Edgar Filing: DIMECO INC

Form 10-Q

UNITED STATES SECURITIES AND EXCHANGE COMMISSION

Washington, DC 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 September 30, 2010

[ ] TRANSITION REPORT UNDER SECTION 13 OF 15(d) OF THE EXCHANGE ACT

Or 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 officers)

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

Yes No

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

Large accelerated filer ¨

Accelerated filer ¨

Non-accelerated filer ¨

(Do not check if a smaller reporting company)

Smaller reporting company x

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

Yes No X

As of November 1, 2010 the registrant had outstanding 1,598,218 shares of its common stock, par value $.50 share.

Dimeco, Inc.

INDEX


PART I – FINANCIAL INFORMATION		Page

Item 1.	Financial Statements

	Consolidated Balance Sheet (unaudited) as of September 30, 2010 and December 31, 2009	3

	Consolidated Statement of Income (unaudited) for the three and nine months ended September 30, 2010 and 2009	4

	Consolidated Statement of Comprehensive Income (unaudited) for the three and nine months ended September 30, 2010 and 2009	5

	Consolidated Statement of Changes in Stockholders’ Equity (unaudited) for the nine months ended September 30, 2010 and 2009	6

	Consolidated Statement of Cash Flows (unaudited) for the nine months ended September 30, 2010 and 2009	7

	Notes to Consolidated Financial Statements (unaudited)	8 - 15

Item 2.	Management’s Discussion and Analysis of Financial Condition and Results of Operations	16 - 23

Item 3.	Quantitative and Qualitative Disclosures about Market Risk	23 - 25

Item 4.	Controls and Procedures	25

PART II – OTHER INFORMATION

Item 1.	Legal Proceedings	27

Item 1a.	Risk Factors	27

Item 2.	Unregistered Sales of Equity Securities and Use of Proceeds	27

Item 3.	Defaults Upon Senior Securities	27

Item 4.	Reserved	27

Item 5.	Other Information	27

Item 6.	Exhibits	27

SIGNATURES		27

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Dimeco, Inc.

CONSOLIDATED BALANCE SHEET (unaudited)


		September 30, 2010		December 31, 2009
(in thousands)
Assets
Cash and due from banks	$	5,756	$	3,991
Interest-bearing deposits in other banks		12,106		14,296
Federal funds sold		-		3,000

Total cash and cash equivalents		17,862		21,287

Mortgage loans held for sale		170		-

Investment securities available for sale		81,007		73,628

Loans (net of unearned income of $37 and $101)		422,128		410,012
Less allowance for loan losses		7,152		6,253

Net loans		414,976		403,759

Premises and equipment		10,456		10,965
Accrued interest receivable		1,857		1,842
Bank-owned life insurance		9,451		9,175
Other real estate owned		1,111		389
Prepaid FDIC insurance		1,780		2,309
Other assets		9,384		7,303

TOTAL ASSETS	$	548,054	$	530,657


Liabilities
Deposits :
Noninterest-bearing	$	48,964	$	39,687
Interest-bearing		410,709		403,429

Total deposits		459,673		443,116

Short-term borrowings		13,536		10,974
Other borrowed funds		20,022		24,402
Accrued interest payable		757		1,080
Other liabilities		3,779		3,968

TOTAL LIABILITIES		497,767		483,540


Stockholders’ Equity
Common stock, $.50 par value; 5,000,000 shares authorized;
1,652,318 and 1,613,878 shares issued		826		807
Capital surplus		6,184		5,552
Retained earnings		44,155		42,318
Accumulated other comprehensive income		1,189		507
Treasury stock, at cost (54,100 shares)		(2,067)		(2,067)

TOTAL STOCKHOLDERS’ EQUITY		50,287		47,117

TOTAL LIABILITIES AND STOCKHOLDERS’ EQUITY	$	548,054	$	530,657

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 September 30,				For the nine months ended September 30,
		2010		2009		2010		2009
Interest Income
Interest and fees on loans	$	5,593	$	5,617	$	16,524	$	16,813
Investment securities:
Taxable		370		263		1,042		914
Exempt from federal income tax		254		240		768		691
Other		16		3		52		6

Total interest income		6,233		6,123		18,386		18,424


Interest Expense
Deposits		1,463		1,887		4,966		5,693
Short-term borrowings		37		31		113		101
Other borrowed funds		237		290		737		811

Total interest expense		1,737		2,208		5,816		6,605


Net Interest Income		4,496		3,915		12,570		11,819

Provision for loan losses		520		260		1,100		900


Net Interest Income After Provision for Loan Losses		3,976		3,655		11,470		10,919


Noninterest Income
Service charges on deposit accounts		303		386		995		1,116
Mortgage loans held for sale gains, net		76		119		171		461
Investment securities gains (losses)		24		(22)		18		(49)
Brokerage commissions		187		121		578		363
Earnings on bank-owned life insurance		108		108		318		307
Other income		320		315		992		759

Total noninterest income		1,018		1,027		3,072		2,957


Noninterest Expense
Salaries and employee benefits		1,653		1,595		5,047		4,772
Occupancy expense, net		265		257		842		823
Furniture and equipment expense		119		150		358		447
Professional fees		215		138		568		451
Data processing expense		172		165		527		472
FDIC insurance		204		181		565		708
Other expense		620		705		1,800		1,854

Total noninterest expense		3,248		3,191		9,707		9,527


Income before income taxes		1,746		1,491		4,835		4,349
Income taxes		471		405		1,273		1,125


NET INCOME	$	1,275	$	1,086	$	3,562	$	3,224


Earnings per Share - basic	$	0.80	$	0.70	$	2.24	$	2.07


Earnings per Share - diluted	$	0.80	$	0.69	$	2.24	$	2.04


Dividends per share	$	0.36	$	0.36	$	1.08	$	1.08


Average shares outstanding - basic		1,597,745		1,559,115		1,589,955		1,558,573
Average shares outstanding - diluted		1,599,302		1,582,631		1,590,703		1,579,926

See accompanying notes to the unaudited consolidated financial statements.

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Dimeco, Inc.

CONSOLIDATED STATEMENT OF COMPREHENSIVE INCOME (unaudited)


	For the three months ended September 30,				For the nine months ended September 30,
(amounts in thousands)	2010		2009		2010		2009
Net income	$	1,275	$	1,086	$	3,562	$	3,224

Other comprehensive income:
Unrealized gain on available for sale securities		431		841		1,033		963
Less: Reclassification adjustment for (gains) losses included in net income		(24)		22		(18)		49

Other comprehensive income before tax		407		863		1,015		1,012
Income tax expense related to other comprehensive income		138		294		345		345

Other comprehensive income, net of tax		269		569		670		667

Comprehensive income	$	1,544	$	1,655	$	4,232	$	3,891

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			Treasury Stock			Total Stockholders’ Equity
Balance, December 31, 2009	$		807	$		5,552	$		42,318	$		507	$		(2,067)	$		47,117
Net income									3,562									3,562
Unrealized gain on available for sale securities, net of tax expense of $351												682						682
Exercise of stock options (38,440 shares)			19			632												651
Cash dividends ($1.08 per share)									(1,725)									(1,725)

Balance, September 30, 2010	$		826	$		6,184	$		44,155	$		1,189	$		(2,067)	$		50,287

See accompanying notes to the unaudited consolidated financial statements.

–6–

Dimeco, Inc.

CONSOLIDATED STATEMENT OF CASH FLOWS (unaudited)


	For the nine months ended September 30,
(in thousands)		2010			2009
Operating Activities
Net income	$		3,562	$		3,224
Adjustments to reconcile net income to net cash provided by operating activities:
Provision for loan losses			1,100			900
Depreciation and amortization			771			883
Amortization (accretion) of premium and discount on investment securities, net			207			(195)
Amortization of net deferred loan origination fees			(110)			(113)
Investment securities (gains) losses			(18)			49
Origination of loans held for sale			(5,220)			(22,351)
Proceeds from sale of loans			5,222			21,144
Mortgage loans sold gains, net			(171)			(461)
Loss on sale of other real estate owned			1			139
Decrease (increase) in accrued interest receivable			(15)			287
Decrease in accrued interest payable			(323)			(235)
Deferred federal income taxes			(617)			(104)
Earnings on bank owned life insurance			(318)			(307)
Decrease in prepayment of FDIC insurance assessment			529			-
Other, net			373			(76)

Net cash provided by operating activities			4,973			2,784


Investing Activities
Investment securities available for sale:
Proceeds from sales			5,478			1,262
Proceeds from maturities or paydown			192,536			141,978
Purchases			(205,549)			(147,077)
Net increase in loans			(13,094)			(25,285)
Investment in Limited Partnership			-			(2,729)
Purchase of Federal Home Loan Bank stock			-			(67)
Purchase of fixed annuity			(1,500)			-
Purchase of bank-owned life insurance			-			(279)
Proceeds from the sale of other real estate owned			165			1,467
Purchase of premises and equipment			(85)			(722)

Net cash used for investing activities			(22,049)			(31,452)


Financing Activities
Net increase in deposits			16,557			39,112
Increase in short-term borrowings			2,562			131
Proceeds of other borrowed funds			-			1,850
Repayment of other borrowed funds			(4,380)			(1,296)
Purchase of treasury stock			-			(35)
Proceeds from exercise of stock options			651			38
Cash dividends paid			(1,739)			(1,683)

Net cash provided by financing activities			13,651			38,117

Increase (decrease) in cash and cash equivalents			(3,425)			9,449

Cash and cash equivalents at beginning of period			21,287			3,993

Cash and cash equivalents at end of period	$		17,862	$		13,442

Amount paid for interest	$		6,140	$		6,840

Amount paid for income taxes	$		1,265	$		1,400


Noncash investing activities:
Transfer of loans to other real estate owned	$		849	$		390

See accompanying notes to the 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 2009, the FASB issued ASU 2009-16, Accounting for Transfer of Financial Assets. ASU 2009-16 provides guidance to improve the relevance, representational faithfulness, and comparability of the information that an entity provides in its financial statements about a transfer of financial assets; the effects of a transfer on its financial position, financial performance, and cash flows; and a transferor’s continuing involvement, if any, in transferred financial assets. ASU 2009-16 is effective for annual periods beginning after November 15, 2009 and for interim periods within those fiscal years. The adoption of this guidance did not have a material impact on the Company’s financial position or results of operation.

In January 2010, the FASB issued ASU 2010-01, Equity (Topic 505): Accounting for Distributions to Shareholders with Components of Stock and Cash – a consensus of the FASB Emerging Issues Task Force. ASU 2010-01 clarifies that the stock portion of a distribution to shareholders that allows them to elect to receive cash or stock with a potential limitation on the total amount of cash that all shareholders can elect to receive in the aggregate is considered a share issuance that is reflected in EPS prospectively and is not a stock dividend. ASU 2010-01 is effective for interim and annual periods ending on or after December 15, 2009 and should be applied on a retrospective basis. The adoption of this guidance did not have a material impact on the Company’s financial position or results of operation.

In January 2010, the FASB issued ASU 2010-05, Compensation – Stock Compensation (Topic 718): Escrowed Share Arrangements and the Presumption of Compensation. ASU 2010-05 updates existing guidance to address the SEC staff’s views on overcoming the presumption that for certain shareholders escrowed share arrangements represent compensation. ASU 2010-05 was effective January 15, 2010. The adoption of this guidance did not have a material impact on the Company’s financial position or results of operation.

In January 2010, the FASB issued ASU No. 2010-06, Fair Value Measurements and Disclosures (Topic 820): Improving Disclosures about Fair Value Measurements. ASU 2010-06 amends Subtopic 820-10 to clarify existing disclosures, require new disclosures, and includes conforming amendments to guidance on employers’ disclosures about postretirement benefit plan assets. ASU 2010-06 is effective for interim and annual periods beginning after December 15, 2009, except for disclosures about purchases, sales, issuances, and settlements in the roll forward of activity in Level 3 fair value measurements. Those disclosures are effective for fiscal years beginning after December 15, 2010 and for interim periods within those fiscal years. The adoption of this guidance is not expected to have a significant impact on the Company’s financial statements.

In February 2010, the FASB issued ASU 2010-08, Technical Corrections to Various Topics. ASU 2010-08 clarifies guidance on embedded derivatives and hedging. ASU 2010-08 is effective for interim and annual periods beginning after December 15, 2009. The adoption of this guidance did not have a material impact on the Company’s financial position or results of operation.

In March 2010, the FASB issued ASU 2010-11, Derivatives and Hedging. ASU 2010-11 provides clarification and related additional examples to improve financial reporting by resolving potential ambiguity about the breadth of the embedded credit derivative scope exception in ASC 815-15-15-8. ASU 2010-11 is effective at the beginning of the first fiscal quarter beginning after June 15, 2010. The adoption of this guidance did not have a significant impact on the Company’s financial statements.

–8–

In April 2010, the FASB issued ASU 2010-18, Receivables (Topic 310): Effect of a Loan Modification When the Loan is a Part of a Pool That is Accounted for as a Single Asset – a consensus of the FASB Emerging Issues Task Force. ASU 2010-18 clarifies the treatment for a modified loan that was acquired as part of a pool of assets. Refinancing or restructuring the loan does not make it eligible for removal from the pool, the FASB said. The amendment will be effective for loans that are part of an asset pool and are modified during financial reporting periods that end July 15, 2010 or later and is not expected to have a significant impact on the Company’s financial statements.

In July 2010, FASB issued ASU No. 2010-20, Receivables (Topic 310): Disclosures about the Credit Quality of Financing Receivables and the Allowance for Credit Losses. ASU 2010-20 is intended to provide additional information to assist financial statement users in assessing an entity’s credit risk exposures and evaluating the adequacy of its allowance for credit losses. The disclosures as of the end of a reporting period are effective for interim and annual reporting periods ending on or after December 15, 2010. The disclosures about activity that occurs during a reporting period are effective for interim and annual reporting periods beginning on or after December 15, 2010. The amendments in ASU 2010-20 encourage, but do not require, comparative disclosures for earlier reporting periods that ended before initial adoption. However, an entity should provide comparative disclosures for those reporting periods ending after initial adoption. The Company is currently evaluating the impact the adoption of this guidance will have on the Company’s financial position or results of operations.

In August, 2010, the FASB issued ASU 2010-21, Accounting for Technical Amendments to Various SEC Rules and Schedules. This ASU amends various SEC paragraphs pursuant to the issuance of Release No. 33-9026: Technical Amendments to Rules, Forms, Schedules, and Codification of Financial Reporting Policies and is not expected to have a significant impact on the Company’s financial statements.

In August, 2010, the FASB issued ASU 2010-22, Technical Corrections to SEC Paragraphs – An announcement made by the staff of the U.S. Securities and Exchange Commission. This ASU amends various SEC paragraphs based on external comments received and the issuance of SAB 112, which amends or rescinds portions of certain SAB topics and is not expected to have a significant impact on the Company’s financial statements.

Stock Options

The Company maintains a stock option plan for key officers and non-employee directors. There were no options granted in 2010 or 2009.

On April 22, 2010 the Company adopted the 2010 Equity Incentive Plan in order to issue options in future periods. No options have been granted under that plan at this time.

As of September 30, 2010 and 2009, there was no unrecognized compensation cost to unvested share-based compensation awards granted.

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 September 30,				Nine months ended September 30,
	2010		2009		2010		2009
Weighted average common stock outstanding		1,651,845		1,613,215		1,644,055		1,612,446

Average treasury stock		(54,100)		(54,100)		(54,100)		(53,873)


Weighted average common stock and common stock equivalents used to calculate basic earnings per share		1,597,745		1,559,115		1,589,955		1,558,573

Additional common stock equivalents (stock options) used to calculate diluted earnings per share		1,557		23,516		748		21,353


Weighted average common stock and common stock equivalents used to calculate diluted earnings per share		1,599,302		1,582,631		1,590,703		1,579,926

–9–

NOTE 3 – INVESTMENTS

The amortized cost and estimated market value of investment securities are summarized as follows (in thousands):


	September 30, 2010
	Amortized Cost		Gross Unrealized Gains		Gross Unrealized Losses		Fair Value
AVAILABLE FOR SALE
U.S. government agencies	$	13,602	$	121	$	(13)	$	13,710
Mortgage-backed securities		24,372		281		(54)		24,599
Obligations of states and political subdivisions:
Taxable		675		39		-		714
Tax-exempt		26,453		959		(7)		27,405
Corporate securities		3,510		530		-		4,040
Commercial paper		10,023		-		-		10,023

Total debt securities		78,635		1,930		(74)		80,491
Equity securities		572		75		(131)		516

Total	$	79,207	$	2,005	$	(205)	$	81,007


	December 31, 2009
	Amortized Cost		Gross Unrealized Gains		Gross Unrealized Losses		Fair Value
AVAILABLE FOR SALE
U.S. government agencies	$	22,178	$	53	$	(111)	$	22,120
Mortgage-backed securities		4,182		143		(20)		4,305
Obligations of states and political subdivisions:
Taxable		400		15		-		415
Tax-exempt		26,279		452		(58)		26,673
Corporate securities		6,211		426		(1)		6,636
Commercial paper		13,045		-		-		13,045

Total debt securities		72,295		1,089		(190)		73,194
Equity securities		565		35		(166)		434

Total	$	72,860	$	1,124	$	(356)	$	73,628

–10–

The following table shows the Company’s fair value and gross unrealized losses, aggregated by investment category and length of time that the individual securities have been in a continuous unrealized loss position (in thousands):


	September 30, 2010
	Less than Twelve Months				Twelve Months or Greater				Total
	Estimated Market Value		Gross Unrealized Losses		Estimated Market Value		Gross Unrealized Losses		Estimated Market Value		Gross Unrealized Losses
U.S. Government agencies	$	2,421	$	13	$	-	$	-	$	2,421	$	13
Mortgage-backed securities		4,883		54		-		-		4,883		54
Obligations of states and political subdivisions		-		-		239		7		239		7
Corporate securities		-		-		-		-		-		-

Total debt securities		7,304		67		239		7		7,543		74
Equity securities		55		5		143		126		198		131

Total	$	7,359	$	72	$	382	$	133	$	7,741	$	205


	December 31, 2009
	Less than Twelve Months				Twelve Months or Greater				Total
	Estimated Market Value		Gross Unrealized Losses		Estimated Market Value		Gross Unrealized Losses		Estimated Market Value		Gross Unrealized Losses
U.S. Government agencies	$	13,765	$	111	$	-	$	-	$	13,765	$	111
Mortgage-backed securities		976		19		23		1		999		20
Obligations of states and political subdivisions		4,442		53		343		5		4,785		58
Corporate securities		131		1		-		-		131		1

Total debt securities		19,314		184		366		6		19,680		190
Equity securities		85		4		158		162		243		166

Total	$	19,399	$	188	$	524	$	168	$	19,923	$	356

The Company reviews its position quarterly and has asserted that at September 30, 2010, the declines outlined in the above tables represent temporary declines and the Company does not intend to sell and does not believe they will be required to sell these securities before recovery of their cost basis, which may be at maturity. There were 26 and 59 positions that were temporarily impaired at September 30, 2010 and December 31, 2009, respectively. The Company has concluded that the unrealized losses disclosed above are not other than temporary, but are the result of interest rate changes, sector credit ratings changes or company-specific ratings changes that are not expected to result in the non-collection of principal and interest during the period.

The Company received proceeds of $18,000 in 2010 from the sales of securities. A loss of $6,000 was due to a merger during the second quarter and a gain of $24,000 was from sales of securities in the third quarter of 2010. The Company received proceeds of $1,262,000 from sales of securities in 2009. Those sales represented gross gains of $52,000 and gross losses of $74,000. In addition, the Company recognized a loss of $27,000 on an equity merger transaction during 2009.

–11–

The amortized cost and estimated market value of debt securities at September 30, 2010, by contractual maturity, are shown below. Expected maturities of mortgage-backed securities will differ from contractual maturities because borrowers may have the right to call or prepay obligations with or without call or prepay penalties (in thousands):


	Available for Sale
	Amortized Cost		Fair Value
Due in one year or less	$	20,175	$	20,263
Due after one year through five years		23,214		23,752
Due after five years through ten years		16,259		16,813
Due after ten years		18,987		19,663

Total debt securities	$	78,635	$	80,491

NOTE 4 – FAIR VALUE MEASUREMENTS

The following disclosures show the hierarchal disclosure framework associated with the level of pricing observations utilized in measuring assets and liabilities at fair value. The three broad levels defined by U.S. generally accepted accounting principles are as follows:


Level I:		Quoted prices are available in active markets for identical assets or liabilities as of the reported date.

Level II:		Pricing inputs are other than quoted prices in active markets, which are either directly or indirectly observable as of the reported date. The nature of these assets and liabilities include items for which quoted prices are available but traded less frequently, and items that are fair valued using other financial instruments, the parameters of which can be directly observed.

Level III:		Assets and liabilities that have little to no pricing observability as of the reported date. These items do not have two-way markets and are measured using management’s best estimate of fair value, where the inputs into the determination of fair value require significant management judgment or estimation.

This hierarchy requires the use of observable market data when available.

The following is a description of the valuation methodologies the Company uses for financial instruments recorded at fair value on either a recurring or nonrecurring basis:

Securities Available for Sale

Securities available for sale consists of both debt and equity securities. These securities are recorded at fair value on a recurring basis. At September 30, 2010 and December 31, 2009, all of these securities used valuation methodologies involving market based or market derived information, collectively Level 1 and Level 2 measurements, to measure fair value.

The Company closely monitors market conditions involving assets that have become less actively traded. If the fair value measurement is based upon recent observable market activity of such assets or comparable assets (other than forced or distressed transactions) that occur in sufficient volume, and do not require significant adjustment using unobservable inputs, those assets are classified as Level I or Level II; if not, they are classified as Level III. Making this assessment requires significant judgment.

The Company uses prices from independent pricing services and, to a lesser extent, indicative (non-binding) quotes from independent brokers to measure securities.

–12–

The following tables present the assets reported on the consolidated statements of financial condition at their fair value as of September 30, 2010 and December 31, 2009 by level within the fair value hierarchy. As required by ASC 820, financial assets and liabilities are classified in their entirety based on the lowest level of input that is significant to the fair value measurement.


	September 30, 2010
	Level I		Level II		Level III		Total
Assets:
U.S. government agencies	$	-	$	13,710	$	-	$	13,710
Mortgage-backed securities		-		24,599		-		24,599
Obligations of states and political subdivisions:
Taxable		-		714		-		714
Tax-exempt		-		27,405		-		27,405
Corporate securities		-		4,040		-		4,040
Commercial paper		10,023		-		-		10,023

Total debt securities		10,023		70,468		-		80,491
Equity securities		516		-		-		516

Total	$	10,539	$	70,468	$	-	$	81,007


	December 31, 2009
	Level I		Level II		Level III		Total
Assets:
U.S. government agencies	$	-	$	22,120	$	-	$	22,120
Mortgage-backed securities		-		4,305		-		4,305
Obligations of states and political subdivisions:
Taxable		-		415		-		415
Tax-exempt		-		26,673		-		26,673
Corporate securities		-		6,636		-		6,636
Commercial paper		13,045		-		-		13,045

Total debt securities		13,045		60,149		-		73,194
Equity securities		434		-		-		434

Total	$	13,479	$	60,149	$	-	$	73,628

The following table presents the assets measured on a nonrecurring basis on the consolidated statements of financial condition at their fair value as of September 30, 2010 and December 31, 2009, by level within the fair value hierarchy. Impaired loans that are collateral dependent are written down to fair value through the establishment of specific reserves. Techniques used to value the collateral that secure the impaired loan include: quoted market prices for identical assets classified as Level I inputs; observable inputs, employed by certified appraisers, for similar assets classified as Level II inputs. In cases where valuation techniques included inputs that are unobservable and are based on estimates and assumptions developed by management based on the best information available under each circumstance, the asset valuation is classified as Level III inputs.


Assets measured on a nonrecurring basis:	Level I		Level II		Level III		Total
Impaired Loans:
September 30, 2010	$	-	$	8,114	$	-	$	8,114
December 31, 2009	$	-	$	4,564	$	1,525	$	6,089
Other real estate owned:
September 30, 2010	$	-	$	1,111	$	-	$	1,111
December 31, 2009	$	-	$	389	$	-	$	389
Mortgage Servicing Rights:
September 30, 2010	$	-	$	-	$	549	$	549
December 31, 2009	$	-	$	-	$	583	$	583

–13–

NOTE 5 – FAIR VALUE DISCLOSURE

The estimated fair values of the Company’s financial instruments are as follows (in thousands):


	September 30, 2010				December 31, 2009
	Carrying Value		Fair Value		Carrying Value		Fair Value
Financial Assets:
Cash and cash equivalents	$	17,862	$	17,862	$	21,287	$	21,287
Mortgage loans held for sale	$	170	$	170	$	-	$	-
Investment securities	$	81,007	$	81,007	$	73,628	$	73,628
Net loans	$	414,976	$	435,764	$	403,759	$	419,825
Accrued interest receivable	$	1,857	$	1,857	$	1,842	$	1,842
Regulatory stock	$	1,741	$	1,741	$	1,741	$	1,741
Bank-owned life insurance	$	9,451	$	9,451	$	9,175	$	9,175
Mortgage servicing rights	$	549	$	549	$	583	$	583

Financial liabilities:
Deposits	$	459,673	$	462,996	$	443,116	$	446,972
Short-term borrowings	$	13,536	$	13,537	$	10,974	$	10,974
Other borrowed funds	$	20,022	$	21,944	$	24,402	$	25,964
Accrued interest payable	$	757	$	757	$	1,080	$	1,080

Financial instruments are defined as cash, evidence of ownership interest in an entity, or a contract which creates an obligation or right to receive or deliver cash or another financial instrument from/to a second entity on potentially favorable or unfavorable terms.

Fair value is defined as the amount at which a financial instrument could be exchanged in a current transaction between willing parties other than in a forced or liquidation sale. If a quoted market price is available for a financial instrument, the estimated fair value would be calculated based upon the market price per trading unit of the instrument.

If no readily available market exists, the fair value estimates for financial instruments should be based upon management’s judgment regarding current economic conditions, interest rate risk, expected cash flows, future estimated losses and other factors as determined through various option pricing formulas or simulation modeling. As many of these assumptions result from judgments made by management based upon estimates that are inherently uncertain, the resulting estimated fair values may not be indicative of the amount realizable in the sale of a particular financial instrument. In addition, changes in assumptions on which the estimated fair values are based may have a significant impact on the resulting estimated fair values.

As certain assets such as deferred tax assets and premises and equipment are not considered financial instruments, the estimated fair value of financial instruments would not represent the full value of the Company.

The Company employed simulation modeling in determining the estimated fair value of financial instruments for which quoted market prices were not available based upon the following assumptions:

Cash and Cash Equivalents, Accrued Interest Receivable, Regulatory Stock, and Accrued Interest Payable

The fair value is equal to the current carrying value.

Investment Securities

The fair value of investment securities available for sale is equal to the available quoted market price. If no quoted market price is available, fair value is estimated using the quoted market price for similar securities.

Loans and Mortgage Servicing Rights

The fair value is estimated by discounting future cash flows using current market inputs at which loans with similar terms and qualities would be made to borrowers of similar credit quality. Where quoted market prices were available, primarily for certain residential mortgage loans, such market rates were utilized as estimates for fair value.

–14–

Deposits, Short Term Borrowings and Other Borrowed Funds

The fair values of certificates of deposit and other borrowed funds are based on the discounted value of contractual cash flows. The discount rates are estimated using rates currently offered for similar instruments with similar remaining maturities. Demand, savings, and money market deposit accounts are valued at the amount payable on demand as of period-end.

Bank-Owned Life Insurance

The fair value is equal to the cash surrender value of the life insurance policies.

Commitments to Extend Credit and Standby Letters of Credit

These financial instruments are generally not subject to sale, and estimated fair values are not readily available. The carrying value represented by the net deferred fee arising from the unrecognized commitment or letter of credit, and the fair value, determined by discounting the remaining contractual fee over the term of the commitment using fees currently charged to enter into similar agreements with similar credit risk, are not considered material for disclosure.

–15–

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 at September 30, 2010 were $548,054,000 or 3.3% greater than at December 31, 2009. Earlier growth during the year was offset in the third quarter due to a decrease in deposits as higher costing certificates of deposit matured and were not all renewed at the lower rates offered.

Total cash and cash equivalents declined $3,425,000 or 16.1% due mainly to elimination of federal funds sold at September 30, 2010. With interest rates at this historically low point, we employed cash in other types of higher yielding investments.

Investment securities available for sale increased $7,379,000 or 10.0 % from balances at December 31, 2009. In an effort to increase yield in the portfolio while working within our investment policy guidelines, we have increased balances of mortgage-backed securities offered by government agencies by $20,294,000 or 471.3%. These securities offer a reasonable yield and return both principal and interest payments monthly, supplementing liquidity. U.S. government agency bonds in the portfolio at December 31, 2009 contained call features and most of those bonds enacted the call in 2010 at the first possible opportunity, thereby decreasing these type investments by $8,410,000 or 38.0%. Smaller changes in other types of investments were responsible for the remaining change.

Total loans increased by $12,116,000 or 3.0% during the first three quarters of 2010 as compared to balances at December 31, 2009. We have seen a decrease in loan originations over the levels we experienced in the past. Loans secured by 1-4 family homes increased $4,950,000 or 6.5%. Small business borrowers continue to use their residential properties for collateral to borrow for various purposes. Additionally, low interest rates have increased activity in the residential and home equity loan categories. Commercial real estate loans increased $3,261,000 or 1.3% in spite of selling loan participations of $3,000,000 within the summer camping industry segment during the first half of 2010. Commercial and industrial loans increased $3,025,000 or 7.1% with the loans spread through various business sectors and carrying an average loan amount of $53,000. Construction and development loans grew by $2,440,000 or 15.0%. This increase consists primarily of owner-occupied commercial projects and owner-occupied residential construction.

Other real estate owned increased $722,000 or 185.6% as we had a foreclosure action on a restaurant and several residential properties in the first half of the year. We also took receipt of a deed in lieu of foreclosure from one residential customer. Management is actively negotiating the sale of these properties.

Other assets increased $2,081,000 or 28.5% since December 31, 2009. The primary increase was the investment of $1,500,000 in a fixed rate annuity. In the current low interest rate environment we decided to purchase this insurance product which offers a spread to market rates and the opportunity to redeem a portion annually. In addition, accounting for federal income tax has created an increase in deferred taxes of $617,000 or 40.9% over the amount at December 31, 2009 due to an increase related to provision for loan loss expense.

Total deposits increased $16,557,000 or 3.7% since December 31, 2009. Although we have seen an increase in this number since the beginning of the year, these deposits declined from balances recorded at June 30, 2010 primarily due to a decline in certificates of deposit. Management decided that it would be best to allow more volatile certificates of deposit to runoff and developed a relationship product to offer those customers who chose to maintain balances with us. Noninterest-bearing deposits increased $9,277,000 or 23.4% as commercial customers’ accounts show greater balances along with the establishment of new relationships within the branch network. At the same time, interest-bearing deposits increased $7,280,000 or 1.8%. Balances of money market accounts increased $22,819,000 or 55.4% since December 31, 2009. Some of this increase was based on the transfer of funds from customers who were invested in our higher rate certificate of deposit accounts which were opened in 2009 and matured in 2010. We are not offering a similar product this year and therefore they are moving balances to money market accounts which offer a higher rate than large money center accounts. In addition, there are new accounts opened in all of our locations that compete directly with regional or larger institutions. We believe that customers are choosing the community bank, and investing in this type of account, in order to maintain

–16–

liquidity while waiting for an increase in interest rates. One customer who has a short term need for the funds moved $6,500,000 from our certificate of deposit to their money market account to maintain liquidity while earning a similar return to what they were paid in a short term certificate of deposit. Interest-bearing checking balances of $410,709,000 at September 30, 2010 were $21,787,000 or 55.0% greater than at the end of 2009. One customer with high deposit balances had a large balance in their interest-bearing checking account at September 30, 2010 which accounted for the majority of that increase. These deposits are typically invested in certificates of deposit shortly after the end of the third quarter. We have continued to offer attractive interest rates on these products and have offered a higher interest rate on certificates of deposit to customers who utilize our platinum checking account, an interest-bearing account that requires a minimum balance along with usage in a particular fashion. Certificates of deposit declined $39,438,000 or 13.8% from balances at year end. This decline includes the transfer of funds to money market accounts as noted above. We have discontinued the certificate of deposit special product which was paying 2.05% for the majority of last year and are currently offering interest rates much more in line with the national average for customers without the platinum relationship. The rates for platinum customers are up to .55% greater than our standard rates, but are still less than the 2009 special rates. In addition, we have increased the balances of CDARS certificate of deposit accounts by $8,543,000 or 142.1%. These accounts have previously been offered to our customers who wish to assure all of their funds are fully insured by the FDIC. In the third quarter of 2010 we also booked $10,379,000 of CDARS deposits that we did not reciprocate, meaning that these balances were purchased rather than originated through our branch network. This is one of the liquidity management tools that we had identified as an alternative to borrowing from correspondent banks and it offered favorable interest rates to other options available at the time.

Other borrowed funds decreased $4,380,000 or 17.9% due to the maturity of $3,000,000 of Federal Home Loan Bank of Pittsburgh advances along with other regularly scheduled principal payments on amortizing borrowings.

Stockholders’ equity increased $3,170,000 or 6.7% during the first three quarters of 2010. Net income of $3,562,000 was offset by dividends declared of $1,725,000. Stock options granted to directors and officers were exercised in 2010 thereby increasing equity by $651,000. In addition, we recognized an increase in the market value of our investment portfolio of $682,000 net of income taxes in the first nine months of 2010, serving to increase the balance of accumulated other comprehensive income. Regulatory capital ratios remain strong with 12.0% total risk-based capital, 10.7% Tier I capital and a Tier I leverage ratio of 9.1%. The regulatory minimums to be well capitalized for these ratios are 10.0%, 6.0% and 5.0%, respectively.

Results of Operations

Comparison of the three months ended September 30, 2010 and 2009

The Company reported net income of $1,275,000 for the quarter ended September 30, 2010, representing an increase of $189,000 or 17.4% over the third quarter of 2009.

Net interest income, the largest portion of income, was $4,496,000 for the third quarter of 2010, an increase of $581,000 or 14.8% greater than recorded for the third quarter of 2009.

Total interest income increased by $110,000 or 1.8% for the third quarter of 2010 as compared to 2009. Interest and fees earned on loans declined $24,000 or .4% in 2010 over 2009 although the average balance of the loan portfolio increased by $15,708,000 or 3.9%. At the same time, the average interest rate of the portfolio declined by .3%, resulting in the average rate earned of 5.4% during the third quarter of 2010. Throughout 2010 we continued to experience rate declines on variable interest rate loans as those with longer-term repricing structures tied to the prime rate adjusted downward. We have implemented interest rate floors on new financing and on renewal of any lines of credit as they mature. Compounding the decline in interest earned was the balance of loans in nonaccrual status at September 30, 2010 of $9,871,000 which would have earned $124,000 of additional income if they were performing. At September 30, 2009, the balance of nonaccrual loans was $7,657,000 which would have earned $118,000 of additional interest income.

–17–

Interest earned on taxable investments increased $107,000 or 40.7% in the third quarter of 2010 as compared to the same period of 2009. The average rate earned on the portfolio for the third quarter of 2010 was 2.3% as compared to 3.2% in 2009. The average balance of taxable investments for the quarter increased $31,114,000 or 94.6% in 2010 compared to balances a year earlier. We have been able to increase the size of the investment portfolio due to growth in deposits combined with lower loan demand. As the prolonged economic recovery continues, new bond offerings are at significantly lower yields than those in the portfolio. During this time we have chosen to invest more heavily in U.S. government agency and government-sponsored agency bonds rather than take the risk of investing in other types of securities. The average balance of U.S. government agency bonds increased $11,209,000 or 160.3% with the interest yield declining by 1.5% in 2010 as compared to those in portfolio during the third quarter of 2009. Balances of government agency issued mortgage-backed securities increased $20,707,000 or 518.2% on average during the third quarter of 2010 as compared to the same quarter of 2009 and the average yield declined from 4.8% in 2009 to 2.9% in 2010. Another benefit to include more of these bonds in our portfolio is that they offer the opportunity to reinvest principal payments over the life of the bond, benefiting our liquidity needs.

Interest expense declined $471,000 or 21.3% in the third quarter of 2010 as compared to the same period of 2009. The main component of this is related to interest paid on deposits. Deposit interest expense declined $424,000 to $1,463,000 for the three months ended September 30, 2010 as compared to the same period in 2009. The average balance of interest-bearing deposits increased $44,268,000 or 12.4% in the third quarter of 2010 while the average cost was .7% less than during the same quarter of 2009. Customers increased their average balance in several deposit categories with money market balances increasing by $19,829,000 or 52.5% and time deposits increasing $11,853,000 or 4.9% along with lesser growth in other interest-bearing deposit accounts. As certificates of deposits which were originated in 2009 matured, we saw volatile deposits leave the bank and were able to renew those deposits that stayed at lower rates of interest. In March 2010 we stepped up marketing on relationship deposit products, offering a higher interest rate on certificates of deposit to those customers who maintained checking accounts with specific activity. This action increased balances for many deposit types.

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 along with national trends; and

•

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

Provision for loan loss expense was $260,000 or 100.0% greater in the third quarter of 2010 than the same quarter of 2009. Growth in the loan portfolio combined with deterioration of many economic indicators has negatively affected the loan rating on several large loans, thereby driving provision expense higher. We have continued to monitor and adjust the allowance for loan loss as the analysis indicates and believe that the allowance for loan loss balance is adequate.

Total noninterest income was similar in the third quarter of 2010 as in 2009. There were variations in various aspects of noninterest income that are noted here. Service charges on deposit accounts declined $83,000 or 21.5% from income a year earlier. As of August 15, 2010 all financial institutions that cover overdrafts generated through an electronic means were required to allow their customers the opportunity to “opt-in” for this coverage. Through this process, some of our customers did not desire to have this option for which we charge a fee. Customers have been taking greater notice of their balances in general adding to the decline in service fee income. Gains on mortgage loans held for sale declined $43,000 or 36.1% over income earned during the same quarter a year earlier. We have begun to see more refinance activity during the third quarter of 2010 than in previous quarters but not as robust as a year earlier. Fewer customers qualify for the low interest rate levels currently offered although we are receiving a greater number of applications. As a liquidity need arose, we took advantage of gains on three investments in the third quarter and recognized gains of $24,000 as compared to a loss of $22,000 in the third quarter of 2009. Brokerage commissions increased $66,000 or 54.5% over the same period last year as the additional employee hired in the fourth quarter of 2008 is gaining more business along with our other seasoned brokers. This fee income was also augmented by market value increases in customers’ investment portfolios since this income includes percentage fees based on market value.

Salaries and employee benefits increased $58,000 or 3.6% in the third quarter of 2010 as compared to 2009. Wages increased $46,000 or 4.0% in 2010 as compared to 2009 due primarily to annual salary increases for 2010. Since the beginning of 2010, we have made a concerted effort to manage the number of hours worked by non-exempt employees in order to control payroll cost thereby decreasing our full time equivalent employees by one even though we have experienced an increase in loans and deposits. Employee

–18–

benefits increased $22,000 or 8.3% as costs of medical insurance increased in 2010 along with having more employees eligible for the benefit in 2010 than a year earlier. Employer contributions for our employees’ 401(k) plan increased $24,000 or 35.7% because in 2009 we decreased the profit sharing contribution to 2% but have accrued that expense at our historical normal rate of 4% for 2010. Other miscellaneous employment expenses account for the remaining changes.

Furniture and equipment expense decreased $31,000 or 20.7% due primarily to nonrenewal of several equipment operating leases that were not needed due to outsourcing the EDP function in 2008.

Professional fees increased $77,000 or 55.8% during the third quarter of 2010 as compared to the same period in 2009. Legal fees increased $112,000 or 473.5% greater in 2010 due to more loan collection activity in general and the need to use out of state counsel in relation to one borrower. Offsetting this increase were declines in audit fees due to accrual for a SOX 404 audit which was eliminated in recent regulatory reform and in compliance expense due to the timing of hiring a new firm to assist in this area.

Other expense declined $85,000 or 12.1% due primarily to a nonrecurring expense experienced in 2009 for loss on the sale of other real estate owned of $139,000. Costs associated with ownership of other real estate were $21,000 greater in 2010 than a year earlier. We experienced a gain on the sale of repossessed assets of $21,000 in 2009 that was unmatched in 2010. Smaller variances in other expense items were responsible for the remaining differences.

Comparison of the nine months ended September 30, 2010 and 2009

Net income for the nine months ended September 30, 2010 was $3,562,000 which was an increase of $338,000 or 10.5% over that reported a year earlier.

Net interest income of $12,570,000 was $751,000 or 6.4% greater than reported for the same period in 2009. To offset the decline in interest income of $38,000 or .2% in the first nine months of 2010 as compared to 2009, interest expense also declined by $789,000 or 11.9% from a year earlier.

Interest and fees on loans of $16,524,000 was $289,000 or 1.7% less in the first three quarters of 2010 than what was earned for the same period in 2009. The average balance of the loans increased by $20,278,000 or 5.2% while the average interest rate received on the loans declined by .39% to 5.4% for the nine months ended September 30, 2010. Approximately 77% of our loan portfolio carries a variable rate of interest with some of those tied for two to three years upon origination and the interest rate adjusting in current periods to the new lower market rates. We expect to experience additional decreases in interest rates on these loans but at a much slower pace as the majority of the variable rate loans will have repriced downward by the end of 2010.

Interest earned on taxable investment securities increased $128,000 or 14.0% in the first nine months of 2010 over income reported for the same time period in 2009. Additional income was derived by growth of $31,135,000 or 93.3% in the average balance of investments. As deposits increased and loan demand was at a slower pace than in recent years, funds were invested in bonds at available market rates which were lower than those purchased in earlier periods. The average interest rate earned on these investments declined to 2.16% in 2010 from 3.66% a year earlier. Nationally all interest sensitive markets have shown similar declines in rates.

Interest earned on tax exempt bonds increased $77,000 or 11.1% for the first nine months of 2010 compared to the same period in 2009. Additional investments made over the course of the past year averaged $2,886,000 or 12.3% more than the same period last year but yielded 6 basis points less than the previous year.

Interest expense of $5,816,000 was $789,000 or 11.9% less for the first three quarters of 2010 than the same period in 2009. Of that decline, interest expense on deposits declined $727,000 or 12.8%. Average interest-bearing deposits increased by $61,946,000 or 17.9% while the average interest rate paid for those deposits declined by .57% to 1.63% for the first nine months of 2010. As noted above, we discontinued offering a special rate on certificates of deposit which is the primary reason for lower interest expense on deposits. The average rate will continue to drop in the next few months as the last of those special rate certificates of deposit mature.

Interest on other borrowed funds declined $74,000 or 9.1% for the first nine months of 2010 as compared to a year earlier. This interest expense is related to long term borrowings from the FHLB. During 2010 we paid off $3,000,000 of these borrowings and have continued to make regularly scheduled payments on the amortizing loans, thereby decreasing principal balances and interest expense over time.

The provision for loan loss was $200,000 or 22.2% greater in the first three quarters of 2010 than a year earlier. This expense is determined as a result of our analysis of the appropriate balance in the allowance for loan loss and therefore is directly related to

–19–

changes in the factors we use to determine the level of the allowance. With deteriorating economic conditions, an increase in the level of substandard or lower rated loans, higher delinquency and other factors considered in the determination and we found it appropriate to fund the allowance at this level.

Noninterest income increased $115,000 for the first three quarters of 2010 as compared to the same period in 2009. Service charges on deposit accounts declined $121,000 or 10.8% in 2010 as compared to 2009. In addition to a decline in these fees as a result of the “opt in” for electronically originated overdrafts, we have noted a general awareness on our customers’ part, not allowing their accounts to overdraw. Brokerage commissions increased $215,000 or 59.2% over the same period in 2009 due to a combination of the gains in market value of customers’ investment portfolio on which asset-based fees are charged along with additional commissions earned by gaining business since increasing the number of brokers to three from two. Other noninterest income was $233,000 or 30.7% greater in 2010 than 2009. This category includes various types of income. Those with the greatest variances are as follows: 1) amortization of mortgage servicing rights is recorded as an offset to other income. As existing mortgages that we service are paid off early we must accelerate the amortization of the mortgage servicing rights. In 2009 there was quite a bit of this activity, resulting in $81,000 of greater amortization expense in the first nine months of 2009 than in 2010. 2) Also in 2009 we recorded a decline in the market value of mortgage servicing rights of $62,000 which was not matched in 2010. 3) Interchange fees earned on customers’ usage of their debit cards increased $77,000 or 25.0% in 2010 over fees earned a year earlier. In addition to issuing additional cards with most new checking accounts opened since the third quarter of 2009, we believe that our customers are using the credit feature more often, an action that generates greater fee income than when they use the cards using the debit feature. 4) Offsetting these gains in noninterest income, title insurance commissions declined $69,000 or 72.3% as the number of mortgages originated and therefore using the services of our title insurance agency declined in 2010 as compared to a year earlier.

Salaries and employee benefits increased $275,000 or 5.8%. The primary item responsible for this increase was due to payroll expense that was $142,000 or 4.1% greater than the year before. Annual salary increases and an increase in the number of officers which was offset by a decline in the total number of hours worked by non-exempt employees were the main reasons for this increase. Employee benefits increased $69,000 or 8.1%, the majority of which was due to an increase in the cost of health insurance for all employees along with having more employees eligible for this benefit. We also increased the 401(k) profit sharing accrual at 4% in 2010 compared to 2% in 2009, resulting in $75,000 or 38.9% greater expense.

Furniture and equipment expense declined $89,000 or 19.9% due primarily to a decrease in the cost of leasing equipment and the associated maintenance on that equipment. As we have outsourced daily data processing, we do not need the same level of equipment as when we processed in-house.

Professional fees increased $117,000 or 25.9% in 2010 compared to 2009 due primarily to an increase in legal fees related to loan collections.

The cost of FDIC insurance declined $143,000 or 20.2% as all banks incurred a one-time special assessment in 2009 for which we had $224,000 of additional costs. This insurance is based on asset size therefore our contribution increased since that one-time assessment as our balance sheet grew over the past year.

Federal income taxes of $1,273,000 were $148,000 or 13.2 greater in 2010 than in 2009 due to higher income before taxes along with smaller changes in the percentage of nontaxable income.

–20–

Liquidity and Cash Flows

To ensure that the Company can satisfy customer credit needs for current and future commitments and deposit withdrawal requirements, we manage 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 September 30, 2010 compared to December 31, 2009:


	September 30, 2010		December 31, 2009
(dollars in thousands)
Cash and due from banks	$	5,756	$	3,991
Interest-bearing deposits with other banks		12,106		14,296
Federal funds sold		-		3,000
Investment securities maturing or repricing in one year or less		19,239		30,924

		37,101		52,211
Less short-term borrowings		13,536		10,974

Net liquidity position	$	23,565	$	41,237

As a percent of total assets		4.3%		7.8%

The Bank has the ability to borrow from the Federal Home Loan Bank of Pittsburgh with the maximum borrowing capacity at September 30, 2010 of $183 million with an available balance of $158 million. Other sources of liquidity are cash flows from regularly scheduled payments and prepayments of loans, sales or maturities in the investment portfolio, sales of residential mortgages in the secondary market, operating income, deposit growth and access to the Federal Reserve Bank of Philadelphia discount window. The Consolidated Statement of Cash Flows specifically details the contribution of each source.

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 are we aware of any current recommendations by regulatory authorities, which if implemented, would have such an effect.

–21–

Risk Elements

The table below presents information concerning nonperforming assets including nonaccrual loans and loans 90 days or more past due at September 30, 2010 and December 31, 2009. 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.


	September 30, 2010
(In thousands)	Past due 90 days or more		Nonaccrual

Real estate-construction loans	$	-	$	-
Real estate-mortgage loans		693		9,848
Commercial and industrial loans		257		2
Installment loans to individuals		14		21
Other loans		-		-

Total	$	964	$	9,871


	December 31, 2009
	Past due 90 days or more		Nonaccrual

Real estate-construction loans	$	6	$	-
Real estate-mortgage loans		1,988		5,966
Commercial and industrial loans		67		1,524
Installment loans to individuals		61		32
Other loans		30		-

Total	$	2,152	$	7,522

Interest income of $378,000 in the first three quarters of 2010 and $357,000 in the same period of 2009 would have been recognized on nonaccrual loans if they had been performing in accordance with their original terms.

At September 30, 2010 there were loans classified as impaired of $9,790,000 with a related allowance for loan loss of $1,676,000. The average balance of these loans during 2010 was $9,841,000. Interest of $36,000 was recognized in 2010 on the loan that was placed in nonaccrual status during the second quarter of 2010. At December 31, 2009 there was $7,418,000 of loans classified as impaired for which there was a related allowance for loan loss of $1,329,000.

Management believes the level of the allowance for loan losses at September 30, 2010 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, along with management analysis, is used to determine the adequacy of the allowance for loan losses. Following is an analysis of transactions within the allowance for the first three quarters of 2010:

–22–


Balance December 31, 2009	$	6,253
Charge-offs:
Commercial, financial and agricultural		35
Real estate-construction		-
Real estate-mortgage		115
Installment loans to individuals		96

Total charge-offs		246


Recoveries:
Commercial, financial and agricultural		10
Real estate-construction		-
Real estate-mortgage		-
Installment loans to individuals		35

Total recoveries		45


Net charge-offs		201


Additions charged to operations		1,100


Balance at September 30, 2010	$	7,152


Ratio of net charge-offs during the period to average loans outstanding during the period		.05	%


Allowance for loan loss as a % of loans outstanding		1.69	%

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 of the bank and other key officers. 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.

–23–


	Statement of Interest Sensitivity Gap
	90 days or less		>90 days but < 1 year		1 - 5 years		>5 years		Total

Assets:
Interest-bearing deposits in other banks and federal funds sold	$	12,106	$	-	$	-	$	-	$	12,106
Mortgage loans held for sale		170		-		-		-		170
Investment securities available for sale ⁽⁵⁾		13,221		6,018		25,264		38,015		82,518
Loans ^{(1) (4)}		93,640		134,849		88,954		95,716		413,159


Rate sensitive assets	$	119,137	$	140,867	$	114,218	$	133,731	$	507,953


Liabilities:
Interest-bearing deposits:
Interest-bearing demand ⁽²⁾	$	4,910	$	15,343	$	41,118	$	-	$	61,371
Money market⁽³⁾		10,880		32,000		21,120		-		64,000
Savings ⁽²⁾		3,152		9,850		26,397		-		39,399
Time deposits		73,695		127,116		45,128		-		245,939
Short-term borrowings		13,536		-		-		-		13,536
Other borrowings		470		3,942		8,703		6,907		20,022


Rate sensitive liabilities	$	106,643	$	188,251	$	142,466	$	6,907	$	444,267


Interest sensitivity gap	$	12,494	$	(47,384)	$	(28,248)	$	126,824	$	63,686
Cumulative gap	$	12,494	$	(34,890)	$	(63,138)	$	63,686
Cumulative gap to total assets		2.28%		(6.37%)		(11.52%)		11.62%

⁽¹⁾

Loans are included in the earlier 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 and savings are segmented based on the percentage of decay method. The decay rates used include “90 days or less” 8%, “ >90 days but <1 year” 25% and “1-5 years” 67%.

⁽³⁾

Money market deposits are segmented based on the percentage of decay method. The decay rates used include “90 days or less” 17%, “>90 days but < 1 year” 50% and “1-5 years” 33%.

⁽⁴⁾	Does not include loans in nonaccrual status, deposit overdrafts, unposted items or deferred fees on loans.

⁽⁵⁾

Investments are included in the earlier period in which interest rates are next scheduled to adjust or in which they are due. Included are U.S. Government Agency step-up bonds characterized by having tiered 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 $500, “1-5 years” increased $501 and “over 5 years” decreased $1,001. A corporate bond with a market value of $251 was reallocated from “over 90 days but less than 1 year” to “90 days or less” because the interest rate reprices quarterly.

As this report shows, the Company was liability sensitive in the one year period at September 30, 2010 with many of the higher costing liabilities maturing or repricing before assets in this timeframe. We expect that interest rates will increase at some point; and as that occurs, the variable interest rate loans will reprice upward. We anticipate that higher interest rate certificate of deposits will reprice to new, lower rates because we do not expect to offer any certificate of deposit special products; therefore interest margins should continue to improve.

–24–

The second report used to monitor interest rate risk is the Analysis of Sensitivity to Changes in Market Interest Rates. This tool attempts to determine the affect on income of various shifts in the interest rate environment. We have presented this analysis for three different scenarios, a change in rates of 100, 200 or 300 basis points in order to offer a more in-depth analysis. A shift of 200 basis points, or 2% in interest rates, is the industry standard. Given an immediate parallel upward shift of 200 basis points, net interest income would decrease by $191,000 or .97% while net income would decrease $110,000 or 1.69%. This analysis makes the shift automatic and equal for both assets and liabilities and does not take into consideration management’s ability to change the rates for deposits in a different fashion. We would not expect to make this parallel shift in deposit interest rates. Even given that this analysis does not actually assimilate the reality of our actions when rates do increase, the results of a potential shift of 200 basis points in either direction are 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. If interest rates were to immediately increase by 200 basis points, the economic value of equity (EVE) would decrease by $6,233,000 or 9.82%, which is within our policy guidelines. The economic value of equity is sometimes referred to as the present value of equity and is presented as one more statistic to monitor in managing interest rate risk.

ANALYSIS OF SENSITIVITY TO CHANGES IN MARKET INTEREST RATES


	100 basis points
	Up					Down
	Amount			%		Amount			%

Net interest income	$	(132	)		-0.67%	$	451			2.28	%
Net income	$	(79	)		-1.22%	$	289			4.43	%
EVE	$	(3,638	)		-5.73%	$	6,873			10.83	%

	200 basis points
	Up					Down
	Amount			%		Amount			%

Net interest income	$	(191	)		-0.97%	$	(349	)		-1.76	%
Net income	$	(110	)		-1.69%	$	(252	)		-3.87	%
EVE	$	(6,233	)		-9.82%	$	12,910			20.35	%

	300 basis points
	Up					Down
	Amount			%		Amount			%

Net interest income	$	(341	)		-1.73%	$	(1,034	)		-5.23	%
Net income	$	(202	)		-3.10%	$	(718	)		-11.01	%
EVE	$	(10,606	)		-16.72%	$	17,054			26.88	%

CONTROLS AND PROCEDURES

Evaluation of disclosure controls and procedures

As of September 30, 2010 an evaluation was performed under the supervision and with the participation of the Company’s management, including the CEO and CFO, on the effectiveness of the design and operation of the Company’s disclosure controls and procedures. Based on that evaluation, the Company’s management, including the CEO and CFO, concluded that the Company’s disclosure controls and procedures were effective as of September 30, 2010. There have been no significant changes in the Company’s internal controls over financial reporting or in other factors that could significantly affect internal controls during the quarter.

Disclosure controls and procedures are the controls and other procedures that are designed to ensure that the information required to be disclosed by the Company in its reports filed and submitted under the Securities Exchange Act of 1934, as amended (“Exchange Act”) is recorded, processed, summarized and reported, within the time periods specified in the Securities and Exchange Commission’s rules and forms. Disclosure controls and procedures include, without limitation, controls and procedures designed to ensure that information required to be disclosed by the Company in its reports filed under the Exchange Act is accumulated and communicated to the Company’s management, including the principal executive officer and principal financial officer, as appropriate to allow timely decisions regarding required disclosure.

–25–

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.

–26–

PART II - OTHER INFORMATION


Item 1	-	Legal Proceedings
		NONE

Item 1a.	-	Risk Factors
		There were no material changes to the risk factors described in Item 1a. of Dimeco’s Annual Report on Form 10K for the period ended December 31, 2009.

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

Item 3	-	Defaults upon Senior Securities
		NONE

Item 4	-	Reserved

Item 5	-	Other Information
		NONE

Item 6	-	Exhibits

		Form 8K – Report on October 21, 2010 – News Release of Registrant

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

2010 Equity Incentive Plan *****

*	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 identically numbered exhibit to the Registrant’s Form 8-K filed July 2, 2007.

*****

Incorporated by reference to Exhibit 10.1 to the form S-8 (File No. 333-169454) filed with the Commission on September 17, 2010.

–27–

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: November 15, 2010	By:	/s/ Gary C. Beilman
		Gary C. Beilman
		President and Chief Executive Officer

Date: November 15, 2010	By:	/s/ Maureen H. Beilman
		Maureen H. Beilman
		Chief Financial Officer

–28–

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