Edgar Filing: DIMECO INC

Form 10-Q

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

FORM 10-Q

x	QUARTERLY REPORT UNDER SECTION 13 OF 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the quarterly period ended June 30, 2005

¨	TRANSITION REPORT UNDER SECTION 13 OR 15(d) OF THE EXCHANGE ACT

For the transition period from to

Commission File Number 33-58936

Dimeco, Inc.

(Exact name of registrant as specified in its charter)

Pennsylvania

23-2250152

(State or other jurisdiction of

incorporation or organization)

(I.R.S. Employer

Identification No.)

820 Church Street

Honesdale, PA 18431

(Address of principal executive offices)

(570) 253-1970

(Issuer’s Telephone Number)

Not Applicable

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

Check whether the issuer (1) filed all reports required to be filed by Sections 13 or 15(d) of the Exchange Act during the past 12 months (or for such shorter period that the Registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes x No ¨

Indicate by check mark whether the registrant is an accelerated filer (as defined by Rule 12b-2 of the Exchange Act) Yes ¨ No x

As of August 1, 2005, the registrant had outstanding 1,544,269 shares of its common stock, par value $.50 share.

Dimeco, Inc.

INDEX


			Page

PART I - FINANCIAL INFORMATION

	Item 1.	Financial Statements

		Consolidated Balance Sheet (unaudited) as of June 30, 2005 and December 31, 2004	3

		Consolidated Statement of Income (unaudited) for the three months and six months ended June 30, 2005 and 2004	4

		Consolidated Statement of Comprehensive Income (unaudited) for the three months and six months ended June 30, 2005 and 2004	5

		Consolidated Statement of Changes in Stockholders’ Equity (unaudited) for the six months ended June 30, 2005	6

		Consolidated Statement of Cash Flows (unaudited) for the six months ended June 30, 2005 and 2004	7

		Notes to Consolidated Financial Statements (unaudited)	8 - 10

	Item 2.	Management’s Discussion and Analysis of Financial Condition and Results of Operations	11 - 16

	Item 3.	Quantitative and Qualitative Disclosures about Market Risk	17 - 19

	Item 4.	Controls and Procedures	20

PART II - OTHER INFORMATION

	Item 1.	Legal Proceedings	21

	Item 2.	Unregistered Sales of Equity Securities and Use of Proceeds	21

	Item 3.	Defaults Upon Senior Securities	21

	Item 4.	Submissions of Matters to a Vote of Security Holders	21

	Item 5.	Other Information	21

	Item 6.	Exhibits	22

SIGNATURES			23

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Dimeco, Inc.

CONSOLIDATED BALANCE SHEET (unaudited)


(in thousands)	June 30, 2005			December 31, 2004
Assets
Cash and due from banks	$	6,297		$	4,139
Interest-bearing deposits in other banks		3,062			15
Federal funds sold		2,132			978

Total cash and cash equivalents		11,491			5,132

Mortgage loans held for sale (market value $112)		—			112
Investment securities available for sale		55,083			55,662
Investment securities held to maturity (market value of $211 and $216)		199			198

Loans (net of unearned income of $622 and $623)		268,510			253,141
Less allowance for loan losses		3,568			3,172

Net loans		264,942			249,969

Premises and equipment		6,182			5,580
Accrued interest receivable		1,179			1,106
Bank-owned life insurance		5,159			5,065
Other assets		2,600			2,897

TOTAL ASSETS	$	346,835		$	325,721

Liabilities
Deposits :
Noninterest-bearing	$	37,103		$	30,380
Interest-bearing		245,293			240,162

Total deposits		282,396			270,542

Short-term borrowings		19,104			12,033
Other borrowed funds		12,639			11,349
Accrued interest payable		614			609
Other liabilities		1,402			1,492

TOTAL LIABILITIES		316,155			296,025

Stockholders’ Equity
Common stock, $.50 par value; 5,000,000 shares authorized; 1,549,269 and 1,548,994 shares issued		775			774
Capital surplus		4,380			4,377
Retained earnings		25,691			24,496
Accumulated other comprehensive income		7			49
Treasury stock, at cost (5,000 shares)		(173	)		—

TOTAL STOCKHOLDERS’ EQUITY		30,680			29,696

TOTAL LIABILITIES AND STOCKHOLDERS’ EQUITY	$	346,835		$	325,721

See accompanying notes to the unaudited consolidated financial statements.

–3–

Dimeco, Inc.

CONSOLIDATED STATEMENT OF INCOME (unaudited)


(in thousands, except per share)	For the three months ended June 30,				For the six months ended June 30,
(in thousands, except per share)	2005		2004		2005		2004
Interest Income
Interest and fees on loans	$	4,132	$	3,315	$	7,843	$	6,547
Investment securities:
Taxable		433		443		837		866
Exempt from federal income tax		36		51		74		124
Other		52		11		74		15

Total interest income		4,653		3,820		8,828		7,552

Interest Expense
Deposits		1,244		965		2,386		1,950
Short-term borrowings		59		32		95		54
Other borrowed funds		119		56		234		77

Total interest expense		1,422		1,053		2,715		2,081

Net Interest Income		3,231		2,767		6,113		5,471

Provision for loan losses		173		488		393		865

Net Interest Income After Provision for Loan Losses		3,058		2,279		5,720		4,606

Noninterest Income
Services charges on deposit accounts		328		324		622		623
Mortgage loans held for sale gains, net		57		62		164		162
Investment securities gains		—		85		2		85
Brokerage commissions		98		65		215		228
Other income		135		149		353		303

Total noninterest income		618		685		1,356		1,401

Noninterest Expense
Salaries and employee benefits		1,126		954		2,217		1,906
Occupancy expense, net		178		152		380		321
Furniture and equipment expense		140		119		277		232
Other expense		712		607		1,323		1,195

Total noninterest expense		2,156		1,832		4,197		3,654

Income before income taxes		1,520		1,132		2,879		2,353
Income taxes		481		348		909		719

NET INCOME	$	1,039	$	784	$	1,970	$	1,634

Earnings per Share - basic	$	0.67	$	0.51	$	1.27	$	1.07

Earnings per Share - diluted	$	0.65	$	0.49	$	1.23	$	1.02

Dividends per share	$	0.25	$	0.23	$	0.50	$	0.46

Average shares outstanding - basic		1,549,269		1,535,347		1,549,228		1,532,636

See accompanying notes to unaudited consolidated financial statements.

–4–

Dimeco, Inc.

CONSOLIDATED STATEMENT OF COMPREHENSIVE INCOME (unaudited)


	Three months ended June 30,					Six months ended June 30,
	2005		2004			2005			2004
Net income	$	1,039	$	784		$	1,970		$	1,634

Other comprehensive income:
Unrealized gain (loss) on available for sale securities		295		(508	)		(62	)		(489	)
Less: Reclassification adjustment for gain included in net income		—		85			2			85

Other comprehensive income (loss) before tax		295		(593	)		(64	)		(574	)

Income tax expense (benefit) related to other comprehensive income (loss)		100		(201	)		(22	)		(195	)

Other comprehensive income (loss), net of tax		195		(392	)		(42	)		(379	)

Comprehensive income	$	1,234	$	392		$	1,928		$	1,255

See accompanying notes to the unaudited consolidated financial statements.

–5–

Dimeco, Inc.

CONSOLIDATED STATEMENT OF CHANGES IN STOCKHOLDERS’ EQUITY (unaudited)


(amounts in thousands)	Common Stock		Capital Surplus		Retained Earnings			Accumulated Other Comprehensive Income (Loss)			Treasury Stock			Total Stockholders’ Equity
Balance December 31, 2004	$	774	$	4,377	$	24,496		$	49		$	—		$	29,696
Net income						1,970									1,970
Net unrealized loss on available for sale securities									(42	)					(42	)
Exercise of stock options		1		3											4
Purchase treasury stock												(173	)		(173	)
Cash dividends ($.50 per share)						(775	)								(775	)

Balance, June 30, 2005	$	775	$	4,380	$	25,691		$	7		$	(173	)	$	30,680

See accompanying notes to the unaudited consolidated financial statements.

–6–

Dimeco, Inc.

CONSOLIDATED STATEMENT OF CASH FLOWS (unaudited)


(in thousands)	2005			2004
For the six months ended June 30,
Operating Activities
Net income	$	1,970		$	1,634
Adjustments to reconcile net income to net cash provided by operating activities:
Provision for loan losses		393			865
Depreciation and amortization		392			345
Amortization of premium and discount on investment securities, net		(306	)		6
Amortization of net deferred loan origination fees		(42	)		(30	)
Investment securities gains		(2	)		(85	)
Origination of loans held for sale		(5,431	)		(4,345	)
Proceeds from sale of loans		5,707			4,417
Mortgage loans sold gains, net		(164	)		(162	)
Decrease (increase) in accrued interest receivable		(73	)		55
Increase (decrease) in accrued interest payable		5			(125	)
Deferred federal income taxes		142			12
Other, net		(236	)		(1,199	)

Net cash provided by operating activities		2,355			1,388

Investing Activities
Investment securities available for sale:
Proceeds from sales		6			160
Proceeds from maturities or paydown		113,229			36,058
Purchases		(112,411	)		(28,947	)
Net increase in loans		(15,324	)		(16,647	)
Redemption of Federal Home Loan Bank stock		112			—
Purchase of premises and equipment		(879	)		(337	)

Net cash provided by investing activities		(15,267	)		(9,713	)

Financing Activities
Net increase (decrease) in deposits		11,854			(279	)
Net increase in short-term borrowings		7,071			3,784
Proceeds from other borrowed funds		1,500			9,000
Repayment of other borrowed funds		(210	)		(64	)
Purchase treasury stock		(173	)		—
Proceeds from exercise of stock options		4			134
Cash dividends paid		(775	)		(696	)

Net cash provided by financing activities		19,271			11,879

Increase in cash and cash equivalents		6,359			3,554

Cash and cash equivalents at beginning of period		5,132			10,210

Cash and cash equivalents at end of period	$	11,491		$	13,764

See accompanying notes to unaudited consolidated financial statements.

–7–

Dimeco, Inc.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Unaudited)

NOTE 1 – SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES

Basis of Presentation

The consolidated financial statements include the accounts of Dimeco, Inc. (the “Company”) and its wholly-owned subsidiary The Dime Bank (the “Bank”). The financial statements of The Dime Bank include the consolidated financial statements of the Bank’s wholly-owned subsidiary, TDB Insurance Services, LLC. All significant intercompany balances and transactions have been eliminated in the consolidation.

The accompanying unaudited consolidated financial statements have been prepared in accordance with the instructions to Form 10-Q and, therefore, do not necessarily include all information that would be included in audited financial statements. The information furnished reflects all adjustments which are, in the opinion of management, necessary for a fair statement of the results of operations. All such adjustments are of a normal recurring nature. The results of operations for the interim periods are not necessarily indicative of the results to be expected for the full year.

Certain comparative amounts for prior periods have been reclassified to conform to current year presentation. The reclassifications did not affect net income or equity capital.

Recent Accounting Pronouncements

In December 2004, the Financial Accounting Standards Board (“FASB”) issued Statement of Financial Accounting Standards No. 123 (revised 2004), Share-Based Payment (FAS No. 123R). FAS No. 123R revised FAS No. 123, Accounting for Stock-Based Compensation, and supersedes APB Opinion No. 25, Accounting for Stock Issued to Employees, and its related implementation guidance. FAS No. 123R will require compensation costs related to share-based payment transactions to be recognized in the financial statement (with limited exceptions). The amount of compensation cost will be measured based on the grant-date fair value of the equity or liability instruments issued. Compensation cost will be recognized over the period that an employee provides service in exchange for the award.

In April, the Securities and Exchange Commission adopted a new rule that amends the compliance dates for FAS No. 123R. The Statement requires that compensation cost relating to share-based payment transactions be recognized in financial statements and that this cost be measured based on the fair value of the equity or liability instruments issued. FAS No. 123R covers a wide range of share-based compensation arrangements including share options, restricted share plans, performance-based awards, share appreciation rights, and employee share purchase plans. The Company will adopt FAS No. 123R on January 1, 2006 and is currently evaluating the impact the adoption of the standard will have on the Company’s results of operations.

In March 2005, the Securities and Exchange Commission (“SEC”) issued Staff Accounting Bulletin No. 107 (“SAB No. 107”), Share-Based Payment, providing guidance on option valuation methods, the accounting for income tax effects of share-based payment arrangements upon adoption of FAS No. 123R, and the disclosures in MD&A subsequent to the adoption. The Company will provide SAB No. 107 required disclosures upon adoption of FAS No. 123R on January 1, 2006 and is currently evaluating the impact the adoption of the standard will have on the Company’s financial condition, results of operations, and cash flows.

In December 2004, FASB issued FAS No. 153, Exchanges of Nonmonetary Assets - An Amendment of APB Opinion

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No. 29. The guidance in APB Opinion No. 29, Accounting for Nonmonetary Transactions, is based on the principle that exchanges of nonmonetary assets should be measured based on the fair value of the assets exchanged. The guidance in that Opinion, however, included certain exceptions to that principle. FAS No. 153 amends Opinion No. 29 to eliminate the exception for nonmonetary exchanges of similar productive assets and replaces it with a general exception for exchanges of nonmonetary assets that do not have commercial substance. A nonmonetary exchange has commercial substance if the future cash flows of the entity are expected to change significantly as a result of the exchange. The provisions of FAS No. 153 are effective for nonmonetary asset exchanges occurring in fiscal periods beginning after June 15, 2005. Early application is permitted and companies must apply the standard prospectively. The adoption of this standard is not expected to have a material effect on the Company’s results of operations or financial position.

In June 2005, the FASB issued FAS No. 154, Accounting Changes and Errors Corrections, a replacement of APB Opinion No. 20 and FAS No. 3. The Statement applies to all voluntary changes in accounting principle, and changes the requirements for accounting for and reporting of a change in accounting principle. FAS No. 154 requires retrospective application to prior periods’ financial statements of a voluntary change in accounting principle unless it is impractical. APB Opinion No. 20 previously required that most voluntary changes in accounting principle be recognized by including in net income of the period of the change the cumulative effect of changing to the new accounting principle. FAS No.154 improves the financial reporting because its requirements enhance the consistency of financial reporting between periods.

Stock Options

As permitted under Statement of Financial Accounting Standards (“FAS”) No. 123 “Accounting for Stock-based Compensation,” the Company has elected to continue following Accounting Principles Board Opinion No. 25, “Accounting for Stock Issued to Employees” (“APB 25”), and related Interpretations, in accounting for stock-based awards to employees. Under APB 25, because the exercise price of the Company’s employee stock options equals the market price of the underlying stock on the date of the grant, no compensation expense is recognized in the Company’s financial statements. The following table represents pro forma net income and earnings per share had compensation expense been included in stock option plan costs as determined based on the fair value at the grant dates for options granted under these plans consistent with FAS No. 123:


	Three months ended June 30,				Six months ended June 30,
	2005		2004		2005		2004
Net income as reported	$	1,039	$	784	$	1,970	$	1,634
Less pro forma expense related to options		3		6		6		10

Pro forma net income	$	1,036	$	778	$	1,964	$	1,624

Basic net income per common share:
As reported	$	0.67	$	0.51	$	1.27	$	1.07
Pro forma	$	0.67	$	0.51	$	1.27	$	1.06

Diluted net income per common share:
As reported	$	0.65	$	0.49	$	1.23	$	1.02
Pro forma	$	0.65	$	0.49	$	1.23	$	1.01

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NOTE 2 – EARNINGS PER SHARE

There are no convertible securities which would affect the numerator in calculating basic and diluted earnings per share; therefore, net income as presented on the Consolidated Statement of Income (unaudited) will be used as the numerator. The following table sets forth the composition of the weighted-average common shares (denominator) used in the basic and diluted earnings per share computation:


	Three months ended June 30,		Six months ended June 30,
	2005	2004	2005	2004
Weighted average common stock outstanding	1,549,269	1,535,347	1,549,228	1,532,636
Average treasury stock	—	—	—	—

Weighted average common stock and common stock equivalents used to calculate basic earnings per share	1,549,269	1,535,347	1,549,228	1,532,636
Additional common stock equivalents (stock options) used to calculate diluted earnings per share	50,943	65,739	52,659	67,804

Weighted average common stock and common stock equivalents used to calculate diluted earnings per share	1,600,212	1,601,086	1,601,887	1,600,440

Options to purchase 1,000 shares of common stock at $35.00 were outstanding during the three and six months periods of 2005, but were not included in the computation of diluted earnings per share because to do so would have been anti-dilutive. There were no anti-dilutive effects for the three and six month period ended June 30, 2004.

–10–

MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION

AND RESULTS OF OPERATIONS

Forward Looking Statement

The Private Securities Litigation Act of 1995 contains safe harbor provisions regarding forward-looking statements. When used in this discussion, the words, “believes,” “anticipates,” “contemplated,” “expects,” and similar expressions are intended to identify forward-looking statements. Such statements are subject to certain risks and uncertainties that could cause actual results to differ materially from those projected. Those risks and uncertainties include changes in interest rates, the ability to control costs and expenses, and general economic conditions. The Company undertakes no obligation to publicly release the results of any revisions to those forward-looking statements which may be made to reflect events or circumstances after the date hereof or to reflect the occurrence of unanticipated events.

Financial Condition

Total assets increased $21,114,000 or 6.5% from December 31, 2004 to June 30, 2005.

Cash and cash equivalents increased $6,359,000 or 123.9% due to investment in a $3,000,000 certificate of deposit purchase in the CDARS (Certificate of Deposit Account Registry Service) program along with normal fluctuations of federal funds sold balances. With entry into sales of certificates of deposit in the CDARS network, the bank also has the ability to invest funds in the product. The interest rate on a three month investment offered a more favorable rate than available in federal funds sold.

Investment securities available for sale declined slightly to $55,083,000 at June 30, 2005, recovering from the decline in the first quarter of 2005. Management has continued to invest primarily in commercial paper.

Loans increased $15,369,000 or 6.1% from December 31, 2004 to June 30, 2005. Commercial real estate loans continued to account for the majority of growth, increasing by $17,028,000 or 12.8%. Loans were originated in various industry segments, including loans for expansion and revitalization of several camps along with loans for real estate investment, a recreational vehicle dealer and businesses in the hospitality industry. Commercial loans declined $2,478,000 during the period due primarily to regularly scheduled payments and the lack of consumer loan originations. Declines in most other categories of loans as a result of regularly scheduled payments and payoffs offset this growth in commercial real estate loans.

Premises and equipment increased $602,000 or 10.8% with the main investment in the purchase of a property adjacent to the Honesdale office. That facility is at maximum capacity with no room for additional needed parking and drive-in lanes which will be accommodated by this purchase.

Total deposits increased $11,854,000 or 4.4% from December 31, 2004 to June 30, 2005. Deposits generated from the new banking office in Dingmans Ferry, PA account for over $5 million of this growth. The bank continued to offer a high rate certificate of deposit product with success in migrating funds which were reaching maturity from a promotion offered three years ago while attracting new deposits and customers. Certificates of deposit less than $100,000 increased $3,779,000 over the period with $912,000 coming from the Dingmans Ferry office. The highest rate is offered to customers who have multiple accounts with the bank, attracting additional lower or noninterest deposits along with the certificates of deposit. Demand deposits have also increased due to temporary deposits associated with the high volume of real estate transactions in our abstract

–11–

and lawyer customers’ accounts. At the same time, municipal school district certificates of deposit of approximately $10,000,000 matured in the first half of 2005 with approximately $6,900,000 used by the municipalities for their expenses.

Short-term borrowings increased $7,071,000 or 58.8% in the first six months of 2005 due to seasonal customer cash increases typically realized in the second quarter of the year.

Other borrowed funds increased $1,290,000 or 11.4% from December 31, 2004 due to borrowing $1,500,000 from the Federal Home Loan Bank of Pittsburgh (FHLB), offset by repayment of previous debt of $210,000. Loan demand for fixed rate financing has continued and the Asset/Liability Committee has used these borrowings as a tool in the management of interest rate risk.

Stockholders’ equity increased $984,000 or 3.3% from December 31, 2004 to June 30, 2005. Net income of $1,970,000 was offset by dividend declarations of $775,000. Available for sale investments declined in market value over the six months, but has shown a recovery from the first quarter, representing a net decrease of $42,000 in accumulated other comprehensive income during the period. Regulatory capital ratios of 11.6% total risk-based capital and 10.4% Tier I capital continue to exceed the regulatory guidelines of 8.0% and 4.0%. The Company’s leverage ratio was 8.9% at June 30, 2005 and compared favorably to the regulatory minimum of 3.0%.

Results of Operations

Comparison of the three months ended June 30, 2005 and 2004

Net income for the quarter ended June 30, 2005 was $1,039,000 representing an increase of $255,000 or 32.5% over net income in the second quarter of 2004.

Net interest income increased $464,000 or 16.8% in the second quarter of 2005 as compared to the same quarter in 2004. The prime interest rate increased 2.00% over the period, driving the average interest rate received on loans up 50 basis points. Approximately 67% of the loan portfolio is in variable interest rate loans. The majority of these loans reprice annually on the anniversary date of the loan and the remaining portfolio reprice at the end of the month based on changes in prime. Commercial real estate loans have generally been granted with a fixed interest rate of up to three years and then revert to annually adjustments based on the prime interest rate. Currently interest rates are fixed for either one or two years based upon interest rate projections. This strategy enhances loan growth but has the effect of slowing both the increase in interest income in a rising rate environment and the decrease in interest rates in a declining interest rate environment. From an interest rate risk assessment management is willing to accept the lag in rate increases at this time due to our ability to quote market rates at origination with the understanding that income will rise in future periods. This increase in average interest rates received is enhanced by an increase of $34,154,000 in average loans from June 2004 to June 2005.

Interest expense increased $369,000 or 35.0% from the second quarter of 2004 to the same period in 2005. Interest on deposits increased $279,000 or 28.9%. The average balance of interest-bearing deposits increased $16,567,000 or 7.2% while the average interest rate paid increased 34 basis points to 2.0%. The bank began advertising certificate of deposit products with nonstandard terms paying a higher than usual interest rate in the fourth quarter of 2004 in order to attract new deposits and maintain a maturing certificate product. In the second quarter of 2002 we offered 36 month certificates of deposit at a rate of 4.0%. With keen competition locally for deposits, the average interest rate of new offerings is slightly less than the maturing certificates and still offers a spread to many other local offerings. Increases in interest rates paid on all other interest-bearing deposits have lagged the increases in market rates while increasing balances in each category.

–12–

Short-term borrowings are comprised of securities sold under agreement to repurchase. The average balance of this type account increased $4,200,000 in the second quarter of 2005 as compared to the same period in 2004 while the average interest rate paid increased 38 basis points. Many of our customers with seasonal businesses have higher balances in this “sweep” account at this point in their business year and we have opened seven more accounts in the past year.

Interest expense of other borrowed funds increased $63,000 or 112.5% with an increase in the average balance of $6,269,000 or 116.6% while the average interest rate paid remained fairly constant in the past year. Management chose to borrow funds at fixed interest rates in the rising rate environment. During 2004, deposit growth was not sufficient to meet liquidity demand for loan growth. Fixed rate funds were borrowed from the Federal Home Loan Bank of Pittsburgh (FHLB) to manage funding for loans after analysis of alternative sources.

Noninterest income declined $67,000 or 9.8% in the second quarter of 2005 as compared to the same quarter in 2004. In 2004 management took advantage of the opportunity to recognize a gain on the sale of equity securities of $85,000 which was not matched in 2005. The investment brokerage department recorded $33,000 or 50.8% more income in the current quarter than in the previous year with a greater number of customers served in all of our branches. Other income declined $14,000 or 9.4% due to a number of individual account variations. Mortgage servicing rights were valued at approximately $75,000 less than recorded on a historical basis and it was necessary to expense this market value adjustment. At the same time, income generated from the bank’s merchant card program has increased $27,000 or 232.6% over the period. A full-time employee is assigned to this program now and rates have been adjusted consistently since her hire to prevent a lag in earnings. Fees earned on our customers use of debit cards has increased $12,000 or 50.3% with a greater number of cards issued and greater use of electronic payments. The title insurance subsidiary recognized income of $10,000 which was unmatched in the previous year.

The provision for loan losses is charged to operations to bring the total allowance for loan losses to a level that represents management’s best estimates of the losses inherent in the portfolio, based on:

•

historical experience;

•

volume;

•

type of lending conducted by the Bank;

•

industry standards;

•

the level and status of past due and non-performing loans;

•

the general economic conditions in the Bank’s lending area; and

•

other factors affecting the collectibility of the loans in its portfolio.

The provision for loan losses decreased $315,000 or 64.5% from 2004 to 2005. In 2004 management recognized a potential problem with a commercial loan and deemed it prudent to record additional provision expense in relation to that loan. The loan is no longer included on the balance sheet. In addition, in the second quarter of 2005, the bank recognized a recovery of $113,000 on a loan which had been charged off in previous periods. After careful analysis of the adequacy of the allowance, management believed that the allowance balance was sufficient at June 30, 2005 and that the quarterly expense of $173,000 was sufficient.

Salaries and employee benefits increased $172,000 or 18.0% in the second quarter of 2005 as compared to 2004.

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This increase in the result of a number of events: 1) several middle managers were hired in late 2004 and January 2005, 2) the title insurance subsidiary employees were not hired until after the second quarter of 2004 so there is no wage expense in the second quarter of 2004 , 3) commission expense increased $18,000 in the second quarter of 2005 as compared to 2004, 4) due to increasing local competition for a limited number of entry level employees, we found it necessary to increase entry level pay scales for new and existing employees in January 2005, 5) the Dingmans Ferry office opened in December 2005 with management staff hired in the third and fourth quarter of 2004 and 6) all other employees were granted annual salary increases in January 2005. Additionally, the cost per employee for benefits was greater in 2005 than in 2004 based upon higher costs of medical insurance along with a greater number of employees who were eligible for all benefits.

Due to the opening of the Dingmans Ferry office, expenses relating to both occupancy and furniture and equipment expense increased in 2005. Occupancy expense of $178,000 was $26,000 or 17.1% greater in 2005 as compared to the same period in 2004 and furniture and equipment expense of $140,000 was $21,000 or 17.6% greater in the second quarter of 2005 than in 2004.

Other expense increased $105,000 in 2005 over the same period in 2004 due to a number of factors, most notable of which were an increase in advertising expense of $32,000 or 58.2% relating to the use of outside consultants to advise on methods to increase deposits and an additional $36,000 to assist in preparation for greater regulatory reporting in the area of Sarbanes-Oxley Section 404 compliance. Many other increases and decreases in individual accounts comprise the remaining difference, no one of which is a material change in itself.

Comparison of the six months ended June 30, 2005 and 2004

Net interest income increased $642,000 or 11.7% in the first half of 2005 as compared to 2004. Due to rising interest rates and greater volume in both interest-earning assets and interest-costing liabilities the Company has been able to recognize this increase. Interest income increased $1,276,000 or 16.9% in 2005 as compared to 2004 with the primary gains in interest and fees on loans. The average balance of loans increased $32,226,000 or 14.1% while the average interest rate rose .31% to 6.07% in 2005.

Interest income derived from the investment portfolio declined $29,000 or 3.3% on taxable investments and $50,000 or 40.3% on tax exempt investments. The average balance of taxable investments decreased $1,099,000 or 2.2% with interest rates earned on most investments higher in 2005 than in 2004 with the exception of interest earned on corporate bonds declining due to the maturity of $3,175,000 in bonds carrying interest rates averaging 8. 7%. Average balances of tax exempt bonds declined $2,447,000 or 41.0% while the average interest rate earned on this type investment increased 5 basis points over the previous year.

Interest expense increased $634,000 or 30.5% in the first half of 2005 as compared to 2004 with greater expense noted for each category. Average interest-bearing deposits increased $14,522,000 or 6.4% over the period while the average interest rate paid increased .26%. While short-term market interest rates rose 200 basis points during the last twelve months, deposit rates were able to increase on a much slower scale and will continue to gradually increase over the rest of the year if there is no significant change in market rates. Balances of securities sold under agreement to resell increased $3,435,000 or 29.2% while the interest rate paid on these liabilities increased 38 basis points. The Bank has offered these products to more business customers and feels that this is one of the reasons we have attracted more funds in the bank. Management took advantage of fixed rate financing from the FHLB in the past twelve months in order to lock in rates while granting fixed rate loans for similar periods. Average balances of these advances increased a net amount of $7,545,000 or 187.0% in the past twelve months while the average interest rate paid on the borrowings increased 13 basis points. Included in the net increase was a maturity of $3,000,000 which carried an interest rate of 6.9%, assisting in tempering the average increase in interest rate.

–14–

The provision for loan loss declined $472,000 or 54.6% due to additional expense recorded in 2004 which was unmatched in 2005. Also, net charge-offs in 2005 represented greater dollars recovered on previous charge-offs than loans actually charged-off for the year. Management and the Board of Directors review the analysis of the allowance for loan loss on a regular basis and believe that the allowance is adequate at its current level.

Salaries and employee benefits increased $311,000 or 16.3% in 2005 as compared to 2004. The reasons for this increase are discussed in the quarterly section.

Expenses relating to occupancy and furniture and equipment increased $59,000 or 18.4% and $45,000 or 19.4% respectively relating primarily to the opening of the newest baking office in Dingmans Ferry, PA in December 2004.

Other expense increased $128,000 or 10.7% over the previous year due primarily to expenses associated with consultation in marketing deposit products of $55,000 or 55.8% and consultation relating to preparation for implementation of Sarbanes Oxley Section 404 compliance of $36,000 which was unmatched in 2004. Expenses relating to computer software amortization, purchase of annual or small programs and maintenance contracts on programs increased $31,000 or 23.2% with new products utilized in the current year. The costs to operate our ATM network increased $18,000 or 26.0% in 2005 due to the cost of generating new cards and higher expenses charged by our processor. Telephone expenses increased $15,000 or 39.1% relating mainly to the addition of the Dingmans Ferry office. Expenses relating to moving the backroom processing of our trust department declined $17,000 due to one time charges paid in 2004 to discontinue a contract with a third party. Various other accounts showed changes in costs, no one of which was material to this discussion.

Liquidity and Cash Flows

To ensure that the Company can satisfy customer credit needs for current and future commitments and deposit withdrawal requirements, the Bank manages the liquidity position by ensuring that there are adequate short-term funding sources available for those needs. Liquid assets consist of cash and due from banks, federal funds sold, interest-bearing deposits with other banks and investment securities maturing in one year or less. The following table shows these liquidity sources, minus short-term borrowings, as of June 30, 2005 compared to December 31, 2004:


(dollars in thousands)	June 30, 2005			December 31, 2004
Cash and due from banks	$	6,297		$	4,139
Interest-bearing deposits with other banks		3,062			15
Federal funds sold		2,132			978
Mortgage loans held for sale		—			112
Investment securities maturing or repricing in one year or less		44,537			45,208

		56,028			50,452
Less short-term borrowings		21,104			12,033

Net liquidity position	$	34,924		$	38,419

As a percent of total assets		10.07	%		11.80	%

–15–

Included in short-term borrowings is $2,000,000 borrowed from FHLB as a long term borrowing with a maturity date of June 28, 2006.

Other sources of liquidity are cash flows from regularly scheduled and prepayments of loans, sales or maturities in the investment portfolio, sales of residential mortgages in the secondary market, operating income and deposit growth. The Consolidated Statement of Cash Flows specifically details the contribution of each source. In addition, the Bank has the ability to borrow from the Federal Home Loan Bank of Pittsburgh with the maximum borrowing capacity at June 30, 2005 of $71 million.

Management monitors liquidity on a consistent basis and feels that liquidity levels are adequate. We are not aware of any known trends, events or uncertainties that will have or is reasonably likely to have a material effect on the Company’s liquidity, capital resources or operations nor is management aware of any current recommendations by regulatory authorities, which if implemented, would have such an effect.

Risk Elements

The table below presents information concerning nonperforming assets including nonaccrual loans, renegotiated loans, loans 90 days or more past due, other real estate loans and repossessed assets at June 30, 2005 and December 31, 2004. A loan is classified as nonaccrual when, in the opinion of management, there are doubts about collectability of interest and principal. At the time the accrual of interest is discontinued, future income is recognized only when cash is received. Impaired loans are recognized according to FASB 114, “Accounting by Creditors for Impairment of a Loan – Income Recognition and Disclosure”. Renegotiated loans are those loans which terms have been renegotiated to provide a reduction or deferral of principal or interest as a result of the deterioration of the borrower.


(dollars in thousands)	June 30, 2005			December 31, 2004
Loans on nonaccrual basis	$	196		$	261
Loans past due 90 days or more		520			293
Impaired loans		—			461

Total nonperforming loans		716			1,015
Other real estate		—			—
Repossessed assets		3			—

Total nonperforming assets	$	719		$	1,015

Nonperforming loans as a percent of total loans		0.3	%		0.4	%

Nonperforming assets as a percent of total assets		0.2	%		0.3	%

Allowance for loan loss as a percent of loans		1.33	%		1.25	%

Management believes the level of the allowance for loan losses at June 30, 2005 is adequate to cover probable losses inherent in the loan portfolio. The relationship between the allowance for loan losses and outstanding loans is a function of the credit quality and known risk attributed to the loan portfolio. The on-going loan review program and management analysis is used to determine the adequacy of the allowance for loan losses.

There are no loans classified as impaired under the terms of FAS No. 114, “Accounting by Creditors for Impairment of a Loan – Income Recognition and Disclosure” at June 30, 2005.

–16–

QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

A key function of management in its role as the Asset/Liability Committee (“ALCO”) is to evaluate the Company’s exposure to interest rate risk. The primary business of the Company in the financial services industry is to act as a depository financial intermediary. In this role, an integral element of risk involves the chance that prevailing interest rates will adversely affect assets, liabilities, capital, income and/or expense at different times and in different amounts. The ALCO is comprised of all Senior Officers and the Vice Presidents in charge of deposit operations and information technology of the Bank. This committee reports directly to the Board of Directors on at least a quarterly basis.

Two separate reports are used to assist in measuring interest rate risk. The first is the Statement of Interest Sensitivity Gap report. This report matches all interest-earning assets and all interest-bearing liabilities by the time frame in which funds can be reinvested or repriced. The second report is the Interest Rate Shock Analysis discussed in more detail below. In both reports, there are inherent assumptions that must be used in the evaluation. These assumptions include the maturity or repricing times of deposits, even though all deposits, other than time deposits, have no stated maturity and the reference that interest rate shifts will be parallel, with the rates of assets and liabilities shifting in the same amount in the same time frame. In reality, various assets and various liabilities will react differently to changes in interest rates, with some lagging behind the change and some anticipating the upcoming change and reacting before any actual change occurs. Each tool also suggests that there is a propensity to replace assets and liabilities with similar assets and liabilities rather than taking into consideration management’s ability to reallocate the Balance Sheet. In addition, the models used do not include any elements to determine how an action by management to increase or decrease interest rates charged on loans or paid on deposits or to increase borrowings at the FHLB will affect the results of the analysis. In spite of these limitations, these analyses are still very good tools to assist in management of the Company and similar versions of these same reports are used by all financial institutions.

–17–

Statement of Interest Sensitivity Gap


(amounts in thousands)	90 days or less			>90 days but < 1 year			1 - 5 years			>5 years			Total
Assets:
Interest-bearing deposits in other banks	$	5,194		$	—		$	—		$	—		$	5,194
Mortgage loans held for sale		—			—			—			—			—
Investment securities available for sale ^{(1) (4) (6)}		38,264			6,273			6,603			3,943			55,083
Investment securities held to maturity ⁽¹⁾		—			—			199			—			199
Loans ^{(1) (5)}		65,786			67,037			91,734			44,910			269,467

Rate sensitive assets	$	109,244		$	73,310		$	98,536		$	48,853		$	329,943

Liabilities:
Interest-bearing deposits:
Interest-bearing demand ⁽²⁾	$	3,348		$	10,462		$	28,039		$	—		$	41,849
Money market ⁽³⁾		5,118			15,053			9,935			—			30,106
Savings ⁽²⁾		3,527			11,023			29,542			—			44,092
Time deposits		26,595			55,015			47,636			—			129,246
Short-term borrowings		19,104			—			—			—			19,104
Other borrowings		—			2,000			3,000			7,639			12,639

Rate sensitive liabilities	$	57,692		$	93,553		$	118,152		$	7,639		$	277,036

Interest sensitivity gap	$	51,552		$	(20,243	)	$	(19,616	)	$	41,214		$	52,907
Cumulative gap	$	51,552		$	31,309		$	11,693		$	52,907
Cumulative gap to total assets		14.87	%		9.03	%		3.37	%		15.27	%

⁽¹⁾	Investments and loans are included in the earlier of the period in which interest rates are next scheduled to adjust or in which they are due. No adjustment has been made for scheduled repayments or for anticipated prepayments.

⁽²⁾	Interest-bearing demand deposits, Passbook savings and Statement savings are segmented based on the percentage of decay method. The decay rates used include 8.00% 0-3 months, 12.50% 4-6 months, 12.50% 7-12 months and 67.00% 13-36 months.

⁽³⁾	Money market deposits are segmented based on the percentage of decay method. The decay rates used include 17.00% 0-3 months, 25.00% 4-6 months, 25.00% 7-12 months and 33.00% 13-36 months.

⁽⁴⁾	Includes Federal Home Loan Bank and Atlantic Central Bankers Bank stock which is included in Other Assets on the Consolidated Financial Statements.

⁽⁵⁾	Does not include loans in nonaccrual status, deposit overdrafts, unposted items or deferred fees on loans.

⁽⁶⁾

Among Dimeco’s investment portfolios are step-up securities. These securities are characterized by having tiered (usually increasing) interest rates over their life. Due to this feature these securities have been reallocated from their maturity date to their next step-up date. The specific impact of this policy by timeframe is as follows: “90 days or less” increased $8,940, “>90 days but < 1” year increased $5,980 “1 - 5 years” decreased $2,995 and “>5 years” decreased $11.925.

As this report shows, the Company was in an asset sensitive position at June 30, 2005. This means that in the one year time frame there were more interest-sensitive assets than liabilities. Management feels that the optimal position in a rising interest rate scenario is to be asset sensitive since assets tend to reprice quicker than liabilities. The Company has classified its callable, step-up U.S. Government Agency bonds in the periods in which the bonds will next reprice versus the period in which they mature since, in management’s judgment, these repricing events will occur either through the purchase terms or through the call functions inherent in the bonds.

–18–

The second report used to monitor interest rate risk is the Interest Rate Shock Analysis. This tool attempts to determine the affect on income of various shifts in the interest rate environment. In particular, a shift of 200 basis points, or 2% in interest rates, is the industry standard. Given a downward shift of 200 basis points, net interest income would decrease by $866,000 or 6.3% while net income would decrease $592,000 or 10.4%. Given the Federal Reserve’s current stance of increasing interest rates quarterly, management feels that a general decrease in interest rates of this magnitude is not probable. The results of a potential shift of 200 basis points in either direction are well within internal policy guidelines. If the results were not tolerable, our policy would determine that management should reallocate the Balance Sheet in order to maintain compliance with the policy.

–19–

CONTROLS AND PROCEDURES

Evaluation of disclosure controls and procedures

Based on their evaluation as of a date within 90 days of the filing date of this Quarterly Report on Form 10-Q, the Registrant’s principal executive officer and principal financial officer have concluded that the Registrant’s disclosure controls and procedures (as defined in Rules 13a-14(c) and 15d-14(c) under the Securities Exchange Act of 1934 (the “Exchange Act”)) are effective to ensure that information required to be disclosed by the Company in reports that it files or submits under the Exchange Act is recorded, processed, summarized and reported within the time periods specified in Securities and Exchange Commission rules and forms.

Changes in internal controls

There were no significant changes in the Registrant’s internal controls or in other factors that could significantly affect these controls subsequent to the date of their evaluation, including any corrective actions with regard to significant deficiencies and material weaknesses.

–20–

PART II - OTHER INFORMATION

Item 1 - Legal Proceedings

NONE

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

Issuer Purchases of Equity Securities


	Total number of shares purchased	Average price paid per share		Total number of shares purchased as part of publicly announced plans or programs	Maximum number of shares that may yet be purchased under the plans or programs
4/1/05 to 4/30/05	—			—	77,300
5/1/05 to 5/31/05	—			—	77,300
6/1/05 to 6/30/05	5,000	$	34.60	5,000	72,300

Total	5,000	$	34.60	5,000	226,900

Item 3 - Defaults upon Senior Securities

NONE

Item 4 - Submissions of Matters to a Vote of Security Holders

The following represents the results of matters submitted to a vote of the stockholders at the Annual Meeting held on April 28, 2005:

Election of Directors:

The following directors were re-elected with terms to expire in 2008:


	For	Withhold Authority
Gary C. Beilman	1,128,720	48,592
Robert E. Genirs	1,128,882	48,430
Thomas A. Peifer	1,167,373	9,939

S.R. Snodgrass, A.C. was elected as the Company’s Independent Auditors for the year ending December 31, 2005 by the following vote:


For		1,163,946
Against		7,671
Abstain		5,694

Item 5 - Other Information

NONE

–21–

Item 6 - Exhibits

Report on July 28, 2005-News Release of Registrant – Dimeco, Inc. Announces 2005 first Quarter Earnings


Exhibit Number:
31.1		Certification Pursuant to 15 U.S.C. Section 10A, as adopted pursuant to Section 302 of the Sarbanes-Oxley Act of 2003

31.2		Certification Pursuant to 15 U.S.C. Section 10A, as adopted pursuant to Section 302 of the Sarbanes-Oxley Act of 2003

32		Certification Pursuant to 18 U.S.C. Section 1350

99		Report of Independent Registered Public Accounting Firm

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



3(i)		Articles of Incorporation of Dimeco, Inc.*

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		Form of Deferred Compensation Plan for Directors****

*	Incorporated by reference to the Exhibit 3A to the Form S-4 (File No. 333-58936) filed with the Commission on February 26, 1993.

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

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

****	Incorporated by reference to the identically numbered exhibits of the Registrant’s Form 10-KSB for the year ended December 31, 2001 filed on March 26, 2002.

–22–

SIGNATURES

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


	DIMECO, INC.

Date: August 10, 2005	By:	/s/ Gary C. Beilman
		Gary C. Beilman
		President and Chief Executive Officer

Date: August 10, 2005	By:	/s/ Maureen H. Beilman
		Maureen H. Beilman
		Chief Financial Officer

–23–

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