE INCOME (LOSS)





Comprehensive income (loss) includes all changes in stockholders' equity during the period, except those resulting from investments by owners and distributions to owners.  Comprehensive income (loss) for all periods consisted of net income and other comprehensive income (loss) relating to the change in unrealized gains (losses) on investment securities available for sale and accretion of the discount on AFS Securities transferred to HTM.  Comprehensive income (loss), net of tax, is disclosed in the following table. The effect of pension adjustments will be made during the last quarter of each fiscal year.





Three Months Ended


Three Months EndedMarch 31, 2010


March 31, 2009(Dollars in thousands)

Net-of-Tax Amount


Net-of-Tax AmountNet Income

$
675


$
480Other Comprehensive Income:Unrealized holding gains (losses) arising during the period


628



(564
)Accretion of discount on AFS to HTM reclassification


12



23Reclassification for gains included in net income


(459
)


(331
)Total Comprehensive Income (Loss)

$
856


$
(392
)








The components of accumulated other comprehensive income included in stockholders’ equity, are as follows:





March 31,


December 31,2010


2009(Dollars in thousands)

Net-of-Tax Amount


Net-of-Tax AmountNet unrealized loss on AFS securities

$
(99
)

$
(268
)Discount on AFS to HTM reclassification


(380
)


(392
)Unrealized actuarial losses-pension


(787
)


(787
)Total of all items above

$
(1,266
)

$
(1,447
)














11














DNB FINANCIAL CORPORATION AND SUBSIDIARY


NOTES TO CONSOLIDATED FINANCIAL STATEMENTS


(Unaudited)





NOTE 5: 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)

2010


2009Commercial mortgage

$
181,387


$
172,117Commercial term and lines of credit


87,410



87,778Consumer


54,135



55,504Residential mortgage


38,546



40,951Commercial leases


2,494



3,077Gross loans and leases


363,972


$
359,427Allowance for credit losses


(5,857
)


(5,477
)Net loans and leases

$
358,115


$
353,950





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




(Dollars in thousands)

Three Months

Ended March 31,

2010


Year Ended

December 31,

2009Beginning balance

$
5,477


$
4,586Provisions


426



1,325Charge-offs


(81
)


(595
)Recoveries


35



161Ending balance

$
5,857


$
5,477








NOTE 6: 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 $5.0 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.





12





DNB FINANCIAL CORPORATION AND SUBSIDIARY


NOTES TO CONSOLIDATED FINANCIAL STATEMENTS


(Unaudited)








NOTE 7: RECENT ACCOUNTING PRONOUNCEMENTS







In June 2009, the FASB issued new guidance impacting FASB ASC 860, Transfers and Servicing ASC Topic 860, “Transfers and Servicing.” New authoritative accounting guidance under ASC Topic 860, “Transfers and Servicing,” amends prior accounting guidance as follows: (i) eliminates the concept of a qualified special purpose entity (“QSPE”); (ii) requires a transferor to consider all arrangements made contemporaneously with or in anticipation of a transfer when determining whether derecognition is appropriate; (iii) clarifies the requirement that a transferred financial asset be legally isolated from the transferor and any of its consolidated affiliates; (iv) introduces the concept of a participating interest which is applied to transfers of portions of financial assets to determine derecognition eligibility; (v) modifies the conditions required for a transfer of financial assets to qualify as a sale; (vi) changes the initial measurement guidance for asset transfers that qualify as sales: and (vii) stipulates that guaranteed mortgage securitizations (“GMS”) that fail to meet the conditions for sale accounting will result in the continued classification of the securitized mortgage loans as loans and will not enable a transferor to recognize a servicing asset or liability. The new authoritative accounting guidance under ASC Topic 860 was be effective January 1, 2010 and had no impact on the Corporation’s consolidated financial statements.




In April 2009, the FASB issued new guidance impacting ASC 820-10, “Fair Value Measurements and Disclosures” to provide guidance on determining fair value when the volume and level of activity for the asset or liability have significantly decreased and identifying transactions that are not orderly. This issuance provides guidance on estimating fair value when there has been a significant decrease in the volume and level of activity for the asset or liability and for identifying transactions that may not be orderly. The guidance requires entities to disclose the inputs and valuation techniques used to measure fair value and to discuss changes in valuation techniques and related inputs, if any, in both interim and annual periods. The Corporation adopted this standard on June 30, 2009. The adoption had no impact on the Corporation’s consolidated financial statements.




In December 2009, the FASB issued FASB ASC 810, Consolidations. This accounting guidance was originally issued in June 2009 and is now included in ASC 810. The guidance amends the consolidation guidance applicable for variable interest entities. The guidance is effective for financial statements issued for fiscal years and interim periods beginning after November 15, 2009. The adoption had no impact on the Corporation’s consolidated financial statements.




In January 2010, the FASB issued ASU 2010-06, Fair Value Measurements and Disclosures (Topic 820) – Improving Disclosures about Fair Value Measurements.  ASU 2010-06 revises two disclosure requirements concerning fair value measurements and clarifies two others.  It requires separate presentation of significant transfers into and out of Levels 1 and 2 of the fair value hierarchy and disclosure of the reasons for such transfers.  It will also require the presentation of purchases, sales, issuances and settlements within Level 3 on a gross basis rather than a net basis.  The amendments also clarify that disclosures should be disaggregated by class of asset or liability and that disclosures about inputs and valuation techniques should be provided for both recurring and non-recurring fair value measurements.  The Corporation’s disclosures about fair value measurements are presented in Note 10 to the consolidated financial statements.  These new disclosure requirements were adopted by the Corporation during the current period, with the exception of the requirement concerning gross presentation of Level 3 activity, which is effective for fiscal years beginning after December 15, 2010.  With respect to the portions of this ASU that were adopted during the current period, the adoption of this standard did not have a significant impact on the Corporation’s financial position, results of operations or disclosures.  Management does not believe that the adoption of the remaining portion of this ASU will have a significant impact on the Corporation’s ongoing financial position, results of operation or disclosures.








NOTE 8: 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 223,079 and 201,335 options available for grant at March 31, 2010 and March 31, 2009, respectively.  All options outstanding are immediately exercisable. Stock option activity for the three-month period ended March 31, 2010 is indicated below.








13





DNB FINANCIAL CORPORATION AND SUBSIDIARY


NOTES TO CONSOLIDATED FINANCIAL STATEMENTS


(Unaudited)










Number


Weighted AverageOutstanding


Exercise PriceOutstanding January 1, 2010


169,503


$
19.19Granted


–



–Exercised


–



–Expired


–



–Forfeited


–



–Outstanding March 31, 2010


169,503


$
19.19





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, 2010Range of
Number
Weighted AverageExercise Prices
Outstanding
Exercise Price
Remaining Contractual Life$ 9.23-10.99
9,419
$9.23
0.25 years11.00-13.99
9,414
11.16
1.25 years14.00-19.99
82,805
17.44
4.73 years20.00-22.99
19,824
22.78
4.73 years23.00-24.27
48,041
24.27
5.05 yearsTotal
169,503
$19.19
4.38 yearsIntrinsic value
$—





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 yearsIntrinsic value
$—








14





DNB FINANCIAL CORPORATION AND SUBSIDIARY


NOTES TO CONSOLIDATED FINANCIAL STATEMENTS


(Unaudited)





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 Corporation.  DNB did not grant any shares of restricted stock during the three-month period ended March 31, 2010. 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.





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, 2010, $26,000 was amortized to expense compared to $25,000 during the same period in 2009.  At March 31, 2010, 206,413 shares were reserved for future grants under the plan.  Stock grant activity is indicated below.





SharesUnvested stock awards - January 1, 2010
24,101Granted
–Forfeited
(500)Unvested stock awards – March 31, 2010
23,601





SharesUnvested stock awards - January 1, 2009
24,574Granted
–Forfeited
(473)Unvested stock awards – March 31, 2009
24,101








NOTE 9:  INCOME TAXES





As of March 31, 2010, the Corporation had no material unrecognized tax benefits or accrued interest and penalties. It is the Corporation’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 2006 through 2009 were open for examination as of March 31, 2010. Income tax expense for the three month period ended March 31, 2010 was $271,000 compared to $89,000 for the same period in 2009. The effective tax rate for the three month periods ended March 31, 2010 was 28.6%, compared to 15.7% for the same period in 2009.





NOTE 10:  FAIR VALUE MEASUREMENT AND DISCLOSURES





FASB ASC Topic 820, Fair Value Measurements and Disclosures, 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.




The three levels of the fair value hierarchy under FASB ASC Topic 820 are as follows:




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 drivers are observable.




Level 3 — Instruments whose significant value drivers are unobservable.




15





DNB FINANCIAL CORPORATION AND SUBSIDIARY


NOTES TO CONSOLIDATED FINANCIAL STATEMENTS


(Unaudited)












A description of the valuation methodologies used for assets measured at fair value is set forth below:




DNB’s available-for-sale investment securities, which generally include U.S. government agencies and mortgage backed securities, collateralized mortgage obligations, corporate bonds and equity 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.




Impaired loans are those loans that the Bank has measured impairment generally based on the fair value of the loan’s collateral. Fair value is generally determined based upon independent third-party appraisals of the properties, or discounted cash flows based upon the expected proceeds. These assets are included as Level 3 fair values, based upon the lowest level of input that is significant to the fair value measurements.




OREO assets are adjusted to fair value less estimated selling costs upon transfer of the loans to OREO. Subsequently, OREO assets are carried at the lower of carrying value or fair value. Fair value is based upon independent market prices, appraised values of the collateral or management’s estimation of the value of the collateral. There assets are included as level 3 fair values.





The following table summarizes the assets at March 31, 2010 and December 31, 2009 that are recognized on DNB’s balance sheet using fair value measurement determined based on the differing levels of input.


March 31, 2010(Dollars in thousands)

Level 1


Level 2


Level 3


Assets at

Fair ValueAssets Measured at Fair Value on a Recurring BasisSecurities available for sale

$
15


$
158,945


$
—


$
158,960Total assets measured at fair value on a recurring basis

$
15


$
158,945


$
—


$
158,960Assets Measured at Fair Value on a Nonrecurring BasisImpaired loans

$
—


$
—


$
3,032


$
3,038OREO & other repossessed property


—



—



3,670



3,670Total assets measured at fair value on a nonrecurring basis

$
—


$
—


$
6,708


$
6,708











December 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


$
155,849


$
—


$
155,862Total assets measured at fair value on a recurring basis

$
13


$
155,849


$
—


$
155,862Assets Measured at Fair Value on a Nonrecurring BasisImpaired loans

$
—


$
—


$
2,966


$
2,966OREO & other repossessed property


—



—



4,489



4,489Total assets measured at fair value on a nonrecurring basis

$
—


$
—


$
7,455


$
7,455






16





DNB FINANCIAL CORPORATION AND SUBSIDIARY


NOTES TO CONSOLIDATED FINANCIAL STATEMENTS


(Unaudited)











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 $9.2 million at March 31, 2010. Of this, $3.8 million had a valuation allowance of $744,000 and $5.4 million had no allowance as of March 31, 2010. Impaired loans had a carrying amount of $9.0 million at December 31, 2009. Of this, $3.5 million had a valuation allowance of $531,000 and $5.5 million had no allowance as of December 31, 2009.




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 are initially recorded at fair value less cost to sell at the date of foreclosure, establishing a new cost basis. Subsequent to foreclosure, valuations are periodically performed by management and the assets are carried 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 $3.7 million of such assets at March 31, 2010, which consisted of $3.5 million in OREO and $155,000 in other repossessed property. DNB had $4.5 million of such assets at December 31, 2009, which consisted of $4.4 million in OREO and $109,000 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, 2010, based on appraisals.




Below is management’s estimate of the fair value of all financial instruments, whether carried at cost or fair value, on the Corporation’s consolidated statement of financial condition. The carrying amounts and estimated fair values of financial instruments at March 31, 2010 and December 31, 2009 are as follows:







March 31, 2010


December 31, 2009(Dollars in thousands)

Carrying

Amount


Estimated

Fair

Value


Carrying

Amount


Estimated

Fair

ValueFinancial assetsCash and cash equivalents

$
19,380


$
19,380


$
43,832


$
43,832AFS Investment securities


158,960



158,960



155,862



155,862HTM Investment securities


39,837



39,562



44,166



43,742Restricted stock


4,365



4,365



4,067



4,067Loans and leases, net of allowance


358,115



350,477



353,950



346,986Accrued interest receivable


2,932



2,932



2,703



2,703Financial liabilitiesDeposits


499,854



496,155



507,347



503,552Borrowings


57,051



59,783



70,171



73,782Junior subordinated debentures


9,279



7,479



9,279



5,647Accrued interest payable


581



581



743



743Off-balance sheet instruments


—



—



—



—




The specific estimation methods and assumptions used can have a substantial impact on the resulting fair values of financial instruments. Following is a brief summary of the significant assumptions, methods, and estimates used in estimating fair value.




Limitations Fair value estimates are made at a specific point in time, based on relevant market information about the financial instrument. These estimates do not reflect any premium or discount that could result from offering for sale at one time DNB’s entire holdings of a particular financial instrument. Because no market exists for a significant portion of DNB’s financial instruments, fair value estimates are based on judgments regarding future expected loss experience, current economic conditions, risk characteristics of various financial instruments, and other factors. These estimates are subjective in nature and involve uncertainties and matters of significant judgment and therefore cannot be determined with precision. Changes in assumptions could significantly affect the estimates.







17









DNB FINANCIAL CORPORATION AND SUBSIDIARY


NOTES TO CONSOLIDATED FINANCIAL STATEMENTS


(Unaudited)







Cash and Cash Equivalents, Investment Securities, Accrued Interest Receivable and Accrued Interest Payable The carrying amounts for short-term investments (cash and cash equivalents) and accrued interest receivable and payable approximate fair value. The fair value of investment securities are determined 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. The carrying amount of non-readily marketable equity securities (restricted stock) approximates liquidation value.




Loans Fair values are estimated for portfolios of loans with similar financial characteristics. Loans are segregated by type such as commercial, commercial mortgages, residential mortgages, consumer loans and non-accrual loans. The fair value of performing loans is calculated by discounting expected cash flows using an estimated market discount rate. Expected cash flows include both contractual cash flows and prepayments of loan balances. Prepayments on consumer loans were determined using the median of estimates of securities dealers for mortgage-backed investment pools.




The estimated discount rate considers credit and interest rate risk inherent in the loan portfolios and other factors such as liquidity premiums and incremental servicing costs to an investor. Management has made estimates of fair value discount rates that it believes to be reasonable. However, because there is no market for many of these financial instruments, management has no basis to determine whether the fair value presented below would be indicative of the value negotiated in an actual sale.




The fair value for non-accrual loans not based on fair value of collateral was derived through a discounted cash flow analysis, which includes the opportunity costs of carrying a non-performing asset. An estimated discount rate was used for these non-accrual loans, based on the probability of loss and the expected time to recovery.




Deposits and Borrowings  The fair value of deposits with no stated maturity, such as non-interest- bearing deposits, savings, NOW and money market accounts, is equal to the amount payable on demand. The fair values of time deposits and borrowings are based on the present value of contractual cash flows. The discount rates used to compute present values are estimated using the rates currently offered for deposits of similar maturities in DNB’s marketplace and rates currently being offered for borrowings of similar maturities.




Off-balance-sheet Instruments (Disclosed at Cost) Off-balance-sheet instruments are primarily comprised of loan commitments, which are generally priced at market at the time of funding. Fees on commitments to extend credit and stand-by letters of credit are deemed to be immaterial and these instruments are expected to be settled at face value or expire unused. It is impractical to assign any fair value to these instruments. At March 31, 2010, un-funded loan commitments totaled $64.9 million. Stand-by letters of credit totaled $2.6 million at March 31, 2010. At December 31, 2009, un-funded loan commitments totaled $55.2 million. Stand-by letters of credit totaled $2.8 million at December 31, 2009.









NOTE 11:  STOCKHOLDERS’ EQUITY




Stockholders' equity was $43.6 million at March 31, 2010 compared to $42.9 million at December 31, 2009. The increase in stockholders’ equity was primarily a result of year-to-date earnings of $675,000 and a $181,000, net-of-tax SFAS 115 adjustment on the securities portfolio. These additions to stockholders equity were partially offset by $79,000 of dividends paid on DNB’s common stock and $147,000 of dividends accrued on DNB’sFixed Rate Cumulative Perpetual Preferred Stock.




18




DNB FINANCIAL CORPORATION AND SUBSIDIARY


NOTES TO CONSOLIDATED FINANCIAL STATEMENTS


(Unaudited)





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 Corporation’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 2010 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.





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 2009, 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 on DNB’s Key Strategies follows below:




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




•
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




19





Strategic Plan Update During the first quarter of 2010, management repaid $18.0 million of borrowings from the Federal Home Loan Bank (FHLB) with an average interest rate of 5.56%. In addition to strengthening DNB’s balance sheet, the transaction is expected to significantly reduce interest expense and increase net income in 2010. Net interest income increased $908,000 during the first quarter of 2010 to $4.4 million, compared to $3.5 million for the same period in 2009. The increase during the three month period was due primarily to higher levels of loan balances and investment securities combined with a reduction in interest expense.  DNB continued to focus on expense control during the first quarter. Absent the $560,000 prepayment penalty paid to the FHLB, non-interest expense would have declined approximately $64,000 compared to the first quarter of 2009.  Management has been able to maintain a stable core level of expenses, despite higher FDIC insurance premiums and additions to the commercial lending staff in the third quarter of 2009. Capital remained strong at the end of the first quarter of 2010, as DNB’s tier 1 leverage ratio stood at 8.43% and its total risk-based capital ratio stood at 14.61%, well above the levels of 5.00% and 10.00% respectively to be deemed “well capitalized” for regulatory purposes and also at levels management feels are appropriate for current market conditions.




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, 2010.





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 and 300 basis points in addition to four yield curve twists over a twelve-month period.





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).








20


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, such as Mobile Banking, Rewards Checking, Credit Cards as well as Executive and employee packages. In addition, DNB has introduced Remote Capture to our commercial customers to expedite their collection of funds.




Deposit Insurance Assessments. The deposits of the Bank are insured by the FDIC up to the limits set forth under applicable law and are subject to deposit insurance premium assessments. The FDIC imposes a risk based deposit premium assessment system, under which the amount of FDIC assessments paid by an individual insured depository institution, such as the Bank, is based on the level of risk incurred in its activities. The FDIC places a depository institution in one of four risk categories determined by reference to its capital levels and supervisory ratings. In addition, in the case of those institutions in the lowest risk category, the FDIC further determines its assessment rates based on certain specified financial ratios. Pursuant to the Federal Deposit Insurance Act, the FDIC has authority and the responsibility to establish deposit insurance assessments at rates sufficient to maintain the designated reserve ratio of the Deposit Insurance Fund at a level between 1.15% and 1.5% of estimated insured deposits, and to take action to restore the designated reserve ratio to at least 1.15% of estimated insured deposits when it falls below that level. As of June 30, 2008, the designated reserve ratio fell below 1.15%, to 1.01%. On October 7, 2008, the FDIC established a restoration plan which is has updated periodically since then to respond to deteriorating economic conditions. Conditions in the banking industry have continued to deteriorate through 2008 and 2009. According to the FDIC’s Quarterly Banking Profile for the Fourth Quarter 2009, as of December 30, 2009 the designated reserve ratio had fallen to (0.39%), down from (0.16%) on September 30, 2009, and 0.36% as of December 31, 2008. The FDIC reports that the December 31, 2009 reserve ratio is the lowest on record for a combined bank and thrift insurance fund. In response to the declining reserve ratio, the FDIC took a series of extraordinary deposit insurance assessment actions during 2009.




Effective for the second quarter of 2009, the FDIC adopted changes to its base and risk-based deposit insurance rates. Pursuant to the new rules, a bank’s annual assessment base rates were as follows, depending on the bank’s risk category:




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




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






21




On May 22, 2009, the FDIC adopted a final rule imposing a 5 basis point special assessment on each insured depository institution’s assets minus Tier 1 capital as of June 30, 2009. The amount of the special assessment for any institution did not exceed 10 basis points times the institution’s assessment base for the second quarter 2009. The assessment, in the amount of $280,000, was collected from the Bank on September 30, 2009.




As of December 31, 2009 the Bank had an assessment rate of 15.68 basis points, and, based on this rate, the Bank’s estimated 2010 FDIC insurance cost projection is $827,000.




On September 29, 2009, the FDIC adopted a uniform three-basis point increase in the assessment rates shown above, effective on January 1, 2011, and on November 12, 2009, the FDIC adopted a final rule to require insured institutions to prepay their estimated quarterly risk-based assessments for the fourth quarter of 2009, and for all of 2010, 2011, and 2012. The prepaid assessment was collected on December 30, 2009, along with the institution’s regular quarterly risk-based deposit insurance assessment for the third quarter of 2009. For purposes of calculating the prepaid assessment, each institution’s assessment rate was its total base assessment rate in effect on September 30, 2009. In calculating the prepayment attributable to 2011 and thereafter, it is calculated using the September 29, 2009 increase in 2011 base assessment rates. In addition, future deposit growth was reflected in the prepayment by assuming that an institution’s third quarter 2009 assessment base would be increased quarterly at a 5 percent annual growth rate through the end of 2012. The FDIC began to draw down institutions’ prepaid assessments on March 30, 2010, representing payment for the regular quarterly risk-based assessment for the fourth quarter of 2009. In announcing these initiatives, the FDIC stated that, while the prepaid assessment would not immediately affect bank earnings, each institution would record the entire amount of its prepaid assessment as a prepaid expense asset as of December 30, 2009, the date the payment was made and, as of December 31, 2009 and each quarter thereafter, record an expense or charge to earnings for its regular quarterly assessment and an offsetting credit to the prepaid assessment until the asset is exhausted. Once the asset is exhausted, institutions would resume paying and accounting for quarterly deposit insurance assessments as they currently do. The total amount of the Bank’s deposit insurance assessment prepayment was $3.1 million.




In addition to deposit insurance assessments, banks are subject to assessments to pay the interest on Financing Corporation bonds. The Financing Corporation was created by Congress to issue bonds to finance the resolution of failed thrift institutions. The FDIC sets the Financing Corporation assessment rate every quarter. The current annual Financing Corporation assessment rate is $0.0102 for each $100 of deposits, which we anticipate will result in an aggregate estimated FICO assessment payment by the Bank of $52,000 in 2010.




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 during the past two years. 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 remains high and availability to borrow against equity in primary residences 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 growth in the loan portfolio and continued negative trends in the economy and their impact on our borrowers’ ability to repay their loans, DNB made a $426,000 provision during the three months ending March 31, 2010.





Pending Financial Regulatory Reform Legislation.  Pending proposed changes in federal and state legislation and regulation may affect DNB’s operations.  Changes will be significant if Congress enacts proposed financial regulatory reform such as the Wall Street Reform and Consumer Protection Act of 2009, which passed in the House of Representatives in December 2009, or the Restoring American Financial Stability Act of 2010, which was approved by the Senate Banking Committee on March 22, 2010.  DNB cannot predict what effect any presently contemplated or future changes in financial market regulation will have on DNB.





Other Material Challenges, Risks and Opportunities. As a financial institution, DNB's earnings are significantly affected by general business and economic conditions.  These conditions include short-term and long-term interest rates, inflation, monetary supply, fluctuations in both debt and equity capital markets, and the strength of the United States economy and local economics in which we operate.  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.







22





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, 2009.





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 allowance for credit losses remains appropriate at March 31, 2010.  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, 2009.





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 $614.8 million at March 31, 2010 compared to $634.2 million at December 31, 2009.  The decrease in total assets was primarily attributable to a $24.5 million decrease in cash and cash equivalents. During the first quarter of 2010, management used $18.6 million of cash and cash equivalents to repay borrowings from the Federal Home Loan Bank (FHLB) with an average interest rate of 5.56%. In addition to strengthening DNB’s balance sheet, the transaction is expected to significantly reduce interest expense and increase net income in 2010.






23





Investment Securities. Investment securities at March 31, 2010 were $203.2 million (including $2.9 million of trade date sales) compared to $204.1 million at December 31, 2009. The $933,000 decrease in investment securities was primarily due to $73.6 million in sales, principal pay-downs and maturities, offset by the purchase of $74.7 million in investment securities. Included in the $59.2 million of investment securities sales was $2.9 million for securities which had a trade date in March 2010, and a settlement date in April 2010. 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 increased $4.5 million to $364.0 million at March 31, 2010 compared to $359.4 million at December 31, 2009.  Total commercial loans increased $8.9 million, while residential loans, consumer loans and commercial leases declined $2.4 million, $1.4 million and $583,000, respectively.





Deposits. Deposits were $499.9 million at March 31, 2010 compared to $507.3 million at December 31, 2009.  Deposits declined $7.5 million or 1.5% during the three-month period ended March 31, 2010.  Time deposits, primarily accounts greater than $100,000, declined $14.0 million, while core deposits, which are comprised of demand, NOW, money markets and savings accounts, increased $6.5 million.





Borrowings.Borrowings were $66.3 million at March 31, 2010 compared to $79.5 million at December 31, 2009.  The decrease of $13.1 million or 16.5% was primarily due to a $23.0 million decrease in FHLB advances offset by a $9.9 million increase in repurchase agreements.





Stockholders’ Equity.Stockholders' equity was $43.6 million at March 31, 2010 compared to $42.9 million at December 31, 2009.The increase in stockholders’ equity was primarily a result of year-to-date earnings of $675,000 and a $181,000, net-of-tax SFAS 115 adjustment on the securities portfolio. These additions to stockholders equity were partially offset by $79,000 of dividends paid on DNB’s common stock and $147,000 of dividends accrued on DNB’s Fixed Rate Cumulative Perpetual Preferred Stock.





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 Corporation’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 2010, 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.










RESULTS OF OPERATIONS







SUMMARY





Net income for the three-month period ended March 31, 2010 was $675,000 compared to $480,000 for the same period in 2009.  Diluted earnings per common share for the three-month period ended March 31, 2010 was $0.20 compared to $0.14 for the same period in 2009.  The $195,000 increase during the most recent three-month period was attributable to a $582,000 increase in net interest income after provision for credit losses and a $291,000 increase in non-interest income, offset by a $496,000 increase in non-interest expense and a $182,000 increase in income tax expense.  During the first quarter of 2010, management took $696,000 of gains on the investment portfolio to offset prepayment penalties totaling $560,000, which is included in non-interest expenses and repaid $18.0 million of FHLB advances with a weighted average rate of 5.56%.  In addition to reducing the size of the Company’s balance sheet and increasing capital ratios, the transaction will increase pre-tax core earnings by $378,000 in 2010.





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, 2010 was $4.0 million, compared to $3.4 million for the same periods in 2009.  Interest income for the three-month period ended March 31, 2010 was $6.7 million, compared to $6.1 million for the same periods in 2009.  The increase in interest income during the three-month period was primarily attributable to an increase in interest on loans and leases due mainly to increased average balances in the commercial mortgage portfolio.  In addition, interest and dividends on investment securities increased due to an increase in the average balance.  The yield on interest-earning assets for the three-month period ended March 31, 2010 was 4.41%, compared to 4.82% for the same period in 2009.  Interest expense for the three-month period ended March 31, 2010 was $2.2 million compared to $2.6 million for the same period in 2009.  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, 2010 was 1.55% compared to 2.14% for the same period in 2009.  The net interest margin for the three-month period ended March 31, 2010 was 2.91%, compared to 2.75% for the same period in 2009.






24





Interest on loans and leases was $5.1 million for the three-month period ended March 31, 2010, compared to $4.7 million for the same period in 2009.  The average balance of loans and leases was $360.4 million with an average yield of 5.73% for the current quarter compared to $332.4 million with an average yield of 5.73% for the same period in 2009.





Interest and dividends on investment securities was $1.5 million for the three-month period ended March 31, 2010, compared to $1.4 million for the same period in 2009.  The average balance of investment securities was $196.9 million with an average yield of 3.08% for the current quarter compared to $137.7 million with an average yield of 4.08% for the same period in 2009.  The decrease in the yield during the quarter was primarily the result of a declining interest rate environment, coupled with the sales of certain higher yielding securities.  Average cash and cash equivalents were $51.1 million for the three-month period ended March 31, 2010, compared to $42.9 million for the same period in 2009. Management’s investment strategy for DNB’s excess liquidity continues to be to seek investments with shorter durations offering good cash flows and minimal extension risk, ensuring adequate funding for future loan growth.








Interest on deposits was $1.5 million for the three-month period ended March 31, 2010, compared to $1.7 million for the same period in 2009.  The average balance of deposits was $511.2 million with an average rate of 1.20% for the current quarter compared to $405.4 million with an average rate of 1.66% for the same period in 2009.  The decrease in rate during the period was primarily attributable to a lower interest rate environment.





Interest on borrowings was $728,000 for the three-month period ended March 31, 2010, compared to $958,000 for the same period in 2009.  The average balance of borrowings was $76.7 million with an average rate of 3.85% for the current quarter compared to $91.2 million with an average rate of 4.26% for the same period in 2009.  The decrease in the average balance and the average rate on borrowings during the three months ended March 31, 2010 compared to the same period in 2009 was attributable to a $16.1 million average decline in FHLB advances, offset by an average $1.6 million increase in repurchase agreements.








PROVISION 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 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 U.S. generally accepted accounting principles, guidance provided by the Securities and Exchange Commission and as prescribed in OCC Bulletin 2006-47. Its methodology for assessing the appropriateness of the allowance consists of several key elements which include: specific allowances for identified problem loans; formula allowances for commercial and commercial real estate loans; and allowances for pooled homogenous loans. In considering national and local economic trends, we review a variety of information including Federal Reserve publications, general economic statistics, foreclosure rates and housing statistics published by third parties. We believe this improves the measure of inherent loss over a complete economic cycle and reduces the impact for qualitative adjustments. This process does not impact losses estimated in accordance with ASC 310.




The unallocated portion of the allowance is intended to provide for probable losses not otherwise accounted for in management’s other elements of its overall estimate. An unallocated component is maintained to cover uncertainties such as changes in the national and local economy, concentrations of credit, expansion into new markets and other factors that could affect management’s estimate of probable losses. The unallocated component of the allowance reflects the margin of imprecision inherent in the underlying assumptions used in the methodologies for estimating specific and general losses in the portfolio.






25






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. A reserve analysis is performed on individually reviewed loans, but not impaired loans, and excludes individually reviewed impaired loans, based on ASC 310. Historical losses are segregated into risk-similar groups and a loss ratio is determined for each group over a three year period. The three year average loss ratio by type is then used to calculate the estimated loss based on the current balance of each group. This three year time period is appropriate given the DNB’s historically low level of losses and, more importantly, represents the current economic environment.




This analysis is intended to assess the potential for loss within the loan portfolio and to substantiate the adequacy of the allowance. Should the analysis indicate that the allowance is not adequate, management will recommend a provision expense be made in an amount equal to the shortfall derived. In establishing and reviewing the allowance for adequacy, emphasis has been placed on utilizing the methodology prescribed in OCC Bulletin 2006-47. Management believes that the following factors create a comprehensive system of controls in which management can monitor the quality of the loan portfolio. Consideration has been given to the following factors and variables which may influence the risk of loss within the loan portfolio:




•
Changes in the nature and volume of the portfolio and in the terms of loans.




•
Changes in the volume and severity of past due loans, the volume of non-accrual loans, and the volume and severity of adversely classified or graded loans.




•
The existence and effect of any concentrations of credit, and changes in the level of such concentrations.




•
Changes in lending policies and procedures, including changes in underwriting standards and collection, charge-off, and recovery practices not considered elsewhere in estimating credit losses.




•
Changes in the experience, ability, and depth of lending management and other relevant staff.




•
Changes in the quality of the institution’s loan review system.




•
Changes in international, national, regional, and local economic and business conditions and developments that affect the collectibility of the portfolio, including the condition of various market segments.




•
The effect of other external factors such as competition and legal and regulatory requirements on the level of estimated credit losses in the institution’s existing portfolio.




•
Changes in the value of underlying collateral for collateral-dependent loans.




Portfolio risk includes the levels and trends in delinquencies, impaired loans and changes in the loan rating matrix, trends in volume and terms of loans. Management is satisfied with the stability of the past due and non-performing loans and believes there has been no further decline in the quality of the loan portfolio due to any trend in delinquent or adversely classified loans. Although the aggregate total of classified loans has increased, management is confident in the adequacy of the sources of repayment. In determining the adequacy of the allowance, management considered the deterioration of asset quality in DNB’s residential construction and residential first mortgage portfolios, which were factors contributing to the increase in the level of allowance during 2009. In addition to ordering new appraisals and creating specific reserves on impaired loans, the allowance allocation rates were increased, reflective of delinquency trends which have been caused by continued weakness in the housing markets, falling home equity values, and rising unemployment. New appraisal values we have obtained for existing loans have been consistent generally with the declines indicated by the Case-Schiller and other indices.




Given the contraction in real estate values, DNB closely monitors the loan to value ratios of all classified assets and requires periodic current appraisals to monitor underlying collateral values. Management also reviews borrower, sponsorship and guarantor’s financial strength along with their ability and willingness to provide financial support of their obligations on an immediate and continuing basis.




There was a $426,000 provision made during the three months ended March 31, 2010, compared to $100,000 during the same period in 2009. DNB’s percentage of allowance for credit losses to total loans and leases was 1.61% at March 31, 2010, compared to 1.52% and 1.40% at December 31, 2009 and March 31, 2009, respectively. Management monitors DNB’s performance metrics including those ratios related to non-performing loans and leases. The allowance as a percentage of total loans and leases has increased over the last three years at the same time DNB has seen deterioration in the credit quality of the loan portfolio, as evidenced by the increase in non-performing assets. However, these increases do not directly impact DNB’s allowance for loan and lease losses as management monitors each of its criticized and classified loans and leases on an individual basis in accordance with ASC 310. Underlying asset values which support collateral dependent loans are monitored on a periodic basis primarily through updated appraisals and reserves are established for any shortfalls in collateral values. In addition, despite the increase in non-performing assets during the last 2 years, charge-offs have been low, relative to the size of the loan and lease portfolio and to the level of non-performing assets. Net charge-offs were $46,000, $434,000 and $45,000 during the three months ended March 31, 2010, year ended December 31, 2009 and three months ended March 31, 2009, respectively. The percentage of net charge-offs to total average loans and leases were .01%, .13% and .01% during the same respective periods.




26




Management is not aware of any potential problem loans, which were accruing and current at March 31, 2010, where serious doubt exists as to the ability of the borrower to comply with the present repayment terms and that would result in a significant loss to DNB.




The increase in the allowance for loan loss ratio reflects management’s estimate of the level of inherent losses in the portfolio, which continued to increase during 2009 and the first three months of 2010 due to a recessionary economy, rising unemployment, a weakened housing market and deterioration in income-producing properties. The increase in non-performing assets, driven by residential homebuilder loans, income producing commercial investor real estate loans and residential loans was a key determining dynamic in the assessment of inherent losses and, as a result, was an important factor in determining the allowance level.




We typically establish a general valuation allowance on classified loans which are not impaired. In establishing the general valuation allowance, we segregate these loans by category. The categories used by DNB include “doubtful,” “substandard,” “special mention,” “watch list” and “pass.” For commercial and construction loans, the determination of the category for each loan is based on periodic reviews of each loan by our lending and credit officers as well as an independent, third-party consultant. The reviews include a consideration of such factors as recent payment history, current financial data, cash flow, financial projections, collateral evaluations, guarantor or sponsorship financial strength and current economic and business conditions. Categories for mortgage and consumer loans are determined through a similar review. Classification of a loan within a category is based on identified weaknesses that increase the credit risk of loss on the loan. Each category carries a target rate for the allowance percentage to be assigned to the loans within that category. The allowance percentage, which is refined based on the specific circumstances of each classified loan, is determined based on inherent losses associated with each type of lending as determined through consideration of our loss history with each type of loan, trends in credit quality and collateral values, and an evaluation of current economic and business conditions.




We establish a general allowance on non-classified loans to recognize the inherent losses associated with lending activities, but which, unlike specific allowances, have not been allocated to particular problem loans. This general valuation allowance is determined by segregating the loans by loan category and assigning allowance percentages to each category. An evaluation of each category is made to determine the need to further segregate the loans within each category by type. For our residential mortgage and consumer loan portfolios, we identify similar characteristics throughout the portfolio including credit scores, loan-to-value ratios and collateral. For our commercial real estate and construction loan portfolios, a further analysis is made in which we segregated the loans by type based on the purpose of the loan and the collateral properties securing the loan. Various risk factors for each type of loan are considered, including the impact of general economic and business conditions, collateral value trends, credit quality trends and historical loss experience.




As of March 31, 2010, DNB had $13.2 million of non-performing assets, which included $9.5 million of non-performing loans and $3.7 million of OREO. Impaired loans, which are measured for impairment using the fair value of the collateral for collateral dependent loans, had a carrying amount of $9.2 million at March 31, 2010. Of this, $3.8 million had a valuation allowance of $744,000 and $5.4 million had no specific allowance as of March 31, 2010. For those impaired loans that management determined that no specific valuation allowance was necessary, management has reviewed the appraisal for each loan and determined that there is no shortfall in the collateral. In general, management reduces the amount of the appraisal by the estimated cost of acquisition and disposition of the underlying collateral and compares that adjusted value with DNB’s carrying value. For those impaired loans that have not been assigned a specific valuation allowance, DNB reserves at the rate of approximately 6% used for loans rated substandard under the general allowance. During the quarter ended March 31, 2010, we did not recognize any impairment charges related to loans. Impaired loans had a carrying amount of $9.0 million at December 31, 2009. The valuation allowance on impaired loans was $531,000 as of December 31, 2009. Loans are reviewed for impairment which is measured in accordance with FASB ASC 310-10-35. Impaired loans can either be secured or unsecured, not including large groups of smaller balance loans that are collectively evaluated. Impairment is measured by the difference between the loan amount and the present value of the future cash flow discounted at the loan’s effective interest rate, or, alternatively the fair value of the collateral if the loan is collateral dependent. An impaired loan may not represent an expected loss.




We typically order new third-party appraisals or collateral valuations when a loan becomes impaired or is transferred to OREO. This is done within two weeks of a loan becoming impaired or a loan moving to OREO. It generally takes two to eight weeks to receive the appraisals, depending on the type of property being appraised. We recognize any provision or related charge-off within two weeks of receiving the appraisal after the appraisal has been reviewed by DNB. We generally order a new appraisal every twelve months, unless management determines more frequent appraisals are necessary. DNB had appraisals dated and reviewed within six months of March 31, 2010 for all impaired loans, with the exception of one loan participation we purchased from another bank. We typically request new appraisals from lead banks so that the receipt and review of the appraisal is in conformity with our own internal policy and procedures. However, DNB does not have any control over the timely delivery of the appraisal from a lead bank. During the later part of March 2010, we received a new appraisal from the lead bank for a $2.8 million residential land development loan.  In the Corporation’s Form 10-K for December 31, 2009, management indicated that they were in the process of reviewing the appraisal and discussing various aspects of the appraisal with the lead bank. As of December 31, 2009, we had $180,000 reserved against this loan in the general allowance. A preliminary review of the appraisal prior to the filing of the 2009 10-K indicated that we might need to provide an additional $100,000-$150,000 for this loan during the first quarter of 2010. Subsequent to the filing of the 2009 Form 10-K, management completed its analysis and discussed the appraisal with the lead bank. Management and the lead bank concluded that the underlying assumptions used by the appraiser were factually incorrect as was the engagement and value. A new appraisal is in process with no further impairment in value anticipated, based on comments from the appraiser.






27




We use updated valuations when time constraints do not permit a full appraisal process, to reflect rapidly changing market conditions. Because appraisals and updated valuations utilize historical data in reaching valuation conclusions, the appraised or updated value may or may not reflect the actual sales price that we will receive at the time of sale. Management uses the qualitative factor “Changes in the value of underlying collateral for collateral-dependent loans” to establish a reserve to mitigate this risk.




Real estate appraisals typically include up to three approaches to value: the sales comparison approach, the income approach (for income-producing property) and the cost approach. Not all appraisals utilize all three approaches to value. Depending on the nature of the collateral and market conditions, the appraiser may emphasize one approach over another in determining the fair value of collateral.




Appraisals may also contain different estimates of value based on the level of occupancy or future improvements. “As-is” valuations represent an estimate of value based on current market conditions with no changes to the collateral’s use or condition. “As-stabilized” or “as-completed” valuations assume that the collateral is improved to a stated standard or achieves its highest and best use in terms of occupancy. “As-stabilized” valuations may be subject to a present value adjustment for market conditions or the schedule for improvements.




In connection with the valuation process, we will typically develop an exit strategy for the collateral by assessing overall market conditions, the current condition and use of the asset and its highest and best use. For most income-producing real estate, investors value most highly a stable income stream from the asset; consequently, we conduct a comparative evaluation to determine whether conducting a sale on an “as-is” basis or on an “as-stabilized” basis is most likely to produce the highest net realizable value and compare these values with the costs incurred and the holding period necessary to achieve the “as stabilized” value.




Our estimates of the net realizable value of collateral include a deduction for the expected costs to sell the collateral or such other deductions as deemed appropriate. For most real estate collateral, we apply an eight to thirteen percent deduction to the value of real estate collateral to determine its expected costs to sell the asset. This estimate generally includes real estate commissions, one year of real estate taxes and miscellaneous repair and closing costs. If we receive a purchase offer that requires unbudgeted repairs, or if the expected holding period for the asset exceeds one year, then we include the additional real estate taxes and repairs or other holding costs in the expected costs to sell the collateral on a case-by-case basis.




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





(Dollars in thousands)

Three Months

Ended March 31,

2010


Year Ended

December 31,

2009


Three Months

Ended March 31,

2009Beginning balance

$
5,477


$
4,586


$
4,586Provisions


426



1,325



100Charge-offs


(81
)


(595
)


(57
)Recoveries


35



161



12Ending balance

$
5,857


$
5,477


$
4,641





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.








28








Non-interest income for the three-month period ended March 31, 2010 was $1.6 million, compared to $1.3 million for the same period in 2009.  Absent the gains on sales of securities, non-interest income was up $97,000 quarter over quarter. The $97,000 increase was primarily caused by an increase of $42,000 in wealth management fees and a $66,000 decrease in losses on sales and write-downs of OREO properties. This increase was offset by a $44,000 decline in deposit service charges.


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, 2010 was $4.6 million compared to $4.1 million for the same period in 2009.  Other non-interest expense increased $450,000, primarily due to a $560,000 in prepayment penalties on FHLB advances. This increase was offset by decreases in professional and consulting of $91,000, furniture and equipment of $39,000 and salary and employee benefits of $20,000. Absent the $560,000 prepayment penalty paid to the FHLB which is included in non–interest expense for the three months ended March 31, 2010, non-interest expense would have declined approximately $64,000 compared to first quarter of 2009. DNB’s non-interest expense to average assets ratio for the three-month period ended March 31, 2010 was 2.93%, compared to 3.10% for the same period in 2009.


INCOME TAXES


Income tax expense for the three month period ended March 31, 2010 was $271,000 compared to $89,000 for the same period in 2009. The effective tax rate for the three month periods ended March 31, 2010 was 28.6%, compared to 15.7% for the same period in 2009.  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, which totaled $13.2 million at March 31, 2010, decreased slightly when compared to December 31, 2009. Total non-performing assets decreased $476,000 to $13.2 million from $13.7 million at December 31, 2009, compared to $10.8 million at March 31, 2009. The decrease during the most recent quarter was primarily due to the sale of one OREO property for $1.3 million, offset by the addition of 5 commercial loans placed on non-accrual status. Additionally, there were 2 leases that moved into the 90 days and still accruing bucket.  The increase over March 31, 2009 was primarily attributable to 5 residential and 11 commercial loans that were placed on non-accrual status during the year, offset by the sale of one OREO property. As a result of the increase in non-performing loans, the non-performing loans to total loans ratio increased to 2.62% at March 31, 2010, up from 1.87% at March 31, 2009. The non-performing assets to total assets ratio increased to 2.15% at March 31, 2010 from 1.91% at March 31, 2009. The non-performing loans to the allowance ratio increased from 133.6% at March 31, 2009 to 162.6% at March 31, 2010. DNB continues to work diligently to improve asset quality by adhering to strict underwriting standards and improving lending policies and procedures. Non-performing assets have, and will continue to have, an impact on earnings; therefore management intends to continue working aggressively to reduce the level of such assets.




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






29




DNB’s Credit Policy Committee monitors the performance of the loan and lease portfolio to identify potential problem assets on a timely basis. Committee members meet to design, implement and review asset recovery strategies, which serve to maximize the recovery of each troubled asset. As of March 31, 2010, DNB had $6.9 million of loans, which, although performing at that date, are believed to require increased supervision and review; and may, depending on the economic environment and other factors, become non-performing assets in future periods. The amount of such loans at December 31, 2009 was $16.3 million. The majority of the loans are secured by commercial real estate, with lesser amounts being secured by residential real estate, inventory and receivables.




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. In addition, the table sets forth DNB's asset quality and allowance coverage ratios at the dates indicated:




Non-Performing Assets


(Dollars in thousands)




March 31,

2010


December 31,

2009


March 31,

2009Non-accrual loans:Residential mortgages

$
2,666


$
3,081


$
1,496Commercial mortgages


1,905



1,317



117Commercial term loans


4,346



4,374



3,996Commercial leases


149



157



248Consumer loans


50



62



13Total non-accrual loans


9,116



8,991



5,870Loans 90 days past due and still accruing


410



191



330Troubled debt restructurings


—



—



—Total non-performing loans


9,526



9,182



6,200Other real estate owned & other repossessed property


3,670



4,489



4,630Total non-performing assets

$
13,196


$
13,671


$
10,830Asset quality ratios:Non-performing loans to total loans


2.62
%


2.55
%


1.87
%Non-performing assets to total assets


2.15



2.16



1.91Allowance for credit losses to:Total loans and leases


1.61



1.52



1.40Non-performing loans and leases


61.5



59.6



74.9





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,

2010


December 31,

2009


March 31,

2009Interest income which would have beenrecorded under original terms

$
96


$
505


$
80Interest income recorded during the period


(1
)


(89
)


(13
)Net impact on interest income

$
95


$
416


$
67


Impaired loans--Impaired loans are measured for impairment using the fair value of the collateral for collateral dependent loans. Information regarding impaired loans is presented as follows:





Three Months Ended


Year Ended


Three Months Ended(Dollars in thousands)

March 31,

2010


December 31,

2009


March 31,

2009Total recorded investment

$
9,229


$
8,991


$
5,870Impaired loans with a specific allowance


3,776



3,497



1,163Impaired loans without a specific allowance


5.453



5,494



4,707Average recorded investment


9,229



7,901



5,870Specific allowance allocation


744



531



120Total cash collected


112



654



—Interest income recorded


1



46



—








30





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 $100.6 million at March 31, 2010.  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 $178.0 million.  Management believes that DNB has adequate resources to meet its short-term and long-term funding requirements.





At March 31, 2010, DNB had $64.9 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, 2010 totaled $42.8 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.





The Corporation and the Bank have each met the definition of “well capitalized” for regulatory purposes on March 31, 2010.  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.





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, 2010:Total risk-based capital

$
58,666



14.61
%

$
32,126



8.00
%


N/A



N/ATier 1 capital


53,640



13.36



16,063



4.00



N/A



N/ATier 1 (leverage) capital


53,640



8.43



25,438



4.00



N/A



N/ADecember 31, 2009:Total risk-based capital

$
58,184



14.27
%

$
32,609



8.00
%


N/A



N/ATier 1 capital


53,088



13.02



16,304



4.00



N/A



N/ATier 1 (leverage) capital


53,088



8.33



25,486



4.00



N/A



N/ADNB First, N.A.March 31, 2010:Total risk-based capital

$
58,128



14.49
%

$
32,092



8.00
%

$
40,115



10.00
%Tier 1 capital


53,101



13.24



16,046



4.00



24,069



6.00Tier 1 (leverage) capital


53,101



8.36



25,420



4.00



31,775



5.00December 31, 2009:Total risk-based capital

$
57,388



14.09
%

$
32,574



8.00
%

$
40,718



10.00
%Tier 1 capital


52,292



12.85



16,287



4.00



24,431



6.00Tier 1 (leverage) capital


52,292



8.21



25,467



4.00



31,834



5.00





31


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





DNB Financial Corp. (the “Corporation”), may from time to time make written or oral “forward-looking statements,” including statements contained in the Corporation’s filings with the Securities and Exchange Commission (including this Quarterly Report on Form 10-Q and the exhibits hereto and thereto), in its reports to shareholders and in other communications by the Corporation, which are made in good faith by the Corporation pursuant to the “safe harbor” provisions of the Private Securities Litigation Reform Act of 1995.





These forward-looking statements include statements with respect to the Corporation’s beliefs, plans, objectives, goals, expectations, anticipations, estimates and intentions, that are subject to significant risks and uncertainties, and are subject to change based on various factors (some of which are beyond the Corporation’s control).  The words “may,” “could,” “should,” “would,” “believe,” “anticipate,” “estimate,” “expect,” “intend,” “plan” and similar expressions are intended to identify forward-looking statements.  The following factors, among others, could cause the Corporation’s financial performance to differ materially from the plans, objectives, expectations, estimates and intentions expressed in such forward-looking statements: the strength of the United States economy in general and the strength of the local economies in which the Corporation conducts operations; the effects of, and changes in, trade, monetary and fiscal policies and laws, including interest rate policies of the Board of Governors of the Federal Reserve System; inflation, interest rate, market and monetary fluctuations; the timely development of and acceptance of new products and services of the Corporation and the perceived overall value of these products and services by users, including the features, pricing and quality compared to competitors’ products and services; the willingness of users to substitute competitors’ products and services for the Corporation’s products and services; the success of the Corporation in gaining regulatory approval of its products and services, when required; the impact of changes in laws and regulations applicable to financial institutions (including laws concerning taxes, banking, securities and insurance); technological changes; acquisitions; changes in consumer spending and saving habits; the nature, extent, and timing of governmental actions and reforms, including the rules of participation for the Trouble Asset Relief Program voluntary Capital Purchase Program under the Emergency Economic Stabilization Act of 2008, which may be changed unilaterally and retroactively by legislative or regulatory actions; and the success of the Corporation at managing the risks involved in the foregoing.





The Corporation cautions that the foregoing list of important factors is not exclusive.  Readers are also cautioned not to place undue reliance on these forward-looking statements, which reflect management’s analysis only as of the date of this report, even if subsequently made available by the Corporation on its website or otherwise.  The Corporation does not undertake to update any forward-looking statement, whether written or oral, that may be made from time to time by or on behalf of the Corporation to reflect events or circumstances occurring after the date of this report.





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.











32





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, 2010 and December 31, 2009, 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 December 31, 2009 was slightly above DNB’s negative 25% guideline. This negative variance was reduced to a negative 20.3%, which was within DNB’s guideline as of March 31, 2010. Management reduced this variance during the first quarter of 2010 scenario by reducing longer term assets, shortening the duration of the investment portfolio and increasing capital levels through increased earnings.







March 31, 2010


December 31, 2009Change in rates

Flat



-200
bp


+200
bp

Flat



-200
bp


+200
bpEVE

$
38,239


$
38,191


$
30,458


$
39,095


$
43,264


$
28,920Change






(48
)


(7,781
)






4,169



(10,175
)Change as a % of assets






—



(1.3
%)






.7
%


(1.6
%)Change as a % of PV equity






(.1
%)


(20.3
%)






10.7
%


(26.0
%)





ITEM 4T - 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, 2010, 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, 2010, that has materially affected, or is reasonably likely to materially affect, DNB’s internal control over financial reporting.





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, 2009, filed with the Commission on March 26, 2010 (File No. 000-16667).





33








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, 2010. The following table provides information on repurchases by DNB of its common stock in each month of the quarter ended March 31, 2010:





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, 2010 – January 31, 2010


—


$
—



—



63,016February 1, 2010 – February 28, 2010


—



—



—



63,016March 1, 2010 – March 31, 2010


—



—



—



63,016Total


—


$
—



—







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. (REMOVED AND RESERVED)





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 36-38 of this report are incorporated by reference or filed or furnished herewith in response to this Item.








34





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 14, 2010
BY:
/s/ William S. LatoffWilliam S. Latoff, Chairman of the

Board and Chief Executive OfficerMay 14, 2010
BY:
/s/ Gerald F. SoppGerald F. Sopp, Chief Financial Officer and Executive Vice President

















35





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.(iii)
Certificate of Designations of Fixed Rate Cumulative Preferred Stock, Series 2008A of DNB Financial Corporation, filed as Exhibit 4.3 to Form 8-K (No. 016667) on January 26, 2009 and incorporated herein by reference.4
(a)
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.(b)
Form of Preferred Stock Certificate to the United States Department of the Treasury, filed as Exhibit 4.4 to Form 8-K (No. 016667) on January 30, 2009 and incorporated herein by reference.(c)
Form of Warrant to Purchase Common Stock to the United States Department of the Treasury, filed as Exhibit 4.5 to Form 8-K (No. 016667) on January 30, 2009 and incorporated herein by reference.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 waiver signed by William S. Latoff, William J. Hieb, Gerald F. Sopp, Bruce E. Moroney and Albert J. Melfi, Jr., each dated January 30, 2009, with respect to U.S. Treasury TARP Capital Purchase Program, filed as Exhibit 4.6 to Form 8-K (No. 016667) on January 30, 2009 and incorporated herein by reference.(d)**
DNB Financial Corporation Incentive Equity and Deferred Compensation Plan (As Amended and Restated Effective May 5, 2009), filed March 31, 2009 as Appendix A to Registrant’s definitive proxy statement on Schedule 14-A (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   36
   (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.(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.   37
  (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.(w)*
Amendments dated December 16, 2009 to Change of Control Agreements among DNB Financial Corporation, DNB First, N.A. and William S. Latoff, William J. Hieb, Albert J. Melfi, Richard J. Hartman, Gerald F. Sopp and Bruce E. Moroney with respect to compliance with certain provisions of the Emergency Economic Stabilization Act of 2008 (“EESA”), the American Recovery Reinvestment Act of 2009 (“ARRA”) and the provisions of the Interim Final Rule on “TARP Standards for Compensation and Corporate Governance” published by the United States Treasury Department (“UST”) on June 15, 2009, filed March 26, 2010 as item 10(w) to Form 10-K for the fiscal year ended December 31, 2009 (No. 0-16667) and incorporated herein by reference.11

Registrant’s Statement of Computation of Earnings Per Share isset forth in Footnote 3 to Registrant's consolidated financial statements at page 10 of this Form 10-Q and is incorporated herein by reference.14

Code of Ethics as amended and restated effective February 23, 2005, filed March 10, 2005 as Item 10(m) to Form 10-K for the fiscal year ended December 31, 2004 (No. 0-16667) and incorporated herein by reference.31.1

Rule 13a-14(a)/15d-14 (a) Certification of Chief Executive Officer, filed herewith.31.2

Rule 13a-14(a)/15d-14 (a) Certification of Chief Financial Officer, filed herewith.32.1

Section 1350 Certification of Chief Executive Officer, filed herewith.32.2

Section 1350 Certification of Chief Financial Officer, filed herewith.*
Management contract or compensatory plan arrangement.**
Shareholder approved compensatory plan pursuant to which the Registrant’s Common Stock may be issued to employees of the Corporation.