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UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549



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FORM 10-K



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(Mark One)

|x | ANNUAL REPORT UNDER SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
|- | ------------------------------------------------------------------------------

For the Fiscal Year Ended December 31, 2006

OR



| ̈ | TRANSITION REPORT UNDER SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
|- | ----------------------------------------------------------------------------------

For the transition period from  to

Commission File Number 0-49639



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DIMECO, INC.

(Exact Name of Registrant as Specified in Its Charter)



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|                                                               |  |                                     
|-------------------------------------------------------------- |  | ------------------------------------
|Pennsylvania                                                   |  | 23-2250152                          
|(State or Other Jurisdiction of Incorporation or Organization) |  | (I.R.S. Employee Identification No.)



|                                           |  |           
|------------------------------------------ |  | ----------
|820 Church Street, Honesdale, Pennsylvania |  | 18431     
|(Address of Principal Executive Offices)   |  | (Zip Code)

Registrants Telephone Number, including area code: (570) 253-1970

Securities Registered Pursuant to Section 12(b) of the Act: None

Securities Registered Pursuant to Section 12(g) of the Act:

Common Stock, $.50 par value

(Title of class)



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Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities
Act. ̈YES     x  NO

Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or Section 15(d) of the
Act. ̈YES    x  NO

Indicate by check mark whether the registrant: (l) has filed all reports required to be filed by Section 13 or 15(d) of the 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.    x  YES ̈NO

Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of
registrants knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K. ̈

Indicate by check mark whether the registrant is a large accelerated filer, an
accelerated filer, or a non-accelerated filer. See definition of accelerated filer and large accelerated filer in Rule 12b-2 of the Exchange Act. (Check one):

Large accelerated filer ̈Accelerated filer ̈Non-accelerated filer  x

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Act). ̈YES    x  NO

The aggregate market value of
the voting and non-voting common equity held by non-affiliates of the registrant was approximately $47 million as of June 30, 2006 based on the last sale ($35.87 per share) reported on the OTC Bulletin Board as of that date. Solely for purposes
of this calculation, the term affiliate refers to all directors and executive officers of the registrant and all stockholders beneficially owning more than 5% of the registrants common stock.

As of March 1, 2007, there were issued and outstanding 1,527,842 shares of the registrants common stock.

DOCUMENTS INCORPORATED BY REFERENCE



|1. | Portions of the Registrants Annual Report to Stockholders for the fiscal year ended December 31, 2006. (Part II)
|-- | -----------------------------------------------------------------------------------------------------------------

|2. | Portions of the Registrants definitive Proxy Statement for the 2007 Annual Meeting of Shareholders. (Part III)
|-- | ---------------------------------------------------------------------------------------------------------------



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DIMECO, INC.

ANNUAL REPORT ON FORM 10-K

for the fiscal year ended December 31, 2006

INDEX



|           |  |                                                                                                              |  |     
|---------- |  | ------------------------------------------------------------------------------------------------------------ |  | ----
|PART I    
|           |  |                                                                                                              |  | Page
|Item 1.    |  | Business                                                                                                     |  | 3   
|Item 1A.   |  | Risk Factors                                                                                                 |  | 21  
|Item 1B.   |  | Unresolved Staff Comments                                                                                    |  | 25  
|Item 2.    |  | Properties                                                                                                   |  | 26  
|Item 3.    |  | Legal Proceedings                                                                                            |  | 26  
|Item 4.    |  | Submission of Matters to a Vote of Security Holders                                                          |  | 26  
|          
|PART II   
|           |  |                                                                                                             
|Item 5.    |  | Market for Registrants Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities |  | 27  
|Item 6.    |  | Selected Financial Data                                                                                      |  | 27  
|Item 7.    |  | Managements Discussion and Analysis of Financial Condition and Results of Operations                        |  | 27  
|Item 7A.   |  | Quantitative and Qualitative Disclosures About Market Risk                                                   |  | 27  
|Item 8.    |  | Financial Statements and Supplementary Data                                                                  |  | 28  
|Item 9.    |  | Changes in and Disagreements with Accountants on Accounting and Financial Disclosure                         |  | 28  
|Item 9A.   |  | Controls and Procedures                                                                                      |  | 28  
|Item 9B.   |  | Other Information                                                                                            |  | 28  
|          
|PART III  
|           |  |                                                                                                             
|Item 10.   |  | Directors, Executive Officers and Corporate Governance                                                       |  | 28  
|Item 11.   |  | Executive Compensation                                                                                       |  | 28  
|Item 12.   |  | Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters               |  | 28  
|Item 13.   |  | Certain Relationships and Related Transactions, and Director Independence                                    |  | 29  
|Item 14.   |  | Principal Accounting Fees and Services                                                                       |  | 29  
|          
|PART IV   
|           |  |                                                                                                             
|Item 15.   |  | Exhibits, Financial Statement Schedules                                                                      |  | 29  
|           | 
|SIGNATURES |  | 31                                                                                                          



2



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PART I

Forward-Looking Statements

Dimeco, Inc. (the Company or Registrant) may, from time to time, make written or oral forward-looking statements, including statements contained in the Companys filings with
the Securities and Exchange Commission (including this annual report on Form 10-K and the exhibits thereto), in its reports to shareholders and in other communications by the Company, which are made in good faith by the Company pursuant to the
safe harbor provisions of the Private Securities Litigation Reform Act of 1995.

These forward-looking statements involve risks
and uncertainties, such as statements of the Companys plans, objectives, expectations, estimates and intentions, that are subject to change based on various important factors (some of which, including those described under Item 1A. Risk
Factors, are beyond the Companys control). The following factors, among others, could cause the Company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 Company 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 Company 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
Companys products and services; the success of the Company in gaining regulatory approval of its products and services, when required; the impact of changes in financial services laws and regulations (including laws concerning taxes,
banking, securities and insurance); technological changes, acquisitions; changes in consumer spending and saving habits; and the success of the Company at managing these risks.

The Company cautions that this list of important factors is not exclusive. The Company 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 Company.



|Item 1. | Business
|------- | --------

General

The Company, a Pennsylvania corporation, is a bank holding company headquartered in Honesdale, Pennsylvania. At December 31, 2006, the Company had
total consolidated assets, deposits and stockholders equity of approximately $404 million, $338 million and $35 million, respectively. The Companys principal business is to serve as a holding company for its wholly-owned subsidiary, The
Dime Bank (the Bank).

The Bank is a Pennsylvania-chartered commercial bank, originally organized in 1905. The Bank provides a
comprehensive range of lending, depository and financial services to individuals and small to medium-sized businesses. The Banks deposit services range from traditional time, demand, and savings deposit accounts to sophisticated cash
management products, including electronic banking and commercial sweep accounts. The Banks lending services include secured and unsecured commercial, real estate and consumer loans. The Bank also operates a trust department and an investment
department which had $68 million in client assets under management at December 31, 2006. The Bank conducts business from five branch offices, located in Honesdale, Hawley, Damascus, Greentown and Dingmans Ferry, Pennsylvania, as well as
maintaining two off-site ATM machines each located in Honesdale and Hawley, Pennsylvania and an Operations Center in Honesdale, Pennsylvania. The Bank maintains a website at www.thedimebank.com.

In 2005, the Bank formed a 100% owned subsidiary, TDB Insurance Services, LLC in order to offer title insurance services in conjunction with the
Banks lending function.



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Competition

The Bank is one of many financial institutions serving its principal market area, which includes Wayne and Pike Counties, Pennsylvania and Sullivan County, New York. Such market areas are approximately 90 miles west of New York City. Pike
County, Pennsylvania is one of the fastest growing counties in Pennsylvania. The competition for deposit products comes primarily from other insured financial institutions such as commercial banks, thrift institutions, credit unions, and multi-state
regional banks in the Companys market area. Based on data compiled by the FDIC as of June 30, 2006 (the latest date for which such information is available), the Bank had the largest share of FDIC-insured deposits in Wayne County with
approximately 22% and the fifth largest share of FDIC-insured deposits in Pike County with approximately 11%. This data does not reflect deposits held by credit unions with which the Bank also competes. Deposit competition also includes a number of
insurance products sold by local agents and investment products such as mutual funds and other securities sold by local and regional brokers. Loan competition varies depending upon market conditions and comes from other insured financial
institutions such as commercial banks, thrift institutions, credit unions, multi-state regional banks, and mortgage brokers.

Lending Activities

General.The principal lending activity of the Bank is the origination of commercial real estate loans, residential mortgage
loans, commercial and industrial loans, installment loans, and, to a lesser extent, construction and development loans, home equity loans, and agricultural loans. Generally, loans are originated in the Companys primary market area of Pike and
Wayne Counties, Pennsylvania and Sullivan County, New York. Substantially all of the Banks borrowers are located in these counties and would be expected to be affected by economic and other conditions in this area. In addition, the Company had
$61 million of loans granted to summer camps and recreational facilities in the northeastern United States. This amount of loans constitutes approximately 20% of the loan portfolio. The Company does not believe that there are any other
concentrations of loans or borrowers exceeding 10% of total loans.



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Analysis of Loan Portfolio.Set forth below is selected data relating to the composition of the
Banks loan portfolio by type of loan on the dates indicated. Prior period information has been reclassified to agree with current year presentation.



|                                                                 |  |                        |         |   |       |   |   |      |         |  |       |   |  |      |         |  |       |   |   |   |         |   |       |   |  |   |         |  |       |  
|---------------------------------------------------------------- |  | ---------------------- | ------- | - | ----- | - | - | ---- | ------- |  | ----- | - |  | ---- | ------- |  | ----- | - | - | - | ------- | - | ----- | - |  | - | ------- |  | ----- | -
|                                                                 |  | At December 31,        |        
|(Dollars in thousands)                                           |  | 2006                   |         |   | 2005  |   |   | 2004 |         |  | 2003  |   |  | 2002 |        
|                                                                 |  | $                      |         | % |       |   | $ |      | %       |  |       | $ |  | %    |         |  | $     |   | % |   |         | $ |       | % | 
|                                                                 |  | (Dollars in thousands) |        
|Loans secured by real estate:                                    |  |                        |         |   |       |   |   |      |         |  |       |   |  |      |         |  |       |   |   |   |         |   |       |   |  |   |         |  |       |  
|Construction and development                                     |  | $                      | 3,733   |   | 1.2   | % |   | $    | 3,771   |  | 1.3   | % |  | $    | 662     |  | 0.3   | % |   | $ | 396     |   | 0.2   | % |  | $ | 111     |  | 0.1   | %
|Mortgage loans secured by farmland                               |  |                        | 1,775   |   | 0.6   |   |   |      | 1,879   |  | 0.7   |   |  |      | 1,786   |  | 0.7   |   |   |   | 1,644   |   | 0.7   |   |  |   | 1,978   |  | 1.1   |  
|Commercial loans-secured by non-farm, non-residential properties |  |                        | 170,910 |   | 56.0  |   |   |      | 157,076 |  | 55.4  |   |  |      | 133,259 |  | 52.7  |   |   |   | 112,443 |   | 51.3  |   |  |   | 88,960  |  | 47.5  |  
|Secured by 1-4 family residential properties:                    |  |                        |         |   |       |   |   |      |         |  |       |   |  |      |         |  |       |   |   |   |         |   |       |   |  |   |         |  |       |  
|Home equity lines of credit                                      |  |                        | 4,218   |   | 1.4   |   |   |      | 2,535   |  | 0.9   |   |  |      | 1,820   |  | 0.7   |   |   |   | 1,367   |   | 0.6   |   |  |   | 1,402   |  | 0.7   |  
|Mortgage loans                                                   |  |                        | 64,188  |   | 21.0  |   |   |      | 54,682  |  | 19.2  |   |  |      | 53,026  |  | 20.9  |   |   |   | 50,986  |   | 23.2  |   |  |   | 48,980  |  | 26.1  |  
|Commercial and industrial loans                                  |  |                        | 38,502  |   | 12.6  |   |   |      | 41,289  |  | 14.6  |   |  |      | 41,795  |  | 16.5  |   |   |   | 32,200  |   | 14.7  |   |  |   | 28,374  |  | 15.1  |  
|Installment loans                                                |  |                        | 16,258  |   | 5.3   |   |   |      | 17,895  |  | 6.3   |   |  |      | 17,517  |  | 6.9   |   |   |   | 18,968  |   | 8.6   |   |  |   | 16,218  |  | 8.7   |  
|Other loans:                                                     |  |                        |         |   |       |   |   |      |         |  |       |   |  |      |         |  |       |   |   |   |         |   |       |   |  |   |         |  |       |  
|Agriculture                                                      |  |                        | 1,132   |   | 0.4   |   |   |      | 858     |  | 0.3   |   |  |      | 606     |  | 0.2   |   |   |   | 465     |   | 0.2   |   |  |   | 700     |  | 0.4   |  
|Other                                                            |  |                        | 4,575   |   | 1.5   |   |   |      | 3,577   |  | 1.3   |   |  |      | 2,674   |  | 1.1   |   |   |   | 1,140   |   | 0.5   |   |  |   | 638     |  | 0.3   |  
|                                                                 |  |                        |         |   |       |   |   |      |         |  |       |   |  |      |         |  |       |   |   |   |         |   |       |   |  |   |         |  |       |  
|Total loans                                                      |  | $                      | 305,291 |   | 100.0 | % |   | $    | 284,562 |  | 100.0 | % |  | $    | 253,141 |  | 100.0 | % |   | $ | 219,609 |   | 100.0 | % |  | $ | 187,361 |  | 100.0 | %
|                                                                 |  |                        |         |   |       |   |   |      |         |  |       |   |  |      |         |  |       |   |   |   |         |   |       |   |  |   |         |  |       |  
|Loans held for sale                                              |  | $                      |        |   |       |   |   | $    | 211     |  |       |   |  | $    | 112     |  |       |   |   | $ | 654     |   |       |   |  | $ | 1,195   |  |       |  
|                                                                 |  |                        |         |   |       |   |   |      |         |  |       |   |  |      |         |  |       |   |   |   |         |   |       |   |  |   |         |  |       |  



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Loan Maturity.The following table sets forth the maturities for selected categories of the
Banks loan portfolio at December 31, 2006. The table does not include prepayments or scheduled principal repayments. All loans are shown as maturing based on contractual maturities. Demand loans and loans having no stated maturity are
shown as due within one year.



|                                          |  |                   |        |                             |   |                  |  |       |         |  |   |        
|----------------------------------------- |  | ----------------- | ------ | --------------------------- | - | ---------------- |  | ----- | ------- |  | - | -------
|(In thousands)                            |  | Due Within 1 year |        | Due after 1 through 5 years |   | Due after 5years |  | Total
|Commercial & agricultural real estate     |  | $                 | 11,168 |                             | $ | 8,521            |  | $     | 152,996 |  | $ | 172,685
|Commercial & industrial, and agricultural |  |                   | 15,059 |                             |   | 11,132           |  |       | 13,443  |  |   | 39,634 
|Construction and development              |  |                   | 3,274  |                             |   | 459              |  |       |        |  |   | 3,733  
|                                          |  |                   |        |                             |   |                  |  |       |         |  |   |        
|Total                                     |  | $                 | 29,501 |                             | $ | 20,112           |  | $     | 166,439 |  | $ | 216,052
|                                          |  |                   |        |                             |   |                  |  |       |         |  |   |        

The following table sets forth the dollar amount as of December 31, 2006 of selected
categories of the Companys loans due more than one year after December 31, 2006, which are based upon fixed interest rates or floating or adjustable interest rates.



|                                          |  |             |        |               |   |         |  |   |        
|----------------------------------------- |  | ----------- | ------ | ------------- | - | ------- |  | - | -------
|(In thousands)                            |  | Fixed Rates |        | Variable Rate |   | Total  
|Commercial & agricultural real estate     |  | $           | 10,013 |               | $ | 151,504 |  | $ | 161,517
|Commercial & industrial, and agricultural |  |             | 8,384  |               |   | 16,191  |  |   | 24,575 
|Construction and development              |  |             | 314    |               |   | 145     |  |   | 459    
|                                          |  |             |        |               |   |         |  |   |        
|Total                                     |  | $           | 18,711 |               | $ | 167,840 |  | $ | 186,551
|                                          |  |             |        |               |   |         |  |   |        

Commercial Real Estate and Farmland Loans. The commercial real estate loan portfolio
consists of loans secured primarily by childrens recreational summer camps, retail stores, restaurants, resorts, investment real estate, and manufacturing facilities. The Bank also makes loans secured by farmland. Loans secured by commercial
property or farmland may be originated in amounts up to 80% of the lower of the appraised value or purchase price, for a maximum term of 20 years. The Bank has a concentration of commercial real estate loans that are secured by summer camps and
recreational facilities for children in the Northeastern United States; these loans are generally adjustable-rate loans, with terms of up to 20 years, with the rate tied to the prime interest rate. At December 31, 2006, $61 million of the loan
portfolio consisted of loans to these summer camps and recreational facilities for children.

Loans secured by commercial properties
generally involve a greater degree of risk than residential mortgage loans and carry larger loan balances. This increased credit risk is a result of several factors, including the concentration of principal in a limited number of loans and
borrowers, the effects of general economic conditions on income-producing properties and the greater difficulty of evaluating and monitoring these types of loans. Any significant adverse change in economic conditions could have an adverse impact on
the borrowers ability to repay loans. A large portion of the Banks commercial real estate loan portfolio consists of loans secured by summer camps and recreational facilities located in the northeastern United States. Such loans are
dependent upon seasonal business and factors beyond the Banks control, such as the general economic condition of the northeastern United States and the impact on discretionary consumer spending.



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Furthermore, the repayment of loans secured by commercial real estate is typically dependent upon the
successful operation of the related business or commercial project. If the cash flow from the project is reduced, the borrowers ability to repay the loan may be impaired. This cash flow shortage may result in the failure to make loan payments.
In such cases, the Bank may be compelled to modify the terms of the loan. In addition, the nature of these loans makes them generally less predictable and more difficult to evaluate and monitor. As a result, repayment of these loans may be subject
to a greater extent than residential loans to adverse conditions in the real estate market or economy.

Residential Real Estate Loans.The residential real estate portfolio consists of one-to-four family residential mortgage loans. The Bank generally originates one-to-four family residential mortgage loans in amounts of up to 80% of the appraised value of the mortgaged property
without requiring mortgage insurance. The Bank will originate residential mortgage loans in amounts up to 95% of the appraised value of a mortgaged property, however, mortgage insurance for the borrower is required. In addition, the Bank
participates in special residential loan programs through various state and federal agencies which provide first time home buyers the ability to finance up to 100% of the property value; these loans are guaranteed by those various federal and state
agencies. The Bank offers residential fixed rate loans and adjustable rate loans with a 15 to 30 year amortization period. Interest rates for adjustable rate loans for residences adjust every one to three years based upon rates on U.S. Treasury
bills and notes. Interest rate adjustments on such loans are generally limited to 2% during any adjustment period and 6% over the life of the loan. These loans are originated for retention in the portfolio.

Fixed-rate loans are generally underwritten in accordance with FreddieMac guidelines. Currently, loans underwritten in accordance with FreddieMac
guidelines are generally sold in the secondary market. However, the number of saleable loans could vary materially as a result of market conditions. Fixed-rate loans which are held in portfolio are underwritten in accordance with FreddieMac credit
guidelines but occasionally may not conform in relation to property guidelines. At December 31, 2006, $32 million of the Banks residential real estate loan portfolio consisted of long-term, fixed-rate first mortgage loans.

Substantially all of the one-to-four family mortgages include due on sale clauses, which are provisions giving the Bank the right to declare
a loan immediately payable if the borrower sells or otherwise transfers an interest in the property to a third party.

Property appraisals
on real estate securing one-to-four family residential loans are made by appraisers approved by the Loan Committee. Appraisals are performed in accordance with applicable regulations and policies. The Bank obtains title insurance policies on most
first mortgage real estate loans originated.

Home equity term loans are written for terms of one to 15 years with fixed rates of interest.
The Bank also offers revolving home equity lines of credit with variable interest rates tied to the New York prime rate. These lines allow for a ten year draw period followed by a ten year repayment period. Both types of home equity loans are
typically based upon the lower of 80% of the collateral value or $100,000.

Commercial and Industrial Loans.Commercial and
industrial loans consist of equipment, accounts receivable, inventory, lines of credit, and other business purpose loans. Such loans are generally originated in amounts up to 75% of the appraised value of the business asset and are secured by either
the underlying collateral and/or by the personal guarantees of the borrower. Commercial and industrial loans are generally made at rates which adjust above the prime interest rate and generally mature in 5 to 10 years.

Unlike residential mortgage loans, which generally are made on the basis of the borrowers ability to make repayment from his or her employment and
other income and which are secured by real property whose value tends to be more easily ascertainable, commercial business loans typically are made on the basis of the borrowers ability to make repayment from the cash flow of the
borrowers business. As a result, the availability of funds for the repayment of commercial business loans is substantially dependent on the success of the business itself and the general economic environment.



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Installment Loans.The installment loan portfolio includes various types of secured and unsecured
consumer loans including automobile, education, and recreational vehicle loans. The Bank originates loans directly and indirectly through local automobile and recreational vehicle dealerships. These loans generally have terms of one to five years,
generally at fixed rates of interest. The interest rates range between 1.70% for loans that are secured by deposits to 15.25% for loans that are unsecured, with an average interest rate of approximately 8.89%. The installment loan portfolio includes
approximately $10 million of new and used automobile and recreational vehicle loans. These loans are originated in amounts up to 90% of the purchase price of the vehicle.

Consumer installment lending may entail greater risk than residential mortgage loans, particularly in the case of consumer loans that are unsecured or secured by assets, such as automobiles or recreational vehicles,
which depreciate rapidly. Repossessed collateral for a defaulted consumer loan may not be sufficient for repayment of the outstanding loan, and the remaining deficiency may not be collectible. Indirect lending exposes us to additional risk in that
we must rely on the dealer to provide accurate information to us and accurate disclosures to the borrowers.

Loans Held For Sale.The Bank holds as available for sale certain residential mortgage loans. These loans conform to FreddieMac guidelines and are readily saleable in the secondary market. The Bank services such loans and is generally not liable for these loans,
since they are sold on a non-recourse basis. At December 31, 2006, no loans were classified as held for sale.

Loan Solicitation
and Processing.The Bank has established various lending limits for its officers and also maintains a loan committee. The loan committee is comprised of the President, Senior Lending Officer and other Bank officers. The loan committee has the
authority to approve all loans up to $500,000. Requests in excess of this limit must be submitted to the Board of Directors Loan Committee for approval. Additionally, the President, and Senior Lending Officer each has the authority to approve
secured loans up to $200,000, and unsecured loans up to $100,000. Loan officers generally have the authority to approve secured loans between $30,000 and $150,000 and unsecured loans between $15,000 and $50,000. Notwithstanding individual lending
authority, certain loan policy exceptions must be submitted to the loan committee for approval.

Hazard insurance coverage is
required on all properties securing loans made by the Bank. Flood insurance is also required, when applicable.

Loan applicants are
notified of the credit decision by letter. If the loan is approved, the loan commitment specifies the terms and conditions of the proposed loan including the amount, interest rate, amortization term, a brief description of the required collateral,
and the required insurance coverage. The borrower must provide proof of fire, flood (if applicable) and casualty insurance on the property serving as collateral, and these applicable insurances must be maintained during the full term of the loan.

Loan Commitments.The Bank generally grants commitments to fund fixed-rate and adjustable-rate, single-family mortgage loans for
periods of 60 days at a specified term and interest rate. The total amount of its commitments to extend credit as of December 31, 2006 was $5 million.

Nonperforming Assets

The following table identifies nonperforming loans including nonaccrual loans and past due loans which
were accruing but contractually past due 90 days or more. Renegotiated loans are those which terms have been renegotiated to provide a reduction or deferral of principal or interest as a result of the deteriorating position of the borrower and
constitute troubled debt restructurings under Financial Accounting Standard (FAS) No. 15. At December 31, 2006, the Bank had no impaired loans within the meaning of FAS No. 114, as amended by FAS No. 118.



8



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|                                                                 |  |                 |      |   |      |   |      |      |  |   |       |   |  |      |       |   |  |   |       |  
|---------------------------------------------------------------- |  | --------------- | ---- | - | ---- | - | ---- | ---- |  | - | ----- | - |  | ---- | ----- | - |  | - | ----- | -
|                                                                 |  | At December 31, |     
|(Dollars in thousands)                                           |  | 2006            |      |   | 2005 |   |      | 2004 |  |   | 2003  |   |  | 2002 |      
|Loans accounted for on a nonaccrual basis:                       |  |                 |      |   |      |   |      |      |  |   |       |   |  |      |       |   |  |   |       |  
|Mortgage loans                                                   |  | $               | 366  |   |      | $ | 487  |      |  | $ | 189   |   |  | $    | 2,269 |   |  | $ | 467   |  
|Commercial and industrial, and agricultural                      |  |                 | 15   |   |      |   |     |      |  |   | 22    |   |  |      | 17    |   |  |   | 62    |  
|Installment                                                      |  |                 | 45   |   |      |   | 39   |      |  |   | 50    |   |  |      | 78    |   |  |   | 73    |  
|                                                                 |  |                 |      |   |      |   |      |      |  |   |       |   |  |      |       |   |  |   |       |  
|Total                                                            |  |                 | 426  |   |      |   | 526  |      |  |   | 261   |   |  |      | 2,364 |   |  |   | 602   |  
|                                                                 |  |                 |      |   |      |   |      |      |  |   |       |   |  |      |       |   |  |   |       |  
|Accruing loans which are contractually past due 90 days or more: |  |                 |      |   |      |   |      |      |  |   |       |   |  |      |       |   |  |   |       |  
|Mortgage loans                                                   |  |                 | 184  |   |      |   | 209  |      |  |   | 244   |   |  |      | 113   |   |  |   | 55    |  
|Commercial and industrial, and agricultural                      |  |                 | 99   |   |      |   | 11   |      |  |   | 10    |   |  |      | 57    |   |  |   | 10    |  
|Installment                                                      |  |                 | 7    |   |      |   | 59   |      |  |   | 39    |   |  |      | 5     |   |  |   | 27    |  
|                                                                 |  |                 |      |   |      |   |      |      |  |   |       |   |  |      |       |   |  |   |       |  
|Total                                                            |  |                 | 290  |   |      |   | 279  |      |  |   | 293   |   |  |      | 175   |   |  |   | 92    |  
|Renegotiated loans                                               |  |                 |     |   |      |   |     |      |  |   | 461   |   |  |      | 482   |   |  |   | 498   |  
|                                                                 |  |                 |      |   |      |   |      |      |  |   |       |   |  |      |       |   |  |   |       |  
|Total nonperforming loans                                        |  |                 | 716  |   |      |   | 805  |      |  |   | 1,015 |   |  |      | 3,021 |   |  |   | 1,192 |  
|Other real estate owned                                          |  |                 |     |   |      |   |     |      |  |   |      |   |  |      |      |   |  |   |      |  
|                                                                 |  |                 |      |   |      |   |      |      |  |   |       |   |  |      |       |   |  |   |       |  
|Total nonperforming assets                                       |  | $               | 716  |   |      | $ | 805  |      |  | $ | 1,015 |   |  | $    | 3,021 |   |  | $ | 1,192 |  
|                                                                 |  |                 |      |   |      |   |      |      |  |   |       |   |  |      |       |   |  |   |       |  
|Non-performing loans as a percent of total loans                 |  |                 | 0.23 | % |      |   | 0.28 | %    |  |   | 0.40  | % |  |      | 1.38  | % |  |   | 0.64  | %
|                                                                 |  |                 |      |   |      |   |      |      |  |   |       |   |  |      |       |   |  |   |       |  
|Non-performing assets as a percent total assets                  |  |                 | 0.18 | % |      |   | 0.22 | %    |  |   | 0.31  | % |  |      | 0.99  | % |  |   | 0.43  | %
|                                                                 |  |                 |      |   |      |   |      |      |  |   |       |   |  |      |       |   |  |   |       |  

Nonaccrual loans increased by $1,802,000 in 2003 as a result of the foreclosure of assets
associated with a large commercial loan which was subsequently sold in 2004.

Interest income of $38,000 would have been recognized on
nonaccrual during 2006 if they had been performing in accordance with their original terms. We recognized no income on such loans during 2006.

Other Real Estate Owned.Real estate acquired by foreclosure is classified within other assets on the consolidated balance sheet at the lower of the recorded investment in the property or its fair value minus estimated costs of sale.
Prior to foreclosure, the value of the underlying collateral is written down by a charge to the allowance for loan losses, if necessary. Any subsequent write-downs are charged against operating expenses. Operating expenses of such properties, net of
related income and losses on their disposition, are included as other expense.

Potential Problem Loans.As of December 31,
2006, there were no loans not disclosed above, where known information about possible credit problems of borrowers caused management to have serious doubts as to the ability of such borrowers to comply with the present loan repayment terms.

Classified Assets.Management, in compliance with regulatory guidelines, has instituted an internal loan review program, whereby
weaker credits are classified as special mention, substandard, doubtful or loss. When a loan is classified as substandard or doubtful, management is required to establish a valuation reserve for loan losses in an amount that is deemed prudent. When
management classifies a loan as a loss asset, a reserve equal to 100% of the loan balance is required to be established or the loan is to be charged-off. The allowance for loan losses is composed of an allowance for both inherent risk associated
with lending activities and particular problem assets.

An asset is considered substandard if it is inadequately protected by the paying
capacity and net worth of the obligor or the collateral pledged, if any. Substandard assets include those characterized by the distinct possibility that the Bank will sustain some loss if the deficiencies are not corrected. Assets classified as
doubtful have all of the weaknesses inherent in those classified substandard, with the added characteristic that the weaknesses present make collection or liquidation in full, highly questionable and improbable, on the basis of currently existing
facts, conditions, and values. Assets classified as loss are those considered uncollectible and of such little value that their continuance as assets without the establishment of a loss reserve is not warranted. Assets which do not currently expose
the insured institution to a sufficient degree of risk to warrant classification in one of the aforementioned categories but possess credit deficiencies or potential weaknesses are required to be designated special mention by management.



9



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Managements evaluation of the classification of assets and the adequacy of the allowance for loan
losses is reviewed by the Board on a regular basis and by the regulatory agencies as part of their examination process.

The following
table sets forth the Banks classified assets in accordance with its classification system.



|                |  |                 |        |      |   |       |  |      |       |      |   |       |  |   |      
|--------------- |  | --------------- | ------ | ---- | - | ----- |  | ---- | ----- | ---- | - | ----- |  | - | -----
|                |  | At December 31,
|(In thousands)  |  | 2006            |        | 2005 |   | 2004  |  | 2003 |       | 2002
|Special mention |  | $               | 8,955  |      | $ | 5,685 |  | $    | 1,862 |      | $ | 2,603 |  | $ | 5,039
|Substandard     |  |                 | 6,964  |      |   | 1,831 |  |      | 4,071 |      |   | 2,263 |  |   | 1,896
|Doubtful        |  |                 | 965    |      |   | 1,049 |  |      |      |      |   |      |  |   |     
|Loss            |  |                 |       |      |   |      |  |      |      |      |   |      |  |   |     
|                |  |                 |        |      |   |       |  |      |       |      |   |       |  |   |      
|Total           |  | $               | 16,884 |      | $ | 8,565 |  | $    | 5,933 |      | $ | 4,866 |  | $ | 6,935
|                |  |                 |        |      |   |       |  |      |       |      |   |       |  |   |      

The dollar amount of loans included in these categories increased in 2006 due to loan review
suggestions regarding cash flow projections alone rather than including collateral value as a source of repayment. Management has evaluated each loan included in the categories above and has determined that although we agree with the cash flow
analysis as performed, several of these loans have strong personal guarantees along with collateral value that would be sufficient to pay off the principal loan balance in case of default. There has been no performance problems related to those
loans in the past.

Allowance for Loan Losses

For a description of the Companys methodology for determining the allowance for loan losses, see Note 1 of the Notes to Consolidated Financial Statements and page 17 of the Managements Discussion and Analysis.



10



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Due to the credit quality of loans in 2006, the Bank did not see a high level of charge-offs as compared
to previous years. The delinquency level was at or below 1.0% for the majority for the year, ending the year at .71% of total loans. Loans charged-off in 2005 were significantly less than in recent years and were substantially offset by recoveries
of previously charged off loans including recovery of a large commercial real estate credit, resulting in a low amount of net loans charged off in 2005. In 2003 and 2004, the Bank experienced higher than average loan charge-offs related to one
borrower. The remaining loans from this borrower were held in nonaccrual status at December 31, 2003 and were subsequently charged down and the property acquired through foreclosure and sold in 2004.



11



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The following table presents a breakdown by loan category of the allowance for loan losses:



|                                            |  |                 |       |                               |       |   |        |      |                               |  |       |        |  |                               |       |  |        |   |                               |   |       |        |       |                                |  |   |       |  |       |  
|------------------------------------------- |  | --------------- | ----- | ----------------------------- | ----- | - | ------ | ---- | ----------------------------- |  | ----- | ------ |  | ----------------------------- | ----- |  | ------ | - | ----------------------------- | - | ----- | ------ | ----- | ------------------------------ |  | - | ----- |  | ----- | -
|                                            |  | At December 31, |      
|                                            |  | 2006            |       |                               | 2005  |   |        | 2004 |                               |  | 2003  |        |  | 2002                          |      
|(Dollars in thousands)                      |  | Amount          |       | Percent ofLoans toTotal Loans |       |   | Amount |      | Percent ofLoansto Total Loans |  |       | Amount |  | Percent ofLoansto Total Loans |       |  | Amount |   | Percent ofLoans toTotal Loans |   |       | Amount |       | Percent ofLoans to Total Loans | 
|Commercial and industrial, and agricultural |  | $               | 798   |                               | 14.5  | % |        | $    | 604                           |  | 16.1  | %      |  | $                             | 586   |  | 17.8   | % |                               | $ | 533   |        | 15.4  | %                              |  | $ | 383   |  | 15.8  | %
|Construction and Development                |  |                 |      |                               | 1.2   |   |        |      |                              |  | 1.3   |        |  |                               |      |  | 0.3    |   |                               |   | 1     |        | 0.2   |                                |  |   | 1     |  | 0.1   |  
|Mortgage                                    |  |                 | 3,433 |                               | 79.0  |   |        |      | 3,079                         |  | 76.1  |        |  |                               | 2,269 |  | 74.8   |   |                               |   | 2,110 |        | 75.5  |                                |  |   | 1,993 |  | 75.4  |  
|Installment                                 |  |                 | 238   |                               | 5.3   |   |        |      | 200                           |  | 6.5   |        |  |                               | 317   |  | 7.1    |   |                               |   | 370   |        | 8.9   |                                |  |   | 245   |  | 8.7   |  
|Unallocated                                 |  |                 |      |                               | 0.0   |   |        |      |                              |  | 0.0   |        |  |                               |      |  | 0.0    |   |                               |   |      |        | 0.0   |                                |  |   | 196   |  | 0.0   |  
|                                            |  |                 |       |                               |       |   |        |      |                               |  |       |        |  |                               |       |  |        |   |                               |   |       |        |       |                                |  |   |       |  |       |  
|Total                                       |  | $               | 4,469 |                               | 100.0 | % |        | $    | 3,973                         |  | 100.0 | %      |  | $                             | 3,172 |  | 100.0  | % |                               | $ | 3,014 |        | 100.0 | %                              |  | $ | 2,818 |  | 100.0 | %
|                                            |  |                 |       |                               |       |   |        |      |                               |  |       |        |  |                               |       |  |        |   |                               |   |       |        |       |                                |  |   |       |  |       |  



12



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Investment Activities

The Bank is required by federal banking regulators to maintain an adequate level of liquid assets which may be invested in specified short-term securities and certain other investments. The level of liquid assets
varies depending upon several factors, including: (i) the yields on investment alternatives, (ii) managements judgment as to the attractiveness of the yields then available in relation to other opportunities, (iii) expectation
of future yield levels, and (iv) managements projections as to the short-term demand for funds to be used in loan origination and other activities. Investment securities are classified at the time of purchase, based upon managements
intentions and abilities, as securities held to maturity or securities available for sale. Management has for several years maintained all current investment purchases in the available for sale category in order to have the ability to liquidate the
investment with no accounting ramifications. It is not our intent to sell these securities, we do expect to hold them until maturity, but have classified them as available for sale in order to have the ability to sell them if the need arises without
accounting reclassification. Securities classified as available for sale are adjusted to market value with the offset booked as an adjustment to stockholders equity. Debt securities classified as held to maturity are those which management
purchased with the intent and ability to hold to maturity and are stated at cost and adjusted for amortization of premium and accretion of discount, which are computed using the interest method and recognized as adjustments of interest income.
Equity securities are classified as available for sale when purchased.

Current regulatory and accounting guidelines regarding investment
securities (including mortgage-backed securities) require the Bank to categorize securities as held to maturity, available for sale or trading. As of December 31, 2006, the Registrant had no securities
classified as held to maturity and had securities in the amount of $67 million classified as available for sale with no securities classified as trading. Securities classified as available for sale are
reported for financial reporting purposes at the fair market value with net changes in the market value from period to period included as a separate component of stockholders equity, net of income taxes. At December 31, 2006, the
Registrants securities available for sale had an amortized cost and market value of $67 million each. Changes in market value in the Registrants available for sale portfolio reflect normal market conditions and vary, either positively or
negatively, based primarily on changes in general levels of market interest rates relative to the yields of the portfolio. Changes in the market value of securities available for sale do not affect the Companys income. In addition, changes in
the market value of securities available for sale do not affect the Banks regulatory capital requirements or its loan-to-one borrower limit.

At December 31, 2006, the Companys investment portfolio policy allowed investments in instruments such as: (i) U.S. Treasury obligations; (ii) U.S. federal agency or federally sponsored agency obligations;
(iii) obligations of state and political subdivisions; (iv) mortgage-backed securities; (v) bankers acceptances; (vi) certificates of deposit; and (vii) investment grade corporate bonds and commercial paper. The Board
of Directors may authorize additional investments.

Investment Portfolio.The following table sets forth the carrying value of the
investment securities portfolio at the dates indicated.



|                                                 |  |                 |        |      |   |        |  |   |       
|------------------------------------------------ |  | --------------- | ------ | ---- | - | ------ |  | - | ------
|                                                 |  | At December 31,
|(In thousands)                                   |  | 2006            |        | 2005 |   | 2004  
|Available-for-Sale:                              |  |                 |        |      |   |        |  |   |       
|                                                 |  |                 |       
|U.S. Government agency securities                |  | $               | 15,841 |      | $ | 22,573 |  | $ | 18,303
|Mortgage-backed securities                       |  |                 | 4,505  |      |   | 1,914  |  |   | 92    
|Obligations of state and political subdivisions  |  |                 | 9,026  |      |   | 6,225  |  |   | 5,224 
|Corporate securities                             |  |                 | 2,742  |      |   | 1,171  |  |   | 6,294 
|Commercial paper                                 |  |                 | 34,774 |      |   | 21,971 |  |   | 25,459
|Equity Securities                                |  |                 | 378    |      |   | 275    |  |   | 290   
|                                                 |  |                 |        |      |   |        |  |   |       
|Total                                            |  | $               | 67,266 |      | $ | 54,129 |  | $ | 55,662
|                                                 |  |                 |        |      |   |        |  |   |       
|                                                 |  |                 |       
|Held to Maturity:                                |  |                 |        |      |   |        |  |   |       
|Obligations of states and political subdivisions |  | $               |       |      | $ | 199    |  | $ | 198   
|                                                 |  |                 |        |      |   |        |  |   |       



13



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Investment Portfolio Maturities.The following table sets forth certain information regarding the
carrying values, weighted average yields and maturities of the Registrants investment and mortgage-backed securities portfolio at December 31, 2006. The following table does not take into consideration the effects of scheduled repayments
of mortgage-backed securities or the effects of possible prepayments. Securities held in the Available for Sale category are carried at their market value.



|                                                |  |                      |        |               |                   |   |                |                   |               |  |                    |                |  |                            |       |  |                |   |                   |   |        |                |      |               |  |   |        |  |       |  
|----------------------------------------------- |  | -------------------- | ------ | ------------- | ----------------- | - | -------------- | ----------------- | ------------- |  | ------------------ | -------------- |  | -------------------------- | ----- |  | -------------- | - | ----------------- | - | ------ | -------------- | ---- | ------------- |  | - | ------ |  | ----- | -
|                                                |  | At December 31, 2006 |       
|                                                |  | One Year or Less     |        |               | One to Five Years |   |                | Five to Ten Years |               |  | More than TenYears |                |  | Total InvestmentSecurities |      
|(Dollars in thousands)                          |  | Carrying Value       |        | Average Yield |                   |   | Carrying Value |                   | Average Yield |  |                    | Carrying Value |  | Average Yield              |       |  | Carrying Value |   | Average Yield (1) |   |        | Carrying Value |      | Average Yield | 
|Available for Sale:                             |  |                      |        |               |                   |   |                |                   |               |  |                    |                |  |                            |       |  |                |   |                   |   |        |                |      |               |  |   |        |  |       |  
|U.S. Government agencies                        |  | $                    |       |               |                  |   |                | $                 | 9,913         |  | 4.31               | %              |  | $                          | 2,946 |  | 4.03           | % |                   | $ | 2,982  |                | 4.38 | %             |  | $ | 15,841 |  | 4.27  | %
|Mortgage-backed securities                      |  |                      |       |               |                  |   |                |                   |              |  |                   |                |  |                            | 788   |  | 4.18           | % |                   |   | 3,717  |                | 5.28 | %             |  |   | 4,505  |  | 5.08  | %
|Obligations of state and political subdivisions |  |                      | 98     |               | 3.26              | % |                |                   | 782           |  | 6.49               | %              |  |                            | 2,288 |  | 6.04           | % |                   |   | 5,858  |                | 6.07 | %             |  |   | 9,026  |  | 6.06  | %
|Corporate                                       |  |                      | 1,500  |               | 5.40              | % |                |                   | 1,242         |  | 6.83               | %              |  |                            |      |  |               |   |                   |   |       |                |     |               |  |   | 2,742  |  | 6.05  | %
|Commercial paper                                |  |                      | 34,774 |               | 5.43              | % |                |                   |              |  |                   |                |  |                            |      |  |               |   |                   |   |       |                |     |               |  |   | 34,774 |  | 5.43  | %
|Equity securities                               |  |                      |       |               |                  |   |                |                   |              |  |                   |                |  |                            |      |  |               |   |                   |   | 378    |                | 3.31 | %             |  |   | 378    |  | 3.31  | %
|                                                |  |                      |        |               |                   |   |                |                   |               |  |                    |                |  |                            |       |  |                |   |                   |   |        |                |      |               |  |   |        |  |       |  
|Total                                           |  | $                    | 36,372 |               | 5.42              | % |                | $                 | 11,937        |  | 4.71               | %              |  | $                          | 6,022 |  | 4.80           | % |                   | $ | 12,935 |                | 5.39 | %             |  | $ | 67,266 |  | 5.23` | %
|                                                |  |                      |        |               |                   |   |                |                   |               |  |                    |                |  |                            |       |  |                |   |                   |   |        |                |      |               |  |   |        |  |       |  

---

|(1) | Weighted average yields have been computed on a taxable equivalent basis assuming a federal income tax rate of 34%.
|--- | -------------------------------------------------------------------------------------------------------------------



14



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Sources of Funds

General.Deposits are the major source of the Banks funds for lending and other investment purposes. Borrowings may be used on a short-term basis to compensate for reductions in the availability of funds
from other sources. They also may be used on a longer-term basis for interest rate risk management and general business purposes. In addition to deposits and borrowings, the Bank derives funds from loan principal repayments, short-term borrowings in
the form of securities sold under agreement to repurchase and proceeds from the sale and maturity of investment securities. Loan payments are a relatively stable source of funds, while deposit inflows are significantly influenced by general interest
rates and money market conditions.

Deposits.The Bank offers a variety of deposit accounts, although a majority of deposits are in
fixed-term, market-rate certificate accounts. Deposit account terms vary, primarily as to the required minimum balance amount, the amount of time that the funds must remain on deposit and the applicable interest rate. In 2004, the Bank joined the
Promontory Interfinancial Network, gaining the ability to offer customers certificates of deposit with FDIC insurance coverage up to $30 million through its Certificate of Deposit Account Registry Service (CDARS). Our customers funds are
reciprocated in the network with funds from other banks, with no bank having total customer deposits at the current maximum FDIC coverage limit of $100,000. The Bank is the only point of contact for the customer. Any deposits placed through
this network are classified as brokered certificates of deposit. The Bank had $5 million of deposits in the program at December 31, 2006.

Jumbo Certificates of Deposit.The following table shows the amount (in thousands) of the Banks certificates of deposit of $100,000 or more by time remaining until maturity as of December 31, 2006:



|                            |  |                        |       
|--------------------------- |  | ---------------------- | ------
|Maturity Period             |  | Certificatesof Deposit
|Within three months         |  | $                      | 18,855
|Four through six months     |  |                        | 21,898
|Seven through twelve months |  |                        | 17,078
|Over twelve months          |  |                        | 13,232
|                            |  |                        |       
|Total                       |  | $                      | 71,063
|                            |  |                        |       

Borrowings. The Bank may obtain advances from the Federal Home Loan Bank (FHLB)
of Pittsburgh to supplement its supply of lendable funds. Advances from the FHLB of Pittsburgh are typically secured by a pledge of the Banks stock in the FHLB of Pittsburgh and a portion of the Banks first mortgage loans and certain
other assets. Each FHLB credit program has its own interest rate, which may be fixed or variable, and range of maturities. The Bank, if the need arises, may also access the Federal Reserve Bank discount window to supplement its supply of lendable
funds and to meet deposit withdrawal requirements. The Bank has offered securities sold with agreements to repurchase to larger commercial customers and had balances of $13 million at December 31, 2006. These arrangements are not deposits within the
definition of the FDIC and therefore do not qualify for FDIC insurance. To collateralize these liabilities, the Bank has pledged securities with amortized cost and market value of $18 million at December 31, 2006.

The following table sets forth information concerning short-term FHLB advances and securities sold under agreements to repurchase during the periods
indicated. There were no short-term FHLB advances outstanding at December 31, 2006.



15



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|                                                            |  |                                        |        |   |      |   |        |      |  |   |        |  
|----------------------------------------------------------- |  | -------------------------------------- | ------ | - | ---- | - | ------ | ---- |  | - | ------ | -
|                                                            |  | At or For the Years Ended December 31, |       
|(in Thousands)                                              |  | 2006                                   |        |   | 2005 |   |        | 2004 | 
|Average outstanding                                         |  | $                                      | 15,733 |   |      | $ | 14,855 |      |  | $ | 13,142 |  
|Maximum amount outstanding at any month-end during the year |  |                                        | 21,191 |   |      |   | 20,204 |      |  |   | 16,087 |  
|Weighted average interest rate during the year              |  |                                        | 2.36   | % |      |   | 1.40   | %    |  |   | 0.98   | %
|                                                            |  |                                        |       
|Total short-term borrowings at year end                     |  | $                                      | 12,705 |   |      | $ | 12,954 |      |  | $ | 12,033 |  
|Weighted average interest rate at year end                  |  |                                        | 2.64   | % |      |   | 2.97   | %    |  |   | 1.22   | %

Trust and Financial Services Activities

The Bank operates a Trust Department and an Investment Department. These departments provide estate planning, investment management and financial planning
to customers. At December 31, 2006, the Bank had $68 million of assets under management, of which $60 million is non-discretionary with no investment authority.

Personnel

As of December 31, 2006, the Registrant had 96 full-time employees and 29 part-time
employees. The employees are not represented by a collective bargaining unit. The Registrant believes its relationship with its employees to be satisfactory.

SUPERVISION AND REGULATION

Set forth below is a brief description of certain laws which relate to
the regulation and supervision of the Company and the Bank. The description does not purport to be complete and is qualified in its entirety by reference to applicable laws and regulations.

Regulation of the Company

Set forth below is a brief
description of certain laws which related to the regulation of the Company and the Bank. The description does not purport to be complete and is qualified in its entirety by reference to applicable laws and regulations.

General. The Company, as a bank holding company under the Bank Holding Company Act of 1956, as amended, is subject to regulation, supervision and
examination by the Board of Governors of the Federal Reserve System and by the Pennsylvania Department of Banking. The Company is required to file annually a report of its operations with the Federal Reserve and the Pennsylvania Department of
Banking. This regulation and oversight is generally intended to ensure that the Company limits its activities to those allowed by law and that it operates in a safe and sound manner without endangering the financial health of the Bank.

Under the Bank Holding Company Act, the Company must obtain the prior approval of the Federal Reserve before it may acquire control of another bank or
bank holding company, merge or consolidate with another bank holding company, acquire all or substantially all of the assets of another bank or bank holding company, or acquire direct or indirect ownership or control of any voting shares of any bank
or bank holding company if, after such acquisition, the Company would directly or indirectly own or control more than 5% of such shares.



16



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Federal statutes impose restrictions on the ability of a bank holding company and its nonbank
subsidiaries to obtain extensions of credit from its subsidiary bank, on the subsidiary banks investments in the stock or securities of the holding company, and on the subsidiary banks taking of the holding companys stock or
securities as collateral for loans to any borrower. A bank holding company and its subsidiaries are also prevented from engaging in certain tie-in arrangements in connection with any extension of credit, lease or sale of property, or furnishing of
services by the subsidiary bank.

A bank holding company is required to serve as a source of financial and managerial strength to its
subsidiary banks and may not conduct its operations in an unsafe or unsound manner. In addition, it is the Federal Reserve policy that a bank holding company should stand ready to use available resources to provide adequate capital to its subsidiary
banks during periods of financial stress or adversity and should maintain the financial flexibility and capital-raising capacity to obtain additional resources for assisting its subsidiary banks. A bank holding companys failure to meet its
obligations to serve as a source of strength to its subsidiary banks will generally be considered by the Federal Reserve to be an unsafe and unsound banking practice or a violation of the Federal Reserve regulations, or both.

Non-Banking Activities. The business activities of the Company, as a bank holding company, are restricted by the Bank Holding Company Act. Under
the Bank Holding Company Act and the Federal Reserves bank holding company regulations, the Company may only engage in, or acquire or control voting securities or assets of a company engaged in (i) banking or managing or controlling banks
and other subsidiaries authorized under the Bank Holding Company Act; or (ii) any non-banking activity the Federal Reserve has determined to be so closely related to banking or managing or controlling banks to be a proper incident thereto.
These include any incidental activities necessary to carry on those activities, as well as a lengthy list of activities that the Federal Reserve has determined to be so closely related to the business of banking as to be a proper incident thereto.

Financial Activities. Provisions of the Gramm-Leach-Bliley Act, which became effective in March 2001, permit greater affiliation
among banks, securities firms, insurance companies, and other companies under a new type of financial services company known as a financial holding company. A financial holding company essentially is a bank holding company with
significantly expanded powers. Financial holding companies are authorized by statute to engage in a number of financial activities previously impermissible for bank holding companies, including: (i) securities underwriting, dealing and market
making; (ii) sponsoring mutual funds and investment companies; (iii) insurance underwriting and agency; and (iv) merchant banking activities. The Gramm-Leach-Bliley Act also permits the Federal Reserve and the Treasury Department to
authorize additional activities for financial holding companies if they are financial in nature or incidental to financial activities. A bank holding company may become a financial holding company if each of its subsidiary
banks is well capitalized, well managed, and has at least a satisfactory CRA rating. A financial holding company must provide notice to the Federal Reserve within 30 days after commencing activities previously determined by statute or by
the Federal Reserve and Department of the Treasury to be permissible. The Company has not submitted notice to the Federal Reserve to become a financial holding company.

Regulatory Capital Requirements. The Federal Reserve has adopted capital adequacy guidelines under which it assesses the adequacy of capital in examining and supervising a bank holding company and in analyzing
applications to it under the Bank Holding Company Act. The Federal Reserves capital adequacy guidelines are similar to those imposed on the Bank by the Federal Deposit Insurance Corporation (FDIC). See Regulation of the
BankRegulatory Capital Requirements.

Restrictions on Dividends. The Federal Reserve has issued a policy statement on
the payment of cash dividends by bank holding companies, which expresses the Federal Reserves view that a bank holding company should pay cash dividends only to the extent that the holding companys net income for the past year is
sufficient to cover both the cash dividends and a rate of earnings retention that is consistent with the holding companys capital needs, asset quality and overall financial condition. The Federal Reserve also indicated that it would be
inappropriate for a company experiencing serious financial problems to borrow funds to pay dividends. Furthermore, under the federal prompt corrective action regulations, the Federal Reserve may prohibit a bank holding company from paying any
dividends if the holding companys bank subsidiary is classified as undercapitalized.



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Regulation of the Bank

General. As a Pennsylvania chartered commercial bank with deposits insured by the FDIC which is not a Federal Reserve System member, the Bank is subject to extensive regulation and examination by the
Pennsylvania Department of Banking and by the FDIC, which insures its deposits to the maximum extent permitted by law. The federal and state laws and regulations applicable to banks regulate, among other things, the scope of their business, their
investments, the reserves required to be kept against deposits, the timing of the availability of deposited funds and the nature and amount of and collateral for certain loans. The laws and regulations governing the Bank generally have been
promulgated to protect depositors and not for the purpose of protecting stockholders. This regulatory structure also gives the federal and state banking agencies extensive discretion in connection with their supervisory and enforcement activities
and examination policies, including policies with respect to the classification of assets and the establishment of adequate loan loss reserves for regulatory purposes. Any change in such regulation, whether by the Pennsylvania Department of Banking,
the FDIC or the United States Congress, could have a material impact on the Bank and its operations.

Federal law provides the federal
banking regulators, including the FDIC and the Federal Reserve, with substantial enforcement powers. This enforcement authority includes, among other things, the ability to assess civil money penalties, to issue cease-and-desist or removal orders,
and to initiate injunctive actions against banking organizations and institution-affiliated parties, as defined. In general, these enforcement actions may be initiated for violations of laws and regulations and unsafe or unsound practices. Other
actions or inactions may provide the basis for enforcement action, including misleading or untimely reports filed with regulatory authorities.

Pennsylvania Banking Law. The Pennsylvania Banking Code contains detailed provisions governing the organization, location of offices, rights and responsibilities of trustees, officers, and employees, as well as corporate powers,
savings and investment operations and other aspects of the Bank and its affairs. The Code delegates extensive rule-making power and administrative discretion to the Pennsylvania Department of Banking so that the supervision and regulation of state
chartered commercial banks may be flexible and readily responsive to changes in economic conditions and in savings and lending practices.

The Code also provides state-chartered commercial banks with all of the powers enjoyed by national banks and federal savings associations, subject to regulation by the Pennsylvania Department of Banking. The Federal Deposit Insurance
Corporation Act, however, prohibits a state-chartered bank from making new investments, loans, or becoming involved in activities as principal and equity investments which are not permitted for national banks unless (1) the FDIC determines the
activity or investment does not pose a significant risk of loss to the relevant insurance fund and (2) the bank meets all applicable capital requirements. Accordingly, the additional operating authority provided to the Bank by the code is
significantly restricted by the Federal Deposit Insurance Act.

The Pennsylvania Banking Code states, in part, that dividends may be
declared and paid only out of accumulated net earnings and may not be declared or paid unless surplus (retained earnings) is at least equal to contributed capital. The Bank has not declared or paid any dividends that have caused its retained
earnings to be reduced below the amount required. Finally, dividends may not be declared or paid if the Bank is in default in payment of any assessment due the FDIC.

Federal Deposit Insurance. The FDIC is an independent federal agency that insures the deposits, up to prescribed statutory limits, of federally insured banks and savings institutions and safeguards the safety
and soundness of the banking and savings industries. The FDIC previously administered two separate insurance funds, the Bank Insurance Fund, which generally insured commercial bank and state savings bank deposits, and the Savings Association
Insurance Fund, which generally insured savings association deposits. The Bank was a member of the Bank Insurance Fund.



18



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The FDIC was authorized to establish separate annual deposit insurance assessment rates for members of
the Bank Insurance Fund and the Savings Association Insurance Fund, and to increase assessment rates if it determined such increases were appropriate to maintain the reserves of either insurance fund. In addition, the FDIC was authorized to levy
emergency special assessments on Bank Insurance Fund and Savings Association Insurance Fund members. The FDICs deposit insurance premiums were assessed through a risk-based system under which all insured depository institutions are placed into
one of nine categories and assessed insurance premiums based upon their level of capital and supervisory evaluation, with the assessment rate for most institutions set at 0%.

Under the Federal Deposit Insurance Reform Act of 2005, which was signed into law on February 15, 2006: (i) the Bank Insurance Fund and the
Savings Association Insurance Fund were merged into a new combined fund, to be called the Deposit Insurance Fund effective March 31, 2006, (ii) the current $100,000 deposit insurance coverage will be indexed for inflation (with adjustments
every five years, commencing January 1, 2011); and (iii) deposit insurance coverage for retirement accounts has been increased to $250,000 per participant subject to adjustment for inflation. The FDIC has been given greater latitude in
setting the assessment rates for insured depository institutions, which could be used to impose minimum assessments.

The FDIC is
authorized to set the reserve ratio for the Deposit Insurance Fund annually at between 1.15% and 1.5% of estimated insured deposits. If the Deposit Insurance Funds reserves exceed the designated reserve ratio, the FDIC is required to pay out
all or, if the reserve ratio is less than 1.5%, a portion of the excess as a dividend to insured depository institutions based on the percentage of insured deposits held on December 31, 1996 adjusted for subsequently paid premiums. Insured
depository institutions that were in existence on December 31, 1996 and paid assessments prior to that date (or their successors) are entitled to a one-time credit against future assessments based on their past contributions to the BIF or SAIF.

Pursuant to the Reform Act, the FDIC has determined to maintain the designated reserve ratio at its current 1.25%. The FDIC has also
adopted a new risk-based premium system that provides for quarterly assessments based on an insured institutions ranking in one of four risk categories based on their examination ratings and capital ratios. Beginning in 2007, well-capitalized
institutions with the CAMELS ratings of 1 or 2 will be grouped in Risk Category I and will be assessed for deposit insurance at an annual rate of between five and seven basis points with the assessment rate for an individual institution to be
determined according to a formula based on a weighted average of the institutions individual CAMEL component ratings plus either five financial ratios or the average ratings of its long-term debt. Institutions in Risk Categories II, III and IV
will be assessed at annual rates of 10, 28 and 43 basis points, respectively. The Bank anticipates that it will be able to offset its deposit insurance premium for 2007 with the special assessment credit.

In addition, all institutions with deposits insured by the FDIC are required to pay assessments to fund interest payments on bonds issued by the
Financing Corporation, an agency of the Federal government established to recapitalize the predecessor to the Savings Association Insurance Fund. These assessments will continue until the Financing Corporation bonds mature in 2017.

Regulatory Capital Requirements. The FDIC has promulgated capital adequacy requirements for state-chartered banks that, like the Bank, are not
members of the Federal Reserve System. At December 31, 2006, the Bank exceeded all regulatory capital requirements and was classified as well capitalized.

The FDICs capital regulations establish a minimum 3% Tier 1 leverage capital requirement for the most highly rated state-chartered, non-member
banks, with an additional cushion of at least 100 to 200 basis points for all other state-chartered, non-member banks, which effectively increases the minimum Tier 1 leverage ratio for such other banks to 4% to 5% or more. Under the FDICs
regulation, the highest-rated banks are those that the FDIC determines are not anticipating or experiencing significant growth and have well diversified risk, including no undue interest rate risk exposure, excellent asset quality, high liquidity,
good earnings and, in general, which are considered a strong banking organization, rated composite 1 under the Uniform Financial Institutions Rating System. Tier 1 or core capital is defined as the sum of common stockholders equity (including
retained earnings), noncumulative perpetual preferred stock and related surplus, and minority interests in consolidated subsidiaries, minus all intangible assets other than certain mortgage and non-mortgage servicing assets and purchased credit card
relationships.



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The FDICs regulations also require that state-chartered, non-member banks meet a risk-based capital
standard. The risk-based capital standard requires the maintenance of total capital (which is defined as Tier 1 capital and supplementary (Tier 2) capital) to risk weighted assets of 8%. In determining the amount of risk-weighted assets, all assets,
plus certain off balance sheet assets, are multiplied by a risk-weight of 0% to 100%, based on the risks the FDIC believes are inherent in the type of asset or item. The components of Tier 1 capital for the risk-based standards are the same as those
for the leverage capital requirement. The components of supplementary (Tier 2) capital include cumulative perpetual preferred stock, mandatory subordinated debt, perpetual subordinated debt, intermediate-term preferred stock, up to 45% of unrealized
gains on equity securities and a banks allowance for loan and lease losses. Allowance for loan and lease losses includable in supplementary capital is limited to a maximum of 1.25% of risk-weighted assets. Overall, the amount of supplementary
capital that may be included in total capital is limited to 100% of Tier 1 capital.

A bank that has less than the minimum leverage capital
requirement is subject to various capital plan and activities restriction requirements. The FDICs regulations also provide that any insured depository institution with a ratio of Tier 1 capital to total assets that is less than 2.0% is deemed
to be operating in an unsafe or unsound condition pursuant to Section 8(a) of the Federal Deposit Insurance Act and could be subject to termination of deposit insurance.

The Bank is also subject to minimum capital requirements imposed by the Pennsylvania Department of Banking on Pennsylvania-chartered depository
institutions. Under the Pennsylvania Department of Bankings capital regulations, a Pennsylvania bank or savings bank must maintain a minimum leverage ratio of Tier 1 capital (as defined under the FDICs capital regulations) to total
assets of 4%. In addition, the Pennsylvania Department of Banking has the supervisory discretion to require a higher leverage ratio for any institutions based on the institutions substandard performance in any of a number of areas. The Bank
was in compliance with both the FDIC and the Pennsylvania Department of Banking capital requirements as of December 31, 2006.

Affiliate Transaction Restrictions.Federal laws strictly limit the ability of banks to engage in transactions with their affiliates, including their bank holding companies. Such transactions between a subsidiary bank and its parent
company or the nonbank subsidiaries of the bank holding company are limited to 10% of a bank subsidiarys capital and surplus and, with respect to such parent company and all such nonbank subsidiaries, to an aggregate of 20% of the bank
subsidiarys capital and surplus. Further, loans and extensions of credit generally are required to be secured by eligible collateral in specified amounts. Federal law also requires that all transactions between a bank and its affiliates be on
terms as favorable to the bank as transactions with non-affiliates.

Federal Home Loan Bank System.The Bank is a member of the
Federal Home Loan Bank of Pittsburgh, which is one of 12 regional Federal Home Loan Banks. Each Federal Home Loan Bank serves as a reserve or central bank for its members within its assigned region. It is funded primarily from funds deposited by
member institutions and proceeds from the sale of consolidated obligations of the Federal Home Loan Bank system. It makes loans to members (i.e., advances) in accordance with policies and procedures established by the board of trustees of the
Federal Home Loan Bank.

As a member, it is required to purchase and maintain stock in the Federal Home Loan Bank of Pittsburgh in an
amount equal to 0.7% of its aggregate unpaid residential mortgage loans, home purchase contracts or similar obligations at the beginning of each year and 4.7% of its outstanding advances from the Federal Home Loan Bank. At December 31, 2006,
the Bank was in compliance with this requirement.

Federal Reserve System.The Federal Reserve requires all depository institutions
to maintain non-interest bearing reserves at specified levels against their transaction accounts (primarily checking and NOW accounts) and non-personal time deposits. The balances maintained to meet the reserve requirements imposed by the Federal
Reserve may be used to satisfy the liquidity requirements that are imposed by the Department. At December 31, 2006, the Bank met its reserve requirements.



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Loans to One Borrower.Under Pennsylvania law, commercial banks have, subject to certain
exemptions, lending limits to one borrower in an amount equal to 15% of the institutions capital accounts. Pursuant to the national bank parity provisions of the Pennsylvania Banking Code, the Bank may also lend up to the maximum amounts
permissible for national banks, which are allowed to make loans to one borrower of up to 25% of capital and surplus in certain circumstances. An institutions capital account includes the aggregate of all capital, surplus, undivided profits,
capital securities and general reserves for loan losses. As of December 31, 2006, loans-to-one borrower limitation was $5.6 million and the Bank was in compliance with such limitation.



|Item 1A. | Risk Factors
|-------- | ------------

In determining whether to
invest in our securities, investors should consider, among other factors, the following:

Risks Related to Our Business

Our success will depend upon our ability to effectively manage our future growth.

We believe that we have in place the management and systems, including data processing systems, internal controls and a strong credit culture, to support
continued growth. However, our continued growth and profitability depend on the ability of our officers and key employees to manage such growth effectively, to attract and retain skilled employees and to maintain adequate internal controls and a
strong credit culture. Accordingly, there can be no assurance that we will be successful in managing our expansion, and the failure to do so would adversely affect our financial condition and results of operations.

If we experience loan losses in excess of our allowance, our earnings will be adversely affected.

The risk of credit losses on loans varies with, among other things, general economic conditions, the type of loan being made, the creditworthiness of the
borrower over the term of the loan and, in the case of a collateralized loan, the value and marketability of the collateral for the loan. Management maintains an allowance for loan losses based upon, among other things, historical experience, an
evaluation of economic conditions and regular reviews of delinquencies and loan portfolio quality. Based upon such factors, management makes various assumptions and judgments about the ultimate collectibility of the loan portfolio and provides an
allowance for loan losses based upon a percentage of the outstanding balances and for specific loans when their ultimate collectibility is considered questionable. If managements assumptions and judgments prove to be incorrect and the
allowance for loan losses is inadequate to absorb future losses, or if the bank regulatory authorities require us to increase the allowance for loan losses as a part of their examination process, our earnings and capital could be significantly and
adversely affected.

As of December 31, 2006, our allowance for loan losses was $4,469,000, which represented 1.46% of outstanding
loans. At such date, we had 34 nonperforming loans totaling $716,000. We actively manage our nonperforming loans in an effort to minimize credit losses. Although management believes that its allowance for loan losses is adequate, there can be no
assurance that the allowance will prove sufficient to cover future loan losses. Further, although management uses the best information available to make determinations with respect to the allowance for loan losses, future adjustments may be
necessary if economic conditions differ substantially from the assumptions used or adverse developments arise with respect to our non-performing or performing loans. Material additions to our allowance for loan losses would result in a decrease in
our net income and capital, and could have a material adverse effect on our financial condition and results of operations.

Most of our loans are to
commercial borrowers, which have a higher degree of risk than other types of loans.

Commercial loans are often larger and may involve
greater risks than other types of lending. Because payments on such loans are often dependent on the successful operation of the property or business involved, repayment of such loans may be more sensitive than other types of loans to adverse
conditions in the real estate market or the economy. Unlike residential mortgage loans, which generally are made on the basis of the borrowers ability to make repayment from his or her employment and other income and which are secured by real
property whose value tends to be more easily ascertainable, commercial loans typically are made on the basis of the



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borrowers ability to make repayment from the cash flow of the borrowers business. As a result, the availability of funds for the repayment of
commercial loans may be substantially dependent on the success of the business itself and the general economic environment. If the cash flow from business operations is reduced, the borrowers ability to repay the loan may be impaired.

Most of our loans are secured, in whole or in part, with real estate collateral which is subject to declines in value.

In addition to the financial strength and cash flow characteristics of the borrower in each case, we often secure our loans with real estate collateral.
As of December 31, 2006, approximately 80% of our loans had real estate as a primary, secondary or tertiary component of collateral. Real estate values and real estate markets are generally affected by, among other things, changes in national,
regional or local economic conditions, fluctuations in interest rates and the availability of loans to potential purchasers, changes in tax laws and other governmental statutes, regulations and policies, and acts of nature. The real estate
collateral in each case provides an alternate source of repayment in the event of default by the borrower. If real estate prices in our markets decline, the value of the real estate collateral securing our loans could be reduced. If we are required
to liquidate the collateral securing a loan during a period of reduced real estate values to satisfy the debt, our earnings and capital could be adversely affected.

Our business is geographically concentrated and is subject to regional economic factors that could have an adverse impact on our business.

Substantially all of our business is with customers in our market area of Northeastern Pennsylvania. Most of our customers are consumers and small and
medium-sized businesses which are dependent upon the regional economy. Adverse changes in economic and business conditions in our markets could adversely affect our borrowers, their ability to repay their loans and to borrow additional funds, and
consequently our financial condition and performance.

Additionally, we often secure our loans with real estate collateral, most of which
is located in Northeastern Pennsylvania. A decline in local economic conditions could adversely affect the values of such real estate. Consequently, a decline in local economic conditions may have a greater effect on our earnings and capital than on
the earnings and capital of larger financial institutions whose real estate loan portfolios are geographically diverse.

The loss of our chief executive
officer and certain other key personnel could hurt our business.

Our success depends, to a great extent, upon the services of Gary C.
Beilman, our President and Chief Executive Officer, who serves on an at will basis. From time to time, we also need to recruit personnel to fill vacant positions for experienced lending and credit administration officers. Competition for
qualified personnel in the banking industry is intense, and there can be no assurance that we will continue to be successful in attracting, recruiting and retaining the necessary skilled managerial, marketing and technical personnel for the
successful operation of our existing lending, operations, accounting and administrative functions or to support the expansion of the functions necessary for our future growth. Our inability to hire or retain key personnel could have a material
adverse effect on our results of operations.

Our legal lending limits are relatively low and restrict our ability to compete for larger customers.

At December 31, 2006, our lending limit per borrower was approximately $5.6 million, or approximately 15.8% of our capital
accounts. Accordingly, the size of loans that we can offer to potential borrowers is less than the size of loans that many of our competitors with larger capitalization are able to offer. We may engage in loan participations with other banks for
loans in excess of our legal lending limits. However, there can be no assurance that such participations will be available at all or on terms which are favorable to us and our customers.



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Risks Related to Our Common Stock

There is a limited trading market for our common stock, which may adversely impact your ability to sell your shares and the price you receive for your shares.

Although our common stock is quoted on the OTC Bulletin Board, there has been limited trading activity in our stock and an active trading market is not
expected to develop. This means that there may be limited liquidity for our common stock, which may make it difficult to buy or sell our common stock, may negatively affect the price of our common stock and may cause volatility in the price of our
common stock.

There are restrictions on our ability to pay cash dividends.

Although we have paid cash dividends on a quarterly basis for at least twenty-five years, there is no assurance that we will continue to pay cash
dividends. Future payment of cash dividends, if any, will be at the discretion of the Board of Directors and will be dependent upon our financial condition, results of operations, capital requirements and such other factors as the Board may deem
relevant and will be subject to applicable federal and state laws that impose restrictions on our ability to pay dividends.

Our common stock is not
insured and you could lose the value of your entire investment.

An investment in shares of our common stock is not a deposit and is
not insured against loss by the government.

Our management and significant shareholders control a substantial percentage of our stock and therefore
have the ability to exercise substantial control over our affairs.

As of December 31, 2006, our directors and executive officers
beneficially owned 292,637 shares, or approximately 18.3% of our common stock, including options to purchase approximately 66,750 shares, in the aggregate, of our common stock at exercise prices ranging from $13.00 to $35.95 per share. Because of
the large percentage of stock held by our directors and executive officers and other significant shareholders, these persons could influence the outcome of any matter submitted to a vote of our shareholders.

We may issue additional shares of common stock, which may dilute the ownership and voting power of our shareholders and the book value of our common stock.

We are currently authorized to issue up to 5,000,000 shares of common stock of which 1,527,842 (as of March 1, 2007) shares are
currently outstanding. Our Board of Directors has authority, without action or vote of the shareholders, to issue all or part of the authorized but unissued shares. In addition, a total of 112,636 shares of common stock have been reserved for
issuance under options outstanding on December 31, 2006, all of which were exercisable and had exercise prices ranging from $13.00 to $35.95. Any such issuance will dilute the percentage ownership interest of shareholders and may further dilute
the book value of our common stock.

Provisions of our Articles of Incorporation and the Pennsylvania Business Corporation Law could deter takeovers
which are opposed by the Board of Directors.

Our articles of incorporation require the approval of 75% of our outstanding shares for
any merger or consolidation of the Company. In addition, our articles of incorporation authorize the Board of Directors to consider a variety of factors other than the price offered in determining whether to oppose a tender or other offer for the
Companys securities. As a Pennsylvania corporation with a class of securities registered with the Securities and Exchange Commission, the Company is governed by certain provisions of the Pennsylvania Business Corporation Law that, inter
alia, permit the disparate treatment of certain shareholders; prohibit calls of special meetings of shareholders; require unanimous written consent for shareholder action in lieu of a meeting; require shareholder approval for certain
transactions in which a shareholder has an interest; and impose additional requirements on business combinations with persons who are the beneficial owners of more than 20% of the Companys stock.



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Risks Related to Our Industry

We operate in a competitive market which could constrain our future growth and profitability.

We
operate in a competitive environment, competing for deposits and loans with commercial banks, savings associations and other financial entities. Competition for deposits comes primarily from other commercial banks, savings associations, credit
unions, money market and mutual funds and other investment alternatives. Competition for loans comes primarily from other commercial banks, savings associations, mortgage banking firms, credit unions and other financial intermediaries. Many of the
financial intermediaries operating in our market area offer certain services, such as international banking services, which we do not offer. Moreover, banks with a larger capitalization and financial intermediaries not subject to bank regulatory
restrictions have larger lending limits and are thereby able to serve the needs of larger customers.

We are required to comply with extensive and
complex governmental regulation which can adversely affect our business.

Our operations are and will be affected by current and future
legislation and by the policies established from time to time by various federal and state regulatory authorities. We are subject to supervision and periodic examination by the Federal Reserve Board (the FRB), the Federal Deposit
Insurance Corporation (the FDIC) and the Pennsylvania Department of Banking. Banking regulations, designed primarily for the safety of depositors, may limit a financial institutions growth and the return to its investors by
restricting such activities as the payment of dividends, mergers with or acquisitions by other institutions, investments, loans and interest rates, interest rates paid on deposits, expansion of branch offices, and the offering of securities or trust
services. We are also subject to capitalization guidelines established by federal law and could be subject to enforcement actions to the extent that we are found by regulatory examiners to be undercapitalized. It is not possible to predict what
changes, if any, will be made to existing federal and state legislation and regulations or the effect that any such changes may have on our future business and earnings prospects. Further, the cost of compliance with regulatory requirements may
adversely affect our ability to operate profitability.

In addition, the monetary policies of the FRB have had a significant effect on the
operating results of banks in the past and are expected to continue to do so in the future. Among the instruments of monetary policy used by the FRB to implement its objectives are changes in the discount rate charged on bank borrowings and changes
in the reserve requirements on bank deposits. It is not possible to predict what changes, if any, will be made to the monetary policies of the FRB or to existing federal and state legislation or the effect that such change may have on our future
business and earnings prospects.

During the past several years, significant legislative attention has been focused on the regulation and
deregulation of the financial services industry. Non-bank financial institutions, such as securities brokerage firms, insurance companies and money market funds, have been permitted to engage in activities which compete directly with traditional
bank business.

We realize income primarily from the difference between interest earned on loans and investments and interest paid on deposits and
borrowings, and changes in interest rates may adversely affect our profitability and assets.

Changes in prevailing interest rates may
hurt our business. We derive our income mainly from the difference or spread between the interest earned on loans, securities and other interest-earning assets, and interest paid on deposits, borrowings and other interest-bearing
liabilities. In general, the larger the spread, the more we earn. When market rates of interest change, the interest we receive on our assets and the interest we pay on our liabilities will fluctuate. This can cause decreases in our spread and can
adversely affect our income.

Interest rates affect how much money we can lend. For example, when interest rates rise, the cost of
borrowing increases and loan originations tend to decrease. In addition, changes in interest rates can affect the average life of loans and investment securities. A reduction in interest rates generally results in increased prepayments of loans and
mortgage-backed securities, as borrowers refinance their debt in order to reduce their borrowing cost. This causes reinvestment risk, because we generally are not able to reinvest prepayments at rates



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that are comparable to the rates we earned on the prepaid loans or securities. Changes in market interest rates could also reduce the value of our financial
assets. If we are unsuccessful in managing the effects of changes in interest rates, our financial condition and results of operations could suffer.

As
a public company, we are subject to numerous reporting requirements that are currently evolving and could substantially increase our operating expenses and divert managements attention from the operation of our business.

The Sarbanes-Oxley Act of 2002, which became law in July 2002, has required changes in some of our corporate governance, securities disclosure and
compliance practices. In response to the requirements of that Act, the SEC has promulgated new rules covering a variety of subjects. Compliance with these new rules has significantly increased our legal and financial and accounting costs, and we
expect these increased costs to continue. In addition, compliance with the requirements has taken a significant amount of managements and the Board of Directors time and resources. Likewise, these developments may make it more difficult
for us to attract and retain qualified members of our board of directors, particularly independent directors, or qualified executive officers.

As directed by Section 404 of the Sarbanes-Oxley Act, the SEC adopted rules requiring public companies to include a report of management on the companys internal control over financial reporting in their annual reports on Form
10-K that contains an assessment by management of the effectiveness of the companys internal control over financial reporting. This requirement becomes applicable to us beginning with our annual report on Form 10-K for the fiscal year ending
December 31, 2007. In addition, in the future, the public accounting firm auditing the companys financial statements must attest to and report on managements assessment of the effectiveness of the companys internal control
over financial reporting. This requirement is first applicable to our annual report on Form 10-K for fiscal 2008 and for all future annual reports. The costs associated with the implementation of this requirement, including documentation and
testing, have not been estimated by us. If we are ever unable to conclude that we have effective internal control over financial reporting or, if our independent auditors are unable to provide us with an unqualified report as to the effectiveness of
our internal control over financial reporting for any future year-ends as required by Section 404, investors could lose confidence in the reliability of our financial statements, which could result in a decrease in the value of our securities.



|Item 1B. | Unresolved Staff Comments
|-------- | -------------------------

Not applicable.



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|Item 2. | Properties
|------- | ----------

The Company operates from its
main office, an operational center, and four branch offices, as described in Item 1. Business. All offices are owned except for two branch offices and the Operations Center. The leases have initial terms of between 5-20 years, with
renewal options for additional years. The following table sets forth certain information regarding our offices:



|                                 |  |            |  |                |     |  |                       |          
|-------------------------------- |  | ---------- |  | -------------- | --- |  | --------------------- | ---------
|                                 |  | YearOpened |  | Owned orLeased |     |  | Book Valueat 12/31/06
|Main Office:                     |  |            |  |                |     |  |                       |          
|820 Church Street                |  | 1985       |  | Owned          |     |  | $                     | 1,492,000
|Honesdale, PA                    |  |            |  |                |     |  |                       |          
|                                 |  |            | 
|Branch Offices:                  |  |            |  |                |     |  |                       |          
|309 Main Avenue                  |  | 1988       |  | Owned          |     |  | $                     | 940,000  
|Hawley, PA                       |  |            |  |                |     |  |                       |          
|                                 |  |            | 
|Route 371                        |  | 1995       |  | Leased         | (1) |  | $                     | 31,000   
|Damascus, PA                     |  |            |  |                |     |  |                       |          
|                                 |  |            | 
|Route 507                        |  | 1997       |  | Leased         | (2) |  | $                     | 449,000  
|Greentown, PA                    |  |            |  |                |     |  |                       |          
|                                 |  |            | 
|Route 739                        |  |            |  |                |     |  |                       |          
|Dingmans Ferry, PA               |  | 2004       |  | Owned          |     |  | $                     | 1,052,000
|                                 |  |            | 
|Operations Center                |  |            |  | Leased         | (3) |  |                       |          
|120 Sunrise Avenue Honesdale, PA |  | 1998       |  |                |     |  | $                     | 512,000  

---

|(1) | Lease expires 2015 with 15 year renewal option.
|--- | -----------------------------------------------

|(2) | Lease expires 2007 with 15 year renewal option.
|--- | -----------------------------------------------

|(3) | Lease expires 2008 with 10 year renewal option.
|--- | -----------------------------------------------



|Item 3. | Legal Proceedings
|------- | -----------------

There are various claims
and lawsuits in which Registrant is periodically involved, such as claims to enforce liens, condemnation proceedings on properties in which Registrant holds security interests, claims involving the making and servicing of real property loans, and
other issues incident to Registrants business. In the opinion of management, no material loss is expected from any of the pending claims or lawsuits.



|Item 4. | Submission of Matters to a Vote of Security Holders
|------- | ---------------------------------------------------

Not applicable.



26



---

PART II



|Item 5. | Market for Registrants Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities
|------- | ------------------------------------------------------------------------------------------------------------

(a) Market for Common Equity.The Information relating to the market for Registrants common equity and related stockholder matters
appears under Market Prices of Stock/Dividends Paid in the Registrants Annual Report to Shareholders for the fiscal year ended December 31, 2006 (Annual Report) which is filed as Exhibit 13 hereto and is
incorporated herein by reference. During the period covered by this report, the Company did not sell any equity securities that were not registered under the Securities Act of 1933.

(b) Use of Proceeds. Not applicable

(c) Issuer Purchases of Equity Securities.Not applicable



|Item 6. | Selected Financial Data
|------- | -----------------------

The information
contained in the table captioned Summary of Selected Financial Data in the Annual Report is incorporated herein by reference.



|Item 7. | Managements Discussion and Analysis of Financial Condition and Results of Operation
|------- | ------------------------------------------------------------------------------------

The information contained in the section captioned Managements Discussion and Analysis of Financial Condition and Results of Operations
in the Annual Report is incorporated herein by reference.



|Item 7A. | Quantitative and Qualitative Disclosure About Market Risk
|-------- | ---------------------------------------------------------

The information contained in the section captioned Quantitative and Qualitative Disclosures About Market Risk in the Annual Report is incorporated herein by reference. The consolidated financial statements
and notes thereto presented herein have been prepared in accordance with U.S. generally accepted accounting principles, which generally require the measurement of financial position and operating results in terms of historical dollars without
considering the changes in the relative purchasing power of money over time due to inflation. Unlike most industrial companies, nearly all of the Registrants assets and liabilities are monetary in nature. As a result, interest rates have a
greater impact on the Registrants performance than do the effects of general levels of inflation. Interest rates do not necessarily move in the same direction or to the same extent as the prices of goods and services.



27



---

|Item 8. | Financial Statements and Supplementary Data
|------- | -------------------------------------------

The Registrants financial statements listed in Item 15 are incorporated herein by reference from the Annual Report.



|Item 9. | Changes In and Disagreements with Accountants on Accounting and Financial Disclosure
|------- | ------------------------------------------------------------------------------------

None.



|Item 9A. | Controls and Procedures
|-------- | -----------------------

Dimecos
management is responsible for establishing and maintaining effective disclosure controls and procedures, as defined under Rules 13a-15(e) and 15d-15(e) of the Securities Exchange Act of 1934. As of December 31, 2006, an evaluation was performed
under the supervision and with the participation of management, including the Chief Executive Officer and the Chief Financial Officer, of the effectiveness of the design and operation of the Registrants disclosure controls and procedures as of
December 31, 2006. Based on that evaluation, the Chief Executive Officer and Chief Financial Officer have concluded that the Registrants disclosure controls and procedures were effective as of that date in ensuring material information
required to be disclosed in this Annual Report on 10-K was recorded, processed, summarized, and reported on a timely basis. Additionally, there were no changes in the Registrants internal control over financial reporting that occurred during
the quarter ended December 31, 2006 that have materially affected, or are reasonably likely to materially affect, the Registrants internal control over financial reporting.



|Item 9B. | Other Information
|-------- | -----------------

Not applicable.

PART III



|Item 10. | Directors, Executive Officers and Corporate Governance
|-------- | ------------------------------------------------------

Other information required under this item is incorporated herein by reference to the Proxy Statement for the 2007Annual Meeting of Shareholders (the Proxy Statement) contained under the sections captioned
Section 16(a) Beneficial Ownership Reporting Compliance, Proposal I  Election of Directors, and Corporate Governance.

The Registrant has adopted a Code of Ethics that applies to its principal executive officers, principal financial officer, principal accounting officer or controller or persons performing similar functions. A copy of
the Registrants Code of Ethics will be provided to any person without charge upon written request to Secretary, Dimeco, Inc., PO Box 509, Honesdale, PA 18431.



|Item 11. | Executive Compensation
|-------- | ----------------------

The information
required by this item is incorporated by reference to the Proxy Statement contained under the sections captioned Executive Compensation and Director Compensation.



|Item 12. | Security Ownership of Certain Beneficial Owners and Management
|-------- | --------------------------------------------------------------



| | (a) | Security Ownership of Certain Beneficial Owners
| | --- | -----------------------------------------------

Information required by this item is incorporated herein by reference to the section captioned Principal Holders of our Common Stock of the Proxy Statement.



| | (b) | Security Ownership of Management
| | --- | --------------------------------

Information
required by this item is incorporated herein by reference to the section captioned Proposal I  Election of Directors of the Proxy Statement.



28



---

| | (c) | Changes in Control
| | --- | ------------------

Management of the Registrant
knows of no arrangements, including any pledge by any person of securities of the Registrant, the operation of which may at a subsequent date result in a change in control of the Registrant.



| | (d) | Securities Authorized for Issuance Under Equity Compensation Plans
| | --- | ------------------------------------------------------------------

Set forth below is information as of December 31, 2006 with respect to compensation plans under which equity securities of the Registrant are authorized for issuance.

EQUITY COMPENSATION PLAN INFORMATION



|                                                       |  |                                                                                         |  |                                                                         |       |                                                                                                                                        |      
|------------------------------------------------------ |  | --------------------------------------------------------------------------------------- |  | ----------------------------------------------------------------------- | ----- | -------------------------------------------------------------------------------------------------------------------------------------- | -----
|                                                       |  | (a)                                                                                     |  | (b)                                                                     |       | (c)                                                                                                                                   
|                                                       |  | Number of securitiesto be issued uponexercise ofoutstanding options,warrants and
rights |  | Weighted-averageexercise price ofoutstandingoptions, warrantsand rights |       | Number of securitiesremaining available forfuture issuance under equitycompensation plans(excluding securitiesreflected in column (a))
|Equity compensation plans approved by shareholders:    |  |                                                                                         |  |                                                                         |       |                                                                                                                                        |      
|2000 Independent Directors Stock Option Plan           |  | 23,496                                                                                  |  | $                                                                       | 21.04 |                                                                                                                                        | 4    
|2000 Stock Incentive Plan                              |  | 89,140                                                                                  |  | $                                                                       | 20.33 |                                                                                                                                        | 2,000
|Equity compensation plans Not approved by shareholders |  |                                                                                        |  |                                                                         |      |                                                                                                                                        |     
|                                                       |  |                                                                                         |  |                                                                         |       |                                                                                                                                        |      
|TOTAL                                                  |  | 112,636                                                                                 |  | $                                                                       | 20.48 |                                                                                                                                        | 2,004
|                                                       |  |                                                                                         |  |                                                                         |       |                                                                                                                                        |      



|Item 13. | Certain Relationships and Related Transactions, and Director Independence
|-------- | -------------------------------------------------------------------------

The information required by this item is incorporated herein by reference to the sections captioned Related Party Transactions And Corporate Governance  Director Independence in the Proxy
Statement.



|Item 14. | Principal Accounting Fees and Services
|-------- | --------------------------------------

The information called for by this item is incorporated herein by reference to the section entitled Ratification of Independent Auditors in the Proxy Statement.

Part IV



|Item 15. | Exhibits, Financial Statement Schedules
|-------- | ---------------------------------------



| | (a) | The following documents are filed as a part of this report:
| | --- | -----------------------------------------------------------

(1) The consolidated balance sheet of Dimeco, Inc. as of December 31, 2006 and 2005 and the related consolidated statements of income, changes in stockholders equity and cash flows for each of the three
years in the period ended December 31, 2006, together with the related notes and the independent auditors report of S.R. Snodgrass, A.C., independent certified public accountants for the three years ended December 31, 2006.

(2) Schedules omitted as they are not applicable.

(3) The following exhibits are included in this Report or incorporated herein by reference:



29



---

|      |  |                                                                                    
|----- |  | -----------------------------------------------------------------------------------
|      | 
|3(i)  |  | Articles of Incorporation of Dimeco, Inc., as amended *                            
|      | 
|3(ii) |  | Amended Bylaws of Dimeco, Inc.**                                                   
|      | 
|10.1 |  | 2000 Independent Directors Stock Option Plan***                                    
|      | 
|10.2 |  | 2000 Stock Incentive Plan****                                                      
|      | 
|10.3 |  | Form of Salary Continuation Plan for Executive Officers**                          
|      | 
|10.4 |  | Change in Control Severance Agreement with Gary C. Beilman                         
|      | 
|10.5 |  | Change in Control Severance Agreement with Maureen H. Beilman                      
|      | 
|10.6 |  | Change in Control Severance Agreement with Peter Bochnovich                        
|      | 
|13    |  | Annual Report to Shareholders for the fiscal year ended December 31, 2006          
|      | 
|14    |  | Code of Ethics for Principal Executive Officers and Senior Financial Officers *****
|      | 
|21    |  | Subsidiaries of the Registrant                                                     
|      | 
|23    |  | Consent of S.R. Snodgrass, A.C.                                                    
|      | 
|31.1  |  | Rule 13a-14(a)/15d-14(a) Certificate                                               
|      | 
|31.2  |  | Rule 13a-14(a)/15d-14(a) Certificate                                               
|      | 
|32    |  | Section 1350 Certification                                                         

---

| | Management contract or compensatory plan or arrangement.
|- | --------------------------------------------------------

|* | Incorporated by reference to the indentically numbered exhibit to the Registrants Form 10-K for the fiscal year ended December 31, 2004.
|- | -----------------------------------------------------------------------------------------------------------------------------------------

|** | Incorporated by reference to the identically numbered exhibits to the Registrants Form 10-KSB for the fiscal year ended December 31, 2001.
|-- | -------------------------------------------------------------------------------------------------------------------------------------------

|*** | Incorporated by reference to Exhibit 99.1 to the Registration Statement on Form S-8 (File No. 333-69416) filed with the Commission on September 14, 2002.
|--- | ---------------------------------------------------------------------------------------------------------------------------------------------------------

|**** | Incorporated by reference to Exhibit 99.1 to the Registration Statement on Form S-8 (File No. 333-69420) filed with the Commission on September 14, 2002.
|---- | ---------------------------------------------------------------------------------------------------------------------------------------------------------

|***** | Incorporated by reference to the identically numbered exhibit to the Registrants Form 10-KSB for the fiscal year ended December 31, 2003.
|----- | ------------------------------------------------------------------------------------------------------------------------------------------



30



---

SIGNATURES

Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934,
the registrant caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.



|                     |  |  |  |              |  |                                      
|-------------------- |  |  |  | ------------ |  | -------------------------------------
|                     |  |  |  | DIMECO, INC.
|                     |  |  | 
|Date: March 22, 2007 |  |  |  | By:          |  | /s/ Gary C. Beilman                  
|                     |  |  |  |              |  | Gary C. Beilman                      
|                     |  |  |  |              |  | President and Chief Executive Officer
|                     |  |  |  |              |  | (Duly Authorized Representative)     

Pursuant to the requirement of the Securities Exchange Act of 1934, this report has been signed
below as of March 20, 2007 by the following persons on behalf of the registrant and in the capacities indicated.



|                                             |  |                                                
|-------------------------------------------- |  | -----------------------------------------------
|                                             | 
|/s/ William E. Schwarz                       |  | /s/ Gary C. Beilman                            
|William E. Schwarz                           |  | Gary C. Beilman                                
|Chairman of the Board and Director           |  | President, Chief Executive Officer and Director
|                                             |  | (Principal Executive Officer)                  
|                                             | 
|/s/ Maureen H. Beilman                       |  | /s/ Robert E. Genirs                           
|Maureen H. Beilman                           |  | Robert E. Genirs                               
|Chief Financial Officer and Treasurer        |  | Director                                       
|(Principal Financial and Accounting Officer) |  |                                                
|                                             | 
|/s/ Barbara Jean Genzlinger                  |  | /s/ John S. Kiesendahl                         
|Barbara Jean Genzlinger                      |  | John S. Kiesendahl                             
|Director                                     |  | Vice Chairman of the Board and Director        
|                                             | 
|/s/ Thomas A. Peifer                         |  | /s/ Henry M. Skier                             
|Thomas A. Peifer                             |  | Henry M. Skier                                 
|Director                                     |  | Director                                       
|                                             | 
|/s/ John F. Spall                            |  |                                                
|John F. Spall                                |  |                                                
|Director                                     |  |                                                



31