dnb10q.htm
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
____________________

FORM 10-Q

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

For the quarterly period ended: March 31, 2009
or
[  ] Transition report pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934.

For the transition period from ________________ to _____________

Commission File Number: 0-16667
DNB Financial Corporation
(Exact name of registrant as specified in its charter)

   
Pennsylvania
23-2222567
(State or other jurisdiction of
(I.R.S. Employer Identification No.)
incorporation or organization)
  
   
   
4 Brandywine Avenue - Downingtown, PA 19335
(Address of principal executive offices and Zip Code)

(610) 269-1040
(Registrant's telephone number, including area code)

Not Applicable
(Former name, former address and former fiscal year, if changed since last report)

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

Yes x
  
No o
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, or a non-accelerated filer, or a smaller reporting company. See definition of “accelerated filer”, “large accelerated filer”, and “smaller reporting company” in Rule 12b-2 of the Exchange Act.
 
Large accelerated filer    o  
Accelerated filer                  o   
 
Non-accelerated filer     o
Smaller reporting company x
 
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).
Yes o
  
No x

Indicate the number of shares outstanding of each of the issuer's classes of common stock, as of the latest practicable date.
Common Stock ($1.00 Par Value)
(Class)
2,603,273
(Shares Outstanding as of May 8, 2009)



DNB FINANCIAL CORPORATION AND SUBSIDIARY


INDEX


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


2
 

PART I – FINANCIAL INFORMATION
ITEM 1 – FINANCIAL STATEMENTS
 
DNB Financial Corporation and Subsidiary
Consolidated Statements of Financial Condition (Unaudited)

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

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


4
 
DNB Financial Corporation and Subsidiary
Consolidated Statements of Cash Flows (Unaudited)

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

 
DNB FINANCIAL CORPORATION AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)

NOTE 1: BASIS OF PRESENTATION

The accompanying unaudited consolidated financial statements of DNB Financial Corporation (referred to herein as the "Corporation" or "DNB") and its subsidiary, DNB First, National Association (the "Bank") have been prepared in accordance with the instructions for Form 10-Q and therefore do not include certain information or footnotes necessary for the presentation of financial condition, statement of operations and statement of cash flows required by generally accepted accounting principles. However, in the opinion of management, the consolidated financial statements reflect all adjustments (which consist of normal recurring adjustments) necessary for a fair presentation of the results for the unaudited periods. Prior amounts not affecting net income are reclassified when necessary to conform to current period classifications. The results of operations for the three-month period ended March 31, 2009, are not necessarily indicative of the results, which may be expected for the entire year.  The consolidated financial statements should be read in conjunction with the Annual Report and report on Form 10-K for the year ended December 31, 2008.

NOTE 2: EARNINGS PER SHARE

Basic earnings per share (“EPS”) is computed based on the weighted average number of common shares outstanding during the period.  Diluted EPS is computed using the treasury stock method and reflects the potential dilution that could occur from the exercise of stock options and unvested stock awards.   Stock options and unvested stock awards for which the exercise or the grant price exceeds the average market price over the period have an anti-dilutive effect on EPS and, accordingly, are excluded from the calculation.  At March 31, 2009, there were 191,247 anti-dilutive stock options outstanding, 24,101 anti-dilutive stock awards and 186,311 anti-dilutive stock warrants.  The dilutive effect of stock options and unvested shares on basic earnings per share is presented below.
 
Three Months Ended
  
Three Months Ended
  
 
March 31, 2009
  
March 31, 2008
  
(In thousands, except per-share data)
Income
  
Shares
  
Amount
  
Income
  
Shares
  
Amount
  
Basic EPS
                        
Income available to common stockholders
$   382
  
2,603
  
$0.14
  
$   409
  
2,597
  
$0.16
  
Effect of dilutive common stock equivalents – stock
options, restricted shares and warrants
 
—
  
 
—
  
 
—
  
 
—
  
 
4
  
 
—
  
Diluted EPS
                        
Income available to common stockholders after
assumed conversions
 
$   382
  
 
 2,603
  
 
$0.14
  
 
$   409
  
 
 2,601
  
 
$0.16
  

 
NOTE 3: COMPREHENSIVE INCOME (LOSS)

Comprehensive income includes all changes in stockholders' equity during the period, except those resulting from investments by owners and distributions to owners.  Comprehensive income for all periods consisted of net income and other comprehensive income relating to the change in unrealized losses on investment securities available for sale.  Comprehensive income (loss), net of tax, is disclosed in the following table.
   
Three Months Ended
Three Months Ended
   
March 31, 2009
March 31, 2008
(Dollars in thousands)
  
Net-of-Tax Amount
Net-of-Tax Amount
Net Income
  
$        480
  
$        409
  
Other Comprehensive Income:
          
Unrealized holding (losses) gains arising during the period
  
(541)
  
1,360
  
Reclassification for gains included in net income
  
(331)
  
(169)
  
   Unrealized actuarial losses-pension
  
—
  
(169)
  
Total Comprehensive (Loss) Income
  
$     (392)
  
$     1,431
  


6
 
DNB FINANCIAL CORPORATION AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)


NOTE 4: COMPOSITION OF LOAN AND LEASE PORTFOLIO

The following table sets forth information concerning the composition of total loans and leases outstanding, as of the dates indicated.

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


NOTE 5: JUNIOR SUBORDINATED DEBENTURES

DNB has two issuances of junior subordinated debentures (the "debentures") as follows:

DNB Capital Trust I

DNB’s first issuance of junior subordinated debentures was on July 20, 2001. This issuance of debentures are floating rate and were issued to DNB Capital Trust I, a Delaware business trust in which DNB owns all of the common equity. DNB Capital Trust I issued $5 million of floating rate (6 month Libor plus 3.75%, with a cap of 12%) capital preferred securities to a qualified institutional buyer. The proceeds of these securities were used by the Trust, along with DNB's capital contribution, to purchase $5.2 million principal amount of DNB's floating rate junior subordinated debentures.  The preferred securities have been redeemable since July 25, 2006 and must be redeemed upon maturity of the debentures on July 25, 2031.

DNB Capital Trust II

DNB’s second issuance of junior subordinated debentures was on March 30, 2005. This issuance of debentures are floating rate and were issued to DNB Capital Trust II, a Delaware business trust in which DNB owns all of the common equity. DNB Capital Trust II issued $4.0 million of floating rate (the rate is fixed at 6.56% for the first 5 years and will adjust at a rate of 3-month LIBOR plus 1.77% thereafter) capital preferred securities. The proceeds of these securities were used by the Trust, along with DNB's capital contribution, to purchase $4.1 million principal amount of DNB's floating rate junior subordinated debentures. The preferred securities are redeemable by DNB on or after May 23, 2010, or earlier in the event of certain adverse tax or bank regulatory developments. The preferred securities must be redeemed upon maturity of the debentures on May 23, 2035.

The majority of the proceeds of each issuance were invested in DNB’s subsidiary, DNB First, National Association, to increase the Bank's capital levels. The junior subordinated debentures issued in each case qualify as a component of capital for regulatory purposes.




7



DNB FINANCIAL CORPORATION AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)

NOTE 6: RECENT ACCOUNTING PRONOUNCEMENTS

 
FASB Statement No. 157 In September 2006, the FASB issued FASB Statement No. 157 — “Fair Value Measurements” (“Statement 157”). Statement 157 establishes a single authoritative definition of fair value, sets out a framework for measuring fair value, and requires additional disclosures about fair-value measurements. The Statement applies only to fair-value measurements that are already required or permitted by other accounting standards. Statement 157 is effective for fair-value measures already required or permitted by other standards for financial statements issued for fiscal years beginning after November 15, 2007 and interim periods within those fiscal years. DNB did not early adopt FASB Statement No. 157. The adoption of SFAS No. 157 did not have a material impact on DNB’s consolidated financial statements.
 
FSP FAS No. 157-1 and FSP FAS No. 157-2 In February 2008, the FASB issued two Staff Positions (FSPs) on Statement No. 157: FSP 157-1 “Application of FASB Statement No. 157 to FASB Statement No. 13 and Other Accounting Pronouncements That Address Fair Value Measurements for Purposes of Lease Classification or Measurement Under Statement 13,” and FSP 157-2, “Effective Date of FASB Statement No. 157.” FSP 157-1 excludes fair value measurements related to leases from the disclosure requirements of Statement No. 157. FSP 157-2 delayed the effective date of Statement No. 157 for all non-recurring fair value measurements of non-financial assets and non-financial liabilities until fiscal years beginning after November 15, 2008. In 2009 DNB became subject to measurement and disclosure requirements applicable to non-financial assets and non-financial liabilities valued at fair value on a non-recurring basis, but those requirements did not have a material impact on DNB’s consolidated financial statements when they became applicable.
 
FSP FAS No. 157-3 In October 2008, the FASB issued FSP FAS No. 157-3, “Determining the Fair Value of a Financial Asset When the Market for That Asset Is Not Active”. FSP FAS No. 157-3 clarifies the application of SFAS No. 157, Fair Value Measurements, in a market that is not active and provides an example to illustrate key considerations in determining the fair value of a financial asset when the market for that financial asset is not active. This FSP was effective upon issuance, and was therefore effective for the consolidated financial statements included in the Company’s quarterly report for the period ended September 30, 2008. The adoption of FSP FAS No. 157-3 did not have a material impact on DNB’s consolidated financial statements.
 
FASB Statement No. 160 In December 2007, the FASB issued FASB Statement No. 160 — “Noncontrolling Interest in Consolidated Financial Statements — Including an Amendment of ARB No. 51” (“Statement 160”). Statement 160 improves the relevance, comparability, and transparency of the financial information that a reporting entity provides in its consolidated financial statements by establishing accounting and reporting standards for the noncontrolling interest in a subsidiary and for the de-consolidation of a subsidiary. Statement 160 is effective as of the beginning of an entity’s first fiscal year that begins on or after December 15, 2008. Statement 160 became effective January 1, 2009 and did not have a material impact on DNB’s consolidated financial statements upon adoption.
 
FASB Statement No. 161 In March 2008, the FASB issued FASB Statement No. 161 — “Disclosures about Derivative Instruments and Hedging Activities — an amendment of FASB Statement No. 133” (“Statement 161”). Statement 161 amends Statement No. 133 and its related guidance by requiring expanded disclosures about derivative instruments and hedging activities. This Statement will require DNB to provide additional disclosure about a) how and why we use derivative instruments; b) how we account for derivative instruments and related hedged items under SFAS No. 133 and its related interpretations; and c) how derivative instruments and related hedged items effect our financial condition, financial performance, and cash flows. Statement 161 does not change the accounting for derivatives under SFAS No. 133. DNB does not currently engage in derivative instruments and hedging activities.
 
FASB Statement No. 141 (revised) In December 2007, FASB issued FASB Statement No. 141 (revised 2007), “Business Combinations” (“Statement 141R). Statement 141R retains the fundamental requirement of FASB Statement No. 141 that the acquisition method of accounting be used for all business combinations. However, Statement 141R does make significant changes to the accounting for a business combination achieved in stages, the treatment of contingent consideration, transaction and restructuring costs, and other aspects of business combination accounting. Statement 141R became effective with the fiscal year that began on January 1, 2009, and will change DNB’s accounting treatment for business combinations on a prospective basis.
 

8
 
DNB FINANCIAL CORPORATION AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)

 
FSP FAS 132(R)-1 In December 2008, the FASB issued FASB Staff Position No. 132(R)-1, “Employers’ Disclosures about Postretirement Benefit Plan Assets” (“FSP 132(R)-1”). This FSP amends FASB Statement No. 132(R), “Employer’s Disclosures about Pensions and Other Postretirement Benefits” (“FAS 132(R)”), to require additional disclosures about assets held in an employer’s defined benefit pension or other postretirement plan. This FSP is applicable to an employer that is subject to the disclosure requirements of FAS 132(R) and is generally effective for fiscal years ending after December 15, 2009. FSP FAS 132(R)-1 will not change the accounting for postretirement plan assets. FSP FAS 132(R)-1 will be effective for DNB for the fiscal year ending December 31, 2009.
 
On April 9, 2009, the FASB finalized three FSPs regarding the accounting treatment for investments including mortgage-backed securities. These FSPs changed the method for determining if an Other-than-temporary impairment (“OTTI”) exists and the amount of OTTI to be recorded through an entity’s income statement. The changes brought about by the FSPs provide greater clarity and reflect a more accurate representation of the credit and noncredit components of an OTTI event. The three FSPs are as follows:
 
·
FSP FAS 157-4 Determining Fair Value When the Volume and Level of Activity for the Assets or Liability Have Significantly Decreased and Identifying Transactions That Are Not Orderly” provides guidelines for making fair value measurements more consistent with the principles presented in SFAS 157, “Fair Value Measurements.”
 
·
FSP FAS 115-2 and FAS 124-2, Recognition and Presentation of Other-than-temporary impairments” provides additional guidance designed to create greater clarity and consistency in accounting for and presenting impairment losses on securities.
 
·
FSP FAS 107-1 and APB 28-1, Interim Disclosures about Fair Value of Financial Instruments” enhances consistency in financial reporting by increasing the frequency of fair value disclosures.
 
These staff positions are effective for financial statements issued for periods ending after June 15, 2009, with early application possible for the first quarter of 2009. DNB did not adopt any of the above positions early. DNB has not completed its evaluation of the impact of these FSPs on its results of operations and financial position.
 
 
 
9

DNB FINANCIAL CORPORATION AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
 

 
NOTE 7: STOCK-BASED COMPENSATION

Stock Option Plan

DNB has a Stock Option Plan for employees and directors.  Under the plan, options (both qualified and non-qualified) to purchase a maximum of 643,368 shares of DNB’s common stock could be issued to employees and directors.

Under the plan, option exercise prices must equal the fair market value of the shares on the date of option grant and the option exercise period may not exceed ten years.  The Plan Committee determines vesting of options under the plan. There were 201,335 options available for grant at both March 31, 2009 and December 31, 2008.

Stock option activity for the three-month period ended March 31, 2009 is indicated below.
 
Number
Weighted Average         
 
Outstanding
Exercise Price         
Outstanding January 1, 2009
191,247
  
$19.03
  
Granted
–
  
–
  
Exercised
–
  
–
  
Expired
–
  
–
  
Forfeited
–
  
–
  
Outstanding March 31, 2009
191,247
  
$19.03
  



The weighted-average price and weighted average remaining contractual life for the outstanding options are listed below for the dates indicated.  All outstanding options are exercisable.

 
March 31, 2009
Range of
Number
     Weighted Average
Exercise Prices
Outstanding
Exercise Price
Remaining Contractual Life
$ 9.23-10.99
 9,419
$9.23
1.25 years
 11.00-13.99
 9,414
  11.16
2.25 years
 14.00-19.99
 103,246
  17.43
4.72 years
 20.00-22.99
 21,127
  22.78
5.73 years
 23.00-24.27
 48,041
  24.27
6.05 years
Total
 191,247
$19.03
4.87 years


Restricted Stock Awards

DNB maintains an Incentive Equity and Deferred Compensation Plan. The plan provides that up to 243,101 (as adjusted for subsequent stock dividends) shares of common stock may be granted, at the discretion of the Board, to individuals of the Company.  DNB did not grant any shares of restricted stock during the three-month period ended March 31, 2009. Shares already granted are issuable on the earlier of three years after the date of the grant or a change in control of DNB if the recipients are then employed by DNB (“Vest Date”).  Upon issuance of the shares, resale of the shares is restricted for an additional one year, during which the shares may not be sold, pledged or otherwise disposed of. Prior to the Vest Date and in the event the recipient terminates association with DNB for reasons other than death, disability or change in control, the recipient forfeits all rights to the shares that would otherwise be issued under the grant.



10



DNB FINANCIAL CORPORATION AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
 
Share awards granted by the plan were recorded at the date of award based on the market value of shares.  Awards are being amortized to expense over the three-year cliff-vesting period. DNB records compensation expense equal to the value of the shares being amortized.  For the three-month period ended March 31, 2009, $25,000 was amortized to expense compared to $49,000 during the same period in 2008.  At March 31, 2009, 205,913 shares were reserved for future grants under the plan.  Stock grant activity is indicated below.

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

 
NOTE 8:  INCOME TAXES

As of March 31, 2009, the Company had no material unrecognized tax benefits or accrued interest and penalties. It is the Company’s policy to account for interest and penalties accrued relative to unrecognized tax benefits as a component of income tax expense.  Federal and state tax years 2005 through 2008 were open for examination as of March 31, 2009. Income tax expense for the three month period ended March 31, 2009 was $89,000 compared to $100,000 for the same period in 2008. The effective tax rate for the three month periods ended March 31, 2009 was 15.7%, compared to 19.6% for the same period in 2008. Although 2009 pre-tax income was $60,000 higher during the first quarter of 2009, income tax expense and the effective tax rate for the current period were lower than the same period in 2008.

NOTE 9:  FAIR VALUE MEASUREMENT

FAS 157 establishes a fair value hierarchy based on the nature of data inputs for fair value determinations, under which DNB is required to value each asset within its scope using assumptions that market participations would utilize to value that asset. When DNB uses its own assumptions, it is required to disclose additional information about the assumptions used and the effect of the measurement on earnings or the net change in assets for the period.
 
DNB’s available-for-sale investment securities, which generally include state and municipal securities, U.S. government agencies and mortgage backed securities, are reported at fair value. These securities are valued by an independent third party (“preparer”). The preparer’s evaluations are based on market data. They utilize evaluated pricing models that vary by asset and incorporate available trade, bid and other market information. For securities that do not trade on a daily basis, their evaluated pricing applications apply available information such as benchmarking and matrix pricing. The market inputs normally sought in the evaluation of securities include benchmark yields, reported trades, broker/dealer quotes (only obtained from market makers or broker/dealers recognized as market participants), issuer spreads, two-sided markets, benchmark securities, bid, offers and reference data. For certain securities additional inputs may be used or some market inputs may not be applicable. Inputs are prioritized differently on any given day based on market conditions.
 
U.S. Government agencies are evaluated and priced using multi-dimensional relational models and option adjusted spreads. State and municipal securities are evaluated on a series of matrices including reported trades and material event notices. Mortgage backed securities are evaluated using matrix correlation to treasury or floating index benchmarks, prepayment speeds, monthly payment information and other benchmarks. Other investments are evaluated using a broker-quote based application, including quotes from issuers.
 
 
11
 
DNB FINANCIAL CORPORATION AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)

These investment securities are classified as available for sale.
 
The value of the investment portfolio is determined using three broad levels of input:
 
Level 1 — Quoted prices in active markets for identical securities.
 
Level 2 — Quoted prices for similar instruments in active markets; quoted prices for identical or similar instruments in markets that are not active and model derived valuations whose inputs are observable or whose significant value drives are observable.
 
Level 3 — Instruments whose significant value drivers are unobservable.
 
These levels are not necessarily an indication of the risks or liquidity associated with these investments. The following table summarizes the assets at March 31, 2009 that are recognized on DNB’s balance sheet using fair value measurement determined based on the differing levels of input.
 
 
March 31, 2009
(Dollars in thousands)
Level 1
Level 2
Level 3
Assets at
Fair Value
Assets Measured at Fair Value on a Recurring Basis
        
Securities available for sale
$13
$71,954
$—
$71,967
Total assets measured at fair value on a recurring basis
$13
$71, 954
$—
$71,967
Assets Measured at Fair Value on a Nonrecurring Basis
        
Impaired loans
$—
$1,163
$—
$1,163
OREO & other repossessed property
—
4,630
—
4,630
Total assets measured at fair value on a nonrecurring basis
$—
$5,793
$—
$5,793

 
Impaired loans.  Impaired loans, which are measured for impairment using the fair value of the collateral for collateral dependent loans, had a carrying amount of $1.2 million at March 31, 2009. The valuation allowance on impaired loans was $120,000 as of March 31, 2009. During the three months ended March 31, 2009, we did not recognize any impairment charges related to loans.
 
Other Real Estate Owned & other repossessed property.    Other real estate owned ("OREO") consists of properties acquired as a result of, or in-lieu-of, foreclosure. Properties or other assets (primarily repossessed assets formerly leased) are classified as OREO and other repossessed property and are reported at the lower of carrying value or fair value, less estimated costs to sell. Costs relating to the development or improvement of the assets are capitalized and costs relating to holding the assets are charged to expense. DNB had $4.6 million of such assets at March 31, 2009. This consisted of $4.5 million in OREO and $107,000 in other repossessed property. Subsequent to the repossession of these assets, DNB did not write down their carrying values during the three month period ending March 31, 2009, based on appraisals.
 


NOTE 10:  STOCKHOLDERS’ EQUITY

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

12
 
   DNB FINANCIAL CORPORATION AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
 
        On January 30, 2009, as part of the Capital Purchase Program administered by the United States Department of the Treasury, DNB entered into a Letter Agreement and a Securities Purchase Agreement — Standard Terms with the U.S. Treasury, pursuant to which DNB issued and sold on January 30, 2009, and the U.S. Treasury purchased for cash on that date (i) 11,750 shares of the DNB's Fixed Rate Cumulative Perpetual Preferred Stock, Series 2008A, par value $10.00 per share, having a liquidation preference of $1,000 per share, and (ii) a ten-year warrant to purchase up to 186,311 shares of the DNB's common stock, $1.00 par value, at an exercise price of $9.46 per share, for an aggregate purchase price of $11,750,000 in cash (this is called the transaction). This transaction closed on January 30, 2009. The issuance and sale of these securities was a private placement exempt from registration pursuant to Section 4(2) of the Securities Act of 1933.  DNB will pay the Treasury Department a five percent dividend annually for each of the first five years of the investment and a nine percent dividend thereafter until the shares are redeemed. The cumulative dividend for the preferred stock is accrued for and payable on February 15th, May 15th, August 15th and November 15th of each year.
 
DNB allocated total proceeds of $11,750,000 based on the relative fair value of preferred stock and common stock warrants, to preferred stock for $11,599,000 and common stock warrants for $151,000.  The preferred stock discount will be accreted, on an effective yield method, to preferred stock over five years.
 

ITEM 2 - MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

DESCRIPTION OF DNB'S BUSINESS AND BUSINESS STRATEGY

DNB Financial Corporation is a bank holding company whose bank subsidiary, DNB First, National Association (the “Bank”) is a nationally chartered commercial bank with trust powers, and a member of the Federal Reserve System. The FDIC insures DNB’s deposits. DNB provides a broad range of banking services to individual and corporate customers through its thirteen community offices located throughout Chester and Delaware Counties, Pennsylvania. DNB is a community banking organization that focuses its lending and other services on businesses and consumers in the local market area. DNB funds all these activities with retail and business deposits and borrowings.  Through its DNB Advisors division, the Bank provides wealth management and trust services to individuals and businesses.  The Bank and its subsidiary, DNB Financial Services, Inc., make available certain non-depository products and services, such as securities brokerage, mutual funds, life insurance and annuities.

DNB earns revenues and generates cash flows by lending funds to commercial and consumer customers in its marketplace. DNB generates its largest source of interest income through its lending function.  Another source of interest income is derived from DNB’s investment portfolio, which provides liquidity and cash flows for future lending needs.

In addition to interest earned on loans and investments, DNB earns revenues from fees it charges customers for non-lending services. These services include wealth management and trust services; brokerage and investment services; cash management services; banking and ATM services; as well as safekeeping and other depository services.

To implement the culture changes necessary at DNB First to become an innovative community bank capable of meeting challenges of the 21st century, we embarked on a strategy called "Loyalty, Bank On It."  In recognizing the importance of loyalty in our everyday lives, we have embraced this concept as the cornerstone of DNB First's new culture.  To that end, DNB continues to make appropriate investments in all areas of our business, including people, technology, facilities and marketing.

Comprehensive 5-Year Plan. During the second quarter of 2008, management updated the 5-year strategic plan that was designed to reposition its balance sheet and improve core earnings. Through the plan, which covers years 2008 through 2012, management will endeavor to expand its loan portfolio through new originations, increased loan participations, as well as strategic loan and lease receivable purchases. Management also plans to reduce the absolute level of borrowings with cash flows from existing loans and investments as well as from new deposit growth. A discussion of DNB's Key Strategies follows below:

·  
Focus on penetrating markets and allowing existing locations to maximize profitability
 
 
13

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

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

·  
Grow loans and diversify the mix

·  
Reduce long-term borrowings

·  
Focus on profitable customer segments

·  
Grow and diversify non-interest income

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

·  
Focus on cost containment and improving operational efficiencies

 
Strategic Plan Update. During the first quarter of 2009, management focused on expense control as well as strengthening DNB's capital and liquidity positions. Non-interest expenses decreased $88,000 or 2.10% year over year and Total Risk Based Capital stood at 14.12% at March 31, 2009.  Cash and cash equivalents increased to $55.1 million, from $48.1 million at December 31, 2008. In addition, management was able to reduce DNB’s composite cost of funds to 2.14% for the three month period ended March 31, 2009 from 3.07% during the same period in 2008.
 
        Management has made a concerted effort to improve the measurement and tracking of business lines and overall corporate performance levels. Improved information systems have increased DNB's ability to track key indicators and enhance corporate performance levels. Better measurement against goals and objectives and increased accountability will be integral in attaining desired loan, deposit and fee income production.
 
MATERIAL CHALLENGES, RISKS AND OPPORTUNITIES

The following is a summary of material challenges, risks and opportunities DNB has faced during the three-month period ended March 31, 2009.

Interest Rate Risk Management. Interest rate risk is the exposure to adverse changes in net interest income due to changes in interest rates. DNB considers interest rate risk the predominant risk in terms of its potential impact on earnings.  Interest rate risk can occur for any one or more of the following reasons: (a) assets and liabilities may mature or re-price at different times; (b) short-term or long-term market rates may change by different amounts; or (c) the remaining maturity of various assets or liabilities may shorten or lengthen as interest rates change.

The principal objective of the Bank’s interest rate risk management is to evaluate the interest rate risk included in certain on and off-balance sheet accounts, determine the level of risk appropriate given the Bank’s business strategy, operating environment, capital and liquidity requirements and performance objectives, and manage the risk consistent with approved guidelines. Through such management, DNB seeks to reduce the vulnerability of its operations to changes in interest rates. The Bank’s Asset Liability Committee (the “ALCO”) is responsible for reviewing the Bank’s asset/liability policies and interest rate risk position and making decisions involving asset liability considerations. The ALCO meets on a monthly basis and reports trends and the Bank’s interest rate risk position to the Board of Directors.  The extent of the movement of interest rates is an uncertainty that could have a negative impact on the earnings of the Bank.

The largest component of DNB’s total income is net interest income, and the majority of DNB’s financial instruments are comprised of interest rate-sensitive assets and liabilities with various terms and maturities.  The primary objective of management is to maximize net interest income while minimizing interest rate risk.  Interest rate risk is derived from timing differences in the re-pricing of assets and liabilities, loan prepayments, deposit withdrawals, and differences in lending and funding rates.  The ALCO actively seeks to monitor and control the mix of in­terest rate-sensitive assets and interest rate-sensitive ­liabilities. One measure of interest rate risk is net interest income simulation analysis.  The ALCO utilizes simulation analysis, whereby the model estimates the variance in net interest income with a change in interest rates of plus or minus 200 basis points in addition to four yield curve twists over a twelve-month period.
 
 
14
 
Liquidity and Market Risk Management Liquidity is the ability to meet current and future financial obligations. The Bank further defines liquidity as the ability to respond to deposit outflows as well as maintain flexibility to take advantage of lending and investment opportunities. The Bank’s primary sources of funds are operating earnings, deposits, repurchase agreements, principal and interest payments on loans, proceeds from loan sales, sales and maturities of mortgage-backed and investment securities, and FHLB advances. The Bank uses the funds generated to support its lending and investment activities as well as any other demands for liquidity such as deposit outflows. While maturities and scheduled amortization of loans and securities are predictable sources of funds, deposit flows, mortgage prepayments, loan and security sales and the exercise of call features are greatly influenced by general interest rates, economic conditions and competition.

The objective of DNB’s asset/liability management function is to maintain consistent growth in net interest income within DNB’s policy limits. This objective is accomplished through the management of liquidity and interest rate risk, as well as customer offerings of various loan and deposit products. DNB maintains adequate liquidity to meet daily funding requirements, anticipated deposit withdrawals, or asset opportunities in a timely manner. Liquidity is also necessary to meet obligations during unusual, extraordinary or adverse operating circumstances, while avoiding a significant loss or cost. DNB’s foundation for liquidity is a stable deposit base as well as a marketable investment portfolio that provides cash flow through regular maturities or that can be used for collateral to secure funding in an emergency. As part of its liquidity management, DNB maintains assets, which comprise its primary liquidity (Federal funds sold, investments and interest-bearing cash balances, less pledged securities).
 
Credit Risk Management. DNB defines credit risk as the risk of default by a customer or counter-party.  The objective of DNB’s credit risk management strategy is to quantify and manage credit risk on an aggregate portfolio basis as well as to limit the risk of loss resulting from an individual customer default.  Credit risk is managed through a combination of underwriting, documentation and collection standards.  DNB’s credit risk management strategy calls for regular credit examinations and quarterly management reviews of large credit exposures and credits that are experiencing credit quality deterioration.  DNB’s loan review procedures provide assessments of the quality of underwriting, documentation, risk grading and charge-off procedures, as well as an assessment of the allowance for credit loss reserve analysis process.

Competition. In addition to the challenges related to the interest rate environment, community banks in Chester and Delaware Counties have been experiencing increased competition from large regional and international banks entering DNB’s marketplace through mergers and acquisitions.  Competition for loans and deposits has negatively affected DNB’s net interest margin.  To compensate for the increased competition, DNB, along with other area community banks, has aggressively sought and marketed customers who have been disenfranchised by these mergers.  To attract these customers, DNB has introduced new deposit products and services, such as Rewards Checking and Executive and employee packages. In addition, DNB has introduced Remote Capture to our commercial customers to expedite their collection of funds.
 
Deposit Insurance Assessments; FICO Assessments. DNB pays deposit insurance premiums to the FDIC based on an assessment rate established by the FDIC. In 2006, the FDIC enacted various rules to implement the provisions of the Federal Deposit Insurance Reform Act of 2005 (the "FDI Reform Act"). Pursuant to the FDI Reform Act, in 2006 the FDIC merged the Bank Insurance Fund with the Savings Association Insurance Fund to create a newly named Deposit Insurance Fund (the "DIF") that covers both banks and savings associations. Effective January 1, 2007, the FDIC revised the risk-based premium system under which the FDIC classifies institutions based on the factors described below and generally assesses higher rates on those institutions that tend to pose greater risks to the DIF.
 
 
        For most banks and savings associations, including DNB, FDIC rates will depend upon a combination of CAMELS component ratings and financial ratios. CAMELS ratings reflect the applicable bank regulatory agency's evaluation of the financial institution's capital, asset quality, management, earnings, liquidity and sensitivity to risk. For large banks and savings associations that have long-term debt issuer ratings, assessment rates will depend upon such ratings and CAMELS component ratings.
 
 
        On February 27, 2009, the FDIC adopted changes to its base and risk-based deposit insurance assessment rates. Effective for the second quarter of 2009, a bank's annual assessment base rates will be as follows, depending on the bank's risk category:
 
                                 
   
Risk Category
  
   
I
              
   
Minimum
  
Maximum
  
II
  
III
  
IV
  
   
Annual rates (in basis points)
    
12
    
16
    
22
    
32
    
45
  
   
 
 
15
 
        The base assessment rate can be adjusted downward based on a bank's unsecured debt and level of excess capital above the well capitalized threshold, or upward based on a bank's secured liabilities including Federal Home Loan Bank advances and repurchase agreements, so that the total risk-based assessment rates will range as follows depending on a bank's risk category:
 
                 
   
Risk Category
   
I
  
II
  
III
  
IV
 
Initial base assessment rate
  
12 to 16
  
22
  
32
  
45
Unsecured debt adjustment
  
–5 to 0
  
–5 to 0
  
–5 to 0
  
–5 to 0
Secured liability adjustment
  
0 to 8
  
0 to 11
  
0 to 16
  
0 to 22.5
Brokered deposit adjustment
  
—
  
0 to 10
  
0 to 10
  
0 to 10
Total base assessment rate
  
7 to 24
  
17 to 43
  
27 to 58
  
40 to 77.5
 
 
 On February 27, 2009, the FDIC adopted an interim rule that imposes a special assessment of 20 basis points as of June 30, 2009, which is to be collected on September 30, 2009. Then, on March 5, 2009, FDIC Chairman Sheila Bair announced that if Congress adopts legislation expanding the FDIC's line of credit with Treasury from $30 billion to $100 billion, the FDIC might have the flexibility to reduce the special emergency assessment, possibly from 20 to 10 basis points. Assuming that deposit levels remain constant, we anticipate that the special assessment for the Bank would total approximately $818,000 at the 20 basis points level, but if the FDIC is able to reduce the special assessment to 10 basis points, the Bank's assessment would total approximately $409,000.
 
        Because the rule has just been issued and is subject to some interpretation, management has not yet determined what the Bank's final risk-based assessment rate will be for periods after the first quarter of 2009.
 
        The FDIA, as amended by the FDI Reform Act, requires the FDIC to set a ratio of deposit insurance reserves to estimated insured deposits, the designated reserve ratio (the "DRR"), for a particular year within a range of 1.15% to 1.50%. For 2009, the FDIC has set the DRR at 1.25%, which is unchanged from 2008 levels. Under the FDI Reform Act and the FDIC's revised premium assessment program, every FDIC-insured institution will pay some level of deposit insurance assessments regardless of the level of the DRR. We cannot predict whether, as a result of an adverse change in economic conditions or other reasons, the FDIC will be required in the future to increase deposit insurance assessments above current levels. The FDIC also adopted rules providing for a one-time credit assessment to each eligible insured depository institution based on the assessment base of the institution on December 31, 1996. The credit may be applied against the institution's 2007 assessment, and for the three years thereafter the institution may apply the credit against up to 90% of its assessment. DNB qualified for a credit of approximately $245,000, of which $170,000 was applied in 2007 and the remaining balance of $75,000 was applied in 2008, thereby exhausting the credit.
 
        In addition, the Deposit Insurance Funds Act of 1996 authorized the Financing Corporation ("FICO") to impose assessments on DIF applicable deposits in order to service the interest on FICO's bond obligations from deposit insurance fund assessments. The amount assessed on individual institutions by FICO will be in addition to the amount, if any, paid for deposit insurance according to the FDIC's risk-related assessment rate schedules. FICO assessment rates may be adjusted quarterly to reflect a change in assessment base. The FICO assessment rate is adjusted quarterly to reflect changes in the assessment bases of the fund based on quarterly Call Report and Thrift Financial Report submissions. The FICO rate for the first quarter of 2009 was at an annual rate of 1.04 basis points (1.04 cents per $100 of assessable deposits).  Under the FDIA, insurance of deposits may be terminated by the FDIC upon a finding that the institution has engaged in unsafe and unsound practices, is in an unsafe or unsound condition to continue operations, or has violated any applicable law, regulation, rule, order or condition imposed by the FDIC.
 
Material Trends and Uncertainties. The global and U.S. economies are experiencing significantly reduced business activity as a result of disruptions in the financial system. Dramatic declines in the housing market, with falling home prices and increasing foreclosures and unemployment, have resulted in significant write-downs of asset values by financial institutions, including government-sponsored entities and major commercial and investment banks. As a result of the recession, retail customers may delay borrowing from DNB as unemployment increases and the value of existing homes decline and the availability to borrow against equity diminishes. As the U.S. economy moves through a period of recession, delinquencies will rise as the value of homes decline and DNB’s borrowers experience financial difficulty due to corporate downsizing, reduced sales, or other negative events which may impact their ability to meet their contractual loan payments. As a result of these negative trends in the economy and their impact on our borrowers’ ability to repay their loans, DNB made a $100,000 provision during the three months ending March 31, 2009 in response to DNB’s increased level of non-performing assets which grew to $10.8 million from $7.7 million at December 31, 2008 along with other changes in our loan and lease portfolio. In addition, during the first quarter of 2009, management strengthened DNB's capital and liquidity positions.  Total Risk Based Capital stood at 14.12% at March 31, 2009. Cash and cash equivalents increased to $55.1 million, from $48.1 million at December 31, 2008.
 
 

 
16
Other Material Challenges, Risks and Opportunities. As a financial institution, DNB's earnings are significantly affected by general business and economic conditions.  These conditions include short-term and long-term interest rates, inflation, monetary supply, fluctuations in both debt and equity capital markets, and the strength of the United States economy and local economics in which we operate.  As mentioned above in Material Trends and Uncertainties, the economic downturn, increased unemployment, and other events  negatively impact household and/or corporate incomes and could decrease the demand for DNB's loan and non-loan products and services and increase the number of customers who fail to pay interest or principal on their loans.  Geopolitical conditions can also affect DNB's earnings.  Acts or threats of terrorism, actions taken by the United States or other governments in response to acts or threats of terrorism and our military conflicts including the war in Afghanistan and Iraq, could impact business conditions in the United States.

CRITICAL ACCOUNTING POLICIES

The following discussion and analysis of financial condition and results of operations is based upon our consolidated financial statements, which have been prepared in accordance with United States generally accepted accounting principals. Generally accepted accounting principles are complex and require management to apply significant judgment to various accounting, reporting and disclosure matters. Management must use assumptions and estimates to apply these principles where actual measurement is not possible or practical. Actual results may differ from these estimates under different assumptions or conditions.

In management's opinion, the most critical accounting policies and estimates impacting DNB's consolidated financial statements are listed below.  These policies are critical because they are highly dependent upon subjective or complex judgments, assumptions and estimates.  Changes in such estimates may have a significant impact on the financial statements.  For a complete discussion of DNB's significant accounting policies, see the footnotes to the Consolidated Financial Statements included in DNB's 10-K for the year ended December 31, 2008.

Determination of the allowance for credit losses. Credit loss allowance policies involve significant judgments, estimates and assumptions by management which may have a material impact on the carrying value of net loans and leases and, potentially, on the net income recognized by DNB from period to period.  The allowance for credit losses is based on management’s ongoing evaluation of the loan and lease portfolio and reflects an amount considered by management to be its best estimate of the amount necessary to absorb known and inherent losses in the portfolio.  Management considers a variety of factors when establishing the allowance, such as the impact of current economic conditions, diversification of the portfolios, delinquency statistics, results of loan review and related classifications, and historic loss rates.  In addition, certain individual loans which management has identified as problematic are specifically provided for, based upon an evaluation of the borrower’s perceived ability to pay, the estimated adequacy of the underlying collateral and other relevant factors.  In addition, regulatory authorities, as an integral part of their examinations, periodically review the allowance for credit losses.  They may require additions to the allowance based upon their judgments about information available to them at the time of examination.  Although provisions have been established and segmented by type of loan, based upon management’s assessment of their differing inherent loss characteristics, the entire allowance for credit losses is available to absorb further losses in any category.

Management uses significant estimates to determine the allowance for credit losses.  Because the allowance for credit losses is dependent, to a great extent, on conditions that may be beyond DNB’s control, management’s estimate of the amount necessary to absorb credit losses and actual credit losses could differ.  DNB’s current judgment is that the valuation of the allowance for credit losses remains adequate at March 31, 2009.  For a description of DNB’s accounting policies in connection with its allowance for credit losses, see, “Allowance for Credit Losses”, in Management’s Discussion and Analysis.

Realization of deferred income tax items. Estimates of deferred tax assets and deferred tax liabilities make up the asset category titled “net deferred taxes”.  These estimates involve significant judgments and assumptions by management, which may have a material impact on the carrying value of net deferred tax assets for financial reporting purposes.  Deferred tax assets and liabilities are recognized for the future tax consequences attributable to differences between the financial statement carrying amounts of existing assets and liabilities and their respective tax basis, as well as operating loss carry forwards.  Deferred tax assets and liabilities are measured using enacted tax rates expected to apply to taxable income in the years in which those temporary differences are expected to be recovered or settled.  The effect on deferred tax assets and liabilities of a change in tax rates is recognized in income in the period that includes the enactment date.  A valuation allowance would be established against deferred tax assets when in the judgment of management, it is more likely than not that such deferred tax assets will not become available.  For a more detailed description of these items, refer to Footnote 11 (Federal Income Taxes) to DNB’s consolidated financial statements for the year ended December 31, 2008.
 
 
17
 
The Footnotes to DNB's most recent Consolidated Financial Statements as set forth in DNB's Annual Report 10-K identify other significant accounting policies used in the development and presentation of its financial statements.  This discussion and analysis, the significant accounting policies, and other financial statement disclosures identify and address key variables and other qualitative and quantitative factors that are necessary for an understanding and evaluation of DNB and its results of operations.

FINANCIAL CONDITION

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

Investment Securities. Investment securities at March 31, 2009 were $132.8 million (after $21.7 million of trade date sales) compared to $124.1 million at December 31, 2008. The $8.6 million increase in investment securities was primarily due to $34.1 million in sales and $10.3 million in principal pay-downs and maturities offset by the purchase of $54.2 million in investment securities. Included in the $34.1 million of investment securities sales was $21.7 million for securities which had a trade date in March 2009, and a settlement date in April 2009. Trade Date accounting is a method used to record transactions that take place on the date at which an agreement has been entered (the trade date), and not on the date the transaction has been finalized (the settlement date). 

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

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

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

RESULTS OF OPERATIONS
 
SUMMARY 

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

NET INTEREST INCOME

DNB's earnings performance is primarily dependent upon its level of net interest income, which is the excess of interest income over interest expense.  Interest income includes interest earned on loans, investments and federal funds sold and interest-earning cash, as well as loan fees and dividend income earned on investment securities.  Interest expense includes interest on deposits, FHLB advances, repurchase agreements, Federal funds purchased and other borrowings.

Net interest income after provision for credit losses for the three month period ended March 31, 2009 was $3.4 million, compared to $3.5 million for the same period in 2008.  Interest income for the three month period ended March 31, 2009 was $6.1 million compared to $7.3 million for the same period in 2008.  The decrease in interest income during the three month period was primarily attributable to a decrease of interest on loans and leases, which was a result of lower yields on the loan and lease portfolio, which was caused by lower market rates.  In addition, interest and dividends on investment securities declined due to a decrease in the average balance and yield.  The yield on interest-earning assets for the three month period ended March 31, 2009 was 4.82%, compared to 5.83% for the same period in 2008.  Interest expense for the three month period ended March 31, 2009 was $2.6 million compared to $3.7 million for the same period in 2008. The decrease in interest expense during the period was primarily attributable to lower rates on interest-bearing liabilities. The composite cost of funds for the three month period ended March 31, 2009 was 2.14% compared to 3.07% for the same period in 2008.   The net interest margin for the three month period ended March 31, 2009 was 2.75%, compared to 2.86% for the same period in 2008.
 
 
18

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

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

Interest on deposits was $1.7 million for the three month period ended March 31, 2009, compared to $2.7 million for the same period in 2008.  The average balance of deposits was $405.4 million with an average rate of 1.66% for the current quarter compared to $403.8 million with an average rate of 2.67% for the same period in 2008.  The decrease in rate during the period was primarily attributable to lower rates being paid on maturing time deposits and certain money market accounts, stimulated by a lower interest rate environment.

Interest on borrowings was $958,000 for the three month period ended March 31, 2009, compared to $1.0 million for the same period in 2008. The average balance of borrowings was $91.2 million with an average rate of 4.26% for the current quarter compared to $82.7 million with an average rate of 5.01% for the same period in 2008.  The increase in the average balance during the three-months ended March 31, 2009 compared to the same period in 2008 was attributable to an average $9.6 million increase in FHLB advances, offset by an average $1.0 million decline in repurchase agreements. The decrease in rate during the period was attributable to a decrease in market rates resulting from the Federal Reserve’s tightening actions over the last twelve months.

ALLOWANCE FOR CREDIT LOSSES

To provide for known and inherent losses in the loan and lease portfolios, DNB maintains an allowance for credit losses. Provisions for credit losses are charged against income to increase the allowance when necessary. Loan and lease losses are charged directly against the allowance and recoveries on previously charged-off loans and leases are added to the allowance. In establishing its allowance for credit losses, management considers the size and risk exposure of each segment of the loan and lease portfolio, past loss experience, present indicators of risk such as delinquency rates, levels of non-accruals, the potential for losses in future periods, and other relevant factors. Management’s evaluation of the loan and lease portfolio generally includes reviews of problem borrowers of $100,000 or greater. Consideration is also given to examinations performed by regulatory agencies, primarily the Office of the Comptroller of the Currency (“OCC”).

In establishing and reviewing the allowance for adequacy, management establishes the allowance for credit losses in accordance with generally accepted accounting principles in the United States and the guidance provided in the Securities and Exchange Commission’s Staff Accounting Bulletin 102 (SAB 102).  Its methodology for assessing the appropriateness of the allowance consists of several key elements which include: specific allowances for identified problem loans; formula based allowances for commercial and commercial real estate loans; and allowances for pooled, homogenous loans.  As a result, management has taken into consideration factors and variables which may influence the risk of loss within the loan portfolio, including: (i) trends in delinquency and non-accrual loans; (ii) changes in the nature and volume of the loan portfolio; (iii) effects of any changes in lending policies; (iv) experience, ability, and depth of management; (v) quality of loan review; (vi) national and local economic trends and conditions; (vii) concentrations of credit; and (viii) effect of external factors on estimated credit losses.  In addition, DNB reviews historical loss experience for the commercial real estate, commercial, residential real estate, home equity and consumer installment loan pools to determine a historical loss factor. The historical loss factors are then applied to the current portfolio balances to determine the required reserve percentage for each loan pool based on risk rating.
 
 
19

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

 
 
Three Months
Ended March 31,
 2009
  
 
Year Ended
December 31,
2008
  
 
Three Months
Ended March 31,
2008
  
 
(Dollars in thousands)
            
Beginning balance
$4,586
  
$3,891
  
$3,891
  
Provisions
100
  
2,018
  
60
  
Charge-offs
(57)
  
(1,401)
  
(42)
  
Recoveries
12
  
78
  
17
  
Ending balance
$4,641
  
$4,586
  
$3,926
  

NON-INTEREST INCOME

Total non-interest income includes service charges on deposit products; fees received in connection with the sale of non-depository products and services, including fiduciary and investment advisory services offered through DNB Advisors; securities brokerage products and services and insurance brokerage products and services offered through DNB Financial Services; and other sources of income such as increases in the cash surrender value of bank owned life insurance ("BOLI"), net gains on sales of investment securities and other real estate owned ("OREO") properties. In addition, DNB receives fees for cash management, merchant services, debit cards, safe deposit box rentals, lockbox services and similar activities.

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

NON-INTEREST EXPENSE

Non-interest expense includes salaries & employee benefits, furniture & equipment, occupancy, professional & consulting fees as well as printing & supplies, marketing and other less significant expense items.  Non-interest expense for the three month period ended March 31, 2009 was $4.1 million compared to $4.2 million for the same period in 2008.  There was a $239,000 decrease in salary & employee benefits due to a lower level of full time equivalent employees, coupled with lower benefit costs. DNB’s non-interest expense to average assets ratio for the three month period ended March 31, 2009 was 3.10%, compared to 3.20% for the same period in 2008.  The level of non-interest expenses declined during the period as a result of management’s focus on expense control.

INCOME TAXES

Income tax expense for the three month period ended March 31, 2009 was $89,000 compared to $100,000 for the same period in 2008. The effective tax rate for the three month periods ended March 31, 2009 was 15.7%, compared to 19.6% for the same period in 2008. Although 2009 pre-tax income was $60,000 higher during the first quarter of 2009, income tax expense and the effective tax rate for the current period were lower than the same period in 2008.  Income tax expense for each period differs from the amount determined at the statutory rate of 34% due to tax-exempt income on loans and investment securities, DNB's ownership of BOLI policies, and tax credits recognized on a low-income housing limited partnership.

ASSET QUALITY

Non-performing assets are comprised of non-accrual loans and leases, loans and leases delinquent over ninety days and still accruing, troubled debt restructurings ("TDRs") and Other Real Estate Owned ("OREO").  Non-accrual loans and leases are loans and leases for which the accrual of interest ceases when the collection of principal or interest payments is determined to be doubtful by management.  It is the policy of DNB to discontinue the accrual of interest when principal or interest payments are delinquent 90 days or more (unless the loan principal and interest are determined by management to be fully secured and in the process of collection), or earlier if considered prudent. Interest received on such loans is applied to the principal balance, or may, in some instances, be recognized as income on a cash basis.  A non-accrual loan or lease may be restored to accrual status when management expects to collect all contractual principal and interest due and the borrower has demonstrated a sustained period of repayment performance in accordance with the contractual terms.  OREO consists of real estate acquired by foreclosure.  OREO is carried at the lower of cost or estimated fair value, less estimated disposition costs.  Any significant change in the level of non-performing assets is dependent, to a large extent, on the economic climate within DNB's market area.
 
 
20

 
The following table sets forth those assets that are: (i) placed on non-accrual status, (ii) contractually delinquent by 90 days or more and still accruing, (iii) troubled debt restructurings other than those included in items (i) and (ii), and (iv) OREO as a result of foreclosure or voluntary transfer to DNB as well as other repossessed assets. Non-performing assets, which totaled $10.8 million at March 31, 2009, increased $3.1 million when compared to December 31, 2008. The increase in non-performing assets is attributed largely to one commercial credit secured by land, totaling $2.8 million.


Non-Performing Assets
              
(Dollars in thousands)
  
March 31,
 2009
December 31,
2008
March 31,
2008
Loans and leases:
              
Non-accrual
  
$   5,870
  
$   1,825
  
$   5,612
  
90 days past due and still accruing
  
330
  
900
  
710
  
Troubled debt restructurings
  
—
  
—
  
—
  
Total non-performing loans and leases
  
6,200
  
2,725
  
6,322
  
OREO & other repossessed property
  
4,630
  
4,997
  
451
  
Total non-performing assets
  
$  10,830
  
$    7,722
  
$  6,773
  



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

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


Included in the loan and lease portfolio are loans for which DNB has ceased the accrual of interest.  If contractual interest income had been recorded on non-accrual loans, interest would have been increased as shown in the following table:

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

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



21



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


LIQUIDITY AND CAPITAL RESOURCES

Management maintains liquidity to meet depositors’ needs for funds, to satisfy or fund loan commitments, and for other operating purposes.  DNB’s foundation for liquidity is a stable and loyal customer deposit base, cash and cash equivalents, and a marketable investment portfolio that provides periodic cash flow through regular maturities and amortization, or that can be used as collateral to secure funding.  As part of its liquidity management, DNB maintains assets that comprise its primary liquidity, which totaled $53.5 million at March 31, 2009.  Primary liquidity includes investments, Federal funds sold, and interest-bearing cash balances, less pledged securities.  DNB also anticipates scheduled payments and prepayments on its loan and mortgage-backed securities portfolios.  In addition, DNB maintains borrowing arrangements with various correspondent banks, the Federal Home Loan Bank of Pittsburgh and the Federal Reserve Bank of Philadelphia to meet short-term liquidity needs.  Through these relationships, DNB has available credit of approximately $128.9 million.  Management believes that DNB has adequate resources to meet its short-term and long-term funding requirements.

At March 31, 2009, DNB had $54.2 million in un-funded loan commitments.  Management anticipates these commitments will be funded by means of normal cash flows.  Certificates of deposit greater than or equal to $100,000 scheduled to mature in one year or less from March 31, 2009 totaled $58.0 million.  Management believes that the majority of such deposits will be reinvested with DNB and that certificates that are not renewed will be funded by a reduction in Federal funds sold or by pay-downs and maturities of loans and investments.

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

In March of 2005, DNB completed a private offering of $4 million Trust Preferred Securities, and in November 2005, DNB completed a private offering of 265,730 shares of its common stock to 53 accredited investors at a price of $21.00 per share, realizing total offering proceeds of $5.6 million.  DNB invested the majority of the proceeds of each of these securities issuances into the Bank to increase the Bank’s capital levels and legal lending limit.

Management believes that the Corporation and the Bank have each met the definition of “well capitalized” for regulatory purposes on March 31, 2009.  The Bank’s capital category is determined for the purposes of applying the bank regulators’ “prompt corrective action” regulations and for determining levels of deposit insurance assessments and may not constitute an accurate representation of the Corporation’s or the Bank’s overall financial condition or prospects. The Corporation’s capital exceeds the FRB’s minimum lever­age ratio requirements for bank holding companies (see additional discussion included in Footnote 17 of DNB’s 10-K).

Under federal banking laws and regulations, DNB and the Bank are required to maintain minimum capital as determined by certain regulatory ratios. Capital adequacy for regulatory purposes, and the capital category assigned to an institution by its regulators, may be determinative of an institution’s overall financial condition.


22

 
The following table summarizes data and ratios pertaining to the Corporation and the Bank's capital structure.

   
For Capital
To Be Well Capitalized Under Prompt Corrective
  
 
Actual
Adequacy Purposes
Action Provisions
  
(Dollars in thousands)
Amount
  
Ratio
  
Amount
  
Ratio
  
Amount
  
Ratio
  
DNB Financial Corporation
                        
                         
March 31, 2009:
                        
Total risk-based capital
$57,538
  
14.12
%
$32,606
  
8.00
%
$40,757
  
10.00
%
Tier 1 capital
52,770
  
12.95
  
16,303
  
4.00
  
24,454
  
6.00
  
Tier 1 (leverage) capital
52,770
  
9.82
  
21,495
  
4.00
  
26,869
  
5.00
  
December 31, 2008:
                        
Total risk-based capital
$45,516
  
12.02
%
$30,306
  
8.00
%
$37,883
  
10.00
%
Tier 1 capital
40,802
  
10.77
  
15,153
  
4.00
  
22,730
  
6.00
  
Tier 1 (leverage) capital
   40,802
  
7.46
  
21,882
  
4.00
  
27,353
  
5.00
  
                         
DNB First, N.A.
                        
                         
March 31, 2009:
                        
Total risk-based capital
$55,732
  
13.75
%
$32,415
  
8.00
%
$40,518
  
10.00
%
Tier 1 capital
50,964
  
12.58
  
16,207
  
4.00
  
24,311
  
6.00
  
Tier 1 (leverage) capital
50,964
  
9.52
  
21,422
  
4.00
  
26,778
  
5.00
  
December 31, 2008:
                        
Total risk-based capital
$45,378
  
12.00
%
$30,257
  
8.00
%
$37,822
  
10.00
%
Tier 1 capital
40,654
  
10.75
  
15,129
  
4.00
  
22,693
  
6.00
  
Tier 1 (leverage) capital
40,654
  
7.44
  
21,862
  
4.00
  
27,328
  
5.00
  

In addition, the Federal Reserve Bank (the "FRB") leverage ratio rules require bank holding companies to maintain a minimum level of "primary capital" to total assets of 5.5% and a minimum level of "total capital" to total assets of 6%.  For this purpose, (i) "primary capital" includes, among other items, common stock, certain perpetual debt instruments such as eligible Trust preferred securities, contingency and other capital reserves, and the allowance for loan losses, (ii) "total capital" includes, among other things, certain subordinated debt, and "total assets" is increased by the allowance for loan losses.  DNB's primary capital ratio and its total capital ratio are both well in excess of FRB requirements.

REGULATORY MATTERS

Dividends payable to the Corporation by the Bank are subject to certain regulatory limitations. Under normal circumstances, the payment of dividends in any year without regulatory permission is limited to the net profits (as defined for regulatory purposes) for that year, plus the retained net profits for the preceding two calendar years.

FORWARD-LOOKING STATEMENTS

This report contains statements which, to the extent that they are not recitations of historical fact may constitute forward-looking statements within the meaning of the United States Private Securities Litigation Reform Act of 1995. Such forward-looking statements may include financial and other projections as well as statements regarding DNB’s future plans, objectives, performance, revenues, growth, profits, operating expenses or DNB’s underlying assumptions. The words “may”, “would”, “could”, “will”, “likely”, “expect,” “anticipate,” “intend”, “estimate”, “plan”, “forecast”, “project” and “believe” or other similar words and phrases may identify forward-looking statements. Persons reading this report are cautioned that such statements are only predictions, and that DNB’s actual future results or performance may be materially different.

Such forward-looking statements involve known and unknown risks and uncertainties. A number of factors, many of which are beyond DNB’s control, could cause our actual results, events or developments, or industry results, to be materially different from any future results, events or developments expressed, implied or anticipated by such forward-looking statements, and so our business and financial condition and results of operations could be materially and adversely affected. Such factors include, among others, our need for capital; the impact of economic conditions on our business; changes in banking regulation and the possibility that any banking agency approvals we might require for certain activities will not be obtained in a timely manner or at all or will be conditioned in a manner that would impair our ability to implement our business plans; our ability to attract and retain key personnel; competition in our marketplace; and other factors as described in our securities filings. All forward-looking statements and information made herein are based on our current expectations as of the date hereof and speak only as of the date they are made. DNB does not undertake to update forward-looking statements.
 
 
23

 
For a complete discussion of the assumptions, risks and uncertainties related to our business, you are encouraged to review our filings with the Securities and Exchange Commission, including this Form 10-Q, as well as any changes in risk factors that we may identify in our quarterly or other reports filed with the SEC.


ITEM 3 - QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

To measure the impacts of longer-term asset and liability mismatches beyond two years, DNB utilizes an Economic Value of Equity ("EVE") model.  The EVE model measures the potential price risk of equity to changes in interest rates and factors in the optionality included on the balance sheet.  EVE analysis is used to dynamically model the present value of asset and liability cash flows, with rates ranging up or down 200 basis points.  The EVE is likely to be different if rates change.  Results falling outside prescribed ranges require action by management.  At March 31, 2009 and December 31, 2008, DNB's variance in the EVE as a percentage of assets with an instantaneous and sustained parallel shift of 200 basis points was within its negative 3% guideline, as shown in the table below.  The change as a percentage of the present value of equity with a 200 basis point increase or decrease at March 31, 2009 and December 31, 2008, was within DNB's negative 25% guideline.

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


ITEM 4 - CONTROLS AND PROCEDURES

DNB’s Chief Executive Officer and Chief Financial Officer have reviewed and evaluated the effectiveness of our disclosure controls and procedures (as defined in Exchange Act Rule 13a-15(e)) as of March 31, 2009, the end of the period covered by this report, in accordance with the requirements of Exchange Act Rule 240.13a-15(b). Based on that evaluation, the Chief Executive Officer and the Chief Financial Officer have concluded that DNB’s current disclosure controls and procedures are effective and timely, providing them with material information relating to DNB and its subsidiaries required to be disclosed in the report DNB files under the Exchange Act.

Management of DNB is responsible for establishing and maintaining adequate internal control over financial reporting for DNB, as such term is defined in Rule 13a-15(f) under the Securities Exchange Act of 1934.  There was no change in the DNB’s “internal control over financial reporting” (as such term is defined in Rule 13a-15(f) under the Exchange Act) that occurred during the fiscal quarter ended March 31, 2009, that has materially affected, or is reasonably likely to materially affect, DNB’s internal control over financial reporting.
 
 
24

 
PART II - OTHER INFORMATION

ITEM 1. LEGAL PROCEEDINGS

Not Applicable

ITEM 1A. RISK FACTORS

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

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

There were no Unregistered Sales of Equity Securities during the quarter ended March 31, 2009 other than DNB’s issuance of its fixed rate Cumulative Perpetual Preferred Stock, Series 2008A and warrant to purchase common stock to the U.S. Treasury. For more information on this issuance, see DNB’s Form 8-K filed with the SEC on January 30, 2009.  The following table provides information on repurchases by DNB of its common stock in each month of the quarter ended March 31, 2009:
 
Period
  
Total Number
Of Shares Purchased
  
Average
Price Paid
Per Share
  
Total Number of
Shares Purchased
as Part of Publicly
Announced Plans
or Programs
  
Maximum Number
of Shares that May
Yet Be Purchased
Under the Plans or
Programs (a)
January 1, 2009 – January 31, 2009
  
2,354
  
$9.03
  
2,354
  
63,216
February 1, 2009 – February 28, 2009
  
—
  
—
  
—
  
63,216
March 1, 2009 – March 31, 2009
  
—
  
—
  
—
  
63,216
Total
  
2,354
  
$9.03
  
2,354
    

 
On July 25, 2001, DNB authorized the buyback of up to 175,000 shares of its common stock over an indefinite period. On August 27, 2004, DNB increased the buyback from 175,000 to 325,000 shares of its common stock over an indefinite period.

ITEM 3. DEFAULTS UPON SENIOR SECURITIES

Not Applicable

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

Not Applicable

ITEM 5. OTHER INFORMATION

Not Applicable

ITEM 6. EXHIBITS

Exhibits required by Item 601 of Regulation S-K.

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


25
SIGNATURES



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

   
DNB FINANCIAL CORPORATION
     
May 15, 2009
BY:
/s/ William S. Latoff
   
William S. Latoff, Chairman of the
Board and Chief Executive Officer
     
     
     
May 15, 2009
BY:
/s/ Gerald F. Sopp
   
Gerald F. Sopp, Chief Financial Officer and Executive Vice President
     
     
























26

 


Index to Exhibits
 
Exhibit No.
Under Item 601
of Regulation S-K
  
3
(i)
Amended and Restated Articles of Incorporation, as amended effective December 8, 2008, filed March 31, 2009 as item 3(i) to Form 10-K for the fiscal year-ended December 31, 2008 (No. 0-16667) and incorporated herein by reference.
 
(ii)
Bylaws of the Registrant as amended December 8, 2008, filed March 31, 2009 as item 3(ii) to Form 10-K for the fiscal year-ended December 31, 2008 (No. 0-16667) and incorporated herein by reference.
4
  
Registrant has certain debt obligations outstanding, for none of which do the instruments defining holders rights authorize an amount of securities in excess of 10% of the total assets of the Registrant and its subsidiaries on a consolidated basis. Registrant agrees to furnish copies of such agreements to the Commission on request.
10
(a)*
Amended and Restated Change of Control Agreements dated December 20, 2006 between DNB Financial Corporation and DNB First, N.A. and the following executive officers, each in the form filed March 26, 2007 as item 10(a) to Form 10-K for the fiscal year-ended December 31, 2006 (No. 0-16667) and incorporated herein by reference: Bruce E. Moroney, C. Tomlinson Kline III, and Richard J. Hartmann.
 
(b)**
1995 Stock Option Plan of DNB Financial Corporation (as amended and restated, effective as of April 27, 2004), filed on March 29, 2004 as Appendix A to Registrant’s Proxy Statement for its Annual Meeting of Stockholders held April 27, 2004, and incorporated herein by reference.
 
(c)*
Form of Change of Control Agreements, as amended November 10, 2003, filed on November 14, 2003 as Item 10(e) to Form 8-K (No. 0-16667) and incorporated herein by reference between DNB Financial Corporation and DNB First, N.A. and each of the following Directors: (i) dated November 10, 2005 with James H. Thornton, James J. Koegel and Eli Silberman, and (ii) dated February 23, 2005 with Mildred C. Joyner, and dated February 22, 2006 with Thomas A. Fillippo. On April 17, 2009, the Registrant approved agreements with each non-employee director to terminate his or her Change of Control Agreement.
 
(d)**
DNB Financial Corporation Incentive Equity and Deferred Compensation Plan filed March 10, 2005 as item 10(i) to Form 10-K for the fiscal year-ended December 31, 2004 (No. 0-16667) and incorporated herein by reference.
 
(e)*
Amended and Restated Change of Control Agreement among DNB Financial Corporation, DNB First, N.A. and William S. Latoff, dated December 20, 2006, filed March 26, 2007 as item 10(e) to Form 10-K for the fiscal year-ended December 31, 2006 (No. 0-16667) and incorporated herein by reference.
 
(f)*
Agreement of Lease dated February 10, 2005 between Headwaters Associates, a Pennsylvania general partnership, as Lessor, and DNB First, National Association as Lessee for a portion of premises at 2 North Church Street, West Chester, Pennsylvania, filed March 10, 2005 as Item 10(l) to Form 10-K for the fiscal year ended December 31, 2004 (No. 0-16667) and incorporated herein by reference, as amended by Addendum to Agreement of Lease dated as of November 15, 2005, filed March 23, 2006 as Item 10(l) to Form 10-K for the fiscal year ended December 31, 2005 (No. 0-16667) and incorporated herein by reference, and as further amended by Second Addendum to Agreement of Lease dated as of May 25, 2006, filed August 14, 2006 as Item 10(l) to Form 10-Q for the fiscal quarter ended June 30, 2006 (No. 0-16667) and incorporated herein by reference.
 
(g)
Marketing Services Agreement between TSG, Inc., a Pennsylvania business corporation (the “Service Provider”) for which Eli Silberman, a Director of Registrant, is the President and owner dated December 17, 2008, filed March 31, 2009 as item 10(g) to Form 10-K for the fiscal year-ended December 31, 2008 (No. 0-16667) and incorporated herein by reference.
 
(h)**
Form of Stock Option Agreement for grants prior to 2005 under the Registrant’s Stock Option Plan, filed May 11, 2005 as Item 10(n) to Form 10-Q for the fiscal quarter ended March 31, 2005 (No. 0-16667) and incorporated herein by reference.
 
(i)**
Form of Nonqualified Stock Option Agreement for April 18, 2005 and subsequent grants under the Stock Option Plan, filed May 11, 2005 as Item 10(o) to Form 10-Q for the fiscal quarter ended March 31, 2005 (No. 0-16667) and incorporated herein by reference.
 
 
 
27
 
 
 
(j)
Agreement of Sale dated June 1, 2005 between DNB First, National Association (the “Bank”), as seller, and Papermill Brandywine Company, LLC, a Pennsylvania limited liability company, as buyer (“Buyer”) with respect to the sale of the Bank’s operations center and an adjunct administrative office (the “Property”) and accompanying (i) Agreement of Lease between the Buyer as landlord and the Bank as tenant, pursuant to which the Property will be leased back to the Bank, and (ii) Parking Easement Agreement to provide cross easements with respect to the Property, the Buyer’s other adjoining property and the Bank’s other adjoining property, filed August 15, 2005 as Item 10(p) to Form 10-Q for the fiscal quarter ended June 30, 2005 (No. 0-16667) and incorporated herein by reference.
 
(k)
Agreement of Lease dated November 18, 2005 between Papermill Brandywine Company, LLC, a Pennsylvania limited liability company (“Papermill”), as Lessor, and DNB First, National Association as Lessee for the banks operations center and adjunct administrative office, filed March 23, 2006 as Item 10(q) to Form 10-K for the fiscal year ended December 31, 2005 (No. 0-16667) and incorporated herein by reference.
 
(l)*
Amended and Restated Change of Control Agreement among DNB Financial Corporation, DNB First, N.A. and William J. Hieb, filed May 15, 2007 as Item 10(l) to Form 10-Q for the fiscal quarter ended March 31, 2007 (No. 0-16667) and incorporated herein by reference.
 
(m)**
Form of Nonqualified Stock Option Agreement for grants on and after December 22, 2005 under the Stock Option Plan, filed March 23, 2006 as Item 10(s) to Form 10-K for the fiscal year ended December 31, 2005 (No. 0-16667) and incorporated herein by reference.
 
(n)*
Deferred Compensation Plan For Directors of DNB Financial Corporation (adopted effective October 1, 2006), filed November 14, 2006 as Item 10(s) to Form 10-Q for the fiscal quarter ended September 30, 2006 (No. 0-16667) and incorporated herein by reference.
 
(o)*
DNB Financial Corporation Deferred Compensation Plan (adopted effective October 1, 2006), filed November 14, 2006 as Item 10(t) to Form 10-Q for the fiscal quarter ended September 30, 2006 (No. 0-16667) and incorporated herein by reference.
 
(p)*
Trust Agreement, effective as of October 1, 2006, between DNB Financial Corporation and DNB First, National Association (Deferred Compensation Plan), filed November 14, 2006 as Item 10(u) to Form 10-Q for the fiscal quarter ended September 30, 2006 (No. 0-16667) and incorporated herein by reference.
 
(q)*
Change of Control Agreements among DNB Financial Corporation, DNB First, N.A. and each of the following executive officers, each in the form filed March 26, 2007 as item 10(q) to Form 10-K for the fiscal year-ended December 31, 2006 (No. 0-16667) and incorporated herein by reference: Albert J. Melfi, Jr. and Gerald F. Sopp.
 
(r)*
DNB Financial Corporation Supplemental Executive Retirement Plan for William S. Latoff as amended and restated effective April 1, 2007, filed May 15, 2007 as Item 10(r) to Form 10-Q for the fiscal quarter ended March 31, 2007 (No. 0-16667) and incorporated herein by reference, as further amended by Amendment dated December 8, 2008, filed March 31, 2009 as item 3(r) to Form 10-K for the fiscal year-ended December 31, 2008 (No. 0-16667) and incorporated herein by reference.
 
(s)*
Trust Agreement effective as of December 20, 2006 between DNB Financial Corporation and DNB First, N.A. (William S. Latoff SERP), filed March 26, 2007 as item 10(s) to Form 10-K for the fiscal year-ended December 31, 2006 (No. 0-16667) and incorporated herein by reference, as modified by Agreement to Terminate Trust dated as of April 1, 2007, filed May 15, 2007 as Item 10(s) to Form 10-Q for the fiscal quarter ended March 31, 2007 (No. 0-16667) and incorporated herein by reference.
 
(t)*
DNB Offer Letter to Albert J. Melfi, Jr., dated November 10, 2006, filed March 26, 2005 as item 10(t) to Form 10-K for the fiscal year-ended December 31, 2006 (No. 0-16667) and incorporated herein by reference.
 
(u)*
DNB Offer Letter to Gerald F. Sopp, dated December 20, 2006, filed March 26, 2007 as item 10(u) to Form 10-K for the fiscal year-ended December 31, 2006 (No. 0-16667) and incorporated herein by reference.
 
(v)**
Form of Restricted Stock Award Agreement dated November, 28, 2007, filed March 28, 2008 as item 10(v) to Form 10-K for the fiscal year-ended December 31, 2007 (No. 0-16667) and incorporated herein by reference.
11
  
Registrant’s Statement of Computation of Earnings Per Share is incorporated in footnote 2.
 
 
 
 
28
 
 
 
 
 
*
Management contract or compensatory plan arrangement.
 
**
Shareholder approved compensatory plan pursuant to which the Registrant’s Common Stock may be issued to employees of the Corporation.
     
     
     

 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
29