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-------------------------------------------------------------------------------- LETTER TO OUR STOCKHOLDERS -------------------------------------------------------------------------------- TO OUR STOCKHOLDERS Any discussion about fiscal 2006 results must be done within the context of the interest rate environment. During this period, the Federal Reserve raised the Fed Funds rate six times, bringing the total to 17 increases since the current tightening cycle began in June 2004. The current Fed Funds rate of 5.25% is 65 basis points higher than the 10-year treasury yield, resulting in an inverted yield curve. Since the majority of our income comes from our net interest margin, this type of a yield curve presents significant challenges to us. We are not alone, however, as our peers and competitors in the industry are also experiencing spread compression. We accomplished much that we are pleased with in fiscal 2006, however. Net income of $4.2 million was on target with internal projections, given the interest rate environment discussed above. We also continued to grow, ending the year at $731 million or about $53 million over the prior year. Most importantly to us, the growth was almost entirely in loans, as the loan portfolio increased $93 million, while our investment portfolio decreased by about $40 million. Equally important is that much of the growth was funded internally, as deposits grew by approximately $47 million. -------------------------------------------------------------------------------- ASSETS -------------------------------------------------------------------------------- [BAR GRAPH SHOWING TOTAL ASSETS IN MILLIONS AT END OF LAST FIVE FISCAL YEARS] 2006 $730.7 2005 $677.8 2004 $627.7 2003 $617.8 2002 $616.4 -------------------------------------------------------------------------------- As noted above, loan growth was significant during the year, with loan originations totaling approximately $154 million. We continue to have a very significant presence in the local mortgage origination market, with construction financing being an area of particular expertise. During fiscal 2006, we originated approximately $80 million in residential real estate loans, the majority of which we retained for our portfolio, selling some into the secondary market. We also had a good year on the commercial lending side, originating approximately $29 million in commercial real estate loans and another $8 million in commercial business loans. In the consumer area, we originated approximately $37 million in loans, the majority of which were home equity loans. The growth in deposits was due primarily to a very competitive money market account that we introduced in early 2005. The rate on this money market account has been priced to be near the top of local offerings, while still being below the cost of wholesale overnight funding sources. While it has been important to generate these deposits, this account has also been successful in attracting new customers to the Bank, giving us the opportunity to establish banking relationships by cross selling additional products and services. Of course, one of the most important things to our stockholders is the price of our stock. The performance was essentially flat during fiscal 2006, ending the year at $19.00 per share, down slightly from $19.20 per share at last fiscal year-end. While we are not in any way satisfied with this, we do note that our stock's performance was very similar to many small bank and thrift stocks over the last year, as all were affected by the interest rate environment discussed above. The Board continues to have confidence in the stock, however, and showed it by increasing the quarterly cash dividend by $.01 or 7.7% to $.14 per share in May 2006. The Board also extended the stock repurchase program originally announced in October 2005 for another year, under which up to 5% of the outstanding common stock can be repurchased. While not all of the accomplishments and initiatives taken during the past year can be easily quantified, I will attempt to describe a few of the things we hope will benefit the Bank in years to come. First, we opened a continued -------------------------------------------------------------------------------- Annual Report 2006 - Fidelity Bancorp, Inc. and Subsidiary 1 -------------------------------------------------------------------------------- LETTER TO OUR STOCKHOLDERS (CONTINUED) -------------------------------------------------------------------------------- new state-of-the-art branch office in Carnegie, our first "from the ground up" facility in over 20 years. While this branch replaced one that was destroyed by a fire, it is in a new location and represents a completely new design for our branches. The results to date at the Carnegie branch have been very positive and we hope that the design can serve as a prototype for any future branch expansion that may occur. -------------------------------------------------------------------------------- DEPOSITS -------------------------------------------------------------------------------- [BAR GRAPH SHOWING TOTAL DEPOSITS IN MILLIONS AT END OF LAST FIVE FISCAL YEARS] 2006 $414.2 2005 $366.8 2004 $359.8 2003 $366.1 2002 $351.4 -------------------------------------------------------------------------------- In the lending area, we introduced our Small Business Lending Unit or "SBLU." This unit provides products geared toward small businesses in our area, including deposit, line of credit and money management products, with a streamlined and simplified application and approval process. We also continued to expand our consumer offerings, including an innovative new product that we call the "Lifeline Loan". This loan is a floating rate home equity line of credit that can be partitioned, at the borrowers direction, into up to three fixed rate loans, without the borrower having to reapply. As the fixed rate loans are paid down, the line of credit automatically increases by the same amount. We believe this loan not only has tremendous potential to attract new customers, but will also enable the Bank to retain and strengthen the relationships of our existing customers. Operationally, we continue to improve our capabilities. We completed an 18 month evaluation of available core processing systems and after careful consideration, decided it to be in the best interest of the Bank to remain with our current system, but in an outsourced environment rather than the system as we currently do in-house. This "conversion" will take place in February 2007 and will provide additional functionality while increasing security. We also selected new internet banking, bill payment and telephone banking providers and will have switched to these new platforms in the first quarter of fiscal 2007. We are also continuing to emphasize a more focused marketing strategy throughout the Bank -- one that targets specific segments of both the Bank's customer base and the Bank's general market area based on demographic characteristics and their potential for growth. In addition, the strategy is being supplemented with a more consistent advertising presence, including television, direct mail and radio advertisements. Fidelity is one of the few remaining community banks in this area and we want to get the message out that there is still a local Bank offering quality products and services, with personalized customer service. Looking ahead to 2007, it promises to be another challenging year. Interest rates and regulatory issues will continue to affect us. We recognize that it would be beneficial to increase other non-interest income sources and will intensify our efforts in that area. We also know that we must grow and will continue to look at appropriate opportunities to do so. Finally, as always, I would like to thank our Board of Directors for their continued support and, most importantly, our employees, who never cease to amaze me with their dedication, loyalty and innovation. As a team, we will continue to meet the challenges ahead with confidence and enthusiasm. /s/ Xxxxxxx X. Xxxxxxx Xxxxxxx X. Xxxxxxx President and Chief Executive Officer -------------------------------------------------------------------------------- 2 Annual Report 2006 - Fidelity Bancorp, Inc. and Subsidiary ------------------------------------------------------------------------------------------------------------------------------- SELECTED FINANCIAL DATA ------------------------------------------------------------------------------------------------------------------------------- FINANCIAL CONDITION DATA September 30, (Dollars in Thousands) 2006 2005 2004 2003 2002 ------------------------------------------------------------------------------------------------------------------------------- Total assets $730,732 $677,779 $627,727 $617,778 $616,432 Loans receivable, net 439,027 346,076 290,389 264,412 316,320 Mortgage-backed securities and collateralized mortgage obligations 1 100,838 131,132 130,738 129,572 114,059 Investment securities and other earning assets 2 159,810 169,192 176,483 193,596 154,563 Total liabilities 686,537 635,730 585,650 577,583 573,852 Savings and time deposits 414,182 366,812 359,772 366,126 351,406 Advances from FHLB and other borrowings 266,865 264,160 221,841 207,062 216,933 Stockholders' equity 44,195 42,049 42,077 40,195 42,580 Number of full service offices 13 13 13 13 11 ------------------------------------------------------------------------------------------------------------------------------- OPERATIONS DATA Years Ended September 30, (Dollars in Thousands, Except Per Share Data) 2006 2005 2004 2003 2002 ------------------------------------------------------------------------------------------------------------------------------- Interest income $37,373 $31,664 $29,325 $32,460 $36,610 Interest expense 23,814 17,823 16,005 20,213 23,114 ------------------------------------------------------------------------------------------------------------------------------- Net interest income 13,559 13,841 13,320 12,247 13,496 Provision for loan losses 600 600 275 555 400 ------------------------------------------------------------------------------------------------------------------------------- Net interest income after provision for loan losses 12,959 13,241 13,045 11,692 13,096 Realized gain (loss) on sale of securities, net 552 609 639 748 234 Writedown of investment securities -- (43) -- (110) (246) Gain on sale of loans 49 36 47 512 292 Service fees and other income 3,232 3,186 3,081 2,865 2,365 Operating expenses 12,086 12,153 11,475 10,711 10,070 ------------------------------------------------------------------------------------------------------------------------------- Income before income tax provision and extraordinary gain 4,706 4,876 5,337 5,014 5,702 Income tax provision 840 1,000 1,016 961 1,276 Income from continuing operations 3,866 3,876 4,321 4,053 4,426 Income from extraordinary gain, net of taxes 318 -- -- -- -- ------------------------------------------------------------------------------------------------------------------------------- Net income $4,184 $3,876 $4,321 $4,053 $4,426 ------------------------------------------------------------------------------------------------------------------------------- Diluted earnings per share 3 $1.38 $1.27 $1.40 $1.24 $1.43 Cash dividends per share 3 .54 .478 .416 .378 .344 Book value per share 3 14.82 14.27 14.31 13.70 13.77 Average interest rate spread 2.03% 2.26% 2.31% 2.15% 2.48% Return on average assets .59% .59% .69% .66% .76% Return on average stockholders' equity 9.89% 9.24% 10.62% 9.45% 11.60% =============================================================================================================================== Common shares outstanding 3 2,960,496 2,945,677 2,940,654 2,932,797 3,089,618 =============================================================================================================================== 1 Consists of mortgage-backed securities and collateralized mortgage obligations classified as held to maturity and available for sale. 2 Consists of interest-bearing deposits, investment securities classified as held to maturity and available for sale, and Federal Home Loan Bank stock. 3 Per share and common shares outstanding amounts were restated to reflect the 10% stock dividends paid in May 2002, May 2003, May 2004, and May 2005. -------------------------------------------------------------------------------- Annual Report 2006 - Fidelity Bancorp, Inc. and Subsidiary 3 Report of Independent Registered Public Accounting Firm To the Board of Directors and Stockholders Fidelity Bancorp, Inc. Pittsburgh, Pennsylvania We have audited the accompanying consolidated statements of financial condition of Fidelity Bancorp, Inc. and subsidiary as of September 30, 2006 and 2005 and the related consolidated statements of income, stockholders' equity, and cash flows for each of the three years in the period ended September 30, 2006. These financial statements are the responsibility of the Company's management. Our responsibility is to express an opinion on these financial statements based on our audits. We conducted our audits in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. The Company is not required to have, nor were we engaged to perform, an audit of its internal control over financial reporting. Our audits included consideration of internal control over financial reporting as a basis for designing audit procedures that are appropriate in the circumstances, but not for the purpose of expressing an opinion on the effectiveness of the Company's internal control over financial reporting. Accordingly, we express no such opinion. An audit also includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements, assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion. In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the financial position of Fidelity Bancorp, Inc. and subsidiary at September 30, 2006 and 2005, and the results of their operations and their cash flows for each of the three years in the period ended September 30, 2006, in conformity with accounting principles generally accepted in the United States of America. /s/Xxxxx Xxxxxx Company LLP Xxxxx Xxxxxx Company LLP Pittsburgh, Pennsylvania December 8, 2006 -------------------------------------------------------------------------------- 4 Annual Report 2006 o Fidelity Bancorp, Inc. and Subsidiary CONSOLIDATED STATEMENTS OF FINANCIAL CONDITION September 30, 2006 2005 ---------------------------------------------------------------------------------------------------------------------------- (Dollars in Thousands, Except per Share Data) ASSETS Cash and due from banks $ 8,480 $ 9,234 Interest bearing demand deposits with other institutions 187 636 ---------------------------------------------------------------------------------------------------------------------------- Cash and Cash Equivalents 8,667 9,870 Securities available for sale, amortized cost 2006 $167,699; 2005 $183,542 165,449 182,157 Securities held to maturity, fair value 2006 $84,851; 2005 $104,962 85,879 105,316 Loans held for sale 40 248 Loans receivable, net of allowance 2006 $2,917; 2005 $2,596 439,027 346,076 Foreclosed real estate, net 215 789 Restricted investments in bank stock, at cost 9,132 12,215 Office premises and equipment, net 6,073 5,126 Accrued interest receivable 3,359 3,113 Other assets 12,891 12,869 ---------------------------------------------------------------------------------------------------------------------------- Total Assets $ 730,732 $ 677,779 ============================================================================================================================ LIABILITIES AND STOCKHOLDERS' EQUITY Liabilities Deposits: Non-interest bearing $ 32,927 $ 32,415 Interest bearing 381,255 334,397 ---------------------------------------------------------------------------------------------------------------------------- Total Deposits 414,182 366,812 Short-term borrowings 78,625 111,141 Subordinated debt 10,310 10,310 Securities sold under agreement to repurchase 83,638 6,674 Advance payments by borrowers for taxes and insurance 1,508 1,425 Long-term debt 94,292 136,035 Other liabilities 3,982 3,333 ---------------------------------------------------------------------------------------------------------------------------- Total Liabilities 686,537 635,730 ============================================================================================================================ Stockholders' Equity Preferred stock, $.01 par value per share; 5,000,000 shares authorized; none issued - - Common stock, $.01 par value per share; 10,000,000 shares authorized; issued 2006 3,569,525 shares; 2005 3,533,632 shares 35 35 Paid-in capital 44,774 44,250 Retained earnings 11,076 8,486 Accumulated other comprehensive loss, net of tax (1,485) (914) Treasury stock, at cost 2006 609,029 shares; 2005 587,955 shares (10,205) (9,808) ---------------------------------------------------------------------------------------------------------------------------- Total Stockholders' Equity 44,195 42,049 ---------------------------------------------------------------------------------------------------------------------------- Total Liabilities and Stockholders' Equity $ 730,732 $ 677,779 ============================================================================================================================ See notes to consolidated financial statements. -------------------------------------------------------------------------------- Annual Report 2006 o Fidelity Bancorp, Inc. and Subsidiary 5 CONSOLIDATED STATEMENTS OF INCOME Years Ended September 30, 2006 2005 2004 ---------------------------------------------------------------------------------------------------------------------------- (In Thousands, Except per Share Data) Interest Income Loans $24,439 $18,859 $17,401 Mortgage-backed securities 5,054 5,387 4,440 Investment securities: Taxable 5,795 5,524 5,296 Tax exempt 2,050 1,886 2,185 Other 35 8 3 ---------------------------------------------------------------------------------------------------------------------------- Total Interest Income 37,373 31,664 29,325 ---------------------------------------------------------------------------------------------------------------------------- Interest Expense Deposits 10,894 7,710 7,635 Short-term borrowings 4,707 2,507 732 Subordinated debt 863 659 500 Securities sold under agreement to repurchase 1,352 131 57 Long-term debt 5,998 6,816 7,081 ---------------------------------------------------------------------------------------------------------------------------- Total Interest Expense 23,814 17,823 16,005 ---------------------------------------------------------------------------------------------------------------------------- Net Interest Income 13,559 13,841 13,320 ---------------------------------------------------------------------------------------------------------------------------- Provision for Loan Losses 600 600 275 ---------------------------------------------------------------------------------------------------------------------------- Net Interest Income after Provision for Loan Losses 12,959 13,241 13,045 ---------------------------------------------------------------------------------------------------------------------------- Other Income Loan service charges and fees 294 363 364 Realized gain on sales of securities, net 552 609 639 Writedown of securities - (43) - Gain on sales of loans 49 36 47 Deposit service charges and fees 1,373 1,401 1,386 ATM fees 586 548 491 Non-insured investment products 414 376 309 Other 565 498 531 ---------------------------------------------------------------------------------------------------------------------------- Total Other Income 3,833 3,788 3,767 ---------------------------------------------------------------------------------------------------------------------------- Other Expenses Compensation and benefits 7,848 7,440 7,116 Office occupancy and equipment expense 1,147 1,075 1,023 Depreciation and amortization 661 726 758 Loss (gain) on sales of foreclosed real estate 58 (103) (78) Foreclosed real estate expense 154 241 190 Amortization of intangible assets 40 46 52 Advertising 360 340 350 Professional fees 267 244 344 Customer fraud loss - 430 - Other 1,551 1,714 1,720 ---------------------------------------------------------------------------------------------------------------------------- Total Other Expenses 12,086 12,153 11,475 ---------------------------------------------------------------------------------------------------------------------------- Income before Provision for Income Taxes and Extraordinary Gain 4,706 4,876 5,337 Provision for Income Taxes 840 1,000 1,016 ---------------------------------------------------------------------------------------------------------------------------- Income from Continuing Operations 3,866 3,876 4,321 Income from Extraordinary Gain, Net of Taxes 318 - - ---------------------------------------------------------------------------------------------------------------------------- Net Income $ 4,184 $ 3,876 $ 4,321 ============================================================================================================================ Earnings per Share Basic Income from Continuing Operations $1.30 $1.32 $1.47 Income from Extraordinary Gain, Net of Taxes .11 - - ---------------------------------------------------------------------------------------------------------------------------- Net Income $1.41 $1.32 $1.47 ============================================================================================================================ Diluted Income from Continuing Operations $1.28 $1.27 $1.40 Income from Extraordinary Gain, Net of Taxes .10 - - ---------------------------------------------------------------------------------------------------------------------------- Net Income $1.38 $1.27 $1.40 ============================================================================================================================ See notes to consolidated financial statements. -------------------------------------------------------------------------------- 6 Annual Report 2006 o Fidelity Bancorp, Inc. and Subsidiary CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY Years Ended September 30, 2006, 2005 and 2004 ------------------------------------------------------------------------------------------------------------------------------------ Accumulated Number of Other Shares Common Paid-in Retained Comprehensive Treasury Issued Stock Capital Earnings Income(Loss) Stock Total ------------------------------------------------------------------------------------------------------------------------------------ (In Thousands, Except Shares and per Share Data) Balance - September 30, 2003 2,805,291 $28 $28,960 $16,388 $2,011 $(7,192) $40,195 ------------------------------------------------------------------------------------------------------------------------------------ Comprehensive income: Net income - - - 4,321 - - 4,321 Net unrealized losses on available for sale securities - - - - (816) - (816) ------------------------------------------------------------------------------------------------------------------------------------ Total Comprehensive Income 3,505 ------------------------------------------------------------------------------------------------------------------------------------ 10% stock dividend distributed 280,654 3 5,882 (5,885) - - - Stock options exercised, including tax benefit of $216 61,423 1 818 - - - 819 Cash dividends declared ($.416 per share) - - - (1,229) - - (1,229) Treasury stock purchased (60,351 shares) - - - - - (1,474) (1,474) Contribution of stock to Employee Stock Ownership Plan (5,000 shares) - - (6) - - 123 117 Sale of stock through Dividend Reinvestment Plan 6,249 - 144 - - - 144 ------------------------------------------------------------------------------------------------------------------------------------ Balance - September 30, 2004 3,153,617 32 35,798 13,595 1,195 (8,543) 42,077 ------------------------------------------------------------------------------------------------------------------------------------ Comprehensive income: Net income - - - 3,876 - - 3,876 Net unrealized losses on available for sale securities - - - - (2,109) - (2,109) ------------------------------------------------------------------------------------------------------------------------------------ Total Comprehensive Income 1,767 ------------------------------------------------------------------------------------------------------------------------------------ 10% stock dividend distributed 319,161 3 7,577 (7,580) - - - Stock options exercised, including tax benefit of $160 53,745 - 722 - - - 722 Cash dividends declared ($.478 per share) - - - (1,405) - - (1,405) Treasury stock purchased (54,210 shares) - - - - - (1,265) (1,265) Sale of stock through Dividend Reinvestment Plan 7,109 - 153 - - - 153 ------------------------------------------------------------------------------------------------------------------------------------ Balance - September 30, 2005 3,533,632 35 44,250 8,486 (914) (9,808) 42,049 ------------------------------------------------------------------------------------------------------------------------------------ Comprehensive income: Net income - - - 4,184 - - 4,184 Net unrealized losses on available for sale securities - - - - (571) - (571) ------------------------------------------------------------------------------------------------------------------------------------ Total Comprehensive Income 3,613 ------------------------------------------------------------------------------------------------------------------------------------ Stock-based compensation expense - - 66 - - - 66 Stock options exercised, including tax benefit of $43 27,936 - 307 - - - 307 Cash dividends declared ($.540 per share) - - - (1,594) - - (1,594) Treasury stock purchased (21,074 shares) - - - - - (397) (397) Sale of stock through Dividend Reinvestment Plan 7,957 - 151 - - - 151 ------------------------------------------------------------------------------------------------------------------------------------ Balance - September 30, 2006 3,569,525 $35 $44,774 $11,076 $(1,485) $(10,205) $44,195 ==================================================================================================================================== See notes to consolidated financial statements. -------------------------------------------------------------------------------- Annual Report 2006 o Fidelity Bancorp, Inc. and Subsidiary 7 CONSOLIDATED STATEMENTS OF CASH FLOWS Years Ended September 30, 2006 2005 2004 ------------------------------------------------------------------------------------------------------------------------------ (In Thousands) Cash Flows from Operating Activities Net income $ 4,184 $ 3,876 $ 4,321 Adjustments to reconcile net income to net cash provided by operating activities: Income from extraordinary gain, net of taxes (318) - - Provision for loan losses 600 600 275 Loss (gain) on foreclosed real estate 58 (103) (78) Provision for depreciation and amortization 661 726 758 Deferred loan fee amortization (112) (196) (269) Amortization of investment and mortgage-backed securities (discounts) premiums, net 500 719 1,402 Deferred income tax provision (91) 37 308 Amortization of intangibles 40 46 52 Net realized gains on sales of investments (552) (609) (639) Writedown of investment securities - 43 - Loans originated for sale (4,300) (2,668) (2,006) Sales of loans held for sale 4,557 2,571 2,222 Net gains on sales of loans (49) (36) (47) Increase in cash surrender value of life insurance policies (196) (198) (209) Tax benefit realized on stock-based compensation - 160 216 (Increase) decrease in interest receivable (258) (15) 327 Increase (decrease) in interest payable (197) 89 (204) Increase (decrease) in accrued taxes 281 103 (253) Contribution to ESOP (240) (235) (103) Changes in other assets, net 133 437 700 Changes in other liabilities, net 1,022 571 121 ------------------------------------------------------------------------------------------------------------------------------ Net Cash Provided by Operating Activities 5,723 5,918 6,894 ------------------------------------------------------------------------------------------------------------------------------ Cash Flows from Investing Activities Proceeds from sales of securities available for sale 16,797 24,185 26,029 Proceeds from maturities and principal repayments of securities available for sale 19,125 41,733 47,972 Purchases of securities available for sale (19,659) (65,098) (68,349) Proceeds from maturities and principal repayments of securities held to maturity 19,262 20,473 45,822 Purchases of securities held to maturity - (16,671) (35,640) Net increase in loans (93,474) (56,314) (27,554) Proceeds from sales of foreclosed real estate 432 813 78 Additions to office premises and equipment (1,742) (641) (154) Proceeds from insurance claim - Carnegie Branch 601 - - Proceeds from sales of office premises and equipment 24 - 31 Net (purchases) redemption of FHLB stock 3,083 (1,059) (709) ------------------------------------------------------------------------------------------------------------------------------ Net Cash Used in Investing Activities $ (55,551) $ (52,579) $ (12,474) ------------------------------------------------------------------------------------------------------------------------------ See notes to consolidated financial statements. -------------------------------------------------------------------------------- 8 Annual Report 2006 o Fidelity Bancorp, Inc. and Subsidiary CONSOLIDATED STATEMENTS OF CASH FLOWS (CONTINUED) Years Ended September 30, 2006 2005 2004 ------------------------------------------------------------------------------------------------------------------------------ (In Thousands) Cash Flows from Financing Activities Net increase (decrease) in deposits $ 47,370 $ 7,040 $ (6,354) Increase (decrease) in reverse repurchase agreements 76,964 1,556 (825) Net increase (decrease) in short-term borrowings (32,516) 47,035 26,005 Increase (decrease) in advances by borrowers for taxes and insurance 83 296 (50) Proceeds from long-term debt 15,000 20,000 10,000 Repayments of long-term debt (56,743) (26,272) (20,401) Cash dividends paid (1,594) (1,405) (1,229) Stock options exercised 264 562 603 Excess tax benefit realized on stock-based compensation 43 - - Proceeds from sale of stock through Dividend Reinvestment Plan 151 153 144 Acquisition of treasury stock (397) (1,265) (1,474) ---------------------------------------------------------------------------------------------------------------------------- Net Cash Provided by Financing Activities 48,625 47,700 6,419 ---------------------------------------------------------------------------------------------------------------------------- Net Increase (Decrease) in Cash and Cash Equivalents (1,203) 1,039 839 Cash and Cash Equivalents - Beginning 9,870 8,831 7,992 ---------------------------------------------------------------------------------------------------------------------------- Cash and Cash Equivalents - Ending $ 8,667 $ 9,870 $ 8,831 ============================================================================================================================ Supplementary Cash Flow Information Interest paid on deposits and borrowings $ 24,011 $ 17,734 $ 16,209 ============================================================================================================================ Income taxes paid $ 753 $ 350 $ 795 ============================================================================================================================ Supplemental Schedule of Noncash Investing and Financing Activities Transfer of loans to foreclosed real estate $ 35 $ 223 $ 1,032 ============================================================================================================================ See notes to consolidated financial statements. -------------------------------------------------------------------------------- Annual Report 2006 o Fidelity Bancorp, Inc. and Subsidiary 9 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS Note 1 - Significant Accounting Policies Nature of Operations Fidelity Bancorp, Inc. (the "Company") is a bank holding company organized under the Pennsylvania Business Corporation Law. It operates principally as a holding company for its wholly-owned subsidiary, Fidelity Bank, PaSB (the "Bank"), a Pennsylvania-chartered, FDIC-insured state savings bank. The Bank conducts full banking services through thirteen offices in Allegheny and Xxxxxx counties. Basis of Presentation The consolidated financial statements include the accounts of the Company and its wholly-owned subsidiary the Bank. Intercompany balances and transactions have been eliminated in consolidation. Estimates The financial statements are prepared in conformity with accounting principles generally accepted in the United States of America. These principles require management to make estimates and assumptions that affect reported amounts of assets and liabilities and require disclosure of contingent assets and liabilities. In the opinion of management, all adjustments considered necessary for a fair presentation have been included and are of a normal, recurring nature. Actual results could differ from those estimates. Material estimates that are particularly susceptible to significant change in the near term relate to the determination of the allowance for loan losses, the valuation of deferred tax assets, and the evaluation of other than temporary impairment of securities. Significant Group Concentrations of Credit Risk Most of the Company's activities are with customers located in the greater Pittsburgh metropolitan area. Note 2 discusses the types of securities that the Company invests in. Note 3 discusses the types of lending that the Company engages in. The Company does not have any significant concentrations to any one industry or customer. Cash and Cash Equivalents For purposes of the statement of cash flows, cash and cash equivalents include cash and amounts due from depository institutions and interest-bearing deposits in other financial institutions. Securities The Company classifies securities as either: (1) Securities Held to Maturity - debt securities that the Company has the positive intent and ability to hold to maturity and which are reported at cost, adjusted for amortization of premium and accretion of discount on a level yield basis; (2) Trading Securities - debt and equity securities bought and held principally for the purpose of selling them in the near term and which are reported at fair value, with unrealized gains and losses included in the current period earnings; or (3) Securities Available for Sale - debt and equity securities not classified as either securities held to maturity or trading securities and which are reported at fair value, with unrealized gains and losses, net of taxes, included as a separate component of accumulated other comprehensive income. Declines in the fair value of held to maturity and available for sale securities below their cost that are deemed to be other than temporary are reflected in earnings as realized losses. In estimating other than temporary impairment losses, management considers (1) the length of time and the extent to which the fair value has been less than cost, (2) the financial condition and near-term prospects of the issuer, and (3) the intent and ability of the Company to retain its investment in the issuer for a period of time sufficient to allow for any anticipated recovery in fair value. Gains and losses on the sale of securities are recorded on the trade date and are determined using the specific identification method. Management determines the appropriate classification of debt securities at the time of purchase and re-evaluates such designation as of each balance sheet date. (Note Continued) -------------------------------------------------------------------------------- 10 Annual Report 2006 o Fidelity Bancorp, Inc. and Subsidiary NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) Loans Receivable Loans receivable that management has the intent and ability to hold for the foreseeable future or until maturity or payoff are stated at their outstanding unpaid principal balances, net of an allowance for loan losses and any deferred fees or costs. Interest income is accrued on the unpaid principal balance. Loan origination fees and costs are deferred and recognized as an adjustment of the yield (interest income) of the related loans. The Bank is generally amortizing these amounts over the contractual life of the loan. The accrual of interest is generally discontinued when the contractual payment of principal or interest has become 90 days past due or management has serious doubts about further collectibility of principal or interest, even though the loan is currently performing. A loan may remain on accrual status if it is in the process of collection and is either guaranteed or well secured. When a loan is placed on nonaccrual status, unpaid interest credited to income in the current year is reversed. Interest received on nonaccrual loans generally is either applied against principal or reported as interest income, according to management's judgment as to the collectibility of principal. Interest accrual resumes when the loan is no longer 90 or more days past due and the borrower, in management's opinion, is able to meet payments as they become due. Allowance for Loan Losses The allowance for loan losses is established through provisions for loan losses charged against income. Loans deemed to be uncollectible are charged against the allowance for loan losses, and subsequent recoveries, if any, are credited to the allowance. The allowance for loan losses is maintained at a level considered adequate to provide for losses that can be reasonably anticipated. Management's periodic evaluation of the adequacy of the allowance is based on the Bank's past loan loss experience, known and inherent risks in the portfolio, adverse situations that may affect the borrower's ability to repay, the estimated value of any underlying collateral, composition of the loan portfolio, current economic conditions and other relevant factors. This evaluation is inherently subjective as it requires material estimates that may be susceptible to significant change, including the amounts and timing of future cash flows expected to be received on impaired loans. The allowance consists of specific and general components. The specific component relates to loans that are classified as either doubtful, substandard or special mention. For such loans that are also classified as impaired, an allowance is established when the discounted cash flows (or collateral value or observable market price) of the impaired loan is lower than the carrying value of that loan. The general component covers non-classified loans and is based on historical loss experience adjusted for qualitative factors. A loan is considered impaired when, based on current information and events, it is probable that the Bank will be unable to collect the scheduled payments of principal or interest when due according to the contractual terms of the loan agreement. Factors considered by management in determining impairment include payment status, collateral value and the probability of collecting scheduled principal and interest payments when due. Loans that experience insignificant payment delays and payment shortfalls generally are not classified as impaired. Management determines the significance of payment delays and payment shortfalls on a case-by-case basis, taking into consideration all of the circumstances surrounding the loan and the borrower, including the length of the delay, the reasons for the delay, the borrower's prior payment record and the amount of the shortfall in relation to the principal and interest owed. Impairment is measured on a loan by loan basis for commercial and construction loans by either the present value of expected future cash flows discounted at the loan's effective interest rate, the loan's obtainable market price or the fair value of the collateral if the loan is collateral dependent. (Note Continued) -------------------------------------------------------------------------------- Annual Report 2006 o Fidelity Bancorp, Inc. and Subsidiary 11 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) Large groups of smaller balance homogeneous loans are collectively evaluated for impairment. Accordingly, the Bank does not separately identify individual consumer and residential loans for impairment disclosures, unless such loans are the subject of a restructuring agreement. Foreclosed Real Estate Foreclosed real estate is comprised of property acquired through a foreclosure proceeding or acceptance of a deed in lieu of foreclosure and loans classified as in-substance foreclosure. A loan is classified as in-substance foreclosure when the Bank has taken possession of the collateral regardless of whether formal foreclosure proceedings take place. Foreclosed assets initially are recorded at fair value, net of estimated selling costs, at the date of foreclosure establishing a new cost basis. After foreclosure, valuations are periodically performed by management and the assets are carried at the lower of cost or fair value minus estimated costs to sell. Revenues and expenses from operations and changes in the valuation allowance are included in other expenses. Loans Held for Sale Loans originated and intended for sale in the secondary market are carried at the lower of cost or estimated fair value in the aggregate. Net unrealized losses, if any, are recognized through a valuation allowance by charges to income. All sales are made without recourse. Office Premises and Equipment Office premises and equipment are stated at cost less accumulated depreciation and amortization. Depreciation is calculated on a straight-line basis over the estimated useful lives of the related assets. Office buildings are depreciated over their estimated useful life of 40 years; furniture, fixtures and equipment are depreciated over their estimated useful lives which vary between three and ten years; and land improvements are depreciated over their estimated useful life of twenty years. Transfer of Financial Assets Transfers of financial assets are accounted for as sales, when control over the assets has been surrendered. Control over transferred assets is deemed to be surrendered when (1) the assets have been isolated from the Company, (2) the transferee obtains the right (free of conditions that constrain it from taking advantage of the right) to pledge or exchange the transferred assets, and (3) the Company does not maintain effective control over the transferred assets through an agreement to repurchase them before their maturity. Goodwill and Intangible Assets Effective October 1, 2002, the Company adopted SFAS No. 142, "Goodwill and Other Intangible Assets." SFAS No. 142 revised the accounting for purchased intangible assets and, in general, requires that goodwill no longer be amortized, but rather that it be tested for impairment on an annual basis at the reporting unit level, which is either at the same level or one level below an operating segment. Other acquired intangible assets with finite lives, such as purchased customer accounts, are required to be amortized over their estimated lives. Prior to October 1, 2002, substantially all of the Company's goodwill was amortized using the straight-line method over 15 years. Other intangible assets are amortized using an accelerated method over estimated weighted average useful lives of ten years. The Company periodically assesses whether events or changes in circumstances indicate that the carrying amounts of goodwill and other intangible assets may be impaired. There were no changes in the carrying amount of goodwill for the years ended September 30, 2006 and 2005. Goodwill amounted to $2.65 million at September 30, 2006 and September 30, 2005. (Note Continued) -------------------------------------------------------------------------------- 12 Annual Report 2006 o Fidelity Bancorp, Inc. and Subsidiary NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) In accordance with the provisions of SFAS No. 142, the Company continues to amortize other intangible assets over the estimated remaining life of each respective asset. Amortizable intangible assets were composed of the following: September 30, 2006 2005 ------------------------------------------------------------------------------------------------------------------ Gross Carrying Amount Accumulated Amortization ------------------------------------------------------------------------------------------------------------------ (Dollars in Thousands) Amortizable intangible assets, acquisition of deposit accounts $ 325 $ 207 $ 167 ================================================================================================================== Aggregate amortization expense: For the year ended September 30, 2006 $ 40 Estimated amortization expense: For the year ending September 30, 2007 34 For the year ending September 30, 2008 28 For the year ending September 30, 2009 22 For the year ending September 30, 2010 17 For the year ending September 30, 2011 11 Other Assets Financing costs related to the Company's issuance of subordinated debt are being amortized over the life of the debentures and are included in other assets. Income Taxes Deferred income taxes are provided on the liability method whereby deferred tax assets are recognized for deductible temporary differences and deferred tax liabilities are recognized for taxable temporary differences. Temporary differences are the differences between the reported amounts of assets and liabilities and their tax basis. Deferred tax assets and liabilities are adjusted through the provision for income taxes for the effects of changes in tax laws and rates on the date of enactment. Treasury Stock The acquisition of treasury stock is recorded under the cost method. At the date of subsequent reissue, the treasury stock is reduced by the cost of such stock on the average cost basis. Stock Option Plans Prior to October 1, 2005, the Company accounted for its stock option plans under the recognition and measurement principles of APB Opinion No. 25, "Accounting for Stock Issued to Employees", and related interpretations. No stock-based employee compensation was reflected in net income for periods ended prior to October 1, 2005 as all options granted had an exercise price equal to the market value of the underlying common stock on the grant date. However, the Company adopted SFAS No. 123R "Share-based Payment" as of October 1, 2005, by using the modified prospective approach, which requires recognizing expense for options granted prior to the adoption date equal to the fair value of the unvested amounts over their remaining vesting period. The portion of these options' fair value attributable to vested awards prior to the adoption of SFAS 123R is never recognized. For unvested stock-based awards granted before October 1, 2005, the Company will expense the fair value of the awards at the grant date over the remaining vesting period. As of September 30, 2006, there was $130,000 of total unrecognized compensation cost related to non-vested share-based compensation arrangements. That cost (Note Continued) -------------------------------------------------------------------------------- Annual Report 2006 o Fidelity Bancorp, Inc. and Subsidiary 13 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) is expected to be recognized over a weighted-average period of 1.6 years. The compensation cost recognized in net income was $66,000 in fiscal 2006. The total income tax benefit recognized in the income statement for share-based compensation arrangements was $22,000 for fiscal 2006. Prior to the adoption of SFAS 123R, tax benefits arising from share-based compensation arrangements were classified as operating cash flows in the Consolidated Statement of Cash Flows. However, SFAS 123R amends FASB Statement 95 "Statement of Cash Flows", and requires excess tax benefits arising from increases in the value of equity instruments issued under share-based payment arrangements to be treated as cash inflows from financing activities. The adoption of SFAS No. 123R had the following impact on reported amounts compared with amounts that would have been reported using the intrinsic value method under previous accounting: 2006 --------------------------------------------------------------------------------------------------------- Using SFAS Previous 123R As Accounting Adjustments Reported --------------------------------------------------------------------------------------------------------- (Dollars in thousands, except per share data) Income before taxes and extraordinary gain $4,772 $ (66) $4,706 Income taxes 862 (22) 840 --------------------------------------------------------------------------------------------------------- Income from continuing operations 3,910 (44) 3,866 Income from extraordinary gain, net of taxes 318 - 318 ========================================================================================================= Net income $4,228 $ (44) $4,184 ========================================================================================================= Basic earnings per share $ 1.42 $(.01) $ 1.41 ========================================================================================================= Diluted earnings per share $ 1.39 $(.01) $ 1.38 ========================================================================================================= 2005 --------------------------------------------------------------------------------------------------------- Pro Forma As Pro Forma if under Reported Adjustments SFAS 123R --------------------------------------------------------------------------------------------------------- (Dollars in thousands, except per share data) Income before taxes $4,876 $ (190) $ 4,686 Income taxes 1,000 (65) 935 --------------------------------------------------------------------------------------------------------- Net income $3,876 $ (125) $ 3,751 ========================================================================================================= Basic earnings per share $ 1.32 $ (.04) $ 1.28 ========================================================================================================= Diluted earnings per share $ 1.27 $ (.04) $ 1.23 ========================================================================================================= (Note Continued) -------------------------------------------------------------------------------- 14 Annual Report 2006 o Fidelity Bancorp, Inc. and Subsidiary NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) 2004 -------------------------------------------------------------------------------------------------------- Pro Forma As Pro Forma if under Reported Adjustments SFAS 123R -------------------------------------------------------------------------------------------------------- (Dollars in thousands, except per share data) Income before taxes $5,337 $ (214) $5,123 Income taxes 1,016 (73) 943 -------------------------------------------------------------------------------------------------------- Net income $4,321 $ (141) $4,180 ======================================================================================================== Basic earnings per share $ 1.47 $ (.05) $ 1.42 ======================================================================================================== Diluted earnings per share $ 1.40 $ (.05) $ 1.35 ======================================================================================================== Earnings per Share Basic earnings per share (EPS) is computed by dividing net income by the weighted average number of common shares outstanding for the period. Diluted EPS reflects the potential dilution that could occur if securities or other contracts to issue common stock were exercised or converted into common stock or resulted in the issuance of common stock that then shared in the earnings of the Company. The following table sets forth the computation of basic and diluted earnings per share: Years Ended September 30, 2006 2005 2004 --------------------------------------------------------------------------------------------------------- (Dollars in Thousands, Except per Share Data) Basic earnings per share: Net income $ 4,184 $ 3,876 $ 4,321 Weighted average shares outstanding 2,957,702 2,929,358 2,941,085 Earnings per share $1.41 $1.32 $1.47 Diluted earnings per share: Net income $ 4,184 $ 3,876 $ 4,321 Weighted average shares outstanding 2,957,702 2,929,358 2,941,085 Dilutive effect of stock options 75,423 127,039 149,702 --------------------------------------------------------------------------------------------------------- Total diluted weighted average shares 3,033,125 3,056,397 3,090,847 outstanding Earnings per share $1.38 $1.27 $1.40 Options to purchase 2,000 shares of common stock at $19.55 per share, 2,200 shares at $21.05 per share, 30,651 shares at $22.91 per share, 49,966 shares at $21.35 per share and 13,200 shares at $20.93 per share were outstanding during 2006, but were not included in the computation of diluted EPS because to do so would have been anti-dilutive. Similarly options to purchase 2,200 shares of common stock at $21.05 per share, 32,301 shares at $22.91 per share, 52,301 shares at $21.35 per share, and 13,200 shares at $20.93 per share were outstanding during 2005 but were not included in the computation of diluted EPS because to do so would have been anti-dilutive. Also, options to purchase 55,723 shares of common stock at $21.35 per share were outstanding during 2004 but were not included in the computation of diluted EPS because to do so would have been anti-dilutive. (Note Continued) -------------------------------------------------------------------------------- Annual Report 2006 o Fidelity Bancorp, Inc. and Subsidiary 15 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) Comprehensive Income Accounting principles generally require that recognized revenue, expenses, gains and losses be included in net income. Although certain changes in assets and liabilities, such as unrealized gains and losses on available for sale securities, are reported as a separate component of the equity section of the balance sheet, such items, along with net income are components of comprehensive income. The only other comprehensive income item that the Company presently has is unrealized gains (losses) on securities available for sale. Years Ended September 30, 2006 2005 2004 --------------------------------------------------------------------------------------------------------- (In Thousands) Unrealized holding losses arising during the year $ (265) $ (2,630) $ (597) Less reclassification adjustment for gains included in net income (600) (566) (639) --------------------------------------------------------------------------------------------------------- Net Unrealized Losses (865) (3,196) (1,236) Tax benefit 294 1,087 420 --------------------------------------------------------------------------------------------------------- Net of Tax Amount $ (571) $ (2,109) $ (816) ========================================================================================================= Off-Balance Sheet Financial Instruments In the ordinary course of business, the Company has entered into off-balance sheet financial instruments consisting of commitments to extend credit, commercial letters of credit and standby letters of credit. Such financial instruments are recorded on the balance sheet when they become payable by the borrower to the Company. New Accounting Standards In February 2006, the FASB issued SFAS No. 155, "Accounting for Certain Hybrid Financial Instruments". SFAS No. 155 amends FASB Statement No. 133 and FASB Statement No. 140, and improves the financial reporting of certain hybrid financial instruments by requiring more consistent accounting that eliminates exemptions and provides a means to simplify the accounting for these instruments. Specifically, SFAS No. 155 allows financial instruments that have embedded derivatives to be accounted for as a whole (eliminating the need to bifurcate the derivative from its host) if the holder elects to account for the whole instrument on a fair value basis. SFAS No. 155 is effective for all financial instruments acquired or issued after the beginning of an entity's first fiscal year that begins after September 15, 2006. The Company is required to adopt the provisions of SFAS No. 155, as applicable, beginning in fiscal year 2007. Management does not believe the adoption of SFAS No. 155 will have any impact on the Company's financial position and results of operations. In March 2006, the FASB issued SFAS No. 156, "Accounting for Servicing of Financial Assets -- An Amendment of FASB Statement No. 140" ("SFAS 156"). SFAS 156 requires that all separately recognized servicing assets and servicing liabilities be initially measured at fair value, if practicable. The statement permits, but does not require, the subsequent measurement of servicing assets and servicing liabilities at fair value. SFAS 156 is effective as of the beginning of an entity's first fiscal year that begins after September 15, 2006, which for the Company will be as of the beginning of fiscal 2007. The Company does not have any separately recognized servicing assets or liabilities outstanding as of September 30, 2006, therefore the adoption of SFAS 156 will not have an effect on its financial statements. (Note Continued) -------------------------------------------------------------------------------- 16 Annual Report 2006 o Fidelity Bancorp, Inc. and Subsidiary NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) In July 2006, the Financial Accounting Standards Board (FASB) issued FASB Interpretation No. 48, "Accounting for Uncertainty in Income Taxes--an interpretation of FASB Statement No. 109" (FIN 48), which clarifies the accounting for uncertainty in tax positions. This Interpretation requires that companies recognize in their financial statements the impact of a tax position, if that position is more likely than not of being sustained on audit, based on the technical merits of the position. The provisions of FIN 48 are effective for fiscal years beginning after December 15, 2006, with the cumulative effect of the change in accounting principle recorded as an adjustment to opening retained earnings. We are currently evaluating the impact of adopting FIN 48 on our financial statements. In September 2006, the FASB issued FASB Statement No. 157, Fair Value Measurements, which defines fair value, establishes a framework for measuring fair value under GAAP, and expands disclosures about fair value measurements. FASB Statement No. 157 applies to other accounting pronouncements that require or permit fair value measurements. The new guidance is effective for financial statements issued for fiscal years beginning after November 15, 2007, and for interim periods within those fiscal years. We are currently evaluating the potential impact, if any, of the adoption of FASB Statement No. 157 on our consolidated financial position, results of operations, and cash flows. On September 13, 2006, the Securities and Exchange Commission "SEC" issued Staff Accounting Bulleting No. 108 ("SAB 108"). SAB 108 provides interpretive guidance on how the effects of the carryover or reversal of prior year misstatements should be considered in quantifying a potential current year misstatement. Prior to SAB 108, Companies might evaluate the materiality of financial-statement misstatements using either the income statement or balance sheet approach, with the income statement approach focusing on new misstatements added in the current year, and the balance sheet approach focusing on the cumulative amount of misstatement present in a company's balance sheet. Misstatements that would be material under one approach could be viewed as immaterial under another approach, and not be corrected. SAB 108 now requires that companies view financial statement misstatements as material if they are material according to either the income statement or balance sheet approach. SAB 108 is effective for publicly-held companies for fiscal years ending after November 15, 2006. We are currently evaluating the potential impact, if any, of the adoption of SAB 108 on our consolidated financial position, results of operations, and cash flows. On September 29, 2006, the FASB issued SFAS No. 158, Employers' Accounting for Defined Benefit Pension and Other Postretirement Plans ("SFAS 158"), which amends SFAS 87 and SFAS 106 to require recognition of the overfunded or underfunded status of pension and other postretirement benefit plans on the balance sheet. Under SFAS 158, gains and losses, prior service costs and credits, and any remaining transition amounts under SFAS 87 and SFAS 106 that have not yet been recognized through net periodic benefit cost will be recognized in accumulated other comprehensive income, net of tax effects, until they are amortized as a component of net periodic cost. The measurement date -- the date at which the benefit obligation and plan assets are measured -- is required to be the company's fiscal year end. SFAS 158 is effective for publicly-held companies for fiscal years ending after December 15, 2006, except for the measurement date provisions, which are effective for fiscal years ending after December 15, 2008. The Company is currently analyzing the effects of SFAS 158 but does not expect its implementation will have a significant impact on the Company's financial condition or results of operations. In September 2006, the FASB's Emerging Issues Task Force (EITF) issued EITF Issue No. 06-4, "Accounting for Deferred Compensation and Postretirement Benefit Aspects of Endorsement Split Dollar Life Insurance Arrangements" ("EITF 06-4"). EITF 06-4 requires the recognition of a liability related to the postretirement benefits covered by an endorsement split-dollar life insurance arrangement. The consensus highlights that the employer (who is also the policyholder) has a liability for the benefit it is providing to its employee. As such, if the policyholder has agreed to maintain the insurance policy in force for the employee's benefit during his or her retirement, then the liability recognized during the employee's active service period should be based on the future cost (Note Continued) -------------------------------------------------------------------------------- Annual Report 2006 o Fidelity Bancorp, Inc. and Subsidiary 17 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) of insurance to be incurred during the employee's retirement. Alternatively, if the policy holder has agreed to provide the employee with a death benefit, then the liability for the future death benefit should be recognized by following the guidance in SFAS No. 106 or Accounting Principals Board (APB) Opinion No. 12, as appropriate. For transition, an entity can choose to apply the guidance using either of the following approaches: (a) a change in accounting principle through retrospective application to all periods presented or (b) a change in accounting principle through a cumulative-effect adjustment to the balance in retained earnings at the beginning of the year of adoption. The disclosures required in fiscal years beginning after December 15, 2007, with early adoption permitted. The Company does not believe that the implementation of this guidance will have a material impact on the Company's consolidated financial statements. Segment Reporting The Company acts as an independent community financial services provider, and offers traditional banking and related financial services to individual, business and government customers. Through its branches, the Company offers a full array of commercial and retail financial services. Management does not separately allocate expenses, including the cost of funding loan demand, between the commercial and retail operations of the Company. As such, discrete financial information is not available and segment reporting would not be meaningful. Restrictions on Cash and Due from Bank Accounts The Bank is required to maintain average reserve balances with the Federal Reserve Bank based upon deposit composition. Based on its deposit classifications in fiscal 2006, the Bank's reserve balance with the Federal Reserve Bank was reduced to zero. The average amount of reserve balances maintained for 2005 was approximately $1.3 million. Investments Required by Law The Bank is a member of the Federal Home Loan Bank System and, as a member, maintains an investment in the capital stock of the Federal Home Loan Bank of Pittsburgh (FHLB), at cost, in an amount not less than1% of its outstanding home loans or 5% of its outstanding notes payable, if any, to the FHLB plus 0.7% of its unused borrowing capacity, whichever is greater. Reclassifications Certain amounts in the 2005 and 2004 financial statements have been reclassified to conform with the 2006 presentation format. These reclassifications had no effect on net income. -------------------------------------------------------------------------------- 18 Annual Report 2006 o Fidelity Bancorp, Inc. and Subsidiary NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) Note 2 - Securities The amortized cost and fair value of securities are as follows: September 30, 2006 ---------------------------------------------------------------------------------------------------------------------------- Gross Gross Amortized Unrealized Unrealized Fair Cost Gains Losses Value ---------------------------------------------------------------------------------------------------------------------------- (In Thousands) Securities Available for Sale: U.S. government and agency obligations $ 23,625 $ - $ 520 $ 23,105 Municipal obligations 20,760 105 95 20,770 Corporate obligations 11,107 68 141 11,034 Equity securities 4,037 83 204 3,916 Mutual funds 12,778 63 328 12,513 Trust preferred securities 27,969 238 131 28,076 Federal Home Loan Mortgage Corp. preferred stock 1,409 42 - 1,451 Mortgage-backed securities and collateralized mortgage obligations 66,014 61 1,491 64,584 ---------------------------------------------------------------------------------------------------------------------------- $ 167,699 $ 660 $ 2,910 $ 165,449 ============================================================================================================================ Securities Held to Maturity: U.S. government and agency obligations $ 21,984 $ 4 $ 494 $ 21,494 Municipal obligations 22,648 696 28 23,316 Corporate obligations 4,993 24 49 4,968 Mortgaged-backed securities and collateralized mortgage obligations 36,254 17 1,198 35,073 ---------------------------------------------------------------------------------------------------------------------------- $ 85,879 $ 741 $ 1,769 $ 84,851 ============================================================================================================================ September 30, 2005 ---------------------------------------------------------------------------------------------------------------------------- Gross Gross Amortized Unrealized Unrealized Fair Cost Gains Losses Value ---------------------------------------------------------------------------------------------------------------------------- (In Thousands) Securities Available for Sale: U.S. government and agency obligations $ 27,001 $ - $ 587 $ 26,414 Municipal obligations 20,721 322 130 20,913 Corporate obligations 10,120 123 101 10,142 Equity securities 4,304 379 201 4,482 Mutual funds 12,247 58 282 12,023 Trust preferred securities 25,434 243 110 25,567 Federal Home Loan Mortgage Corp. preferred stock 1,409 40 - 1,449 Mortgage-backed securities and collateralized mortgage obligations 82,306 156 1,295 81,167 ---------------------------------------------------------------------------------------------------------------------------- $ 183,542 $ 1,321 $ 2,706 $ 182,157 ============================================================================================================================ Securities Held to Maturity: U.S. government and agency obligations $ 25,972 $ 23 $ 454 $ 25,541 Municipal obligations 22,662 970 21 23,611 Corporate obligations 6,717 117 30 6,804 Mortgaged-backed securities and collateralized mortgage obligations 49,965 74 1,033 49,006 ---------------------------------------------------------------------------------------------------------------------------- $ 105,316 $ 1,184 $ 1,538 $ 104,962 ============================================================================================================================ (Note Continued) -------------------------------------------------------------------------------- Annual Report 2006 o Fidelity Bancorp, Inc. and Subsidiary 19 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) The amortized cost and fair value of debt securities at September 30, 2006, by contractual maturity, are shown in the following table. Expected maturities will differ from contractual maturities because borrowers have the right to call or prepay obligations with or without call or prepayment penalties. Securities Available for Sale Securities Held to Maturity ---------------------------------------------------------------------------------------------------------------- Amortized Fair Amortized Fair Cost Value Cost Value ---------------------------------------------------------------------------------------------------------------- (In Thousands) Due in one year or less $ - $ - $ 3,509 $ 3,480 Due after one year through five years 25,705 25,228 16,554 16,276 Due after five years through ten years 33,229 32,796 19,551 19,013 Due after ten years 90,541 89,545 46,265 46,082 Equity securities and mutual funds 18,224 17,880 - - ---------------------------------------------------------------------------------------------------------------- $ 167,699 $ 165,449 $ 85,879 $ 84,851 ================================================================================================================ Gross gains of $842,000, $866,000, and $906,000 and gross losses of $290,000, $257,000, and $267,000 were realized on sales of securities in fiscal 2006, 2005 and 2004, respectively. During fiscal 2006 the Company recognized gains of $5,000 and losses of $53,000 on the sales of securities, which were classified as held-to-maturity. The held-to-maturity sales qualified as maturities for purposes of FAS 115. There were no sales of held-to-maturity securities during fiscal 2005 and 2004. In addition, losses of $43,000 resulting from the writedown of investments in equity securities that are considered other than temporary were realized in fiscal 2005. There were no writedowns of securities during fiscal 2006 and 2004. (Note Continued) -------------------------------------------------------------------------------- 20 Annual Report 2006 o Fidelity Bancorp, Inc. and Subsidiary NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) The following tables show the Company's investments' gross unrealized losses and fair value, aggregated by investment category and length of time that individual securities have been in a continuous unrealized loss position: September 30, 2006 ------------------------------------------------------------------------------------------------------------------------------ Less than 12 Months 12 Months or More Total ------------------------------------------------------------------------------------------------------------------------------ Fair Unrealized Fair Unrealized Fair Unrealized Value Losses Value Losses Value Losses ------------------------------------------------------------------------------------------------------------------------------ (In Thousands) Securities Available for Sale: U.S. government and agency obligations $ - $ - $ 23,105 $ 520 $ 23,105 $ 520 Municipal obligations 4,169 38 8,664 57 12,833 95 Corporate obligations 1,960 30 3,435 111 5,395 141 Equity securities 1,439 31 692 173 2,131 204 Mutual funds - - 12,356 328 12,356 328 Trust preferred securities 3,397 73 10,428 58 13,825 131 Mortgage-backed securities and collateralized mortgage obligations 2,920 11 57,004 1,480 59,924 1,491 Securities Held to Maturity: U.S. government and agency obligations - - 20,492 494 20,492 494 Municipal obligations 569 3 3,324 25 3,893 28 Corporate obligations 1,007 1 1,937 48 2,944 49 Mortgage-backed securities and collateralized mortgage obligations - - 33,705 1,198 33,705 1,198 ------------------------------------------------------------------------------------------------------------------------------ Total Temporarily Impaired Securities $15,461 $187 $175,142 $4,492 $190,603 $4,679 ============================================================================================================================== (Note Continued) -------------------------------------------------------------------------------- Annual Report 2006 o Fidelity Bancorp, Inc. and Subsidiary 21 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) September 30, 2005 ----------------------------------------------------------------------------------------------------------------------------- Less than 12 Months 12 Months or More Total ----------------------------------------------------------------------------------------------------------------------------- Fair Unrealized Fair Unrealized Fair Unrealized Value Losses Value Losses Value Losses ----------------------------------------------------------------------------------------------------------------------------- (In Thousands) Securities Available for Sale: U.S. government and agency obligations $ 20,641 $ 372 $ 5,773 $ 215 $ 26,414 $ 587 Municipal obligations 10,312 130 - - 10,312 130 Corporate obligations 3,458 101 - - 3,458 101 Equity securities 2,303 201 - - 2,303 201 Mutual funds 1,011 17 10,859 265 11,870 282 Trust preferred securities 10,419 110 - - 10,419 110 Mortgage-backed securities and collateralized mortgage obligations 58,553 894 15,893 401 74,446 1,295 Securities Held to Maturity: U.S. government and agency obligations 16,787 196 7,732 258 24,519 454 Municipal obligations 3,452 11 563 10 4,015 21 Corporate obligations 1,951 30 - - 1,951 30 Mortgage-backed securities and collateralized mortgage obligations 20,418 373 24,059 660 44,477 1,033 ----------------------------------------------------------------------------------------------------------------------------- Total Temporarily Impaired Securities $149,305 $2,435 $64,879 $1,809 $214,184 $4,244 ============================================================================================================================= Management evaluates securities for other than temporary impairment at least on a quarterly basis, and more frequently when economic or market concerns warrant such evaluation. Consideration is given to (1) the length of time and the extent to which the fair value has been less than cost, (2) the financial condition and near-term prospects of the issuer, and (3) the intent and ability of the Company to retain its investment in the issuer for a period of time sufficient to allow for any anticipated recovery in fair value. Unrealized losses detailed above relate primarily to U.S. Government agency, mortgage-backed securities and collateralized mortgage obligations. The Company had 127 and 132 securities in an unrealized loss position as of September 30, 2006 and 2005, respectively. In management's opinion, the decline in fair value is due only to interest rate fluctuations. The Company has the intent and ability to hold such investments until maturity or anticipated market price recovery. None of the individual unrealized losses are significant. -------------------------------------------------------------------------------- 22 Annual Report 2006 o Fidelity Bancorp, Inc. and Subsidiary NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) Note 3 - Loans Receivable Loans receivable, net are summarized as follows: September 30, 2006 2005 -------------------------------------------------------------------------------------------------------- (In Thousands) First mortgage loans: Conventional: 1-4 family dwellings $190,040 $156,889 Multi-family dwellings 259 275 Commercial 72,171 67,889 Construction 61,399 35,224 -------------------------------------------------------------------------------------------------------- 323,869 260,277 Less: Loans in process (13,369) (23,070) Unearned discounts and fees (28) (343) -------------------------------------------------------------------------------------------------------- 310,472 236,864 -------------------------------------------------------------------------------------------------------- Installment loans: Home equity 90,263 76,045 Consumer loans 440 993 Other 2,603 2,742 -------------------------------------------------------------------------------------------------------- 93,306 79,780 -------------------------------------------------------------------------------------------------------- Commercial business loans and leases: Commercial business loans 37,930 31,577 Commercial leases 236 451 -------------------------------------------------------------------------------------------------------- 38,166 32,028 -------------------------------------------------------------------------------------------------------- Less allowance for loan losses (2,917) (2,596) -------------------------------------------------------------------------------------------------------- Loans Receivable, Net $439,027 $346,076 ======================================================================================================== (Note Continued) -------------------------------------------------------------------------------- Annual Report 2006 o Fidelity Bancorp, Inc. and Subsidiary 23 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) Commitments to originate loans at September 30, 2006 were approximately as follows: Rate Amount -------------------------------------------------------------------------------------------------------- (Dollars in Thousands) First mortgage loans: Fixed rate 6.125% to 6.500% $ 561 Adjustable rate 6.750% 274 Other loans: Fixed rate 5.990% to 13.375% 323 Adjustable rate 8.000% to 11.000% 6,285 -------------------------------------------------------------------------------------------------------- $7,443 ======================================================================================================== The Bank conducts its business through thirteen offices located in the greater Pittsburgh metropolitan area. At September 30, 2006, the majority of the Bank's loan portfolio was secured by properties located in this region. The Bank does not believe it has significant concentrations of credit risk to any one group of borrowers given its underwriting and collateral requirements. Note 4 - Allowance for Loan Losses Changes in the allowance for loan losses are as follows: Years Ended September 30, 2006 2005 2004 -------------------------------------------------------------------------------------------------------- (In Thousands) Balance, beginning $2,596 $2,609 $3,091 Provision for loan losses 600 600 275 Loans charged off (326) (670) (819) Recoveries 47 57 62 -------------------------------------------------------------------------------------------------------- Balance, ending $2,917 $2,596 $2,609 ======================================================================================================== Non-accrual loans were approximately $2,685,000, $2,319,000, and $3,647,000 at September 30, 2006, 2005 and 2004, respectively. The foregone interest on those loans for the years ended September 30, 2006, 2005 and 2004 was $168,000, $176,000, and $184,000, respectively. The amount of interest income on such loans actually included in income in the years ended September 30, 2006, 2005 and 2004 was $55,000, $18,000, and $93,000, respectively. There are no commitments to lend additional funds to debtors in non-accrual status. Loan balances past due 90 days or more and still accruing interest, but which management expects will eventually be paid in full, amounted to $255,000 and $53,000 at September 30, 2006 and 2005, respectively. The recorded investment in loans that are considered to be impaired under SFAS No. 114 was $2,043,000 and $1,669,000 at September 30, 2006 and 2005, respectively. Included in the 2006 amount is $322,000 of impaired loans for which the related allowance for credit losses was $322,000 and $1,721,000 of impaired loans for which there is no allowance for credit losses. Included in the 2005 amount is $859,000 of impaired loans for which the related allowance for credit losses was $197,000 and $810,000 of impaired loans for which there is no allowance for credit losses. The average recorded investment in impaired loans during the fiscal years ended (Note Continued) -------------------------------------------------------------------------------- 24 Annual Report 2006 o Fidelity Bancorp, Inc. and Subsidiary NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) September 30, 2006, 2005 and 2004 was approximately $1,702,000, $2,182,000, and $2,449,000, respectively. For the fiscal years ended September 30, 2006, 2005 and 2004, the Company recognized interest income on those impaired loans of $34,000, $45,000, and $75,000, respectively, using the cash basis of income recognition. Management believes that the allowance for losses on loans is reasonable. While management uses available information to recognize losses on loans, future additions to the allowance may be necessary based on changes in economic conditions. In addition, various regulatory agencies, as an integral part of their examination process, periodically review the Bank's allowance for losses on loans. Such agencies may require the Bank to recognize additions to the allowance based on their judgments using information available to them at the time of examination. Note 5 - Office Premises and Equipment Office premises and equipment are summarized as follows: September 30, 2006 2005 ---------------------------------------------------------------------------- (In Thousands) Land $ 833 $ 847 Office buildings 6,333 5,199 Furniture, fixtures and equipment 2,835 2,963 Leasehold improvements 331 322 ---------------------------------------------------------------------------- 10,332 9,331 Accumulated depreciation and amortization (4,259) (4,205) ---------------------------------------------------------------------------- $ 6,073 $ 5,126 ============================================================================ The Bank has operating leases with respect to four branch offices, the Bank's Loan Center, one automated teller machine location, and a non-deposit investment office which expire on various dates through fiscal 2013. Lease expense amounted to $275,000, $237,000, and $235,000 in fiscal years 2006, 2005 and 2004, respectively. Minimum annual lease commitments are approximately as follows (in thousands): 2007 $225 2008 146 2009 118 2010 76 2011 55 Thereafter 78 -------------------------------------------------------------------------------- $698 ================================================================================ -------------------------------------------------------------------------------- Annual Report 2006 o Fidelity Bancorp, Inc. and Subsidiary 25 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) Note 6 - Deposits Deposit balances are summarized as follows: September 30, Weighted Average Rates 2006 2005 ------------------------------------------------------------------------------------------------------------- (In Thousands) Demand deposits Noninterest bearing $ 32,927 $ 32,415 Savings deposits: NOW accounts .64% in 2006 and .47% in 2005 38,892 43,039 Passbooks 1.12% in 2006 and 1.15% in 2005 60,979 78,997 Money market deposit accounts 4.29% in 2006 and 2.95% in 2005 112,569 44,742 ------------------------------------------------------------------------------------------------------------- 245,367 199,193 ------------------------------------------------------------------------------------------------------------- Time deposits: Fixed rate Less than 1.00% 12 - 1.00% to 2.99% 12,514 40,604 3.00% to 4.99% 125,060 115,870 5.00% to 6.99% 31,213 11,130 7.00% to 8.99% 16 15 ------------------------------------------------------------------------------------------------------------- 168,815 167,619 ------------------------------------------------------------------------------------------------------------- $414,182 $366,812 ============================================================================================================= The weighted average interest rate for all deposits was 3.31% and 2.35% at September 30, 2006 and 2005, respectively. Time deposits with balances of $100,000 or more totaled $34,090,000 and $28,605,000 at September 30, 2006 and 2005, respectively. At September 30, 2006, no investment securities were required to be pledged to secure deposits of public funds. The maturities of time deposits at September 30, 2006 are summarized as follows (in thousands): 2007 $ 99,821 2008 27,242 2009 27,796 2010 8,062 2011 4,115 Thereafter 1,779 -------------------------------------------------------------------------------- $168,815 ================================================================================ (Note Continued) -------------------------------------------------------------------------------- 26 Annual Report 2006 o Fidelity Bancorp, Inc. and Subsidiary NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) Interest expense by deposit category is as follows: Years Ended September 30, 2006 2005 2004 -------------------------------------------------------------------------------- (In Thousands) NOW accounts $ 220 $ 209 $ 270 Passbooks 788 1,037 1,099 Money market deposit accounts 3,343 622 128 Time deposits 6,543 5,842 6,138 -------------------------------------------------------------------------------- $10,894 $7,710 $7,635 ================================================================================ Note 7 - Borrowings FHLB "RepoPlus" advances are short-term borrowings maturing within one day to one year, bear a fixed interest rate and are subject to prepayment penalty. Although no specific collateral is required to be pledged for these borrowings, "RepoPlus" advances are secured under the blanket collateral pledge agreement. The Bank utilized "RepoPlus" advances during fiscal 2006 and 2005, ranging individually from $690,000 to $134,650,000 and from $50,000 to $104,500,000, respectively. The daily average balance during 2006 and 2005 was $73,111,000 and $79,860,000, respectively, and the daily average interest rate was 4.60% and 2.88%, respectively. The maximum amount outstanding at any month-end during 2006 and 2005 was $131,520,000 and $110,800,000, respectively. At September 30, 2006, there were no "RepoPlus" advances outstanding. There were $110,800,000 "RepoPlus" advances outstanding at an interest rate of 3.84% at September 30, 2005. In fiscal 2006 the Bank opened a revolving line of credit with the Federal Home Loan Bank of Pittsburgh, which carries a commitment of $125,000,000 maturing on July 16, 2010. The rate is adjusted daily by the Federal Home Loan Bank, and any borrowings on this line may be repaid at any time without penalty. The daily average balance during 2006 was $14,546,000 and the daily average interest rate was 5.35%. The maximum amount outstanding at any month-end during 2006 was $73,611,000. At September 30, 2006 the amount outstanding on the line was $70,768,000 at an interest rate of 5.30%. In fiscal 2006 the Bank purchased federal funds as a short-term funding source. Federal funds purchased represent unsecured borrowings from other banks and generally mature daily. The daily average balance during 2006 was $3,329,000 and the daily average interest rate was 5.11%. The maximum amount outstanding at any month-end during 2006 was $7,500,000. At September 30, 2006 the amount outstanding was $7,500,000 at an interest rate of 5.41% Also included in short-term borrowings are treasury, tax and loan balances of $357,000 and $341,000 at September 30, 2006 and 2005, respectively. (Note Continued) -------------------------------------------------------------------------------- Annual Report 2006 o Fidelity Bancorp, Inc. and Subsidiary 27 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) Long-term debt consisted of the following: Interest September 30, Rate 2006 2005 -------------------------------------------------------------------------------- (In Thousands) Fixed Rate Advances: January 17, 2006 4.43% $ - $ 10,000 July 3, 2006 4.31 - 7,500 August 30, 2007 3.89 10,000 10,000 October 12, 2007 3.90 10,000 10,000 January 14, 2008 3.79 10,000 10,000 June 23, 2010 3.24 198 248 Convertible Select Advances: December 22, 2005 4.05 - 1,000 December 22, 2005 2.28 - 504 April 7, 2006 6.44 - 15,000 July 22, 2006 5.26 - 1,984 July 22, 2006 4.57 - 5,000 July 23, 2006 2.95 - 529 February 20, 2008 5.48 10,000 10,000 December 18, 2008 5.15 10,000 10,000 January 10, 2010 3.24 756 773 January 21, 2010 3.23 1,626 1,662 February 8, 2010 3.26 1,086 1,103 March 1, 2010 3.24 1,086 1,110 March 17, 2010 6.05 20,000 20,000 March 17, 2010 3.15 871 891 April 21, 2010 3.12 542 554 May 19, 2010 5.39 1,042 1,052 June 23, 2010 3.50 223 228 August 18, 2010 3.39 549 560 August 30, 2010 5.93 10,000 10,000 September 22, 2010 3.42 552 564 September 22, 2010 3.35 327 333 October 20, 2010 3.33 434 440 November 2, 2011 4.40 5,000 5,000 -------------------------------------------------------------------------------- Total Long-Term Debt $94,292 $136,035 ================================================================================ (Note Continued) -------------------------------------------------------------------------------- 28 Annual Report 2006 o Fidelity Bancorp, Inc. and Subsidiary NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) Contractual maturities of long-term debt at September 30, 2006 were as follows (in thousands): 2007 $10,000 2008 30,000 2009 10,000 2010 38,859 2011 433 Thereafter 5,000 -------------------------------------------------------------------------------- $94,292 ================================================================================ Under a blanket collateral pledge agreement, the Bank has pledged, as collateral for advances from the FHLB of Pittsburgh, all stock in the Federal Home Loan Bank and certain other qualifying collateral, such as investment securities, mortgage-backed securities and loans, with market values equal to at least 110% of the unpaid amount of outstanding advances. The remaining maximum borrowing capacity with the FHLB of Pittsburgh at September 30, 2006 was approximately $163,639,000. FHLB "Convertible Select" advances are long-term borrowings with terms of up to ten years, and which have a fixed rate for the first three months to five years of the term. After the fixed rate term expires, and quarterly thereafter, the FHLB may convert the advance to an adjustable rate advance at their option. If the advance is converted to an adjustable rate advance, the Bank has the option at the conversion date, and quarterly thereafter, to prepay the advance with no prepayment fee. Note 8 - Subordinated Debt Subordinated debt was $10,310,000 at September 30, 2006 and 2005. The Subordinated Debt represents obligations of the wholly-owned statutory business trust subsidiary (the "Trust"), which is not consolidated for financial statement purposes. The Trust was formed with initial capitalization in common stock of $310,000 and for the exclusive purpose of issuing $10,000,000 of Preferred Securities and using the total proceeds to acquire Junior Subordinated Debt Securities ("Debt Securities") issued by the Company. The Debt Securities are unsecured and rank subordinate and junior in right of payment to all indebtedness, liabilities and obligations of the Company. The Debt Securities are due concurrently with the Preferred Securities and bear the same rate of interest as the Preferred Securities. The Preferred Securities qualify as Tier 1 capital for regulatory capital purposes. The costs associated with these issuances have been capitalized and are being amortized to maturity using the straight-line method. The $10,000,000 8.77% Floating Rate Preferred Securities are callable in whole or in part at par on September 26, 2007 and quarterly thereafter, except in certain circumstances. These securities mature on September 26, 2032. These securities bear a current interest rate of 8.77% through December 25, 2006, and adjust quarterly at a rate equal to the three-month LIBOR plus 3.40%. Prior to September 26, 2007, the rate may not exceed 11.90%. -------------------------------------------------------------------------------- Annual Report 2006 o Fidelity Bancorp, Inc. and Subsidiary 29 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) Note 9 - Securities Sold Under Agreements to Repurchase The Bank enters into sales of securities under agreements to repurchase. Such repurchase agreements are treated as financings and the obligations to repurchase securities sold are reflected as a liability in the consolidated statements of financial condition. The dollar amount of securities underlying the agreements remains in the asset accounts. The securities sold under agreements to repurchase are collateralized by various securities that are either held in safekeeping by the FHLB or delivered to the broker/dealer who arranged the transaction. The fair value of such securities exceeds the value of the securities sold under agreements to repurchase. Securities Sold Under Agreements to Repurchase included retail borrowings during fiscal 2006 and 2005. The daily average balance during 2006 and 2005 was $7,146,000 and $6,715,000, respectively, and the daily average interest rate was 4.44% and 2.33%, respectively. The maximum amount outstanding at any month-end during 2006 and 2005 was $9,282,000 and $8,811,000, respectively. At September 30, 2006 retail borrowings outstanding were $8,638,000 at a weighted average interest rate of 4.99%. There were $6,674,000 retail borrowings outstanding at a weighted average interest rate of 3.49% at September 30, 2005. Securities underlying sales of securities under retail repurchase agreements consisted of investment securities that had an amortized cost of $11,990,000 and a market value of $11,742,000 at September 30, 2006. During the fiscal year ended September 30, 2006, the Bank began using structured reverse repurchase agreements to replace various FHLB borrowings. The Bank has six separate reverse repurchase agreements with PNC Bank, N.A. ("PNC") and Citigroup Global Markets, Inc. ("CGMI"). Each agreement is structured as the sale of a specified amount of identified securities to the counterparty which the Bank has agreed to repurchase five to seven years after the initial sale. The underlying securities consist of various U.S. Government and agency obligations and mortgage-backed securities which continue to be carried as assets of the Bank and the Bank is entitled to receive interest and principal payments on the underlying securities. The Bank is required to post additional collateral if the market value of the securities subject to repurchase falls below 105% of principal amount. While the repurchase agreements are in effect, the Bank is required to pay interest quarterly at the rate specified in the agreement. Each of the agreements provide an initial fixed or floating interest rate that converts to a floating or fixed rate at the end of six months to one year. At September 30, 2006, the Bank had $30.0 million in reverse repurchase agreements that bore interest at a rate equal to three-month LIBOR minus 100 basis points and are scheduled to convert to fixed rates from 4.73% to 4.97% in fiscal 2007. At September 30, 2006, the Bank had $30.0 million in reverse repurchase agreements with initial fixed rates between 3.98% to 4.65% scheduled to convert in early 2007 to floating rates equal to 9.5% minus three month LIBOR with a cap of 5.8% and floor of 0.0%. At September 30, 2006, the Bank had an additional $15.0 million in reverse repurchase agreements that had already reset to a fixed rate of 4.64%. The counterparty has the option of terminating the reverse repurchase agreement at the reset date and quarterly thereafter. The counterparty may also terminate the repurchase agreement upon certain events of default including the Bank's failure to maintain well capitalized status. Upon termination, the Bank would be required to repurchase the securities. The Bank borrowed $35,000,000, with PNC, with a weighted average maturity of 4.45 years and borrowed $40,000,000, with CGMI, with a weighted average maturity of 5.39 years. There were no structured borrowings outstanding at September 30, 2005. Securities underlying sales of securities under structured repurchase agreements consisted of investment securities that had an amortized cost of $87,843,000 and a market value of $85,754,000 at September 30, 2006. -------------------------------------------------------------------------------- 30 Annual Report 2006 o Fidelity Bancorp, Inc. and Subsidiary NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) Note 10 - Financial Instruments with Off-Balance Sheet Risk The Bank is party to financial instruments with off-balance sheet risk in the normal course of business to meet the financing needs of its customers. These financial instruments include commitments to extend credit and letters of credit. Those instruments involve, to varying degrees, elements of credit and interest rate risk in excess of the amount recognized in the consolidated statements of financial condition. The Bank's exposure to credit loss in the event of nonperformance by the other party to the financial instrument for commitments to extend credit and letters of credit is represented by the contractual amount of those instruments. The Bank uses the same credit policies in making commitments and conditional obligations as it does for on-balance sheet instruments. A summary of the contractual amount of the Bank's financial instrument commitments is as follows: September 30, 2006 2005 -------------------------------------------------------------------------------- (In Thousands) Commitments to grant loans $ 7,443 $ 1,369 Unfunded commitments under lines of credit 43,416 39,414 Financial and performance standby letters of credit 218 295 The Bank's customers have available lines of credit as follows: consumer, both secured and unsecured, and commercial, generally secured. The amount available at September 30, 2006 and 2005 was $21,508,000 and $18,586,000, respectively, for consumer lines of credit and $21,908,000 and $20,828,000, respectively, for commercial lines of credit. The interest rate for the consumer lines of credit range from 6.00% to 12.25%, the majority of which is at variable rates. The interest rates for the commercial lines of credit are generally variable and based on prevailing market conditions at the time of funding. The Bank's customers also have available letters of credit. The amount available under these letters of credit at September 30, 2006 and 2005 was $218,000 and $295,000, respectively. The interest rates are generally variable and based on prevailing market conditions at the time of funding. The Company does not issue any guarantees that would require liability recognition or disclosure, other than its standby letters of credit. Standby letters of credit written are conditional commitments issued by the Company to guarantee the performance of a customer to a third party. Generally, all letters of credit, when issued have expiration dates within one year. The credit risk involved in issuing letters of credit is essentially the same as that involved in extending other loan commitments. The Bank requires collateral supporting these letters of credit as deemed necessary. Management believes that the proceeds obtained through a liquidation of such collateral would be sufficient to cover the maximum potential amount of future payments required under the corresponding guarantees. The current amount of liability as of September 30, 2006 and 2005 for guarantees under standby letters of credit issued is not material. Commitments to extend credit are agreements to lend to a customer as long as there is no violation of any condition established in the commitment. Commitments generally have fixed expiration dates or other termination clauses and may require payment of a fee. The Bank evaluates each customer's credit worthiness on a case-by-case basis. The amount of collateral obtained, if deemed necessary by the Bank upon extension of credit, is based on management's credit evaluation of the borrower. The collateral consists primarily of residential real estate and personal property. The Company does not have any off-balance sheet risk at September 30, 2006, except for the commitments referenced above. -------------------------------------------------------------------------------- Annual Report 2006 o Fidelity Bancorp, Inc. and Subsidiary 31 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) Note 11 - Income Taxes The provision for income taxes in the consolidated statements of income consists of the following: Years Ended September 30, 2006 2005 2004 --------------------------------------------------------------------------------------------------------------------------- (In Thousands) Current: Federal $ 767 $ 933 $ 697 State - 30 11 --------------------------------------------------------------------------------------------------------------------------- 767 963 708 Deferred, federal 73 37 308 --------------------------------------------------------------------------------------------------------------------------- $ 840 $1,000 $1,016 =========================================================================================================================== The differences between the expected and actual tax provision expressed as percentages of income before tax are as follows: Years Ended September 30, 2006 2005 2004 ---------------------------------------------------------------------------------------------------------------------------- Expected federal tax rate 34.0 % 34.0 % 34.0 % Tax-exempt interest (12.4) (11.4) (12.4) State income tax, net of federal tax benefit - .1 .2 Other items, net (3.8) (2.2) (2.8) ---------------------------------------------------------------------------------------------------------------------------- Actual Tax Rate 17.8 % 20.5 % 19.0 % ============================================================================================================================ Deferred income taxes consisted of the following components: September 30, 2006 2005 --------------------------------------------------------------------------------------------------------------------------- (In Thousands) Deferred tax assets: Office premises and equipment $ 495 $ 418 Allowance for loan losses 995 886 Deferred compensation 414 381 Net operating losses 91 116 Intangible assets 168 244 Unrealized losses on securities available for sale 765 471 Other 310 338 --------------------------------------------------------------------------------------------------------------------------- Gross Deferred Tax Assets $3,238 $2,854 --------------------------------------------------------------------------------------------------------------------------- Deferred tax liabilities: Insurance proceeds $ (163) $ - --------------------------------------------------------------------------------------------------------------------------- Gross Deferred Tax Liabilities $ (163) $ - --------------------------------------------------------------------------------------------------------------------------- Net Deferred Tax Asset $3,075 $2,854 =========================================================================================================================== (Note Continued) -------------------------------------------------------------------------------- 32 Annual Report 2006 o Fidelity Bancorp, Inc. and Subsidiary NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) Net operating loss carryforwards in the amount of $73,000, obtained from acquisitions, were utilized in fiscal 2006 and 2005, respectively. Net operating loss carryforwards in the amount of $142,000, obtained from acquisitions, were utilized in fiscal 2004. The federal net operating loss carryforward of $267,000 is available to offset future taxable income through 2022. The Company has determined that it is not required to establish a valuation allowance for deferred income taxes since it is more likely than not that the deferred income taxes will be realized through carryback to taxable income in prior years, future reversals of existing temporary differences and, to a lesser extent, future taxable income. Tax basis bad debt reserves established after 1987 are treated as temporary differences on which deferred income taxes have been provided. Deferred taxes are not required to be provided on tax bad debt reserves recorded in 1987 and prior years (base year bad debt reserves). Approximately $3,404,000 of the balance in retained earnings at September 30, 2006, represent base year bad debt deductions for tax purposes only. No provision for federal income tax has been made for such amount. Should amounts previously claimed as a bad debt deduction be used for any purpose other than to absorb bad debts (which is not anticipated), tax liabilities will be incurred at the rate then in effect. Note 12 - Stockholders' Equity The Bank is subject to various regulatory capital requirements administered by the federal banking agencies. Failure to meet minimum capital requirements can initiate certain mandatory, and possibly additional discretionary, actions by regulators that, if undertaken, could have a direct material effect on the Bank's financial statements. Under capital adequacy guidelines and the regulatory framework for prompt corrective action, the Bank must meet specific capital guidelines that involve quantitative measures of the Bank's assets, liabilities and certain off-balance-sheet items as calculated under regulatory accounting practices. The Bank's capital amounts and classification are also subject to qualitative judgments by the regulators about components, risk weightings and other factors. Quantitative measures established by regulation to ensure capital adequacy require the Bank to maintain minimum amounts and ratios (set forth in the table below) of total and Tier 1 capital (as defined in the regulations) to risk-weighted assets (as defined) and of Tier 1 capital (as defined) to average assets (as defined). Management believes, as of September 30, 2006, that the Bank meets all capital adequacy requirements to which it is subject. As of September 30, 2006, the most recent notification from the Federal Deposit Insurance Corporation categorized the Bank as well capitalized under the regulatory framework for prompt corrective action. To be categorized as well capitalized, the Bank must maintain minimum total risk-based, Tier 1 risk-based, and Tier 1 leverage ratios as set forth in the table. There are no conditions or events since that notification that management believes have changed the Bank's category. The Federal Reserve Board (FRB) measures capital adequacy for bank holding companies on the basis of a risk-based capital framework and a leverage ratio. The minimum ratio of total risk-based capital to risk-weighted assets is 8%. At least half of the total capital must be common stockholders' equity (not inclusive of net unrealized gains and losses on available for sale debt securities and net unrealized gains on available for sale equity securities) and perpetual preferred stock, less goodwill and other nonqualifying intangible assets (Tier 1 capital). The remainder (i.e., the Tier 2 risk-based capital) may consist of hybrid capital instruments, perpetual debt, term subordinated debt, other preferred stock and a limited amount of the allowance for loan losses. At September 30, 2006, the Company had Tier I capital as a percentage of risk-weighted assets of 12.1% and total risk-based capital as a percentage of risk-weighted assets of 12.7%. (Note Continued) -------------------------------------------------------------------------------- Annual Report 2006 o Fidelity Bancorp, Inc. and Subsidiary 33 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) In addition, the FRB has established minimum leverage ratio guidelines for bank holding companies. These guidelines currently provide for a minimum ratio of Tier 1 capital as a percentage of average total assets (the Leverage Ratio) of 3% for bank holding companies that meet certain criteria, including that they maintain the highest regulatory rating. The minimum leverage ratio for all other bank holding companies is 4%. At September 30, 2006, the Company had a leverage ratio of 7.5%. The following table sets forth certain information concerning the Bank's regulatory capital at September 30, 2006 and 2005: To be Well Capitalized under For Capital Adequacy Prompt Corrective Actual Purposes Action Provisions -------------------------------------------------------------------------------------------------------------------------- Amount Ratio Amount Ratio Amount Ratio -------------------------------------------------------------------------------------------------------------------------- (Dollars in Thousands) As of September 30, 2006: Total capital (to risk-weighted assets) $48,056 10.2 % $=>37,556 =>8.0 % $=>46,945 =>10.0 % Tier 1 capital (to risk-weighted assets) 45,139 9.6 =>18,778 =>4.0 =>28,167 => 6.0 Tier 1 capital (to average assets) 45,139 6.3 =>28,841 =>4.0 =>36,051 => 5.0 As of September 30, 2005: Total capital (to risk-weighted assets) $45,750 10.7 % $=>34,122 =>8.0 % $=>42,653 =>10.0 % Tier 1 capital (to risk-weighted assets) 43,154 10.1 =>17,061 =>4.0 =>25,592 => 6.0 Tier 1 capital (to average assets) 43,154 6.5 =>26,745 =>4.0 =>33,431 => 5.0 Federal and state banking regulations place certain restrictions on dividends paid and loans or advances made by the Bank to the Company. The total amount of dividends which may be paid at any date is generally limited to the retained earnings of the Bank and loans or advances are limited to 10 percent of the Bank's capital stock and surplus on a secured basis. At September 30, 2006, the Bank's retained earnings available for the payment of dividends was $1.1 million. Accordingly, $45.5 million of the Company's equity in the net assets of the Bank was restricted at September 30, 2006. Funds available for loans or advances by the Bank to the Company amounted to $4.8 million. Any such borrowing must be on terms that would be available to unaffiliated parties and must be fully collateralized in accordance with FRB regulations. In addition, dividends paid by the Bank to the Company would be prohibited if the effect thereof would cause the Bank's capital to be reduced below applicable minimum capital requirements. -------------------------------------------------------------------------------- 34 Annual Report 2006 o Fidelity Bancorp, Inc. and Subsidiary NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) Note 13 - Stock Option Plans On September 30, 2006, the Company has seven share-based compensation plans, which are described below. The compensation cost that has been charged against income for those plans was $66,000 in fiscal 2006. The total income tax benefit recognized in the income statement for share-based compensation arrangements was $22,000 for fiscal 2006. The Company's 2005 Stock-Based Incentive Plan (the Plan), which is shareholder-approved, permits the grant of share options and shares to its employees and non-employee directors for up to 165,000 shares of common stock. Option awards are generally granted with an exercise price equal to the market value of the common stock on the date of grant, the options generally vest over a three-year period, and have a contractual term of seven years, although the Plan permits contractual terms of up to ten years. Option awards provide for accelerated vesting if there is a change in control, as defined in the Plan. At September 30, 2006, there were 108,100 options which remain unawarded. No share awards have been made under the Plan. The Company also maintains the 1993 Employee Stock Compensation Program and the 1997 Employee Stock Compensation Program, both of which were shareholder approved. At September 30, 2006, no remaining options are available for grant under these programs. Option awards under these programs were granted with an exercise price equal to the market value of the common stock on the date of grant, had vesting periods of from zero to two years, and had contractual terms of from seven to ten years. Option awards under these programs provided for accelerated vesting if there is a change in control, as defined in the programs. The Company also maintains the 1998 Stock Compensation Program, the 2000 Stock Compensation Plan, the 2001 Stock Compensation Plan and the 2002 Stock Compensation Plan, which provided for the grant of stock options to non-employee directors. At September 30, 2006, no remaining options are available for grant under these programs. Option awards under these programs were granted with an exercise price equal to the market value of the common stock on the date of grant, were exercisable immediately, and had contractual terms of ten years. The fair value of each option award is estimated at the date of grant using a Black-Scholes option-pricing model that uses the assumptions noted in the following table. Expected volatilities are based on the historical volatility of the Company's stock. The Company uses historical data to estimate option exercise and employee and director terminations within the model, as well as the expected term of options granted, which represents the period of time that options granted are expected to be outstanding. Separate groups of employees and directors that have similar historical exercise behavior are considered separately for valuation purposes. Ranges given below result from certain groups pf employees and directors exhibiting different behavior. The risk-free rate for periods within the contractual life of the option is based on the U.S. Treasury yield curve in effect at the time of grant. 2006 2005 2004 -------------------------------------------------------------------------------- Expected volatility 22% - 23% 19% 23% Weighted-average volatility 22% 19% 23% Expected dividends 3.6% - 3.8% 2.4% - 2.8% 2.8% - 3.0% Expected term (in years) 5.5 5.0 - 6.0 5.0 - 7.0 Risk-free rate 4.2% - 4.5% 3.6% - 4.3% 3.6% (Note Continued) -------------------------------------------------------------------------------- Annual Report 2006 o Fidelity Bancorp, Inc. and Subsidiary 35 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) Weighted Weighted Average Average Remaining Aggregate Exercise Contractual Intrinsic Shares Price Term Value --------------------------------------------------------------------------------------------- Outstanding as of September 30, 2005 379,803 $14.13 Granted 41,500 18.90 Exercised (27,936) 9.45 Forfeited (4,025) 21.91 --------------------------------------------------------------------------------------------- Outstanding at September 30, 2006 389,342 $14.89 5.0 $1,868,476 ============================================================================================= Exercisable at September 30, 2006 337,575 $14.21 4.8 $1,863,341 ============================================================================================= The weighted-average grant-date fair value of options granted during the fiscal years 2006, 2005, and 2004 was $3.35, $3.98, and $4.07, respectively. The total intrinsic value of options exercised during the fiscal years ended September 30, 2006, 2005, and 2004, was $275,000, $621,000, and $774,000, respectively. A summary of the status of non-vested shares as of September 30, 2006, and changes during the year ended September 30, 2006 is presented below: Weighted Average Grant-Date Non-vested Shares Shares Fair Value -------------------------------------------------------------------------------- Non-vested at September 30, 2005 25,050 $3.79 Granted 41,500 3.35 Vested (13,876) 3.85 Forfeited (907) 3.93 -------------------------------------------------------------------------------- Non-vested at September 30, 2006 51,767 $3.37 As of September 30, 2006, there was $130,000 of total unrecognized compensation cost related to non-vested share-based compensation arrangements. That cost is expected to be recognized over a weighted-average period of 1.6 years. The total fair value of shares vested during the years ended September 2006, 2005, and 2004, was $53,000, $202,000, and $186,000, respectively. Xxxx received from options exercised under all share-based payment arrangements for the fiscal years ended September 30, 2006, 2005, and 2004 was $264,000, $562,000 and $603,000, respectively. The actual tax benefit realized for the tax deductions from option exercise of the share-based payment arrangements totaled $43,000, $160,000, and $216,000 for the fiscal years ended September 30, 2006, 2005 and 2004, respectively. The Company has a policy of issuing shares from authorized but unissued shares to satisfy share option exercises. -------------------------------------------------------------------------------- 36 Annual Report 2006 o Fidelity Bancorp, Inc. and Subsidiary NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) Note 14 - Employee Benefit Plans Post-Retirement Benefits Plan During 1998, the Bank established a non-qualified Salary Continuation Plan covering certain officers of the Bank. The Plan is unfunded and provides benefits to participants based upon amounts stipulated in the Plan agreements for a period of 15 years from normal retirement, as defined in the respective Plan agreements. Participants vest in benefits based upon years of service from Plan initiation to normal retirement age. Expense is being accrued based on the present value of future benefits in which the participant is expected to be vested. Expense recognized under the Plan for 2006, 2005, and 2004 was approximately $173,000, $143,000, and $141,000, respectively. The accrued liability under the Plan for 2006, 2005, and 2004 was approximately $1,218,000, $1,121,000, and $1,054,000, respectively. The Bank has entered into life insurance policies designed to offset the Bank's contractual obligation to pay preretirement death benefits and to recover the cost of providing benefits. Participants in the Plan are the insured under the policy, and the Bank is the owner and beneficiary. Group Term Replacement Plan The Bank has purchased life insurance policies on the lives of certain officers of the Bank. By way of separate split dollar agreements, the policy interest is divided between the Bank and the officer. The Bank owns the policy cash surrender value, including accumulated policy earnings, and the policy death benefits over and above the cash surrender value are endorsed to the employee and beneficiary. Death benefit payments are the obligation of the insurance company. The Bank has no benefit obligation to the officer. Xxxxxx recognized in 2006, 2005 and 2004 as a result of increased cash surrender value was approximately $60,000, $89,000, and $99,000, respectively. Employee Stock Ownership Plan The Bank maintains a non-contributory, tax qualified Employee Stock Ownership Plan ("ESOP") for the benefit of officers and employees who have met certain eligibility requirements related to age and length of service. Each year, the Bank makes a discretionary contribution to the ESOP in cash, Company common stock or a combination of cash and Company stock. Amounts charged to compensation expense were $251,000, $289,000, and $255,000 in 2006, 2005 and 2004, respectively. -------------------------------------------------------------------------------- Annual Report 2006 o Fidelity Bancorp, Inc. and Subsidiary 37 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) Note 15 - Selected Quarterly Financial Data (Unaudited) Three Month Periods Ended December 31 March 31 June 30 September 30 ------------------------------------------------------------------------------------------------------------------------- (Dollars in Thousands, Except per Share Data) Fiscal 2006 Interest income $8,664 $9,139 $9,567 $10,003 Interest expense 5,354 5,736 6,171 6,553 ------------------------------------------------------------------------------------------------------------------------- Net interest income 3,310 3,403 3,396 3,450 Provision for loan losses 125 - 125 350 Other income 942 903 931 1,057 Other expenses 2,906 3,140 2,999 3,041 ------------------------------------------------------------------------------------------------------------------------- Income before income taxes and extraordinary gain 1,221 1,166 1,203 1,116 Income tax provision 257 181 234 168 ------------------------------------------------------------------------------------------------------------------------- Income from continuing operations 964 985 969 948 ------------------------------------------------------------------------------------------------------------------------- Income from extraordinary gain, net of taxes - - - 318 ------------------------------------------------------------------------------------------------------------------------- Net income $964 $985 $969 $1,266 ========================================================================================================================= Earnings per share: Basic Income from continuing operations $0.32 $0.33 $0.33 $0.32 Income from extraordinary gain, net of taxes - - - .11 ------------------------------------------------------------------------------------------------------------------------- Net income $0.32 $0.33 $0.33 $0.43 ========================================================================================================================= Diluted Income from continuing operations $0.32 $0.32 $0.32 $0.32 Income from extraordinary gain, net of taxes - - - .10 ------------------------------------------------------------------------------------------------------------------------- Net income $0.32 $0.32 $0.32 $0.42 ========================================================================================================================= (Note Continued) -------------------------------------------------------------------------------- 38 Annual Report 2006 o Fidelity Bancorp, Inc. and Subsidiary NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) Fiscal 2005 Interest income $7,608 $7,753 $8,003 $8,300 Interest expense 4,152 4,255 4,529 4,888 ------------------------------------------------------------------------------------------------------------------------- Net interest income 3,456 3,498 3,474 3,412 Provision for loan losses 175 25 225 175 Other income 841 1,071 940 936 Other expenses 2,876 3,366 2,948 2,962 ------------------------------------------------------------------------------------------------------------------------- Income before income taxes 1,246 1,178 1,241 1,211 Income tax provision 241 214 300 245 ------------------------------------------------------------------------------------------------------------------------- Net income $1,005 $964 $941 $966 ========================================================================================================================= Earnings per share: Basic $0.34 $0.33 $0.32 $0.33 ========================================================================================================================= Diluted $0.33 $0.32 $0.31 $0.31 ========================================================================================================================= Note 16 - Fair Value of Financial Instruments FASB Statement No. 107 "Disclosures about Fair Value of Financial Instruments" (FAS 107), requires disclosure of fair value information about financial instruments, whether or not recognized in the statement of financial condition, for which it is practical to estimate that value. In cases where quoted market prices are not available, fair values are based on estimates using present value or other valuation techniques. These techniques are significantly affected by the assumptions used, including the discount rate and estimates of future cash flows. Management uses its best judgment in estimating the fair value of the Company's financial instruments, however, there are inherent weaknesses in any estimation technique. Therefore, for substantially all financial instruments, the fair value estimates herein are not necessarily indicative of the amounts the Company could have realized in a sales transaction on the dates indicated. The estimated fair value amounts have been measured as of their respective year-ends, and have not been reevaluated or updated for purposes of these financial statements subsequent to those respective dates. As such, the estimated fair values of these financial instruments subsequent to the respective reporting dates may be different than the amounts reported at each year-end. The following information should not be interpreted as an estimate of the fair value of the entire Company since a fair value calculation is only provided for a limited portion of the Company's assets and liabilities. Due to a wide range of valuation techniques and the degree of subjectivity used in making the estimates, comparisons between the Company's disclosures and those of other companies may not be meaningful. The Company, in estimating its fair value disclosures for financial instruments, used the following methods and assumptions: Cash and Due From Banks The carrying amounts reported approximate those assets' fair value. Interest Bearing Demand Deposits with Other Institutions The carrying amounts reported approximate those assets' fair value. (Note Continued) -------------------------------------------------------------------------------- Annual Report 2006 o Fidelity Bancorp, Inc. and Subsidiary 39 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) Securities Fair values of securities are based on quoted market prices, where available. If quoted market prices are not available, fair values are based on quoted market prices of comparable securities. Loans Receivable For variable rate loans that reprice frequently and with no significant change in credit risk, fair values are based on carrying values. The fair values for other loans receivable were estimated using discounted cash flow analyses, using interest rates currently offered for loans with similar terms to borrowers of similar credit quality. Loans with significant collectibility concerns were fair valued on a loan-by-loan basis utilizing a discounted cash flow method or the fair market value of the underlying collateral. Restricted Investments in Bank Stock The carrying amounts reported approximate those assets' fair value. Accrued Interest Receivable and Payable The carrying amount of accrued interest receivable and payable approximate their fair value. Deposit Liabilities The fair values disclosed for demand deposits (e.g., interest bearing and noninterest bearing checking, passbook savings and certain types of money market accounts) are, by definition, equal to the amount payable on demand at the reporting date (i.e., their carrying amounts). Fair values for fixed rate certificates of deposit are estimated using a discounted cash flow calculation that applies interest rates currently being offered on certificates of deposit to a schedule of aggregated expected monthly maturities on time deposits. Short-Term Borrowings The carrying amounts for short-term borrowings approximate the estimated fair value of such liabilities. Securities Sold Under Agreements to Repurchase The fair values for securities sold under agreement to repurchase were estimated using the interest rate currently available from the party that holds the existing debt. Subordinated Debt Fair values for subordinated debt are estimated using a discounted cash flow calculation similar to that used in valuing fixed rate certificate of deposit liabilities. Long-Term Debt The fair values for long-term debt were estimated using the interest rate currently available from the party that holds the existing debt. Off-Balance Sheet Instruments Fair values for the Company's off-balance sheet instruments are based on fees currently charged to enter into similar agreements, taking into account the remaining terms of the agreements and the counterparties' credit standing. (Note Continued) -------------------------------------------------------------------------------- 40 Annual Report 2006 o Fidelity Bancorp, Inc. and Subsidiary NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) The carrying amounts and fair values of the Company's financial instruments are presented in the following table: September 30, 2006 2005 --------------------------------------------------------------------------------------------------------------------------- Carrying Fair Carrying Fair Amount Value Amount Value --------------------------------------------------------------------------------------------------------------------------- (In Thousands) Financial assets: Cash and due from banks $ 8,480 $ 8,480 $ 9,234 $ 9,234 Interest bearing demand deposits with other institutions 187 187 636 636 Securities available for sale 165,449 165,449 182,157 182,157 Securities held to maturity 85,879 84,851 105,316 104,962 Loans, net (including loans held for sale) 439,067 426,394 346,324 342,689 Restricted investments in bank stock 9,132 9,132 12,215 12,215 Accrued interest receivable 3,359 3,359 3,113 3,113 Financial liabilities: Deposits 414,182 412,399 366,812 365,231 Short-term borrowings 78,625 78,625 111,141 111,141 Securities sold under agreements to repurchase 83,638 83,220 6,674 6,674 Subordinated Debt 10,310 10,310 10,310 10,310 Accrued interest payable 996 996 1,193 1,193 Long-term debt 94,292 94,634 136,035 137,846 Off-balance sheet financial instruments: Standby letters of credit - - - - Commitments to extend credit - - - - -------------------------------------------------------------------------------- Annual Report 2006 o Fidelity Bancorp, Inc. and Subsidiary 41 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) Note 17 - Fidelity Bancorp, Inc. Financial Information (Parent Company Only) Following are condensed financial statements for the parent company: Condensed Statements of Financial Condition September 30, 2006 2005 ------------------------------------------------------------------------------------------------------ (In Thousands) Assets Cash $ 2,592 $ 1,596 Investment in subsidiary bank 46,623 45,035 Investment in unconsolidated subsidiary trust 310 310 Securities available for sale 4,289 4,900 Other assets 710 521 ------------------------------------------------------------------------------------------------------ Total Assets $54,524 $52,362 ====================================================================================================== Liabilities and Stockholders' Equity Liabilities: Subordinated debentures $10,310 $10,310 Other liabilities 19 3 ------------------------------------------------------------------------------------------------------ Total Liabilities 10,329 10,313 Total Stockholders' Equity 44,195 42,049 ------------------------------------------------------------------------------------------------------ Total Liabilities and Stockholders' Equity $54,524 $52,362 ====================================================================================================== Condensed Statements of Income Years Ended September 30, 2006 2005 2004 -------------------------------------------------------------------------------------------------------- (In Thousands) Dividends from subsidiary $2,239 $8,911 $1,725 Interest income 248 241 257 Interest expense (863) (659) (500) Other income 788 572 163 Other expense (195) (108) (81) -------------------------------------------------------------------------------------------------------- Income Before Equity in Undistributed Net Income of Subsidiary and Income Taxes 2,217 8,957 1,564 Income tax benefit 35 17 84 Equity in(excess of) undistributed net income of subsidiary 1,932 (5,098) 2,673 -------------------------------------------------------------------------------------------------------- Net Income $4,184 $3,876 $4,321 ======================================================================================================== (Note Continued) -------------------------------------------------------------------------------- 42 Annual Report 2006 o Fidelity Bancorp, Inc. and Subsidiary NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) Condensed Statements of Cash Flows Years Ended September 30, 2006 2005 2004 ----------------------------------------------------------------------------------------------------------------------------- (In Thousands) Cash Flows from Operating Activities Net income $4,184 $3,876 $4,321 Adjustments to reconcile net income to net cash provided by operating activities: (Equity in) excess of undistributed earnings of subsidiary (1,932) 5,098 (2,673) Gain on sale of investments (668) - (101) Tax benefit realized on stock-based compensation - 160 216 Increase (decrease) in interest receivable (5) (14) 19 Increase (decrease) in payable to subsidiary 8 (5,867) 1,990 Other changes, net 7 61 147 ----------------------------------------------------------------------------------------------------------------------------- Net Cash Provided by Operating Activities 1,594 3,314 3,919 ----------------------------------------------------------------------------------------------------------------------------- Cash Flows from Investing Activities Purchase of securities available for sale (1,183) (1,801) (2,409) Sale of securities available for sale 2,118 527 421 Maturities and principal repayments of securities available for sale - 1,064 457 ----------------------------------------------------------------------------------------------------------------------------- Net Cash Provided by (Used in) Investing Activities 935 (210) (1,531) ----------------------------------------------------------------------------------------------------------------------------- Cash Flows from Financing Activities Stock options exercised 264 562 603 Excess tax benefit realized on stock-based compensation 43 - - Sale of stock through Dividend Reinvestment Plan 151 153 144 Dividends paid (1,594) (1,405) (1,229) Acquisition of treasury stock (397) (1,265) (1,474) ----------------------------------------------------------------------------------------------------------------------------- Net Cash Used in Financing Activities (1,533) (1,955) (1,956) ----------------------------------------------------------------------------------------------------------------------------- Net Increase in Cash and Cash Equivalents 996 1,149 432 ----------------------------------------------------------------------------------------------------------------------------- Cash and Cash Equivalents - Beginning 1,596 447 15 ----------------------------------------------------------------------------------------------------------------------------- Cash and Cash Equivalents - Ending $2,592 $1,596 $447 ============================================================================================================================= Note 18 - Contingent Liabilities The Company is subject to a number of asserted and unasserted potential claims encountered in the normal course of business. In the opinion of management, after consultation with legal counsel, the resolution of these claims will not have a material adverse effect on the Company's financial position, liquidity or results of operations. Note 19 - Extraordinary Gain During the fourth quarter of fiscal 2006, the Bank recorded an extraordinary gain of $481,000, before taxes of $163,000, related to insurance proceeds received from the destructive fire that devastated the Bank's Carnegie Branch location in October 2005. While the insurance proceeds were reinvested in the construction of the new Carnegie Branch location, the proceeds, net of the book value of the associated assets at the time of the fire, were recorded as a gain in accordance with accounting literature. Insurance proceeds received to date total $601,000, however, the insurance claim has not been settled and additional proceeds may be recovered in future periods. -------------------------------------------------------------------------------- Annual Report 2006 o Fidelity Bancorp, Inc. and Subsidiary 43 MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS Overview The Company reported net income of $4.18 million or $1.38 per share on a diluted basis (including an extraordinary gain of $318,000, net of tax or $.10 per diluted share) for fiscal 2006 compared to $3.88 million or $1.27 per share on a diluted basis for fiscal 2005 compared to $4.32 million or $1.40 per share on a diluted basis for fiscal 2004. Return on average equity was 9.89%, 9.24%, and 10.62% for fiscal years 2006, 2005 and 2004, respectively. Return on average assets was .59%, .59%, and .69% for fiscal 2006, 2005, and 2004, respectively. The ratio of other expenses to average assets for fiscal 2006 was 1.70% compared to 1.85% in fiscal 2005 and 1.83% in fiscal 2004. Total assets of the Company totaled $730.7 million at September 30, 2006, compared to $677.8 million at September 30, 2005. Increases were noted in loans receivable, partially offset by decreases in securities and cash and cash equivalents. The operating results of the Company depend primarily upon its net interest income, which is the difference between the yield earned on its interest earning assets and the rates paid on its interest bearing liabilities (interest-rate spread) and also the relative amounts of its interest earning assets and interest bearing liabilities. For the fiscal year ended September 30, 2006, the tax-equivalent interest-rate spread decreased to 2.03%, as compared to 2.26% in fiscal 2005. The tax-equivalent spread in fiscal 2004 was 2.31%. The ratio of average interest earning assets to average interest bearing liabilities decreased slightly to 102.7% in fiscal 2006, from 102.8% in fiscal 2005. The ratio was 102.7% in fiscal 2004. The decrease in the spread for fiscal 2006 is attributed to the average yield on total interest earning assets increasing less than the average rate paid on interest bearing liabilities. The Company's operating results are also affected to varying degrees by, among other things, service charges and fees, gains and losses on sales of securities and loans, provision for loan losses, other operating income, operating expenses and income taxes. Critical Accounting Policies, Judgments and Estimates Certain critical accounting policies affect the more significant judgments and estimates used in the preparation of the consolidated financial statements. These policies are contained in Note 1 to the consolidated financial statements. Our accounting and reporting policies conform with the accounting principles generally accepted in the United States of America and general practices within the financial services industry. Recent accounting pronouncements are contained in Note 1 to the consolidated financial statements. The preparation of the financial statements in conformity with accounting principles generally accepted in the United States of America requires management to make estimates and assumptions that affect the amounts reported in the financial statements and the accompanying notes. Actual results could differ from those estimates. Management bases its estimates and judgments on historical experience and on various other factors that are believed to be reasonable under the circumstances, the results of which form the basis for making judgments about the carrying values of assets and liabilities that are not readily apparent from other sources. There can be no assurances that actual results will not differ from those estimates. If actual results are different than management's judgments and estimates, the Company's financial results could change, and such change could be material. Allowance for Loan Losses. The Company considers that the determination of the allowance for loan losses involves a higher degree of judgment and complexity than its other significant accounting policies. The balance in the allowance for loan losses is determined based on management's review and evaluation of the loan portfolio in relation to past loss experience, the size and composition of the portfolio, current economic events and conditions, and other pertinent factors, including management's assumptions as to future delinquencies, recoveries -------------------------------------------------------------------------------- 44 Annual Report 2006 o Fidelity Bancorp, Inc. and Subsidiary MANAGEMENT'S DISCUSSION AND ANALYSIS (CONTINUED) and losses. All of these factors may be susceptible to significant change. To the extent actual outcomes differ from management's estimates, additional provisions for loan losses may be required that would adversely impact earnings in future periods. Valuation of Goodwill. The Company assesses the impairment of goodwill at least annually, and whenever events or significant changes in circumstances indicate that the carrying value may not be recoverable. Factors that the Company considers important in determining whether to perform an impairment review include significant underperformance relative to forecasted operating results and significant negative industry or economic trends. If the Company determines that the carrying value of goodwill may not be recoverable, then the Company will assess impairment based on a projection of undiscounted future cash flows and measure the amount of impairment based on fair value. Accounting for Stock Options. Prior to October 1, 2005, the Company accounted for its stock option plans under the recognition and measurement principles of APB Opinion No. 25, "Accounting for Stock Issued to Employees", and related interpretations. No stock-based employee compensation was reflected in net income, for periods ended prior to October 1, 2005 as all options granted had an exercise price equal to the market value of the underlying common stock on the grant date. However, the Company adopted SFAS No. 123R as of October 1, 2005 and stock based compensation expense is reported in net income. Stock based compensation expense is reported in net income utilizing the fair-value-based method set forth in SFAS No. 123R. The fair value of each option award is estimated at the date of grant using a Black-Scholes option-pricing model that uses the assumptions noted in Note 13. Expected volatilities are based on the historical volatility of the Company's stock. The Company uses historical data to estimate option exercise and employee and director terminations within the model, as well as the expected term of options granted, which represents the period of time that options granted are expected to be outstanding. Separate groups of employees and directors that have similar historical exercise behavior are considered separately for valuation purposes. Ranges result from certain groups of employees and directors exhibiting different behavior. The risk-free rate for periods within the contractual life of the option is based on the U.S. Treasury yield curve in effect at the time of grant. All of these assumptions may be susceptible to change and would impact earnings in future periods. Securities. Securities for which the Company has the positive intent and ability to hold to maturity are reported at cost adjusted for premiums and discounts that are recognized in interest income using the interest method over the period to maturity. Declines in the fair value of individual securities below their amortized cost that are other than temporary result in writedowns of the individual securities to their estimated fair value. Such writedowns are included in earnings as realized losses. For a discussion on the determination of an other than temporary decline, please refer to Note 1 of the consolidated financial statements. The Company recognized other than temporary writedowns of $43,000 in fiscal 2005. There were no writedowns in fiscal 2006 and 2004. Asset and Liability Management The Company's vulnerability to interest rate risk exists to the extent that its interest bearing liabilities, consisting of customer deposits and borrowings, mature or reprice more rapidly or on a different basis than its interest earning assets, which consist primarily of intermediate or long-term loans and investment securities, mortgage-backed securities and collateralized mortgage obligations. The principal determinant of the exposure of the Company's earnings to interest rate risk is the timing difference between the repricing or maturity of the Company's interest earning assets and the repricing or maturity of its interest bearing liabilities. If the repricing and maturities of such assets and liabilities were perfectly matched, and if the interest rates carried by its assets and liabilities were equally flexible and moved concurrently, neither of which is the case, the impact on net interest income of rapid increases or decreases in interest rates would be minimized. -------------------------------------------------------------------------------- Annual Report 2006 o Fidelity Bancorp, Inc. and Subsidiary 45 MANAGEMENT'S DISCUSSION AND ANALYSIS (CONTINUED) The objective of interest rate risk management is to control, to the extent possible, the effects that interest rate fluctuations have on net interest income and on the net present value of the Company's interest earning assets and interest bearing liabilities. Management and the Board are responsible for managing interest rate risk and employing risk management policies that monitor and limit exposure to interest rate risk. Interest rate risk is measured using net interest margin simulation and asset/liability net present value sensitivity analyses. These analyses provide a range of potential impacts on net interest income and portfolio equity caused by interest rate movements. The Company uses financial modeling to measure the impact of changes in interest rates on net interest margin. Assumptions are made regarding loan and mortgage-backed securities prepayments and amortization rates of passbook, money market and NOW account withdrawal rates. In addition, certain financial instruments may provide customers with a degree of "optionality," whereby a shift in interest rates may result in customers changing to an alternative financial instrument, such as from a variable to fixed rate loan product. Thus, the effects of changes in future interest rates on these assumptions may cause actual results to differ from simulation results. The Company has established the following guidelines for assuming interest rate risk: Net interest margin simulation - Given a +/- 200 basis point parallel shift in interest rates, the estimated net interest margin may not change by more than 20% for a one-year period. Portfolio equity simulation - Portfolio equity is the net present value of the Company's existing assets and liabilities. Given a +200 basis point change in interest rates, portfolio equity may not decrease by more than 50% of total stockholders' equity. Given a -200 basis point change in interest rates, portfolio equity may not decrease by more than 20% of total stockholders' equity. The following table illustrates the simulated impact of a 100 basis point or 200 basis point upward or downward movement in interest rates on net interest income and the change in portfolio equity. This analysis was done assuming that interest earning asset and interest bearing liability levels at September 30, 2006 remained constant. The impact of the rate movements was developed by simulating the effect of rates changing immediately from the September 30, 2006 levels. Interest Rate Simulation Sensitivity Analysis Movements in interest rates from September 30, 2006 rates: Increase Decrease --------------------------------------------------------------------------------------- +100 bp +200 bp -100 bp -200 bp --------------------------------------------------------------------------------------- Net interest income increase(decrease) (12.5%) (25.6%) 4.9% 4.2% Portfolio equity increase (decrease) (23.2%) (50.2%) 12.3% 18.0% The matching of assets and liabilities may be analyzed by examining the extent to which such assets and liabilities are "interest rate sensitive" and by monitoring an institution's interest rate sensitivity "gap." An asset or liability is said to be interest rate sensitive within a specific time period if it will mature or reprice within that time period. The interest rate sensitivity gap is defined as the difference between interest earning assets and interest bearing liabilities maturing or repricing within a given time period. A gap is considered positive when the amount of interest rate sensitive assets exceeds interest rate sensitive liabilities. A gap is considered negative when the amount of interest rate sensitive liabilities exceeds interest rate sensitive assets. During a period of rising interest rates, a negative gap would tend to adversely affect net interest income, while a positive gap would -------------------------------------------------------------------------------- 46 Annual Report 2006 o Fidelity Bancorp, Inc. and Subsidiary MANAGEMENT'S DISCUSSION AND ANALYSIS (CONTINUED) tend to result in an increase in net interest income. During a period of falling interest rates, a negative gap would tend to result in an increase in net interest income, while a positive gap would tend to adversely affect net interest income. The Company's one-year gap was a negative 23.4% at September 30, 2006 compared to a negative 8.5% at September 30, 2005. The Company considers this result at September 30, 2006 to be within its acceptable target range. The increase in the negative gap position is attributed to an increase in liabilities with shorter terms. During fiscal 2006, customers sought shorter-term deposit products, particularly money market deposit accounts, in anticipation of rising interest rates. In addition, the Company utilized short-term borrowings, as well as long-term fundings with adjustable-rate features, to supplement shortfalls in deposit growth. As part of its efforts to minimize the impact of changes in interest rates, the Company continues to emphasize the origination of loans with adjustable-rate features or which have shorter average lives, the purchase of adjustable-rate securities, the extension of interest bearing liabilities when market conditions permit, and the maintenance of a large portion of the investment and mortgage-backed securities portfolios in the available for sale category that could be sold in response to interest rate movements. The table below shows the Bank's gap position at September 30, 2006. Assumptions used in developing the table include cash flow and repricing projections for assets and liabilities. In developing the cash flow projections, prepayment estimates for loans and investments were also used. At September 30, 2006, these estimates anticipate a moderate rate of prepayment due to the relatively low interest rate environment that continues to exist. The assumptions used may not be indicative of the actual prepayments and withdrawals which may be experienced by the Company. September 30, 2006 ----------------------------------------------------------------------------------------------------------- Over Three Three Months After One Months or Through Year Through After Five Less Twelve Months Five Years Years ----------------------------------------------------------------------------------------------------------- (Dollars in Thousands) Interest earning assets $ 131,103 $ 98,899 $ 335,115 $ 139,746 Deposits, escrow liabilities and borrowed funds 283,962 116,640 218,124 62,320 ----------------------------------------------------------------------------------------------------------- Interest sensitivity $ (152,859) $ (17,741) $ 116,991 $ 77,426 =========================================================================================================== Cumulative interest sensitivity $ (152,859) $ (170,600) $ (53,609) $ 23,817 Cumulative ratio as a percent of assets (20.9%) (23.4%) (7.3%) 3.3% In addition to managing the Company's gap as discussed above, the Bank has an Asset Liability Management Committee composed of senior officers which meets periodically to review the Company's exposure to interest rate risk resulting from other factors. Among the areas reviewed are progress on previously determined strategies, national and local economic conditions, the projected interest rate outlook, loan and deposit demand, pricing, liquidity position, capital position and regulatory developments. Management's evaluation of these factors indicates the current strategies of emphasizing the origination and purchase of adjustable rate or shorter-term loan products, while retaining in the portfolio, a portion of the fixed rate loans originated, purchasing investments with either fixed or adjustable rates and competitively pricing deposits produces an acceptable level of interest rate risk in the current environment. -------------------------------------------------------------------------------- Annual Report 2006 o Fidelity Bancorp, Inc. and Subsidiary 47 MANAGEMENT'S DISCUSSION AND ANALYSIS (CONTINUED) Liquidity and Capital Resources The Company has no operating business other than that of the Bank. The Company's principal liquidity needs are for the payment of dividends and the payment of interest on its outstanding subordinated debt. The Company's principal sources of liquidity are earnings on its investment securities portfolio and dividends received from the Bank. The Bank is subject to various regulatory restrictions on the payment of dividends. At September 30, 2006, the Bank could pay approximately $1.1 million in dividends to the Company without prior approval from regulators. The Bank's primary sources of funds have historically consisted of deposits, amortization and prepayments of outstanding loans and mortgage-backed securities, borrowings from the FHLB of Pittsburgh and other sources, including repurchase agreements and sales of investments. During fiscal 2006, the Bank used its capital resources primarily to meet its ongoing commitments to fund maturing savings certificates and savings withdrawals, fund existing and continuing loan commitments and asset growth, and to maintain its liquidity. At September 30, 2006 the total of approved loan commitments amounted to $7.4 million and the Company had $13.4 million of undisbursed loan funds. Unfunded commitments under lines and letters of credit amounted to $43.6 million at September 30, 2006. The amount of savings certificates which are scheduled to mature in the twelve-month period ended September 30, 2007 is $99.8 million. Management believes that, by evaluation of competitive instruments and pricing in its market area, it can, in most circumstances, manage and control maturing deposits so that a substantial amount of such deposits are redeposited in the Company. Contractual Obligations The following table represents the Company's balance sheet aggregate contractual obligations to make future payments as of September 30, 2006 September 30, 2006 ----------------------------------------------------------------------------------------------------------- One Three Less Year to Years to Than Three Five Over Five Total One Year Years Years Years ----------------------------------------------------------------------------------------------------------- (Dollars in Thousands) Long-Term Debt Obligations: Time deposits $168,815 $ 99,821 $55,038 $ 12,177 $ 1,779 FHLB Advances 94,292 10,000 40,000 39,292 5,000 Structured reverse repurchase agreements 75,000 - - 60,000 15,000 Subordinated debt 10,310 - - - 10,310 Operating leases 698 225 264 131 78 ----------------------------------------------------------------------------------------------------------- Total $349,115 $110,046 $95,302 $111,600 $32,167 =========================================================================================================== In addition, the Company, in the conduct of ordinary business operations routinely enters into contracts for services. These contracts may require payment for services to be provided in the future and may also contain penalty clauses for the early termination of the contract. Management is not aware of any additional commitments or contingent liabilities, which may have a material adverse impact on the liquidity or capital resources of the Company. -------------------------------------------------------------------------------- 48 Annual Report 2006 o Fidelity Bancorp, Inc. and Subsidiary MANAGEMENT'S DISCUSSION AND ANALYSIS (CONTINUED) Off-Balance Sheet Arrangements The Company is also party to financial instruments with off-balance sheet risk in the normal course of business to meet the financing needs of its customers. These financial instruments include commitments to extend credit and standby letters of credit. The Company is not party to any off-balance sheet arrangements that are reasonably likely to have a material current or future effect on the Company's financial condition, revenues or expenses, results of operations, liquidity or capital expenditures or resources. Capital At September 30, 2006, the Company had capital in excess of all applicable regulatory capital requirements. At September 30, 2006, the ratio of the Company's Tier 1 capital to average assets was 7.46%. The Company's ratio of Tier 1 capital to risk-weighted assets was 12.06% and its ratio of total capital to risk-weighted assets was 12.73%. The Bank currently exceeds all regulatory capital requirements, having a leverage ratio of Tier 1 capital to total average assets of 6.26%, a ratio of Tier 1 capital to risk-weighted assets of 9.62%, and a ratio of qualifying total capital to risk-weighted assets and off-balance sheet items of 10.24% at September 30, 2006. As a result, regulatory capital requirements are not expected to have a material impact on operations. Financial Condition The Company's assets were $730.7 million at September 30, 2006, an increase of $53.0 million or 7.8% over assets at September 30, 2005. Increases were noted in net loans receivable, partially offset by decreases in securities and cash. The growth was primarily funded by deposits. Loan Portfolio Net loans receivable increased $93.0 million or 26.9% to $439.0 million at September 30, 2006 from $346.1 million at September 30, 2005. Loans originated totaled $183.7 million in fiscal 2006, including amounts disbursed under lines of credit, versus $158.6 million in fiscal 2005. Mortgage loans originated amounted to $108.5 million, including $4.4 million originated for sale, and $102.3 million, including $2.7 million originated for sale, in fiscal 2006 and 2005, respectively. The Bank did not purchase any mortgage loans in fiscal 2006 or fiscal 2005. The increase in the level of mortgage loan originations in fiscal 2006 primarily reflects the continuing low interest rate environment that existed during fiscal 2006. The origination of adjustable rate mortgages (ARM's) decreased to $53.8 million in fiscal 2006 from $62.2 million in fiscal 2005. The decrease reflected the increased popularity of fixed rate loans with customers as mortgage rates were low. Primarily for asset/liability management purposes, the Company initiated a program in fiscal 2001 in which a portion of the fixed rate, single-family mortgage loans originated were sold. Gains of $49,000 were realized on these sales in fiscal 2006. Principal repayments on outstanding mortgage loans decreased to $40.9 million in fiscal 2006 as compared to $51.2 million in fiscal 2005, reflecting less customer refinancing. The combination of the above factors resulted in an overall increase in mortgage loans receivable to $323.9 million at September 30, 2006 from $260.3 million at September 30, 2005. Other loan originations, including installment loans, commercial business loans and disbursements under lines of credit totaled $75.2 million in fiscal 2006 versus $56.4 million in fiscal 2005. During fiscal 2006, the Bank continued to emphasize other loans, particularly home equity loans, equity lines of credit, and commercial business loans, since they generally have shorter terms than mortgage loans and would perform better in a rising rate environment. Installment loan originations and consumer lines of credit disbursements were $37.4 million in fiscal 2006 compared to $25.7 million in fiscal 2005. Commercial business loan originations and business line of credit disbursements were $37.8 million in fiscal 2006 compared to $30.7 million in fiscal 2005. Principal -------------------------------------------------------------------------------- Annual Report 2006 o Fidelity Bancorp, Inc. and Subsidiary 49 MANAGEMENT'S DISCUSSION AND ANALYSIS (CONTINUED) repayments on other loans were $55.3 million in fiscal 2006 compared to $52.7 million in 2005. The net result of the above factors caused the balance of installment loans to increase to $93.3 million at September 30, 2006, as compared to $79.8 million at September 30, 2005. Commercial business loans and leases were $38.2 million at September 30, 2006 versus $32.0 million at September 30, 2005. Non-Performing Assets The following table sets forth information regarding non-accrual loans and foreclosed real estate at the dates indicated. The table does not include $255,000, $53,000 and $481,000 in loans at September 30, 2006, 2005 and 2004, respectively, that were more than 90 days past maturity but were otherwise performing in accordance with their terms. The Bank did not have any loans which were classified as troubled debt restructurings at the dates presented. September 30, 2006 2005 2004 -------------------------------------------------------------------------------------------------------- (Dollars in Thousands) Non-accrual residential real estate loans (one-to-four family) $ 403 $ 533 $ 777 Non-accrual construction, multi-family residential and commercial real estate loans 344 179 269 Non-accrual installment loans 238 188 530 Non-accrual commercial business and lease loans 1,700 1,419 2,071 -------------------------------------------------------------------------------------------------------- Total non-performing loans $2,685 $2,319 $3,647 ======================================================================================================== Total non-performing loans as a percent of net loans receivable 0.61% 0.67% 1.26% ======================================================================================================== Total foreclosed real estate, net of related reserves $ 215 $ 789 $1,517 ======================================================================================================== Total non-performing loans and foreclosed real estate as a percent of total assets 0.40% 0.46% 0.82% ======================================================================================================== At September 30, 2006, non-accrual loans consisted of seven 1-4 family residential real estate loans totaling $403,000, one commercial real estate loan totaling $344,000, eighteen installment loans totaling $238,000 and seven commercial business loans totaling $1.70 million. The largest individual non-accrual loan is a commercial business loan for $768,000. Management has evaluated these loans and is satisfied that the allowance for loan losses at September 30, 2006 is adequate. The allowance for loan losses was $2.917 million at September 30, 2006, $2.596 million at September 30, 2005, and $2.609 million at September 30, 2004. The balance at September 30, 2006, at .66% of net loans receivable and 108.6% of non-performing loans, is considered reasonable by management. Foreclosed real estate at September 30, 2006 consists of seven single-family houses, and two commercial real estate properties, all of which are located in the Bank's market area. Management believes that the carrying value of the properties at September 30, 2006 approximates the fair value less costs to sell. However, while management uses the best information available to make such determinations, future adjustments may become necessary. -------------------------------------------------------------------------------- 50 Annual Report 2006 o Fidelity Bancorp, Inc. and Subsidiary MANAGEMENT'S DISCUSSION AND ANALYSIS (CONTINUED) Securities Available for Sale Securities available for sale decreased $16.7 million to $165.4 million at September 30, 2006 from $182.2 million at September 30, 2005. These securities may be held for indefinite periods of time and are generally used as part of the Bank's asset/liability management strategy. These securities may be sold in response to changes in interest rates, prepayment rates or to meet liquidity needs. These securities consist of mortgage-backed securities, collateralized mortgage obligations, U.S. Government and Agency securities, tax-exempt municipal obligations, mutual funds, Federal Home Loan Mortgage Corporation stock, corporate obligations, trust preferred securities and other equity securities. During fiscal 2006, the Bank purchased $19.7 million of these securities and sold $16.8 million. Sales of these securities in fiscal 2006 resulted in a net pretax gain of $600,000. Fiscal 2005 results include a loss of $43,000, resulting from the write-down of investments in equity securities for declines in value that are considered other than temporary. There were no such write-downs during fiscal 2006. Securities Held to Maturity Securities held to maturity decreased $19.4 million or 18.5% to $85.9 million at September 30, 2006, compared to $105.3 million at September 30, 2005. These investments are comprised of mortgage-backed securities, collateralized mortgage obligations, U.S. Government and Agency securities, tax-exempt municipal securities and corporate obligations. During fiscal 2006, the Bank did not purchase any of these securities but sold $3.6 million. Sales of these securities in fiscal 2006 resulted in a net pretax loss of $48,000. The held-to-maturity sales qualified as maturities for purposes of FAS 115. There were no sales of held-to-maturity investment securities during fiscal 2005. Deposits Deposits increased $47.4 million during fiscal 2006 to $414.2 million at September 30, 2006 compared to $366.8 million at September 30, 2005. The increase in deposits in primarily attributed to an increase in money market accounts and time deposits, partially offset by decreases in passbook accounts and checking accounts. In April 2005 the Bank introduced a new Super Money Market product whose rate is based on current short-term market rates. Although a significant amount of new money to the Bank has been deposited in these accounts, the increase is also correlated to the decrease in passbook accounts, as customers sought a higher return. Furthermore, competition for time deposits from other banks and thrifts in the Bank's market area is intense. In addition, the Bank faces competition for these deposits from alternative sources such as the stock market and mutual funds. Short-Term Borrowings Short-term borrowings include Federal Home Loan Bank "RepoPlus" advances, a Federal Home Loan Bank revolving line of credit, federal funds purchased, and to a much lesser extent, treasury, tax and loan notes. These borrowings decreased $32.5 million to $78.6 million at September 30, 2006, from $111.1 million at September 30, 2005. The decrease was a result of the Bank converting some of these fundings to structured repurchase agreements with adjustable-rate features, as well as the increase in the Bank's deposits. The Bank continues to utilize short-term borrowings as both a short-term funding source and as an effective means to structure borrowings to complement asset/liability management goals. -------------------------------------------------------------------------------- Annual Report 2006 o Fidelity Bancorp, Inc. and Subsidiary 51 MANAGEMENT'S DISCUSSION AND ANALYSIS (CONTINUED) Subordinated Debt Subordinated debt represents debt issued by the Company to the Trust in conjunction with the issuance of trust preferred securities by the Trust. The debt is unsecured and ranks subordinated and junior in right of payment to all indebtedness, liabilities and obligations of the Company. The debt is due concurrently with the trust preferred securities. Subordinated debt was $10.3 million at both September 30, 2006 and September 30, 2005. Long-Term Debt Long-term debt represents FHLB advances, including fixed-rate advances and "Convertible Select" advances. Long-term debt decreased $41.7 million or 30.7% to $94.3 million at September 30, 2006, from $136.0 million at September 30, 2005. As noted above, structured repurchase agreements were utilized to replace short-term borrowings and long-term debt consistent with asset/liability management strategies. Securities Sold Under Agreements To Repurchase Securities sold under agreements to repurchase represents retail and structured borrowings. Securities sold under agreement to repurchase increased $77.0 million or 1153.2% to $83.6 million at September 30, 2006, from $6.7 million at September 30, 2005. As noted above, structured repurchase agreements were utilized to replace short-term borrowings and long-term debt consistent with asset/liability management strategies. Stockholders' Equity Stockholders' equity increased $2.1 million or 5.1% to $44.2 million at September 30, 2006 compared to September 30, 2005. This result reflects net income of $4.18 million, stock options exercised of $264,000, and a related tax benefit of $43,000, stock issued under the Dividend Reinvestment Plan of $151,000, and stock based compensation of $66,000. Offsetting these increases was an increase in unrealized holding losses, net of unrealized holding gains, on securities available for sale of $571,000, common stock cash dividends paid of $1.6 million and the purchase of treasury stock at cost for $397,000. Results of Operations Comparison of Fiscal Years Ended September 30, 2006, 2005, and 2004 Net income was $4.18 million ($1.38 per diluted share) for the year ended September 30, 2006 compared to $3.88 million ($1.27 per diluted share) for fiscal 2005 and $4.32 million ($1.40 per diluted share) for fiscal 2004. Fiscal 2006 results include a $318,000 extraordinary gain which was recorded in the fourth quarter. The gain was related to insurance proceeds received from the destructive fire that devastated the Bank's Carnegie Branch location in October 2005. While the insurance proceeds were reinvested in the construction of the new Carnegie Branch location, the proceeds, net of the book value of the associated assets at the time of the fire, were recorded as a gain in accordance with accounting literature. There were no extraordinary items recorded in fiscal 2005 and fiscal 2004. Income from continuing operations for the fiscal year ended September 30, 2006 was $3.87 million ($1.28 per diluted share) compared to $3.88 million ($1.27 per diluted share) for the fiscal year ended September 30, 2005 and $4.32 million ($1.40 per diluted share) for the fiscal year ended September 30, 2004. Factors contributing to the decrease in net income from continuing operations from fiscal 2005 include a decrease in net interest income of $282,000 or 2.04% which offset an increase in other income of $45,000, or 1.19%, a decrease in the provision for income taxes of $160,000, or 16.00%, and a decrease in other expenses of $67,000, or .55%. -------------------------------------------------------------------------------- 52 Annual Report 2006 o Fidelity Bancorp, Inc. and Subsidiary MANAGEMENT'S DISCUSSION AND ANALYSIS (CONTINUED) Interest Rate Spread The Bank's interest rate spread, the difference between yields on interest earning assets and the cost of funds, decreased to 2.03% on a tax-equivalent basis in fiscal 2006 from 2.26% in fiscal 2005. The tax-equivalent spread was 2.31% in fiscal 2004. The following table shows the average tax-equivalent yields earned on the Bank's interest earning assets and the average rates paid on its interest bearing liabilities for the periods indicated, the resulting interest rate spreads, and the net yields on interest earning assets. Fiscal Years Ended September 30, 2006 2005 2004 -------------------------------------------------------------------------------------------------------------- Average yield on: Mortgage loans 5.88 % 6.00 % 6.37 % Mortgage-backed securities and collateralized mortgage obligations 4.33 3.94 3.53 Installment loans 6.25 5.90 5.96 Commercial business loans and leases 8.54 6.29 5.83 Interest earning deposits with other institutions, investment securities, and FHLB stock(1) 5.21 4.66 4.41 -------------------------------------------------------------------------------------------------------------- Total interest earning assets 5.62 5.17 5.06 -------------------------------------------------------------------------------------------------------------- Average rates paid on: Deposits 2.76 2.12 2.09 Borrowed funds 4.81 4.08 3.84 -------------------------------------------------------------------------------------------------------------- Total interest bearing liabilities 3.59 2.91 2.75 -------------------------------------------------------------------------------------------------------------- Average interest rate spread 2.03 % 2.26 % 2.31 % =============================================================================================================- Net yield on interest earning assets 2.12 % 2.34 % 2.39 % ============================================================================================================== (1) Interest income on tax-exempt investments has been adjusted for federal income tax purposes using a rate of 34%. Interest Income on Loans Interest income on loans increased by $5.6 million or 29.6% to $24.4 million in fiscal 2006 as compared to fiscal 2005. The increase primarily reflects both an increase in the average size of the loan portfolio and an increase in the average yield earned on the loan portfolio. The average size of the loan portfolio increased from an average balance of $314.2 million in fiscal 2005 to $396.5 million in fiscal 2006. The increase in the average balance of the loan portfolio is primarily attributed to a record high level of residential mortgage loan originations in fiscal 2006. Interest income on loans increased by $1.5 million or 8.4% to $18.9 million in fiscal 2005 as compared to fiscal 2004. The increase primarily reflects an increase in the average size of the loan portfolio, partially offset by a decrease in the average yield earned on the loan portfolio. The average size of the loan portfolio increased from an average balance of $280.7 million in fiscal 2004 to $314.2 million in fiscal 2005. -------------------------------------------------------------------------------- Annual Report 2006 o Fidelity Bancorp, Inc. and Subsidiary 53 MANAGEMENT'S DISCUSSION AND ANALYSIS (CONTINUED) Interest Income on Mortgage-Backed Securities Interest income on mortgage-backed securities decreased by $333,000 or 6.2% to $5.1 million in fiscal 2006 from $5.4 million in fiscal 2005. The decrease reflects a decrease in the average balance of mortgage-backed securities held, partially offset by an increase in the yield earned on these securities in fiscal 2006. The average balance of mortgage-backed securities held, including mortgage-backed securities available for sale, decreased from $136.8 million in fiscal 2005 to $116.8 million in fiscal 2006. The yield earned on mortgage-backed securities is affected, to some degree, by the repayment rate of loans underlying the securities. Premiums or discounts on the securities, if any, are amortized to interest income over the life of the securities using the level yield method. During periods of falling interest rates, repayments of the loans underlying the securities generally increase, which shortens the average life of the securities and accelerates the amortization of the premium or discount. Falling rates, however, also tend to increase the market value of the securities. A rising rate environment generally causes a reduced level of loan repayments and a corresponding decrease in premium/discount amortization rates. Rising rates generally decrease the market value of the securities. Interest income on mortgage-backed securities increased $947,000 or 21.3% to $5.4 million in fiscal 2005 from $4.4 million in fiscal 2004. The increase reflects both an increase in the average balance of mortgage-backed securities held, as well as an increase in the yield earned on these securities in fiscal 2005. The average balance of mortgage-backed securities held, including mortgage-backed securities available for sale, increased from $125.9 million in fiscal 2004 to $136.8 million in fiscal 2005. Interest Income on Investments Interest income on investments (including those available for sale), which includes interest earning deposits with other institutions and FHLB stock, was $7.9 million in fiscal 2006, compared to $7.4 million in fiscal 2005. The fiscal 2006 results reflect a decrease in the average balance of such investments to $167.9 million in fiscal 2006 as compared to $177.6 million in fiscal 2005, partially offset by an increase in the average tax-equivalent yield earned in fiscal 2006 as compared to fiscal 2005. Interest income on investments was $7.4 million in fiscal 2005 compared to $7.5 million in fiscal 2004. The fiscal 2005 results reflect a decrease in the average balance of such investments to $177.6 million in fiscal 2005 as compared to $192.9 million in fiscal 2004, partially offset by an increase in the average tax-equivalent yield earned in fiscal 2005 as compared to fiscal 2004. Interest Expense on Deposits Interest on deposits increased $3.2 million or 41.3% to $10.9 million in fiscal 2006 from $7.7 million in fiscal 2005. The increase reflects both an increase in the average balance of deposits, as well as an increase in the average rate paid on deposits in fiscal 2006, as compared to fiscal 2005. Interest on deposits increased $75,000 or 1.0% to $7.7 million in fiscal 2005 from $7.6 million in fiscal 2004. The increase reflects an increase in the average rate paid on deposits in fiscal 2005, as compared to fiscal 2004, partially offset by a decrease in the average balance of deposits in fiscal 2005. -------------------------------------------------------------------------------- 54 Annual Report 2006 o Fidelity Bancorp, Inc. and Subsidiary MANAGEMENT'S DISCUSSION AND ANALYSIS (CONTINUED) Interest Expense on Short-Term Borrowings Interest expense on short-term borrowings (including FHLB "RepoPlus" advances, FHLB revolving line of credit, federal funds purchased, and treasury, tax and loan notes) increased $2.2 million or 87.8% to $4.7 million in fiscal 2006 compared to fiscal 2005. The increase reflects both a higher level of average short-term borrowing in fiscal 2006 and an increase in the cost of these funds. The Bank continues to use short-term borrowings as cost effective sources of funding in fiscal 2006. Interest expense on short-term borrowings increased $1.8 million or 242.5% to $2.5 million in fiscal 2005 compared to $732,000 in fiscal 2004. The increase reflects both a higher level of average short-term borrowing in fiscal 2005 and an increase in the cost of these funds. Interest Expense on Securities Sold Under Agreement to Repurchase Interest expense on securities sold under agreement to repurchase (including retail and structured borrowings) increased $1.2 million or 932.1% to $1.4 million in fiscal 2006 compared to fiscal 2005. The increase reflects both a higher level of average securities sold under agreement to repurchase in fiscal 2006 and an increase in the cost of these funds. Interest expense on securities sold under agreement to repurchase increased $74,000 or 129.8% to $131,000 in fiscal 2005 compared to $57,000 in fiscal 2004. The increase reflects both a higher level of average securities sold under agreement to repurchase in fiscal 2005 and an increase in the cost of these funds. Interest Expense on Long-Term Debt Interest expense on long-term debt (including FHLB fixed rate advances, and "Convertible Select" advances ) decreased $818,000 or 12.0% to $6.0 million in fiscal 2006, compared to $6.8 million in fiscal 2005. The decrease reflects a decrease in the average balance of long-term debt, partially offset by an increase in the cost of these borrowings. Interest expense on long-term debt decreased $265,000 or 3.7% to $6.8 million in fiscal 2005 compared to fiscal 2004. The decrease reflects a decrease in the average balance of long-term debt, as well as a slight decrease in the cost of these borrowings. Provision for Loan Losses The provision for loan losses is charged to operations to bring the total allowance for loan losses to a level that represents management's best estimates of the losses inherent in the portfolio, based on a monthly review by management of the following factors: o historical experience; o volume; o type of lending conducted by the Bank; o industry standards; o the level and status of past due and non-performing loans; o the general economic conditions in the Bank's lending area; and o other factors affecting the collectibility of the loans in its portfolio. -------------------------------------------------------------------------------- Annual Report 2006 o Fidelity Bancorp, Inc. and Subsidiary 55 MANAGEMENT'S DISCUSSION AND ANALYSIS (CONTINUED) Large groups of smaller balance homogenous loans, such as residential real estate, small commercial real estate and home equity and consumer loans, are evaluated in the aggregate using historical loss factors and other data. Large balance and/or more complex loans, such as multi-family and commercial real estate loans may be evaluated on an individual basis and are also evaluated in the aggregate to determine adequate reserves. As individually significant loans become impaired, specific reserves are assigned to the extent of the impairment. The provision for loan losses was $600,000 for the fiscal years ended September 30, 2006 and 2005. The provision for loan losses was $275,000 for the fiscal year ended September 30, 2004. The provisions reflect management's evaluation of the loan portfolio, current economic conditions, and other factors as described below. The allowance increased from $2.60 million at September 30, 2005 to $2.92 million at September 30, 2006. Loan charge-offs, net of recoveries, were $279,000 in fiscal 2006 compared to $613,000 in fiscal 2005 and $757,000 in fiscal 2004. The balance of non-performing loans has increased at September 30, 2006 compared to September 30, 2005. The allowance for loan losses is maintained at a level that represents management's best estimate of losses in the loan portfolio at the balance sheet date. However, there can be no assurance that the allowance for losses will be adequate to cover losses which may be realized in the future and that additional provisions for losses will not be required. Other Income Fidelity's non-interest or total other income increased by $45,000 or 1.2% to $3.83 million in fiscal 2006 compared to $3.79 million in fiscal 2005. Other income increased by $21,000 or .6% to $3.79 million in fiscal 2005 as compared to $3.78 million in fiscal 2004. Included in non-interest income is service fee income on loans and late charges of $294,000, which decreased by $69,000 in fiscal 2006. These fees were relatively unchanged in fiscal 2005 over the prior year. Fiscal 2006 results include decreases in late charges on loans and title insurance fees. The Company recorded net gains on sales of securities of $552,000, $566,000 and $639,000 in fiscal 2006, 2005 and 2004, respectively. The Company recorded net gains on available-for-sale securities of $600,000 and net losses on held-to maturity securities of $48,000 during fiscal 2006. Sales during fiscal years 2005 and 2004 were made from the available-for sale category only. The sales reflected normal efforts to reposition portions of the portfolio at various times during the years to reflect changing economic conditions, changing market conditions and to carry out asset/liability management strategies. Included in the above amounts are losses resulting from the write-down of investments in equity securities for declines in value that are considered other-than-temporary of $43,000 in fiscal year 2005. There were no similar write-downs in fiscal years 2006 or 2004. Gain on sale of loans was $49,000, $36,000, and $47,000 in fiscal years 2006, 2005 and 2004, respectively. In fiscal 2001, the Company began a program to sell, servicing released, a portion of the fixed-rate, first mortgage residential loans originated. This program is intended to allow the Company to offer competitive market rates on loans, while not retaining in portfolio some loans that may not fit the current asset/liability strategy. In addition, such loans can generally be sold at a profit when a commitment to sell is locked in when the application is taken. In addition, the Company sells a portion of the loans originated under low-income housing programs in which it participates in the Pittsburgh area. Deposit service charges and fee income was $1.37 million, $1.40 million, and $1.39 million, in fiscal 2006, 2005 -------------------------------------------------------------------------------- 56 Annual Report 2006 o Fidelity Bancorp, Inc. and Subsidiary MANAGEMENT'S DISCUSSION AND ANALYSIS (CONTINUED) and 2004, respectively. Fiscal 2006 results include a decrease in service charge fees on savings and checking accounts, partially offset by an increase in fees related to returned checks. The increase in fiscal 2005 is primarily attributed to a slight increase in service charge fees on savings and checking accounts and fees related to returned checks. Automated teller machine (ATM) fees were $586,000, $548,000, and $491,000 in fiscal years 2006, 2005, and 2004, respectively. The increase in fiscal 2006 and 2005 is primarily attributed to an increase in the interchange fees earned on debit card transactions. Non-insured investment product income was $414,000, $376,000, and $309,000 in fiscal years 2006, 2005, and 2004, respectively. The increase in fiscal 2006 and 2005 is primarily attributed to an increase in the commissions earned on the sales of these products. Other operating income includes miscellaneous sources of income, which consist primarily of earnings on bank-owned life insurance, fees from the sale of cashiers checks and money orders, and safe deposit box rental income. Such income amounted to $565,000, $498,000, and $531,000 in fiscal 2006, 2005, and 2004, respectively. Fiscal 2006 results were attributed to increases in the profit on sale of fixed assets. Also, fiscal 2006 results included recoveries relating to a customer check kiting fraud loss discovered in March 2005 attributable to one business customer. The decrease in fiscal 2005 primarily reflects decreases in the profit on sale of fixed assets. Other Expenses Other expenses decreased $67,000 or .6% to $12.1 million in fiscal 2006 and increased $678,000 or 5.9% to $12.2 million in fiscal 2005, from $11.5 million in fiscal 2004. The lower level of other expenses in fiscal 2006 compared to fiscal 2005 is primarily attributable to the fiscal 2005 loss of $430,000 due to customer fraud. Compensation, payroll taxes and fringe benefits, the largest component of operating expenses, increased $408,000 or 5.5% to $7.8 million in fiscal 2006, and increased $324,000 or 4.6% to $7.4 million in fiscal 2005 over the respective prior years. Factors contributing to the increase in fiscal 2006 were normal salary increases, increases in the cost of health insurance, increased director fees, increased payroll taxes, and increased training expenses, partially offset by decreases in personnel expense and officer's expense. Factors contributing to the increase in fiscal 2005 were normal salary increases for employees, increases in the cost of health insurance, increased retirement costs, increased payroll taxes, and increased training expenses. Office occupancy and equipment expense increased $72,000 or 6.7% to $1.15 million in fiscal 2006 and increased $52,000 or 5.1% to $1.08 million in fiscal 2005 over the respective prior years. The increase in fiscal 2006 reflects increases in furniture, fixtures and equipment expense, utility expense, rent expense and real estate taxes paid on office buildings, partially offset by a decrease in office repairs and maintenance expense. The increase in 2006 is also due to the opening of the new Carnegie branch. The increase in fiscal 2005 primarily reflects an increase in office repairs and maintenance expense and furniture, fixtures and equipment expense. Depreciation and amortization decreased $65,000 or 9.0% to $661,000 in fiscal 2006 and decreased $32,000 or 4.2% to $726,000 in fiscal 2005 over the respective prior years. The decrease in depreciation in fiscal 2006 reflects equipment becoming fully depreciated, partially offset by depreciation on additions in fiscal 2006. The result in fiscal 2005 reflects equipment becoming fully depreciated, partially offset by depreciation on additions in fiscal 2005. -------------------------------------------------------------------------------- Annual Report 2006 o Fidelity Bancorp, Inc. and Subsidiary 57 MANAGEMENT'S DISCUSSION AND ANALYSIS (CONTINUED) The Bank recorded net losses on the sales of and writedowns of foreclosed real estate of $58,000 in fiscal year 2006 and recorded net gains of $103,000 and $78,000 in fiscal years 2005 and 2004, respectively. The results reflect the costs associated with the holding and disposition of properties during the periods. At September 30, 2006, the Bank had seven single-family residential properties, six of which were owned by the same borrower as investment properties, and two commercial real estate property classified as foreclosed real estate. Intangible amortization was $40,000, $46,000, and $52,000 in fiscal years 2006, 2005 and 2004, respectively. The results reflect the amortization of the intangibles generated by the acquisitions of Pennwood Bancorp, Inc. in July 2000, Carnegie Financial Corporation in February 2002, and First Pennsylvania Savings Association in December 2002, on an accelerated basis over ten years. Advertising expense was $360,000, $340,000, and $350,000 in fiscal years 2006, 2005, and 2004, respectively. The Company strives to market its products and services in a cost effective manner and incorporates a market segmentation strategy in its business plan to effectively manage its advertising dollars. Professional fees were $267,000, $244,000, and $344,000 in fiscal years 2006, 2005, and 2004, respectively. Professional fees include legal fees, audit fees, and supervisory examination and assessment fees. The increase in fiscal 2006 is primarily attributed to an increase in legal fees, partially offset by a decrease in audit fees. The decrease in fiscal 2005 includes a decrease in legal fees. Included in fiscal 2005 results is a pre-tax charge of $430,000 related to a customer check kiting fraud loss attributable to one business customer. While a portion or all of the loss may ultimately be recovered, the customer was unable to provide restitution or adequate collateral at that time; however, as of September 30, 2006 approximately $27,000 has been recovered and included in other income. Other operating expenses, which consist primarily of check processing costs, bank service charges, and other administrative expenses, amounted to $1.55 million in fiscal 2006, $1.71 million in fiscal 2005, and $1.72 million in fiscal 2004. Significant variations in fiscal 2006, compared to fiscal 2005, include decreases in consulting fees, and losses sustained from ATM disputes, partially offset by increases in checking account charge-offs and losses sustained from branch robberies. Significant variations in fiscal 2005, compared to fiscal 2004, include increases in check printing charges, consulting fees, construction loan inspection fees, stationery and supplies expense, and losses sustained from ATM disputes, partially offset by decreases in bank service charges, checking account charge-offs, ATM network fees, and losses sustained from branch robberies. The FDIC has adopted a new risk-based deposit insurance assessment system that will require all FDIC-insured institutions to pay quarterly premiums beginning in 2007. Annual premiums will range from 5 and 7 basis points for well-capitalized banks with the highest examination ratings to up to 43 basis points for undercapitalized institutions. The Bank will be able to offset the premium with an estimated assessment credit of $420,000 for premiums paid prior to 1996. -------------------------------------------------------------------------------- 58 Annual Report 2006 o Fidelity Bancorp, Inc. and Subsidiary MANAGEMENT'S DISCUSSION AND ANALYSIS (CONTINUED) Income Taxes The Company generated taxable income and, as a consequence, recorded tax provisions of $840,000, $1.00 million, and $1.02 million for fiscal 2006, 2005 and 2004, respectively. These changes reflect the difference in the Bank's profitability for the periods as well as differences in the effective tax rate, which was 17.8%, 20.5%, and 19.0% for fiscal 2006, 2005 and 2004, respectively. The difference between the Company's effective tax rate and the statutory rate is primarily attributable to the Bank's tax-exempt income. Tax-exempt income includes income earned on certain municipal investments that qualify for state and/or federal income tax exemption; income earned by the Bank's Delaware subsidiary which is not subject to state income tax, and earnings on Bank-owned life insurance policies which are exempt from federal taxation. State and federal tax-exempt income for fiscal 2006 was $8.0 million and $1.8 million, respectively, compared to $8.4 million and $1.7 million, respectively, for fiscal 2005, and $8.4 million and $2.0 million, respectively, for fiscal 2004. Forward-Looking Statements The Company may from time to time make written or oral "forward-looking statements," including statements contained in the Company's filings with the Securities and Exchange Commission (including this Annual Report and Form 10-K and the exhibits hereto and thereto), in its reports to stockholders and in other communications by the Company, which are made in good faith by the Company pursuant to the "safe harbor" provisions of the Private Securities Litigation Reform Act of 1995. These forward-looking statements include statements with respect to the Company's beliefs, plans, objectives, goals, expectations, anticipations, estimates and intentions, that are subject to significant risks and uncertainties and are subject to change based on various factors (some of which are beyond the Company's control). The words "may," "could," "should," "would," "believe," "anticipate," "estimate," "expect," "intend," "plan," and similar expressions are intended to identify forward-looking statements. The following factors, among others, could cause the Company's financial performance to differ materially from that expressed in such forward-looking statements: the strength of the United States economy in general and the strength of the local economies in which the Company conducts operations; the effects of, and changes in, trade, monetary and fiscal policies, including interest rate policies of the Board of Governors of the Federal Reserve System ("the FRB"); inflation; interest rate, market and monetary fluctuations; the timely development of competitive new products and services by the Company and the acceptance of such products and services by customers; the willingness of customers to substitute competitors' products and services for the Company's products and services and vice versa; laws concerning taxes, banking, securities and insurance; technological changes; future acquisitions; the expense savings and revenue enhancements from acquisitions being less than expected; the growth and profitability of the Company's noninterest or fee income being less than expected; unanticipated regulatory or judicial proceedings; changes in consumer spending and saving habits; and the success of the Company at managing the risks involved in the foregoing. The Company cautions that the foregoing list of important factors is not exclusive. The Company does not undertake to update any forward-looking statements, whether written or oral, that may be made from time to time by or on behalf of the Company. -------------------------------------------------------------------------------- Annual Report 2006 o Fidelity Bancorp, Inc. and Subsidiary 59 MANAGEMENT'S DISCUSSION AND ANALYSIS (CONTINUED) Impact of Inflation and Changing Prices The Consolidated Financial Statements and related notes presented herein have been prepared in accordance with generally accepted accounting principles which require the measurement of financial position and operating results in terms of historical dollars, without considering changes in the relative purchasing power of money over time due to inflation. Unlike most industrial companies, substantially all of the assets and liabilities of the Bank are monetary in nature. As a result, interest rates have a more significant impact on the Bank's performance than the effects of general levels of inflation. Interest rates do not necessarily move in the same direction or in the same magnitude as the prices of goods and services, since such prices are affected by inflation to a larger extent than interest rates. In the current interest rate environment, liquidity and the maturity structure of the Company's assets and liabilities are critical to the maintenance of acceptable performance levels. -------------------------------------------------------------------------------- 60 Annual Report 2006 o Fidelity Bancorp, Inc. and Subsidiary -------------------------------------------------------------------------------- CAPITAL STOCK INFORMATION -------------------------------------------------------------------------------- STOCK INFORMATION The following table sets forth for each quarter of fiscal 2006 and 2005 the high and low prices as reported on the NASDAQ Global Market System and the dividends declared per common share. Amounts shown have been adjusted to reflect the 10% stock dividend paid in May 2005. Stock Price Dividends -------------------------------------------------------------------------------- Quarter Ended: High Low Cash Stock -------------------------------------------------------------------------------- September 30, 2006 $19.95 $17.13 $.14 -- June 30, 2006 20.02 17.74 .14 -- March 31, 2006 20.17 18.37 .13 -- December 31, 2005 20.90 18.04 .13 -- -------------------------------------------------------------------------------- September 30, 2005 $21.45 $18.05 $.13 -- June 30, 2005 23.00 19.40 .13 10% March 31, 2005 22.60 20.73 .109 -- December 31, 2004 23.17 19.77 .109 -- -------------------------------------------------------------------------------- As of September 30, 2006, Fidelity Bancorp, Inc. had 2,960,496 shares of stock outstanding and approximately 1,000 stockholders, including beneficial owners whose stock is held in nominee name. COMMON STOCK MARKET MAKERS NASDAQ Global Market: Common Stock Symbol FSBI Market Makers Xxxxxx/Xxxxxx, Inc. 000 Xxxxx Xxxxxx, 00xx Xxxxx Xxxxxxxxxx, Xxxxxxxxxxxx 00000 -- (000)000-0000 Xxxx, Xxxx & Co. 00 Xxxxxxxx Xxxxxxxx Xxxxxxx, Xxx Xxxxxx 00000 -- (000) 000-0000 Xxxxxxx X'Xxxxx & Partners, LP 000 Xxxxx Xxxxxx, 0xx Xxxxx Xxx Xxxx, Xxx Xxxx 00000 -- (000)000-0000 -------------------------------------------------------------------------------- Annual Report 2006 - Fidelity Bancorp, Inc. and Subsidiary 61 -------------------------------------------------------------------------------- CORPORATE INFORMATION -------------------------------------------------------------------------------- ANNUAL MEETING -- The annual meeting of the stockholders will be held at 5:00 p.m., on February 13, 2007 at the Perrysville Office of the Bank at 0000 Xxxxx Xxxxxxx, Xxxxxxxxxx, Xxxxxxxxxxxx. Stockholders are encouraged to attend. ANNUAL REPORT ON FORM 10-K -- A copy of Fidelity Bancorp, Inc.'s Annual Report on Form 10-K is available without charge to stockholders upon written request. Requests should be addressed to Investor Relations at the Company's headquarters. Also, periodic reporting documents filed with the Securities and Exchange Commission can be found on the Company's website: xxx.xxxxxxxxxxxxxxx.xx.xxx. INVESTOR RELATIONS -- Analysts, investors, stockholders and others seeking financial information are asked to contact Xxxxx X. XxXxxxx, Corporate Secretary, at the Company's headquarters. Requests for all other information should be addressed to Investor Relations at the Company's headquarters. STOCK TRANSFER/ADDRESS CHANGES -- The Transfer Agent and Registrar of Fidelity Bancorp, Inc. is Registrar and Transfer Company. Questions regarding transfer of stock, address changes or lost certificates should be directed to Investor Relations at the Company's headquarters or the transfer agent, Registrar and Transfer Company. DIVIDEND REINVESTMENT PLAN INFORMATION -- The Fidelity Bancorp, Inc. Dividend Reinvestment Plan enables shareholders of common stock to reinvest quarterly dividends for the purchase of additional shares. Registered holders who enroll in this plan may also make optional cash purchases of additional shares of stock conveniently and without paying brokerage commissions or service charges. A brochure describing the plan and an application to participate may be obtained from Investor Relations. -------------------------------------------------------------------------------- INVESTOR RELATIONS DIVIDEND REINVESTMENT FINANCIAL INFORMATION Xxxxx X. XxXxxxx PLAN INFORMATION Xxxx X. Xxxxxxxx, CPA Fidelity Bancorp, Inc. Investor Relations Chief Financial Officer 1009 Perry Highway Fidelity Bancorp, Inc. Fidelity Bancorp, Inc. Pittsburgh, Pennsylvania 00000 0000 Xxxxx Xxxxxxx 0000 Xxxxx Xxxxxxx (000) 000-0000, x3139 Pittsburgh, Pennsylvania 00000 Xxxxxxxxxx, Xxxxxxxxxxxx 00000 (000) 000-0000, x3139 (000) 000-0000, x3180 TRANSFER AGENT Registrar and Transfer Company ANNUAL REPORT ON FORM 10-K 00 Xxxxxxxx Xxxxx Xxxxxxxx Xxxxxxxxx Xxxxxxxx, Xxx Xxxxxx 00000 Fidelity Bancorp, Inc. (800) 866-0000 0000 Xxxxx Xxxxxxx Xxxxxxxxxx, Xxxxxxxxxxxx 00000 (000) 000-0000, x 3139 or xxx.xxxxxxxxxxxxxxx-xx.xxx -------------------------------------------------------------------------------- 62 Annual Report 2006 - Fidelity Bancorp, Inc. and Subsidiary -------------------------------------------------------------------------------- FIDELITY BANCORP, INC. -------------------------------------------------------------------------------- Corporate Headquarters 0000 Xxxxx Xxxxxxx, Xxxxxxxxxx, Xxxxxxxxxxxx 00000 - (000) 000-0000 FAX (000) 000-0000 - E-Mail: XX@xxxxxxxxxxxxxxx-xx.xxx BOARD OF DIRECTORS ------------------ J. XXXXXX XXXXX XXXXXX X. XXXXX XXXXXX X. XXXXXX XXXXXXX X. XXXXXXX, CPA President President Owner President X.X. Xxxxx & Associates Allegheny Plywood Xxxxx X. Xxxx, P.C. Chief Executive Officer Partner XXXXXXXXXXX X. XXXXX APCO Management XXXXXXX X. XXXXXXXX XXXXXX XXXX XXXXXX Managing Partner Retired President Attorney Green & Bridges, LLP XXXXXX X. XXXXXXXX Xxxxxx & Xxxxxxxx, Inc. Xxxxxx & Xxxxxx, P.C. Registered Representative Retired President Retirement Designs Select Financial Group, LLC X-Mark/CDT Unlimited, Inc. XXXXXXX X. XXXXXXXX Chairman OFFICERS ------------------ XXXXXXX X. XXXXXXX, CPA XXXX X. XXXXXXXX, CPA XXXXX X. XxXXXXX President Senior Vice President Corporate Secretary Chief Executive Officer Chief Financial Officer Treasurer XXXXXXX X. XXXXXX XXXXXXX X. XXXXXX Assistant Secretary Executive Vice President SPECIAL COUNSEL ------------------ XXXXXXX SPIDI & XXXXX, PC 000 Xxx Xxxx Xxxxxx, Xxxxx 000 Xxxx Xxxxxxxxxx, XX 00000 INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM ---------------------- XXXXX XXXXXX COMPANY LLP 0000 Xxxxxxx Xxx Xxxx, 0xx Floor P.O. Box 101086 Pittsburgh, Pennsylvania 15237 -------------------------------------------------------------------------------- Annual Report 2006 - Fidelity Bancorp, Inc. and Subsidiary 63 -------------------------------------------------------------------------------- FIDELITY BANK -------------------------------------------------------------------------------- BANK HEADQUARTERS 0000 Xxxxx Xxxxxxx, Xxxxxxxxxx, Xxxxxxxxxxxx 00000 - (000) 000-0000 FAX (000) 000-0000 - E-Mail:XX@xxxxxxxxxxxx-xx.xxx BOARD OF DIRECTORS ------------------ J. XXXXXX XXXXX XXXXXX X. XXXXX XXXXXX X. XXXXXX XXXXXXX X. XXXXXXX, CPA President President Owner President X.X. Xxxxx & Associates Allegheny Plywood Xxxxx X. Xxxx, P.C. Chief Executive Officer Partner XXXXXXXXXXX X. XXXXX APCO Management XXXXXXX X. XXXXXXXX XXXXXX XXXX XXXXXX Managing Partner President Attorney Green & Bridges, LLP XXXXXX X. XXXXXXXX Xxxxxx & Xxxxxxxx, Inc. Xxxxxx & Xxxxxx, P.C. Registered Representative Retired President Retirement Designs Select Financial Group, LLC X-Mark/CDT Unlimited, Inc. XXXXXXX X. XXXXXXXX Chairman OFFICERS ------------------ XXXXXXX X. XXXXXXX, CPA XXXXXXX X. XXXXXXX XXXXXX X. XXXXXX President Vice President Assistant Vice President Chief Executive Officer Financial Advisor Business Development Officer XXXXXXX X. XXXXXX XXXX X. XXXXXXXX XXXXXXXXX X. XXXXXXX Executive Vice President Vice President Assistant Vice President Chief Lending Officer Consumer Lending Operations XXXXX X. XXXXXXX XXXXX X. XXXXXX XXXX X. XXXXXXX Corporate Secretary Vice President Assistant Vice President Marketing Business Development Officer XXXXXXX X. XXXXXX Senior Vice President XXXX X. XxXXXXX XXXX X. XXXXXX Human Resources Vice President Assistant Vice President Assistant Secretary Commercial Loan Officer Commercial Lending XXXX X. XXXXXXXX, CPA XXXXX X. XXXXXXXXX XXXXXXX X. XXXXX Senior Vice President Vice President Assistant Vice President Chief Financial Officer Internal Audit/Compliance Business Development Officer Treasurer XXXXX X. XXXXXXXX XXXXX X. TILL XXXXXX X. XXX Vice President Assistant Vice President Senior Vice President Chartered Financial Consultant Branch Manager Operations XXXXXX X. XXXXXX XXXXXXX X. XXXXXXX XXXXXXX X. XXXXX Vice President Assistant Vice President Senior Vice President Commercial Lending Data Processing Community Banking XXXXXX X. XXXXXX XXXXXX XXXXX XXXX XXXXX X. XXXXXXXXXX Assistant Vice President Assistant Vice President Vice President Business Development Officer Business Development Officer Financial Consultant/ Registered Principal XXXX X. XXXXXXX, CPA XXXXX X. XXX Assistant Vice President Assistant Vice President XXXXXXX X. XXXXXX Accounting Business Development Officer Vice President Residential Lending XXXX X. XXXXXXX Assistant Vice President Business Development Officer -------------------------------------------------------------------------------- 64 Annual Report 2006 - Fidelity Bancorp, Inc. and Subsidiary