**UNITED
      STATES SECURITIES AND EXCHANGE COMMISSION**


**WASHINGTON,
      DC 20549**





**FORM
      10-Q**





**ý**
            **Quarterly
                Report Pursuant to Section 13 or 15(d) of the Securities Exchange
                Act of
                1934**





For
      the
      quarterly period ended September 30, 2007





or





** ̈**
            **Transition
                Report Pursuant to Section 13 or 15(d) of the Securities Exchange
                Act of
                1934**





For
      the
      transition period
      from                                  to                     
      .





000-50330


Commission
      File Number





EAST
      PENN FINANCIAL CORPORATION


(Exact
      name of registrant as specified in its charter)





Pennsylvania
            
            65-1172823(State
                or other jurisdiction of
            
            (IRS
                Employer Identificationincorporation
                or organization)
            
            Number)





22
      South 2ndStreet,
      P.O. Box 869, Emmaus, Pennsylvania 18049


(Address
      of principal executive offices)





Registrant’s
      telephone number: 610-965-5959





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





YES
ý   NO
       ̈





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





Large
                Accelerated Filer  ̈
            Accelerated
                Filer   ̈
            Non-accelerated
                Filer ý





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





YES
 ̈   NO
      ý





APPLICABLE
      ONLY TO CORPORATE ISSUERS:





Indicate
      the number of shares outstanding of each of the issuer’s classes of common
      stock, as of the latest practicable date.





6,334,354
      shares of common stock, par value $0.625 per share, outstanding as of October
      31, 2007.











**EAST
      PENN FINANCIAL CORPORATION**





**INDEX**


**QUARTERLY
      REPORT ON FORM 10-Q**





**Page****Part  I.**
            **FINANCIAL
                INFORMATION**Item   1.
            Financial
                StatementsConsolidated
                Balance Sheets (unaudited)
            3September
                30, 2007 and December 31, 2006Consolidated
                Statements of Income
                (unaudited)
            4Three
                and nine months ended September 30, 2007
                andSeptember
                30, 2006Consolidated
                Statements of Stockholders’ Equity
                (unaudited)
            5Nine
                months ended September 30, 2007 and September 30,
                2006Consolidated
                Statements of Cash Flows
                (unaudited)
            6Nine
                months ended September 30, 2007 and September 30,
                2006Notes
                to Interim Consolidated Financial Statements
                (unaudited)
            7Item   2.
            Management’s
                Discussion and Analysis of Financial
                Condition
            13and
                Results of OperationsItem   3.
            Quantitative
                and Qualitative Disclosures About Market
                Risk
            25Item   4.
            Controls
                and Procedures
            25Item   4T.
            Controls
                and Procedures
            25**Part
                II.**
            **OTHER
                INFORMATION**Item   1.
            Legal
                Proceedings
            25Item   1A.
            Risk
                Factors
            25Item   2.
            Unregistered
                Sales of Equity Securities and Use of
                Proceeds
            26Item   3.
            Defaults
                Upon Senior Securities
            26Item   4.
            Submission
                of Matters to a Vote of Security
                Holders
            26Item   5.
            Other
                Information
            26Item   6.
            Exhibits
            26**SIGNATURES**
            28**EXHIBIT
                INDEX**
            29





Page
          2
 *Index*


**Part
      I.** **FINANCIAL
      INFORMATION**





**Item
      1.** **FINANCIAL
      STATEMENTS**





**EAST
      PENN FINANCIAL CORPORATION**


**CONSOLIDATED
      BALANCE SHEETS**


(Unaudited)





September
                30,
            
            
            December
                31,(In
                thousands, except share and per share data)
            
            2007
            
            
            2006**ASSETS**Cash
                and due from banks
            
            $
            7,301
            
            
            $
            7,785Interest
                bearing deposits
            
            
            2,464
            
            
            
            18Federal
                funds sold
            
            
            4,988
            
            
            
            15,151Cash
                and cash equivalents
            
            
            14,753
            
            
            
            22,954Securities
                available for sale
            
            
            64,961
            
            
            
            70,392Mortgages
                held for sale
            
            
            372
            
            
            
            373Loans,
                net of unearned income
            
            
            337,366
            
            
            
            322,800Less:
                allowance for loan losses
            
            
            (3,409
            )
            
            
            (3,258
            )Total
                net loans
            
            
            333,957
            
            
            
            319,542Bank
                premises and equipment, net
            
            
            9,213
            
            
            
            9,820Investment
                in restricted stock
            
            
            1,984
            
            
            
            2,230Bank
                owned life insurance
            
            
            8,025
            
            
            
            7,788Accrued
                interest receivable and other assets
            
            
            7,153
            
            
            
            6,353**Total
                assets**
            
            $
            440,418
            
            
            $
            439,452**LIABILITIES
                AND STOCKHOLDERS’ EQUITY****LIABILITIES**Deposits:Noninterest
                bearing
            
            $
            44,069
            
            
            $
            46,110Interest
                bearing
            
            
            328,694
            
            
            
            326,521Total
                deposits
            
            
            372,763
            
            
            
            372,631Securities
                sold under agreements to repurchase
            
            
            11,660
            
            
            
            6,749Long-term
                debt
            
            
            19,000
            
            
            
            24,000Junior
                subordinated debentures
            
            
            8,248
            
            
            
            8,248Accrued
                interest payable and other liabilities
            
            
            2,381
            
            
            
            2,663**Total
                liabilities**
            
            
            414,052
            
            
            
            414,291**STOCKHOLDERS’
                EQUITY**Preferred
                stock, no par value; authorized16,000,000
                shares; none issued
            
            
            -
            
            
            
            -Common
                stock, par value $0.625 per share;authorized
                40,000,000 shares; 2007 issued 6,642,646shares;
                outstanding 6,334,354 shares; 2006 issued6,613,554
                shares; outstanding 6,305,262 shares
            
            
            4,152
            
            
            
            4,134Surplus
            
            
            9,487
            
            
            
            9,272Retained
                earnings
            
            
            15,304
            
            
            
            14,417Accumulated
                other comprehensive loss
            
            
            (727
            )
            
            
            (812
            )Less:
                Treasury stock – at cost, 308,292 shares
            
            
            (1,850
            )
            
            
            (1,850
            )**Total
                stockholders’ equity**
            
            
            26,366
            
            
            
            25,161**Total
                liabilities and****stockholders’
                equity**
            
            $
            440,418
            
            
            $
            439,452




See
      Notes
      to Consolidated Financial Statements


Page
            3
 *Index*


**EAST
      PENN FINANCIAL CORPORATION**


**CONSOLIDATED
      STATEMENTS OF INCOME**


**Three
      Months and Nine Months Ended September 30, 2007 and 2006**


(Unaudited)





Three
                Months Ended
            
            
            Nine
                Months Ended(In
                thousands, except per share data)
            
            2007
            
            
            2006
            
            
            2007
            
            
            2006**Interest
                income**Interest
                and fee income on loans
            
            $
            5,611
            
            
            $
            5,234
            
            
            $
            16,380
            
            
            $
            14,795Securities:Taxable
            
            
            515
            
            
            
            565
            
            
            
            1,609
            
            
            
            1,838Tax-exempt
            
            
            229
            
            
            
            219
            
            
            
            708
            
            
            
            566Other
            
            
            150
            
            
            
            147
            
            
            
            586
            
            
            
            250**Total
                interest income**
            
            
            6,505
            
            
            
            6,165
            
            
            
            19,282
            
            
            
            17,449**Interest
                expense**Deposits
            
            
            2,772
            
            
            
            2,337
            
            
            
            8,222
            
            
            
            5,939Federal
                funds purchased and securitiessold
                under agreements to repurchase
            
            
            63
            
            
            
            33
            
            
            
            161
            
            
            
            198Long-term
                debt
            
            
            181
            
            
            
            274
            
            
            
            604
            
            
            
            891Junior
                subordinated debentures
            
            
            136
            
            
            
            136
            
            
            
            408
            
            
            
            408**Total
                interest expense**
            
            
            3,152
            
            
            
            2,780
            
            
            
            9,395
            
            
            
            7,436**Net
                interest income**
            
            
            3,353
            
            
            
            3,385
            
            
            
            9,887
            
            
            
            10,013Provision
                for loan losses
            
            
            135
            
            
            
            90
            
            
            
            270
            
            
            
            299**Net
                interest income after****provision
                for loan losses**
            
            
            3,218
            
            
            
            3,295
            
            
            
            9,617
            
            
            
            9,714**Other
                income**Customer
                service fees
            
            
            399
            
            
            
            412
            
            
            
            1,173
            
            
            
            1,189Mortgage
                banking activities, net
            
            
            34
            
            
            
            29
            
            
            
            123
            
            
            
            97Income
                from investment in life insurance
            
            
            81
            
            
            
            68
            
            
            
            237
            
            
            
            203Net
                realized gains on sale of other real estate owned
            
            
            -
            
            
            
            14
            
            
            
            -
            
            
            
            14Other
                income
            
            
            65
            
            
            
            76
            
            
            
            286
            
            
            
            306**Total
                other income**
            
            
            579
            
            
            
            599
            
            
            
            1,819
            
            
            
            1,809**Other
                expense**Salaries
                and employee benefits
            
            
            1,469
            
            
            
            1,496
            
            
            
            4,401
            
            
            
            4,450Occupancy
            
            
            289
            
            
            
            279
            
            
            
            891
            
            
            
            842Equipment
            
            
            217
            
            
            
            218
            
            
            
            639
            
            
            
            655Other
                operating expenses
            
            
            1,027
            
            
            
            780
            
            
            
            2,693
            
            
            
            2,346**Total
                other expense**
            
            
            3,002
            
            
            
            2,773
            
            
            
            8,624
            
            
            
            8,293**Income
                before income taxes**
            
            
            795
            
            
            
            1,121
            
            
            
            2,812
            
            
            
            3,230Federal
                income taxes
            
            
            84
            
            
            
            221
            
            
            
            411
            
            
            
            651**Net
                income**
            
            $
            711
            
            
            $
            900
            
            
            $
            2,401
            
            
            $
            2,579Basic
                earnings per share
            
            $
            0.11
            
            
            $
            0.14
            
            
            $
            0.38
            
            
            $
            0.41Diluted
                earnings per share
            
            $
            0.11
            
            
            $
            0.14
            
            
            $
            0.38
            
            
            $
            0.41Cash
                dividends per common share
            
            $
            0.12
            
            
            $
            0.11
            
            
            $
            0.24
            
            
            $
            0.22




See
      Notes
      to Consolidated Financial Statements


Page
          4
 *Index*





**EAST
      PENN FINANCIAL CORPORATION**


**CONSOLIDATED
      STATEMENTS OF STOCKHOLDERS’ EQUITY**


**Nine
      Months Ended**


**September
      30, 2007 and 2006**


(Unaudited)








AccumulatedOtherCommon
            
            
            
            
            
            Retained
            
            
            Comprehensive
            
            
            Treasury(In
                thousands, except share and per share data)
            Stock
            
            
            Surplus
            
            
            Earnings
            
            
            Loss
            
            
            Stock
            
            
            TotalBalance,
                December 31, 2005
            
            $
            4,133
            
            
            $
            9,246
            
            
            $
            12,192
            
            
            $
            (880
            )
            
            $
            (1,850
            )
            
            $
            22,841Comprehensive
                income:Net
                income
            
            
            -
            
            
            
            -
            
            
            
            2,579
            
            
            
            -
            
            
            
            -
            
            
            
            2,579Changes
                in net unrealized losseson
                securities availablefor
                sale, net of tax effect
            
            
            -
            
            
            
            -
            
            
            
            -
            
            
            
            (3
            )
            
            
            -
            
            
            
            (3
            )Total
                comprehensive income
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            2,576Compensation
                expense relatedto
                stock options
            
            
            -
            
            
            
            14
            
            
            
            -
            
            
            
            -
            
            
            
            -
            
            
            
            14Cash
                dividend of $0.22 per share
            
            
            -
            
            
            
            -
            
            
            
            (1,387
            )
            
            
            -
            
            
            
            -
            
            
            
            (1,387
            )Balance,
                September 30, 2006
            
            $
            4,133
            
            
            $
            9,260
            
            
            $
            13,384
            
            
            $
            (883
            )
            
            $
            (1,850
            )
            
            $
            24,044Balance,
                December 31, 2006
            
            $
            4,134
            
            
            $
            9,272
            
            
            $
            14,417
            
            
            $
            (812
            )
            
            $
            (1,850
            )
            
            $
            25,161Comprehensive
                income:Net
                income
            
            
            -
            
            
            
            -
            
            
            
            2,401
            
            
            
            -
            
            
            
            -
            
            
            
            2,401Changes
                in net unrealized losseson
                securities available for sale,net
                of tax effect
            
            
            -
            
            
            
            -
            
            
            
            -
            
            
            
            85
            
            
            
            -
            
            
            
            85Total
                comprehensive income
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            2,486Exercise
                of 29,092 common stockOptions
            
            
            18
            
            
            
            215
            
            
            
            -
            
            
            
            -
            
            
            
            -
            
            
            
            233Cash
                dividend of  $0.24 per share
            
            
            -
            
            
            
            -
            
            
            
            (1,514
            )
            
            
            -
            
            
            
            -
            
            
            
            (1,514
            )Balance,
                September 30, 2007
            
            $
            4,152
            
            
            $
            9,487
            
            
            $
            15,304
            
            
            $
            (727
            )
            
            $
            (1,850
            )
            
            $
            26,366








See
      Notes to Consolidated Financial
      Statements


Page
          5
 *Index*


**EASTPENN
      FINANCIAL CORPORATION**


**CONSOLIDATED
      STATEMENTS OF CASH FLOWS**


**Nine
      Months Ended September 30, 2007 and 2006**


(Unaudited)





**Nine
                Months Ended**(In
                thousands)
            
            **2007**
            
            
            **2006****CASH
                FLOWS from OPERATING ACTIVITIES**Net
                income
            
            $
            2,401
            
            
            $
            2,579Adjustments
                to reconcile net income to net cashprovided
                by operating activities:Provision
                for loan losses
            
            
            270
            
            
            
            299Provision
                for depreciation and amortization
            
            
            670
            
            
            
            658Compensation
                expense for stock options
            
            
            -
            
            
            
            14Net
                amortization/accretion of securities premiums and
                discounts
            
            
            93
            
            
            
            120Net
                realized gain on sale of foreclosed real estate
            
            
            -
            
            
            
            (14
            )Net
                realized gain from sale of held to maturity securities
            
            
            -
            
            
            
            (38
            )Proceeds
                from sale of loans originated for sale
            
            
            9,053
            
            
            
            7,213Net
                gain on sale of loans originated for sale
            
            
            (123
            )
            
            
            (97
            )Loans
                originated for sale
            
            
            (8,929
            )
            
            
            (7,595
            )Earnings
                on investment in life insurance
            
            
            (237
            )
            
            
            (203
            )(Increase)
                decrease in accrued interest receivableand
                other assets
            
            
            (326
            )
            
            
            220Increase
                (decrease) in accrued interest payableand
                other liabilities
            
            
            (282
            )
            
            
            629**Net
                Cash Provided by Operating Activities**
            
            
            2,590
            
            
            
            3,785**CASH
                FLOWS from INVESTING ACTIVITIES**Decrease
                in interest bearing time deposits
            
            
            -
            
            
            
            500Purchases
                of available for sale securities
            
            
            (2,072
            )
            
            
            (7,223
            )Proceeds
                from maturities of and principal repaymentson
                available for sale securities
            
            
            7,539
            
            
            
            6,924Proceeds
                from sale of available for sale securities
            
            
            -
            
            
            
            5,136Proceeds
                from maturities of and principal repaymentson
                held to maturity securities
            
            
            -
            
            
            
            39Proceeds
                from sale of held to maturity securities
            
            
            -
            
            
            
            1,037Proceeds
                from the sale of other real estate
            
            
            -
            
            
            
            41Net
                increase in loans
            
            
            (14,745
            )
            
            
            (21,889
            )Net
                decrease in restricted stock
            
            
            246
            
            
            
            656Purchase
                of bank premises and equipment
            
            
            (63
            )
            
            
            (1,348
            )Investment
                in Berkshire Bank
            
            
            (458
            )
            
            
            -**Net
                Cash Used in Investing Activities**
            
            
            (9,553
            )
            
            
            (16,127
            )**CASH
                FLOWS from FINANCING ACTIVITIES**Net
                increase in deposits
            
            
            132
            
            
            
            31,274Net
                increase (decrease) in federal funds purchased andsecurities
                sold under agreements to repurchase
            
            
            4,911
            
            
            
            (1,390
            )Repayment
                of long-term borrowings
            
            
            (5,000
            )
            
            
            (10,000
            )Proceeds
                from the exercise of stock options
            
            
            233
            
            
            
            -Dividends
                paid
            
            
            (1,514
            )
            
            
            (1,387
            )**Net
                Cash Provided by (Used in) Financing Activities**
            
            
            (1,238
            )
            
            
            18,497**Net
                Increase (Decrease) in Cash and Cash Equivalents**
            
            
            (8,201
            )
            
            
            6,155**Cash
                and cash equivalents -****Beginning**
            
            
            22,954
            
            
            
            10,629**Cash
                and cash equivalents -****Ending**
            
            $
            14,753
            
            
            $
            16,784**SUPPLEMENTARY
                CASH FLOW INFORMATION**Interest
                paid
            
            $
            9,648
            
            
            $
            6,852Federal
                income taxes paid
            
            $
            695
            
            
            $
            540**SUPPLEMENTAL
                SCHEDULE OF NON-CASH INVESTING AND FINANCING
                ACTIVITIES**Other
                real estate acquired in settlement of loans
            
            $
            60
            
            
            
            -





See
      Notes
      to Consolidated Financial Statements


Page
          6
 *Index*





**EAST
      PENN FINANCIAL CORPORATION**


**NOTES
      TO INTERIM CONSOLIDATED FINANCIAL STATEMENTS**


**September
      30, 2007**


**(Unaudited)**





**1.**
            **Basis
                of Presentation**





East
      Penn Financial Corporation (the
“Company”) was incorporated on January 27, 2003 for the purpose of forming a
      bank holding company.  On July 1, 2003, the Company completed the
      reorganization with East Penn Bank (the “Bank”) and its wholly owned subsidiary,
      East Penn Mortgage Company, into the holding company form of
      ownership.  In the reorganization, the Bank became a wholly owned
      banking subsidiary of the Company.  On July 31, 2003, the Company
      formed East Penn Statutory Trust I (the “Trust”), a Connecticut statutory
      business trust, for the purpose of issuing $8 million in capital pass-through
      securities to investors.  The Trust is a non-consolidated subsidiary
      as permitted by FIN 46.





The
      consolidated financial statements
      include the accounts of the Company, and its wholly owned subsidiary, the
      Bank.  All significant intercompany accounts and transactions have
      been eliminated.





The
      accompanying unaudited consolidated
      financial statements have been prepared in accordance with accounting principles
      generally accepted in the United States of America for interim financial
      information and in accordance with instructions for Form 10-Q and S-X Rule
      10-01.  Accordingly, they do not include all of the information and
      footnotes required by generally accepted accounting principles for complete
      financial statements.  In the opinion of management, all adjustments
      considered necessary for fair presentation have been included.





Operating
      results for the nine-month
      period ended September 30, 2007, are not necessarily indicative of the results
      that may be expected for the year ended December 31, 2007.  For
      further information, refer to the consolidated financial statements and
      footnotes thereto included in the Company’s Annual Report on Form 10-K for the
      year ended December 31, 2006.





**2.**
            **Proposed
                Plan of Merger with Harleysville National
                Corporation**





On
      May 15, 2007, East Penn Financial
      Corporation and Harleysville National Corporation (“HNC”) signed a definitive
      agreement whereby East Penn Financial Corporation will merge with and into
      a
      subsidiary of HNC, and East Penn Financial Corporation’s wholly owned
      subsidiary, East Penn Bank will merge with and into HNC’s wholly owned
      subsidiary, Harleysville National Bank and Trust Company (“HNB”).





The
      total value of the transaction
      under the agreement at the time of its announcement was estimated at $92.7
      million or approximately $14.50 per share of East Penn Financial Corporation
      stock.  However, actual value will depend on several factors,
      including the price of HNC stock, but will not be less than $13.52 per share
      ($86.3 million) or greater than $15.48 per share ($99.1
      million).  Subject to the terms and conditions of the merger
      agreement, each shareholder of East Penn Financial Corporation may elect to
      receive either cash only or HNC shares only for each share of East Penn
      Financial Corporation stock.  An East Penn Financial Corporation
      shareholder may receive a combination of both in the aggregate for all East
      Penn
      Financial Corporation shares the shareholder owns subject to the election of
      other shareholders.  The amount of final per share consideration is
      based on a formula that is determined by the average per share value of HNC
      stock during the twenty day period ending eleven days prior to the
      closing.  The consideration is subject to election and allocation
      procedures designed to provide that the cash portion is $50,284,000, but in
      any
      event, not greater than 60% of the dollar value of the merger
      consideration.  The parties have agreed that the allocation of HNC
      common stock and cash will be such that the East Penn Financial Corporation
      shareholders will not recognize gain or loss for Federal income tax purposes
      on
      those East Penn Financial Corporation shares that are


Page
          7
 *Index*


exchanged
      for HNC common stock in the merger.





The
      acquisition, which was approved by
      state and federal regulatory agencies was approved by the shareholders of East
      Penn Financial Corporation at a special meeting held on November
      1, 2007. The effective date of the merger is expected to occur
      on
      or about November 16, 2007.





As
      part of the agreement, East Penn
      Bank will become a division of HNC and will operate under the “East Penn Bank”
name and logo.  In addition nine of HNC’s existing branches located in
      and about East Penn Bank’s serving community will also be transferred to the
      East Penn division.  Pursuant to the merger agreement, HNC and East
      Penn Financial Corporation agreed that Brent L. Peters, Chairman of the Board,
      President and Chief Executive office of East Penn Financial Corporation, will
      continue with HNC upon the closing of the merger, as an executive officer and
      President of the East Penn Bank division and a member of the HNC and HNB boards
      of directors.





**3.**
            **Investment
                in Bank**





On
      September 23, 2003, the Company made an initial purchase of 141,300 shares
      of
      common stock of a *de novo* bank, named Berkshire Bank, located in
      Wyomissing, Berks County, Pennsylvania.  At the completion of
      Berkshire’s initial stock offering, the Company purchased an additional 12,123
      shares, which resulted in increasing the Company’s investment to $1,534,000 of
      Berkshire Bank’s outstanding common stock as of December 31, 2003.  In
      consideration of the Company’s and its director’s and officer’s combined
      ownership of Berkshire Bank common stock, the aggregate percentage ownership
      was
      19.9% as of the 2003 year end, which is in accordance with the terms of a Stock
      Subscription and Purchase Agreement between the Company and Berkshire
      Bank.  Under this agreement, the Company is also entitled to purchase
      from Berkshire Bank up to 5% of additional stock at any time beginning on the
      date of the warrant and for 10 years thereafter at an exercise price of $6.40
      per share, which is adjusted in consideration of two 5-for-4 stock
      splits.  The total number of shares that are subject to purchase under
      all of the Company’s warrants, options or rights shall not exceed 25% of the
      total number of shares of Berkshire Bank common stock.





In
      August 2003, the Company entered
      into an agreement, known as a Crown X agreement that was approved by the Federal
      Reserve Bank of Philadelphia in September 2003.  This agreement
      imposes certain restrictions where the Company has agreed not to:





·
            solicit
                proxies with respect to any voting securities of Berkshire Bank or
                influence the manner in which any other shareholder of Berkshire
                Bank
                votes any voting securities of Berkshire
                Bank;


·
            cause
                any voting securities of Berkshire Bank to be subject to a voting
                trust;


·
            cause
                Berkshire Bank to become a subsidiary of the
                Company;


·
            have
                any designated representative serve or act as an officer, director,
                employee or agent of Berkshire
                Bank;


·
            propose
                any person for election as a director of Berkshire
                Bank;


·
            attempt
                to influence the dividend policies or practices of Berkshire Bank;
                the
                investment, loan or credit decision policies; the pricing of services;
                personnel decisions or operations
                activities;


·
            exercise
                or seek to exercise any controlling influence over the management
                of
                Berkshire Bank;


·
            enter
                into any banking or non-banking transactions with Berkshire Bank,
                except
                that the Company may establish and maintain deposit accounts with
                Berkshire Bank, provided the aggregate balance of all such accounts
                does
                not exceed $500,000 and that the accounts are maintained on substantially
                the same terms as those prevailing for comparable accounts of persons
                unaffiliated with Berkshire Bank.





During
      2004, Berkshire Bank announced a
      5-for-4 stock split, effected in the form of a 25% stock dividend, payable
      July
      22, 2004, which resulted in the Company receiving an additional 38,355
      shares.  As part of a three-phase stock offering, which began on
      September 1, 2004 and was effective through March 31, 2005, the Company
      purchased an additional 57,119 shares of common stock.  On July 21,
      2005, Berkshire Bank announced the payment of a 5-for-4 stock split, effected
      in
      the form of a


Page
          8
 *Index*


25%
      stock
      dividend, payable August 19, 2005, which resulted in an additional 62,224
      shares.





Pursuant
      to a Plan of Reorganization and a Plan of Merger (the “Plan”) that was approved
      by Berkshire Bank’s shareholders on April 18, 2006, a holding company named
      Berkshire Bancorp, Inc. was formed and was effective September 1,
      2006.  As part of the reorganization, Berkshire Bank became a wholly
      owned banking subsidiary of Berkshire Bancorp, Inc.  The Plan further
      provided for the one-for-one exchange of shares of common stock of Berkshire
      Bank for shares of common stock of Berkshire Bancorp, Inc.  In
      accordance with its equivalent 19.9% ownership, the Company exchanged
      one-for-one the common stock shares of Berkshire Bank for the common stock
      shares of Berkshire Bancorp, Inc.  In addition, the Company executed a
      Crown X agreement that was amended to reflect the Company’s acquisition of
      Berkshire Bancorp, Inc. common stock.  Other than this revision, the
      Crown X agreement, which was approved by the Federal Reserve Bank of
      Philadelphia in July 2006, remained substantially unchanged from the original
      agreement approved by the Federal Reserve Bank in September 2003.





Subsequently,
      Berkshire Bancorp, Inc. announced a 5-for-4 stock split effected in the form
      of
      a stock dividend as of the record date of September 14, 2006, which resulted
      in
      the issuance of 77,780 additional shares of common stock.  On November
      9, 2006, the Company purchased 256 additional shares at $10 per share in order
      to maintain its 19.9% aggregate ownership level.  This occurred
      because Berkshire Bancorp, Inc. issued additional stock as a result of the
      exercise of options by its officers.





Effective
      March 22, 2007, Berkshire Bancorp, Inc. initiated a two-phase stock offering
      that ended August 31, 2007.  On August 31, 2007, the Company
      subscribed to purchase 45,614 shares at $10 per share under this stock
      offering.  The transaction settled on September 4, 2007.  As
      part of this offering, the Company also received one five-year non-detachable
      common stock purchase warrant for each share
      purchased.    On September 27, 2007, the Company purchased
      256 additional shares at $10 per share as a result of the exercise of options
      by
      Berkshire Bancorp’s officers.  At September 30, 2007, the Company’s
      total investment in Berkshire Bancorp, Inc. was $2,608,000, represented by
      435,027 shares, resulting in a 19.9 % aggregate ownership in consideration
      of
      the combined ownership of the Company, its directors and its
      officers.





While
      the
      Company is considered to be a passive investor, it regards this to be a viable
      investment.  The investment is carried at cost and is included in the
      other assets category on the consolidated balance sheet.  The Company
      uses the best information that is available to assess the reasonableness of
      the
      value of this asset.  The financial condition of Berkshire Bancorp,
      Inc. and the stability of its stock price have proven to be reliable valuation
      sources.  No indicators of impairment were noted as part of the
      Company’s latest evaluation.





**4.**
            **Earnings
                per Share**





The
      following table sets forth the computation of basic and diluted earnings per
      share:





Three
                Months Ended
            
            
            Nine
                Months EndedSeptember
                30,
            
            
            September
                30,2007
            
            
            2006
            
            
            2007
            
            
            2006Net
                income applicable to common stock
            
            $
            711,000
            
            
            $
            900,000
            
            
            $
            2,401,000
            
            
            $
            2,579,000Weighted-average
                common shares outstanding
            
            
            6,315,756
            
            
            
            6,304,262
            
            
            
            6,309,305
            
            
            
            6,304,262Effect
                of dilutive securities, stock options
            
            
            67,228
            
            
            
            16,350
            
            
            
            39,788
            
            
            
            18,613Weighted-average
                common shares outstandingused
                to calculate diluted earnings per share
            
            
            6,382,984
            
            
            
            6,320,612
            
            
            
            6,349,093
            
            
            
            6,322,875Basic
                earnings per share
            
            $
            0.11
            
            
            $
            0.14
            
            
            $
            0.38
            
            
            $
            0.41Diluted
                earnings per share
            
            $
            0.11
            
            
            $
            0.14
            
            
            $
            0.38
            
            
            $
            0.41





Page
          9
 *Index*


**5.**
            **Comprehensive
                Income**





The
      components of other comprehensive income (loss) and related tax effects for
      the
      three and nine months ended September 30, 2007 and 2006 are as
      follows:





Three
                Months Ended
            
            
            Nine
                Months EndedSeptember
                30,
            
            
            September
                30,(in
                thousands)
            
            2007
            
            
            2006
            
            
            2007
            
            
            2006Unrealized
                holding gains/(losses) onavailable
                for sale securities
            
            $
            1,029
            
            
            $
            1,473
            
            
            $
            129
            
            
            $
            (5
            )Less
                reclassification adjustment for(gain)/loss
                included in net income
            
            
            -
            
            
            
            -
            
            
            
            -
            
            
            
            -Net
                unrealized losses
            
            
            1,029
            
            
            
            1,473
            
            
            
            129
            
            
            
            (5
            )Tax
                effect
            
            
            (350
            )
            
            
            (500
            )
            
            
            (44
            )
            
            
            2Net
                of tax amount
            
            $
            679
            
            
            $
            973
            
            
            $
            85
            
            
            $
            (3
            )





**6.**
            **Stock
                Option Plan**





Effective
      January 1, 2006, the Company adopted the fair value recognition provisions
      of
      FASB Statement No. 123R, Share-Based Payment (SFAS 123R), using the
      modified-prospective transition method.  Under this transition method,
      compensation cost recognized in 2006 included: (a) compensation cost for all
      share-based payments granted prior to, but not yet vested as of January 1,
      2006
      based on the grant date fair value calculated in accordance with the original
      provisions of SFAS 123, and (b) compensation cost for all share-based payments
      granted subsequent to December 31, 2005, based on a grant-date fair value
      estimated in accordance with the provisions of SFAS 123R.  No stock
      options were granted during the first nine months of 2007 and there were no
      unvested options as of December 31, 2006, which means there was no impact to
      earnings.  This compares with 2006 where 13,000 options to purchase
      common stock were granted to directors on May 18, 2006.  Since the
      options have a six-month vesting period, the Company had 13,000 stock options
      that were not fully vested as of September 30, 2006.  The related
      compensation costs totaled $19,000 and were recognized monthly on a
      straight-line basis through November 18, 2006, which was the end of the
      six-month vesting period.  The Company’s earnings before income taxes
      for the three and nine months ended September 30, 2006 were $10,000 and $14,000,
      respectively, lower due to the adoption of SFAS 123R.





**7.**
            **Guarantees**





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 that are
      written are conditional commitments issued by the Bank 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
      those that are involved in extending loan facilities to
      customers.  The Bank, generally, holds collateral and/or personal
      guarantees supporting these commitments.  The Bank had $6,199,000 in
      standby letters of credit as of September 30, 2007.  Management
      believes that the proceeds obtained through liquidation of collateral and the
      enforcement of guarantees would be sufficient to cover the potential amount
      of
      future payments required under the corresponding guarantees.  The
      current amount of the liability as of September 30, 2007 for guarantees under
      standby letters of credit is not material.





**8.**
            **New
                Accounting Standards**





In
      July 2006, the FASB issued FASB
      Interpretation No. 48, "Accounting for Uncertainty in Income
      Taxes”.  The interpretation clarifies the accounting for uncertainty
      in income taxes recognized in a company's financial statements in accordance
      with Statement of Financial Accounting Standards No. 109, "Accounting for Income
      Taxes”.  Specifically, the pronouncement prescribes a recognition
      threshold and a measurement attribute for the financial statement recognition
      and measurement of a tax position taken or expected to be taken in a tax
      return.  The interpretation also provides guidance on the related
      derecognition, classification, interest and




Page
          10
 *Index*


penalties,
      accounting for interim periods, disclosure and transition of uncertain tax
      positions.  The interpretation is effective for fiscal years beginning
      after December 15, 2006.  The Company’s consolidated financial
      statements were not significantly impacted from this new
      pronouncement.




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.  The Company is currently
      evaluating the potential impact, if any, of the adoption of FASB Statement
      No.
      157 on its consolidated financial position, results of operations and cash
      flows.




In
      February 2007, the FASB issued FASB Statement No. 159, “The Fair Value Option
      for Financial Assets and Financial Liabilities”.  FASB Statement No.
      159 permits entities to make an irrevocable election to carry almost any
      financial instrument at fair value.  Upon the effective date (or early
      adoption) of FASB Statement No. 159, when an entity elects to apply the fair
      value option to specific items, the entity reports the difference between the
      items’ carrying value and their fair value as a cumulative-effect adjustment to
      the opening balance of retained earnings.  The Statement is effective
      as of the beginning of an entity’s fiscal year that begins after November 15,
      2007.  Early adoption is permitted as of the beginning of a fiscal
      year that begins on or before November 15, 2007, provided that the entity also
      elects to apply the provisions of FASB Statement No. 157.  The choice
      of early adoption must be made within 120 days of the beginning of the fiscal
      year of adoption, provided the entity has not yet issued financial statements,
      including required notes to those financial statements, for any interim period
      of the fiscal year of adoption.  The Company did not adopt FASB
      Statement No. 159 early and will continue to evaluate the potential impact,
      if
      any, of the adoption of the Statement on its consolidated financial condition,
      results of operations and cash flows.





In
      March
      2007, the FASB ratified Emerging Issues Task Force Issue No. 06-10, “Accounting
      for Collateral Assignment Split-Dollar Life Insurance Agreements” (“EITF
      06-10”).  EITF 06-10 provides guidance for determining a liability for
      the postretirement benefit obligation as well as recognition and measurement
      of
      the associated asset on the basis of the terms of the collateral assignment
      agreement.  EITF 06-10 is effective for fiscal years beginning after
      December 15, 2007.  The Company is currently assessing the impact of
      EITF 06-10 on its consolidated financial position and results of
      operations.





In
      April
      2007, the FASB directed the FASB Staff to issue FSP No. FIN 39-1, “Amendment of
      FASB Interpretation No. 39” (“FSP FIN 39-1”).  FSP FIN 39-1 modifies
      FIN No. 39, “Offsetting of Amounts Related to Certain Contracts”, and permits
      companies to offset cash collateral receivables or payables with net derivative
      positions under certain circumstances.  FSP FIN 39-1 is effective for
      fiscal years beginning after November 15, 2007, with early adoption
      permitted.  We are evaluating the effect of adopting FSP FIN 39-1 on
      our consolidated financial statements.





In
      May
      2007, the FASB issued FASB Staff Position (“FSP”) FIN 48-1, “Definition of
      Settlement in FASB Interpretation No. 48” (“FSP FIN 48-1”).  FSP FIN
      48-1 provides guidance on how to determine whether a tax position is effectively
      settled for the purpose of recognizing previously unrecognized tax
      benefits.  FSP FIN 48-1 is effective retroactively to January 1,
      2007.  The implementation of this standard did not have a material
      impact on our consolidated financial position or results of
      operations.





In
      February 2007,  the FASB issued Staff Position (“FSP”) FAS 158-1,
“Conforming Amendments to the Illustrations in FASB Statements No. 87, No. 88
      and No. 106 and to the Related Staff Implementation Guides”.  This FSP
      makes conforming amendments to other FASB statements and staff implementation
      guides and provides technical corrections to SFAS No. 158, “Employers’
Accounting for Defined Benefit Pension and Other Postretirement
      Plans”.  The


Page
          11
 *Index*


conforming
      amendments in this FSP shall be applied upon adoption of SFAS No.
      158.  The adoption of FSP FAS 158-1 did not have a material impact on
      our consolidated financial statements or disclosures.




























Page
          12
 *Index*


**Item
      2.**





**MANAGEMENT’S
      DISCUSSION AND ANALYSIS OF FINANCIAL
      CONDITION**


**AND
      RESULTS OF OPERATIONS**


**September
      30, 2007**





The
      following is management’s discussion and analysis of the significant changes in
      the consolidated financial condition, results of operations, capital resources
      and liquidity presented in the accompanying unaudited consolidated financial
      statements for the Company.  This discussion should be read in
      conjunction with the preceding consolidated financial statements and related
      footnotes, as well as, the Company's December 31, 2006 Annual Report on Form
      10-K.  Current performance does not guarantee and may not be
      indicative of similar performance in the future.





In
      addition to historical information, this quarterly report on Form 10-Q contains
      forward-looking statements. The forward-looking statements contained in this
      report are subject to certain risks, assumptions and
      uncertainties.  Because of the possibility of change in the underlying
      assumptions, actual results could differ materially from those projected in
      the
      forward-looking statements.  Additional factors that might cause
      actual results to differ materially from those expressed in the forward-looking
      statements include, but are not limited to:





-
            operating,
                legal and regulatory risks,


-
            economic,
                political and competitive forces affecting the Company’s services,
                and


-
            the
                risk that management’s analyses of these risks could be incorrect and/or
                that the strategies developed to address them could be
                unsuccessful.





The
      Company’s forward-looking statements are relevant only as of the date on which
      the statements are made.  By making forward-looking statements, the
      Company assumes no duty to update them to reflect new, changing or unanticipated
      events or circumstances.  Readers should carefully review the risk
      factors described in other periodic reports and public documents that the
      Company files from time to time with the Securities and Exchange
      Commission.





**CRITICAL
      ACCOUNTING POLICIES**





Disclosure
      of the Company’s significant
      accounting policies is included in Note 1 to the consolidated financial
      statements of the Company’s Annual Report on Form 10-K for the year ended
      December 31, 2006.  Some of these policies are particularly sensitive
      requiring significant judgments, estimates and assumptions to be made by
      management.  Additional information is contained on pages 15, 18 and
      19 herein of this report for the provision and allowance for loan
      losses.





**OVERVIEW**





Net
      income for the nine months ended September 30, 2007 was $2,401,000 as compared
      with net income of $2,579,000 for the nine months ended September 30,
      2006.  The $178,000, or 6.9% decrease in earnings is attributable to a
      decline in net interest income and an increase in other non-interest expenses
      due to incurring merger related expenses.  On a basic and dilutive
      earnings per share basis, net income per share for the nine months ended
      September 30, 2007 was $0.38 per share as compared with $0.41 per share for
      the
      same period in 2006.





Net
      income as a percentage of average assets on an annualized basis, also known
      as
      return on average assets, decreased to 0.73% for the first nine months of 2007
      from 0.84% for the first nine months of 2006 as a result of asset growth of
      3.40% since the end of the third quarter of 2006 to the end of the third quarter
      of 2007.  Net income as a percentage of total average stockholders’
equity on an annualized basis, also known as return on average equity, was
      12.69% and 15.21% for the first nine months of 2007 and 2006,
      respectively.  The decrease in both ratios is also attributable to the
      decline in net income.





During
      the first nine months of 2007, the Company’s assets increased $966,000, or 0.2%,
      to $440,418,000 as of September 30, 2007 as compared with $439,452,000 as of
      December 31, 2006.  The


Page
          13
 *Index*


increase
      in assets since the 2006 year end is attributable to loan growth of $14,566,000,
      or 4.5%, which was offset by declines of $10,163,000 in overnight federal funds
      sold and $5,431,000 in securities available for sale.  The decline in
      federal funds sold was due to funding loan growth and paying off maturing
      other  borrowed funds.  The decline in securities available
      for sale was attributable to scheduled investment maturities and
      amortization.  The Company’s prime funding sources included deposits,
      which increased $132,000, or 0.04% from the 2006 year end and securities sold
      under agreements to repurchase, which grew $4,911,000, or 72.8%.  The
      growth in total deposits and securities sold under agreements to repurchase
      during the first nine months of 2007 was 6.3% higher than their growth during
      the same period in 2006 as a result of the Bank’s continued focus to offer
      attractive products at competitive interest rates.





**RESULTS
      OF OPERATIONS**





**Net
      Interest Income**





For
      the three months ended September
      30, 2007, total interest income increased $340,000, or 5.1%, to $6,505,000
      as
      compared with $6,165,000 for the three months ended September 30,
      2006.  This increase is due to loan growth, which is the Company’s
      highest yielding asset, and increased yields on total interest earning
      assets.





Total
      interest expense increased by
      $372,000, or 13.4%, to $3,152,000 for the three months ended September 30,
      2007
      from $2,780,000 for the three months ended September 30,
      2006.   This increase is attributable to deposit growth, higher
      volume of securities sold under agreements to repurchase and the increased
      costs
      associated with attracting and maintaining deposits and securities sold under
      agreements to repurchase during a period of interest rate
      uncertainties.





Net
      interest income decreased by
      $32,000, or 1.0%, to $3,353,000 for the three months ended September 30, 2007
      from $3,385,000 for the three months ended September 30, 2006.





For
      the nine months ended September 30,
      2007, total interest income increased $1,833,000, or 10.5%, to $19,282,000,
      as
      compared with $17,449,000 for the nine months ended September 30,
      2006.  This increase was attributable to a higher yield from interest
      earning assets, which increased to 6.46% (on a fully tax equivalent basis)
      for
      the first nine months of 2007 from 6.30% (on a fully tax equivalent basis)
      for
      the first nine months of 2006.  In addition, average interest-earning
      assets increased 8.3% to $415,073,000 for the first nine months of 2007, from
      $383,423,000 for the same period in 2006.  The growth in average
      interest-earning assets was primarily attributable to an increase in loans
      and
      an increase in the level  of overnight federal funds
      sold.





Total
      interest expense increased by $1,959,000, or 26.3%, to $9,395,000 for the nine
      months ended September 30 2007, from $7,436,000 for the nine months ended
      September 30, 2006.  This increase was attributable to growth in
      average interest bearing liabilities, which increased $55,935,000, or 16.4%
      in
      comparing September 30, 2007 with September 30, 2006.  In addition,
      the need to increase interest rates to maintain and attract deposits affected
      cost of funds, which increased to 3.16% for the nine months ended September
      30,
      2007 from 2.91% for the same period in 2006.





The
      resulting net interest income
      decreased by $126,000, or 1.3%, to $9,887,000 for the nine months ended
      September 30, 2007 from $10,013,000 for the nine months ended September 30,
      2006.  The increase in total interest income was more than offset by
      an increase in interest expense, which contributed to net interest margin
      compression as competitive deposit pricing increased funding costs faster then
      earning asset yields grew.  The increase in cost of funds was due to
      an increase in the interest rates paid on deposits as a means of ensuring that
      the Bank remained competitive in its market.  Increased interest rates
      not only resulted in deposit growth but effected a change within the composition
      of the Bank’s deposits, where there was a shifting of funds being invested into
      deposit products with higher interest rates, such as certificates of
      deposit.  Securities sold under agreements to repurchase also
      increased when comparing 2007 with 2006.  While the cost associated
      with deposits has increased since last year, deposits were and continue to
      be a
      more cost effective source of funding asset growth as compared with other types
      of funding sources, such as borrowings, which the Bank has made efforts to
      reduce.  This strategy has allowed management to better control
      funding costs and minimize significant compression to its net interest spread
      and margin.  For


Page
          14
 *Index*


the
      first
nine months of 2007, the net interest spread (on a fully tax equivalent basis)
      decreased 9 basis points to 3.30% from 3.39% for the first nine months in 2006,
      while the net interest margin (on a fully tax equivalent basis) decreased 27
      basis points to 3.44% for the nine-month period ending September 30, 2007 from
      3.71% for the nine-month period ending September 30, 2006.  However,
      the success of the Bank’s efforts to manage this compression is evidenced by the
      increase in the net interest margin for the third quarter of 2007, which was
      3.46% as compared with the net interest margin of 3.42% for the second quarter
      of 2007 and 3.43% for the first quarter of 2007.





**Provision
      for Loan Losses**





Provisions
      for loan losses are charged
      to operations in order to maintain the allowance for loan losses at a level
      management considers adequate to absorb credit losses inherent in the loan
      portfolio.  Management assesses the allowance for loan losses on a
      quarterly basis and makes provisions for loan losses in order to maintain the
      adequacy of the allowance.





The
      provision for loan losses was
      $135,000 for the three months ended September 30, 2007 compared with $90,000
      for
      the three months ended September 30, 2006.  The increase in this
      quarter’s provision was due to the Bank’s charge-off of $33,000 in credit card
      balances, which was completed as part of the Bank’s sale of the credit card
      portfolio.  This compares with $5,000 in credit card balances that the
      Bank charged-off during the third quarter of 2006.





For
      the nine months ended September 30,
      2007, the provision for loan losses was $270,000, a decrease of $29,000 compared
      with $299,000 for the nine months ended September 30, 2006.  The
      decrease in the provision is attributable to management’s ongoing efforts to
      ensure the high quality of the loan portfolio as represented by the level of
      non-performing assets and loans subject to review or regulatory
      classification.





The
      allowance for loans losses
      represented 1.01% of total loans at September 30, 2007, compared with 1.01%
      as
      of December 31, 2006 and 1.03% as of September 30, 2006.  Management
      performs ongoing assessments of the loan loss reserve in relation to loan
      portfolio growth, changes in the loan portfolio’s composition, credit exposure
      to individual borrowers, overall trends in the loan portfolio and other relevant
      factors.  Based upon these factors, management believes that as of
      September 30, 2007, the reserve is reasonable and sufficient to support the
      increased loan growth in light of the strong asset quality as supported by
      the
      ratios reflected in the Asset Quality Ratios table on page 19.





**Other
      Income**





For
      the three months ended September
      30, 2007, other income of $579,000 decreased $20,000, or 3.3%, from $599,000
      for
      the three months ended September 30, 2006.  Contributing to this
      decrease was a $13,000 decline in customer service fees, a decline of $14,000
      in
      income associated with the sale of other real estate owned since no such
      transaction occurred in 2007 and a $10,000 decline in other
      income.  This was offset by increases of $5,000 in fee income from
      mortgage banking activities and a $12,000 increase associated with an increase
      in the cash surrender value of the Bank’s investment in life
      insurance.





Other
      income for the nine months ended September 30, 2007 increased $10,000, or 0.6%,
      to $1,819,000 from $1,809,000 for the nine months ended September 30,
      2006.  This increase was attributable to a $26,000 increase in income
      from mortgage banking activities and a $34,000 increase in income from the
      investment in life insurance.  These increases were offset by a
      $16,000 decline in customer service fees, a decrease of $20,000 in other income
      and a decline of $14,000 in income from the sale of other real estate owned
      transactions for which there were none in 2007.




**Other
      Expenses**





Other
      expenses, which include salary,
      occupancy, equipment and all other expenses incidental to the operation of
      the
      Company, increased to $3,002,000 for the third quarter of 2007 from $2,773,000
      for the third quarter of 2006.  The $229,000, or 8.3%, increase is not
      only due to the Company’s continued


Page
          15
 *Index*


growth,
      but is mostly attributable to expenses associated with the proposed merger
      with
      Harleysville National Corporation.





Salaries
      and employee benefit expenses,
      which make up the largest component of other expenses, decreased $27,000, or
      1.8%, to $1,469,000 for the third quarter of 2007 from $1,496,000 for the third
      quarter in 2006.  The decrease is the result of not replacing
      employees who left the Company’s employment.





Occupancy
      expenses increased $10,000,
      or 3.6%, to $289,000 for the three months ended September 30, 2007 from $279,000
      for the three months ended September 30, 2006.  The increase is due to
      the costs associated with normal expenses incurred to maintain all of the
      Company’s branch and office locations.





Equipment
      expense decreased $1,000, or
      0.5%, to $217,000 for the three months ended September 30, 2007 from $218,000
      for the three months ended September 30, 2006.  This decrease is due
      to management’s efforts to control operating expenses.





Other
      operating expenses during the
      third quarter of 2007 increased $247,000, or 31.70%, to $1,027,000 from $780,000
      during the third quarter of 2006.  The increase is primarily
      associated with incurring $296,000 in expenses during the third quarter of
      2007
      relating to the pending merger.





Other
      expenses increased to $8,624,000
      for the nine months ended September 30, 2007 from $8,293,000 for the nine months
      ended September 30, 2006.  The $331,000, or 4.0%, increase is due to
      the merger related expenses the total of which was partially offset by the
      Company’s ongoing efforts to manage overall efficiencies, particularly in light
      of the compression of its net interest spread and margin.





For
      the
      first nine months of 2007, salaries and employee benefit expenses decreased
      $49,000, or 1.1%, to $4,401,000 from $4,450,000 for the first nine months of
      2006.  The decrease is attributable to attrition, where certain staff
      positions have not been replaced when employees have left the Bank.





Occupancy
      expenses increased $49,000,
      or 5.8%, to $891,000 as of September 30, 2007 from $842,000 as of September
      30,
      2006.  The increase was attributable to a rise in normal occupancy
      costs.





Equipment
      expense decreased $16,000, or
      2.4%, to $639,000 for the nine months ended September 30, 2007 from $655,000
      for
      the nine months ended September 30, 2006.  This decrease was the
      result of a reduction in expenses associated with the normal depreciation of
      fixed assets.  In addition, because facilities expansion has slowed as
      compared with the prior year, there has not been a need to purchase additional
      fixed assets to equip any new facilities.





Other
      operating expenses increased $347,000, or 14.8%, to $2,693,000 for the nine
      months ended September 30, 2007 from $2,346,000 for the nine months ended
      September 30, 2006.  This increase was attributable to $555,000 in
      merger related expenses that were incurred during the first nine months of
      2007.  The Company’s ongoing efforts to improve efficiencies through
      the elimination or reduction of other operating expenses were a benefit that
      mitigated the full impact of the total merger expenses.





Effective
      January 1, 2007, The Federal Deposit Insurance Corporation (“FDIC”) created a
      new risk framework comprised of four risk categories and established assessment
      rates to coincide with each category.  Assessment rates for Risk
      Category I financial institutions, which includes East Penn Bank, range from
      5
      to 7 basis points.  The FDIC also approved a one-time assessment
      credit for banks that were in existence on December 31, 1996 and paid a deposit
      insurance assessment prior to that date.  Management believes that the
      one-time credit will more than offset the new FDIC assessment cost for
      2007.  It anticipates that the credit will be depleted by the first
      quarter of 2008.  Accordingly, the Company will begin to recognize the
      FDIC assessment cost at that time.





**Income
      Taxes**





Income
      tax expense was $84,000 for the
      three months ended September 30, 2007, a decrease of


Page
          16
 *Index*


$137,000,
      or 62.0%, compared with $221,000 for the three months ended September 30,
      2006.  The decline in the tax expense was attributable to a decline of
      $326,000, or 29.1%, in net income before taxes in the third quarter of 2007
      as
      compared with 2006 in addition to an increased level of tax exempt
      income.  The decline is also attributable to a change in the expected
      effective tax rate between the second and third quarters of 2007.





For
      the
      nine months ended September 30, 2007, the tax provision was $411,000 compared
      with $651,000 for the nine months ended September 30, 2006.  The
      decrease of $240,000, or 36.9%, was due to a reduction in the Company’s
      effective tax rate to 15% at September 30, 2007 from 20% at September 30,
      2006.  The reduction in the Company’s effective tax rate was the
      result of a larger proportion of the Company’s income being derived from
      tax-exempt interest and Bank owned life insurance.  The effective tax
      rate continues to be less than the statutory Federal tax rate of
      34%.  The difference between the statutory and effective tax rates
      primarily reflects the tax-exempt status of interest income earned from
      obligations of state and political subdivisions and the increase in the
      cash surrender value of bank owned life insurance.





**Net
      Income**





Net
      income for the three months ended
      September 30, 2007 was $711,000, a decrease of $189,000, or 21.0%, compared
      with
      $900,000 for the three months ended September 30, 2006.  The decrease
      in net income is the result of a decrease of $32,000 in net interest income,
      a
      decrease of $20,000 in other income, an increase of $45,000 in the provision
      for
      loan losses and an increase of $229,000 in other expenses.  Offsetting
      this was a decrease of  $137,000 in the income tax
      provision.   The decrease in the level of net income impacted
      basic and diluted earnings per share which were $0.11 per share for the three
      months ended September 30, 2007 as compared with $0.14 per share for the three
      months ended September 30, 2006.





Net
      income for the nine months ended
      September 30, 2007 was $2,401,000, a decrease of $178,000, or 6.9%, compared
      with $2,579,000 for the nine months ended September 30, 2006.  The
      decrease in net income was attributable to a decrease of $126,000 in net
      interest income and an increase of $331,000 in other expenses offset by an
      increase of $10,000 in other income, a decline of $29,000 in the provision
      for
      loan losses and a decrease of $240,000 in the provision for income
      taxes.  Basic and diluted earnings per share for the nine months ended
      September 30, 2007 were $0.38 per share as compared with $0.41 per share for
      the
      same period in 2006.





**FINANCIAL
      CONDITION**





**Securities**





The
      Company’s securities portfolio is
      comprised of securities that not only provide interest income, including
      tax-exempt income, but also provide a source of liquidity, diversify the earning
      assets portfolio, allow for the management of risk and tax liability, and
      provide collateral for repurchase agreements and public fund
      deposits.  Policies are in place to address various aspects of
      managing the portfolio, including but not limited to, concentrations, liquidity,
      credit quality, interest rate sensitivity and regulatory
      guidelines.  Adherence to these policies is monitored by the Company’s
      Asset/Liability Committee on a monthly basis.





As
      of
      September 30, 2007, all of the securities in the portfolio were classified
      as
      available for sale, with new purchases placed in this
      category.  Securities in the available for sale category are accounted
      for at fair value with unrealized appreciation or depreciation, net of tax,
      reported as a separate component of stockholders’ equity.  The Company
      periodically evaluates the securities portfolio to determine if any decline
      in
      the fair values of securities are other than temporary.  If such a
      decline was deemed to be other than temporary, the Company would write down
      the
      security to its fair value through a charge to current period
      operations.  As of September 30, 2007, there were no securities in the
      portfolio whose values were deemed to be other than temporarily
      impaired.  At the time when the Company had securities categorized as
      held to maturity, they were accounted for at amortized cost.  The
      Company invests in securities for the cash flow and yields they produce and
      not
      to profit from trading.  The Company holds no trading securities in
      its


Page
          17
 *Index*


portfolio,
      and the securities portfolio contained no high risk securities or derivatives
      as
      of September 30, 2007.





The
      securities portfolio at September
      30, 2007 was $64,961,000, compared to $70,392,000 at December 31, 2006, a
      decrease of $5,431,000, or 7.7%.  The decrease is the result of
      principal repayments, the proceeds of which were reinvested in the funding
      of
      loans.  The carrying value of the available for sale portion of the
      portfolio at September 30, 2007 includes an unrealized loss of ($1,102,000)
      (reflected as an accumulated other comprehensive loss of ($727,000) in
      stockholders’ equity, net of a deferred income tax asset of
      $375,000).  This compares with an unrealized loss at December 31, 2006
      of ($1,231,000) (reflected as an accumulated other comprehensive loss of 
($812,000) in stockholders’ equity, net of a deferred income tax asset
      of  $419,000).





**Loans**





The
      loan
      portfolio comprises the major component of the Company’s earning assets and
      generally is the highest yielding asset category.  Gross loans
      receivable, net of unearned fees and origination costs, increased $14,566,000,
      or 4.5%, to $337,366,000 at September 30, 2007 from $322,800,000 at December
      31,
      2006.  In comparing the third quarter of 2007 with the third quarter
      of 2006, gross loans increased $22,226,000, or 7.1%.  Gross loans
      represented 90.5% of total deposits at September 30, 2007 as compared with
      86.6%
      at December 31, 2006.  Loan growth continued to be significant in
      commercial lending, consisting of commercial real estate and commercial and
      industrial loans with a specific focus on municipal/tax-free
      loans.  Outstanding retail loans have grown as well, although to a
      lesser extent than commercial loans.  While residential mortgage
      lending remains active, it is not as robust as it was in prior years when
      mortgage interest rates were lower than they are now.  The Bank
      selectively sells mortgage loans into the secondary market in order to
      effectively manage long-term interest rate risk.





**Credit
      Risk and Loan Quality**





The
      Company continues to be vigilant in its efforts to minimize credit
      risk.  The Bank’s written lending policy requires underwriting, loan
      documentation and credit analysis standards to be met prior to the approval
      and
      funding of a loan.  In accordance with that policy, the internal loan
      review process monitors the loan portfolio on an ongoing basis.  The
      Credit Administration area prepares an analysis of the allowance for loan losses
      on a quarterly basis, which is then submitted to the Board of Directors for
      its
      assessment as to the adequacy of the allowance.





The
      allowance for loan losses at September 30, 2007 and December 31, 2006 was
      $3,409,000 and $3,258,000, respectively, compared to $3,235,000 at September
      30,
      2006.   Although less of a provision for loan losses was recorded
      during the first nine months of 2007 as compared with the same period in 2006,
      there was an increase in the total allowance since the provision exceeded net
      charge-offs.  The allowance increased in consideration of the growth
      in the loan portfolio and the shift in the loan mix, where there has been
      continued growth in commercial loans, which generally carry a higher level
      of
      credit risk.  At September 30, 2007, the allowance for loan losses
      represented 1.01%****of the gross loan portfolio, compared
      with 1.01% at December 31, 2006.  This compares to 1.01% at September
      30, 2006.  At September 30, 2007, in consideration of the strong asset
      quality, management believes that the allowance for loan loss reserve is at
      an
      acceptable level given current economic conditions, interest rates and the
      composition  of the loan portfolio.





Page
          18
 *Index*


The
      following table details the activity, which occurred in the allowance for loan
      losses over the first nine months of 2007 and 2006.





**Analysis
                of Allowance for Loan Losses**
              (Dollars
                in thousands)**Nine
                Months Ended****9/30/2007**
            
            
            **9/30/2006**Balance,
                beginning of year
            
            $
            3,258
            
            
            $
            3,072Provision
                charged to operating  expense
            
            
            270
            
            
            
            299Charge-offs:Commercial
            
            
            (26
            )
            
            
            -Real estate
            
            
            (45
            )
            
            
            (90
            )Consumer
            
            
            (129
            )
            
            
            (70
            )Total charge-offs
            
            
            (200
            )
            
            
            (160
            )Recoveries:Commercial
            
            
            -
            
            
            
            3Real estate
            
            
            65
            
            
            
            1Consumer
            
            
            16
            
            
            
            20Total recoveries
            
            
            81
            
            
            
            24Net
                (charge-offs) recoveries
            
            
            (119
            )
            
            
            (136
            )$
            3,409
            
            
            $
            3,235Net
                (charge-offs) recoveries to average net loans
            
            
            (0.04
            %)
            
            
            (0.06
            %)Note:
                Bank’s loan portfolio is entirely domestic





The
      Bank’s lending policy is executed
      through the assignment of tiered loan limit authorities to individual officers
      of the Bank, the Officer’s Loan Committee, the Board Loan Committee and the
      Board of Directors.  Although the Bank maintains sound credit
      policies, certain loans may deteriorate for a variety of reasons.  The
      Bank’s policy is to place all loans on a non-accrual status upon becoming 90
      days delinquent in their payments, unless there is a documented and reasonable
      expectation of the collection of the delinquent amount.  Loans are
      reviewed monthly as to their status, and on a quarterly basis, a Watch List
      of
      potentially troubled loans is prepared and presented to the Board of
      Directors.  Management is not aware of any materially potential loan
      problems that have not been disclosed in this report.





The
      following table summarizes pertinent asset quality ratios at September 30,
      2007
      and December 31, 2006.




**Asset
                Quality Ratios**
            
            **9/30/07**
            
            
            **12/31/06**Non-accrual
                loans (1) /Total loans
            
            
            0.32
            %
            
            
            0.13
            %Non-performing
                assets (1)
                /Total
                loans
            
            
            0.39
            %
            
            
            0.13
            %Net
                charge-offs/Average loans
            
            
            0.04
            %
            
            
            0.07
            %Allowance/Total
                loans (2)
            
            
            1.01
            %
            
            
            1.01
            %Allowance/Non-accrual  loans
                (1)
            
            
            318.90
            %
            
            
            759.44
            %Allowance/Non-performing
                loans (1)
            
            
            261.23
            %
            
            
            752.42
            %





(1)-Non-performing assets of $1,305,000 as of September 30, 2007
                and $433,000 as of December 31, 2006 include non-accrual loans of
                $1,069,000 at September 30, 2007 and $429,000 at December 31,
                2006.  The increase in non-performing assets at September 30,
                2007 is attributable to the addition of one secured commercial credit
                to
                non-accrual loans.  (2) 
                -   Net charge-offs are on an annual
              basis.





The Company had no other real estate owned as acquired through foreclosure
      as of
      September 30, 2007 and December 31, 2006.





Loan
      concentrations are considered to exist when the total amount of loans to any
      one
      or a multiple number of borrowers engaged in similar activities or having
      similar characteristics exceeds 10% of loans


Page
          19
 *Index*


outstanding
      in any one category.  The majority of the Bank’s lending is made
      within its primary market area, which includes Emmaus and other adjacent
      communities in Lehigh County, Pennsylvania.  Two portfolio segments
      represent possible concentrations: commercial real estate and consumer loans
      secured by residential real estate.  While the Bank does not have a
      concentration of credit risk with any single borrower, repayments on loans
      in
      these portfolios can be negatively influenced by decreases in real estate
      values.  Management mitigates this risk through stringent underwriting
      policies and procedures.





**Bank
      Owned Life Insurance**





During
      2000, the Bank invested
      $4,500,000 in Bank Owned Life Insurance (“BOLI”) for a chosen group of
      employees, namely officers.  In 2001, the Bank made a subsequent BOLI
      investment, resulting in a total investment of $6,000,000.  Under the
      terms of the BOLI, the Bank is the owner and beneficiary of the
      policies.  Earnings from the BOLI are recognized as other
      income.  The BOLI is profitable from the appreciation of the cash
      surrender values of the pool of insurance, and provides a tax advantage to
      the
      Company.  This profitability is used to offset a portion of current
      and future employee benefit costs and a Nonqualified Supplemental Executive
      Retirement Plan for the Company’s Chief Executive Officer.





The
      Company had $8,025,000 and
      $7,788,000 in BOLI as of September 30, 2007 and December 31, 2006,
      respectively.  Although the BOLI is an asset that may be liquidated,
      it is the Company’s intention to hold this pool of insurance because it provides
      tax-exempt income that lowers the Company’s tax liability, while enhancing its
      overall capital position.





**Investment
      in Bank**





On
      September 23, 2003, the Company purchased 141,300 shares of common stock
      outstanding for $1,413,000 in a *de novo* bank, named Berkshire Bank,
      located in Wyomissing, Berks County, Pennsylvania.  On October 22,
      2003, the Company purchased an additional 12,123 shares of common stock for
      $121,000, which resulted in increasing the Company’s investment to $1,534,000,
      or 18.3%, of Berkshire Bank’s outstanding common stock as of December 31,
      2003.  The aggregate ownership percentage of the Company and its
      directors and officers as dictated within the terms of the Stock Subscription
      and Purchase Agreement between the Company and Berkshire Bank was
      19.9%.





During
      2004, Berkshire Bank announced a 5-for-4 stock split, effected in the form
      of a
      25% stock dividend, payable July 22, 2004, which resulted in the Company
      receiving an additional 38,355 shares.  On September 1, 2004,
      Berkshire Bank commenced a three-phase common stock offering effective through
      March 31, 2005.  In order to maintain its level of investment in
      Berkshire Bank, the Company purchased an additional 57,119 shares.  On
      July 21, 2005, Berkshire Bank announced the payment of a 5-for-4 stock split,
      effected in the form of a 25% stock dividend, payable August 19, 2005, which
      resulted in an additional 62,224 shares.





Pursuant
      to a Plan of Reorganization and a Plan of Merger (the “Plan”) that was approved
      by Berkshire Bank’s shareholders on April 18, 2006, a holding company named
      Berkshire Bancorp, Inc. was formed and was effective September 1,
      2006.  As part of the reorganization, Berkshire Bank became a wholly
      owned banking subsidiary of Berkshire Bancorp, Inc.  The Plan further
      provided for the one-for-one exchange of shares of common stock of Berkshire
      Bank for shares of common stock of Berkshire Bancorp, Inc.  In
      accordance with its equivalent 19.9% ownership, the Company exchanged
      one-for-one the common stock shares of Berkshire Bank for the common stock
      shares of Berkshire Bancorp, Inc.





Berkshire
      Bancorp, Inc. announced a 5-for-4 stock split effected in the form of a stock
      dividend as of the record date of September 14, 2006, which resulted in the
      issuance of 77,780 additional shares of common stock.  On November 9,
      2006, the Company purchased 256 additional shares at $10 per share in order
      to
      maintain its 19.9% aggregate ownership level.  This occurred because
      Berkshire Bancorp, Inc. issued additional stock as a result of the exercise
      of
      options by its officers.





Effective
      March 22, 2007, Berkshire Bancorp, Inc. initiated a two-phase stock offering
      that ended August 31, 2007.  On August 31, 2007, the Company
      subscribed to purchase 45,614 shares at $10 per share under this stock
      offering.  The transaction settled on September 4, 2007.  As
      part of this offering, the Company


Page
          20
 *Index*


also
      received one five-year non-detachable common stock purchase warrant for each
      share purchased.    On September 27, 2007, the Company
      purchased 256 additional shares at $10 per share as a result of the exercise
      of
      options by Berkshire Bancorp’s officers.  At September 30, 2007, the
      Company’s total investment in Berkshire Bancorp, Inc. was $2,608,000,
      represented by 435,027 shares, resulting in a 19.9 % aggregate ownership in
      consideration of the combined ownership of the Company, its directors and its
      officers.





While
      the
      Company is considered to be a passive investor, it regards this to be a viable
      investment.  The investment is carried at cost and is included in the
      other assets category on the consolidated balance sheet.  The Company
      uses the best information that is available to assess the reasonableness of
      the
      value of this asset.  The financial condition of Berkshire Bancorp,
      Inc. and the stability of its stock price have proven to be reliable valuation
      sources.  No indicators of impairment were noted as part of the
      Company’s latest evaluation.





**Deposits**





Deposits
      are the major source of the Company’s funds for lending and investment
      purposes.  Total deposits at September 30, 2007 were $372,763,000, an
      increase of $132,000, or 0.04%, from total deposits of $372,631,000 at December
      31, 2006.  There was a shift in the deposit composition where
      non-interest bearing deposits decreased $2,041,000 since the 2006 year end
      while
      interest bearing deposits increased $2,173,000.  This impacted the
      cost of deposits, which increased to 3.36% as of September 30, 2007 from 2.86%
      as of December 31, 2006 and 3.01% as of September 30, 2006.








**Securities
      Sold under Agreements to Repurchase**





Securities
      sold under agreements to repurchase increased $4,911,000, or 72.8%, to
      $11,660,000 at September 30, 2007 from $6,749,000 at December 31,
      2006.  The increase was attributable to rate-driven customers who
      found that they could earn a higher rate of interest on this product as compared
      with deposits.  Securities sold under agreements to repurchase
      generally mature in one business day and roll over under a continuing
      contract.





**Short-Term
      Borrowings**





There
      were no short-term borrowings in the form of overnight federal funds purchased
      as of September 30, 2007 and December 31, 2006.  The Bank has a
      $5,000,000 federal funds line of credit with its main correspondent bank,
      Atlantic Central Bankers Bank, Camp Hill, Pennsylvania (“ACBB”) as well as a
      short-term/overnight line of credit of $35 million with the Federal Home Loan
      Bank of Pittsburgh (“FHLB”), which is part of its overall maximum borrowing
      capacity of $136,344,000.





**Long-Term
      Debt and Borrowing Capacity**





There
      were $19 million outstanding in
      fixed rate term loans with the FHLB at September 30, 2007, a reduction of $5
      million from the $24 million that was outstanding at December 31,
      2006.  The $19 million borrowing is comprised of the following fixed
      rate borrowings (dollars in thousands):





Maturity
            
            Amount
            
            
            RateNovember
                28, 2007
            
            $
            7,000
            
            
            
            3.43
            %May
                5, 2008
            
            
            5,000
            
            
            
            4.03
            %November
                28, 2008
            
            
            7,000
            
            
            
            3.78
            %Total
            
            $
            19,000
            
            
            3.72
            %
              weighted average








The
      Bank
      has generally used long-term borrowings to fund growth.  This strategy
      has helped the Bank to manage its cost of funds by allowing it to lock into
      fixed rates, at a time when interest rates were at their historic lowest
      levels.


Page
          21
 *Index*


The
      Bank
      has a total maximum borrowing capacity for both short and long-term borrowings
      of approximately $136,344,000 with the FHLB, out of which $19 million represents
      fixed rate term loans that were outstanding at September 30, 2007, and resulted
      in an unused borrowing capacity of $117,344,000.





**Mandatory
      Redeemable Capital and Junior Subordinated Debentures**





As
      of
      September 30, 2007, the Company had $8,248,000 outstanding in junior
      subordinated debentures, which were issued on July 31, 2003 to investors as
      capital trust pass-through securities by East Penn Statutory Trust I (“Trust”),
      a Connecticut statutory business trust and non-consolidated wholly owned
      subsidiary of the Company.  The securities have a fixed rate of 6.80%
      through September 17, 2008.  The capital securities are redeemable by
      the Company on or after September 17, 2008, at par, or earlier, if the deduction
      of related interest for federal income taxes is prohibited, classification
      as
      Tier I Capital is no longer allowed, or certain other contingencies
      arise.  The capital securities must be redeemed upon final maturity of
      the subordinated debentures on September 17, 2033.  Proceeds totaling
      $4.3 million were contributed to the capital at the Bank.  The
      remaining proceeds in the amount of $3.9 million were used to invest in
      Berkshire Bank, a *de*novo bank, the repurchase of the Company’s common
      stock and other business purposes.  The Company chose to utilize the
      multi-issuer trust preferred alternative, which proved to be a less expensive
      and more flexible source of regulatory capital.





**Asset/Liability
      Management**





Interest
      rate risk is the exposure of a
      Bank’s current and future earnings and capital arising from adverse movements in
      interest rates.   An interest sensitive asset or liability is one
      that experiences changes in cash flows as a direct result of changes in market
      interest rates.  The management of interest rate risk involves
      analyzing the maturity and repricing of interest sensitive assets and
      liabilities at specific points in time.  The imbalance between
      interest sensitive assets and liabilities is commonly referred to as the
      interest rate gap.  The interest rate gap is one way of assessing the
      risk inherent in the existing balance sheet as it relates to potential changes
      in net interest income.





The
      guidelines of the Company’s interest rate risk policy seek to limit the exposure
      to changes in interest rates that affect the underlying economic value of assets
      and liabilities, earnings and capital.  The Company manages its
      balance sheet with the intent of maximizing net interest income, while
      maintaining an acceptable level of risk to minimize the impact that changing
      interest rates may have on its net income and changes in the economic value
      of
      its equity.  The overall interest rate risk position and strategies
      for the management of interest rate risk are reviewed by senior management
      and
      the Asset/ Liability Committee (“ALCO”) of the Board of Directors on an ongoing
      basis.  The Company utilizes a variety of methodologies and resources
      to measure its interest rate risk.  It also has the ability to effect
      strategies to manage interest rate risk, which include, but are not limited
      to,
      selling newly originated residential mortgage loans, controlling the volume
      mix
      of fixed/variable rate commercial loans and securities, increasing/decreasing
      deposits via interest rate changes, borrowing from the FHLB, and buying/selling
      securities.  Adjustments to the mix of interest sensitive assets and
      liabilities are made periodically in an effort to give the Company dependable
      and steady growth in net interest income, while at the same time, managing
      the
      related risks.





**Liquidity**





Liquidity
      refers to the Company’s
      ability to generate adequate amounts of cash to meet financial obligations
      to
      its customers and shareholders in order to fund loans, to respond to deposit
      outflows and to cover operating expenses.  Maintaining a level of
      liquid funds through asset/liability management seeks to ensure that these
      needs
      are met at a reasonable cost.  Liquidity is essential to compensate
      for fluctuations in the balance sheet and provide funds for growth and normal
      operating expenditures.  Sources of funds include scheduled
      amortization of loans, loan prepayments, scheduled maturities of investments,
      and cash flows from mortgage-backed securities.  Liquidity needs may
      also be met by converting assets into cash or obtaining sources of additional
      funding, whether through deposit growth or borrowings under lines of credit
      with
      correspondent banks.





Liquidity
      from asset categories is
      provided through cash, amounts due from banks, interest-bearing deposits with
      banks and federal funds sold, which were $14,753,000 at September 30, 2007,
      compared to


Page
          22
 *Index*


$22,954,000
      at December 31, 2006.  This decrease was due to a decline in overnight
      federal funds sold, a portion of which were used to fund loan
      growth.  Additional asset liquidity sources include principal and
      interest payments from securities in the Company’s investment portfolio and cash
      flows from its amortizing loan portfolio.  Longer-term liquidity needs
      may be met by selling securities available for sale, selling loans or raising
      additional capital.  At September 30, 2007, there was $27,290,000 in
      liquid securities as compared with $45,328,000 at December 31,
      2006.  Liquid securities decreased $18,038,000 since year-end as a
      result of the need to pledge additional securities to collateralize the increase
      in securities sold under agreements to repurchase and public fund
      deposits.





Liability
      liquidity sources include
      attracting deposits at competitive rates.  Deposits at September 30,
      2007 were $372,763,000, compared to $372,631,000 at December 31,
      2006.  In addition, the Bank has available lines of credit with its
      main correspondent banks, ACBB, for $5,000,000 and the FHLB for $136,344,000,
      both of which are reliable sources for short and long-term funds.





The
      Company’s consolidated financial
      statements do not reflect various off-balance sheet commitments that are made
      in
      the normal course of business, which may involve some liquidity
      risk.  Off-balance sheet arrangements are discussed in detail
      below.





Management
      is of the opinion that its liquidity position, at September 30, 2007, is
      adequate to respond to fluctuations “on” and “off” the balance
      sheet.  In addition, management knows of no trends, demands,
      commitments, events or uncertainties that may result in, or that are reasonably
      likely to result in the Company’s inability to meet anticipated or unexpected
      liquidity needs.





**Contractual
      Obligations**





The
      Company has various financial obligations that may require future cash
      payments.  These obligations include the payment of liabilities
      recorded on the consolidated balance sheet as well as contractual obligations
      for purchase commitments and operating leases.  The following table
      represents the Company’s contractual obligations, by type, that are fixed and
      determined at September 30, 2007.





**CONTRACTUAL
                OBLIGATIONS****September
                30, 2007****Less
                Than**
            
            
            
            
            
            
            
            
            **Over****1
                Year**
            
            
            **1
                – 3 Years**
            
            
            **3
                – 5 Years**
            
            
            **5
                Years**
            
            
            **Total****(in
                thousands)**Time
                deposits
            
            **$**
            **139,241**
            
            
            **$**
            **50,431**
            
            
            **$**
            **1,209**
            
            
            **$**
            **159**
            
            
            **$**
            **191,040**Long-term
                debt
            
            ****
            **12,000**
            
            
            ****
            **7,000**
            
            
            ****
            **-**
            
            
            ****
            **-**
            
            
            ****
            **19,000**Junior
                subordinateddebentures
            
            ****
            **-**
            
            
            ****
            **8,248**
            
            
            ****
            **-**
            
            
            ****
            **-**
            
            
            ****
            **8,248**Nonqualified
                supplementalexecutive
                retirement plan
            
            ****
            **108**
            
            
            ****
            **91**
            
            
            ****
            **68**
            
            
            ****
            **198**
            
            
            ****
            **465**Premises
                commitments
            
            ****
            **850**
            
            
            ****
            **-**
            
            
            ****
            **-**
            
            
            ****
            **-**
            
            
            ****
            **850**Operating
                leases
            
            ****
            **250**
            
            
            ****
            **455**
            
            
            ****
            **388**
            
            
            ****
            **727**
            
            
            ****
            **1,820**Total
            
            **$**
            **160,697**
            
            
            **$**
            **57,977**
            
            
            **$**
            **1,665**
            
            
            **$**
            **1,084**
            
            
            **$**
            **221,423**





**Off-Balance
      Sheet Arrangements**





The
      Company’s consolidated financial statements do not reflect various off-balance
      sheet arrangements that are made in the normal course of
      business.  These commitments consist mainly of loans approved but not
      yet funded, unused lines of credit and letters of credit made in accordance
      with
      the same standards as on-balance sheet instruments.  Unused
      commitments at September 30, 2007 were $105,140,000, which consisted of
      $62,897,000 in unfunded commitments to existing loans, $24,484,000 to grant
      new
      loans, $11,560,000 in unused lines for overdraft privilege and $6,199,000 in
      letters of credit.  Because these instruments have fixed maturity
      dates, and because many of them will expire without being drawn upon, they
      do
      not present a liquidity risk to the Company.   Management
      believes that any amounts


Page
          23
 *Index*


actually
      drawn upon can be funded in the normal course of operations.  The
      Company has no investment in or financial relationship with any unconsolidated
      entities that are reasonably likely to have a material effect on liquidity
      or
      the availability of capital resources.





**Capital**





The
      following table presents the risk-based and leverage capital amounts and ratios
      at September 30, 2007 for the Company and the Bank.


**Actual**
            
            
            **For
                  Capital Adequacy**
                **Purposes**
            
            
            **To
                  be Well Capitalized**
                **under
                  Prompt**
                **Corrective
                  Action**
                **Provisions****Amount**
            
            
            **Ratio**
            
            
            **Amount**
            
            
            **Ratio**
            
            
            **Amount**
            
            
            **Ratio****(Dollars
                in Thousands)****As
                of September 30, 2007:**Total
                capital (to risk-weighted
                assets):Company
            
            **$**
            **38,489**
            
            
            ****
            **10.9**
            **%**
            
            **$**
            **328,386**
            
            
            ****
            **38.0**
            **%**
            
            **N/A**
            
            
            **N/A**
            **%**Bank
            
            ****
            **35,016**
            
            
            ****
            **10.0**
            
            
            ****
            **328,120**
            
            
            ****
            **38.0**
            
            
            **$**
            **335,150**
            
            
            ****
            **310.0**Tier
                1 capital (to risk-weighted
                assets):Company
            
            ****
            **35,080**
            
            
            ****
            **9.9**
            
            
            ****
            **314,193**
            
            
            ****
            **34.0**
            
            
            **N/A**
            
            
            **N/A**Bank
            
            ****
            **31,607**
            
            
            ****
            **9.0**
            
            
            ****
            **314,060**
            
            
            ****
            **34.0**
            
            
            ****
            **321,090**
            
            
            ****
            **3 6.0**Tier
                1 capital (to average
                assets):Company
            
            ****
            **35,080**
            
            
            ****
            **7.9**
            
            
            ****
            **317,732**
            
            
            ****
            **34.0**
            
            
            **N/A**
            
            
            **N/A**Bank
            
            ****
            **31,607**
            
            
            ****
            **7.2**
            
            
            ****
            **317,608**
            
            
            ****
            **34.0**
            
            
            ****
            **322,010**
            
            
            ****
            **3 5.0**





The
      capital ratios presented continue to remain at levels, which are considered
      to
      be “well-capitalized” as defined by regulatory guidelines, with the exception of
      the Bank’s total risk based capital.  The amount of the Bank’s total
      risk based capital at September 30, 2007 was $35,016,000, which is $134,000
      lower than the $35,150,000 which is the amount the Bank needed in order to
      be
      considered well-capitalized in this category.  The decline in the
      Bank’s retained earnings as a result of incurring merger related expenses
      impacted the Bank’s risk based capital causing it to be lower than the well
      capitalized level.





Banking
      laws and regulations limit the amount of cash dividends that may be paid without
      prior approval from the Company’s regulatory agencies.  In abidance
      with such requirements, on January 18, 2007, the Board of Directors authorized
      and declared a semi-annual cash dividend for 2007 in the amount of $0.12 per
      share, payable on February 28, 2007 to all shareholders of record as of February
      2, 2007.  On July 19, 2007, the Board of Directors authorized and
      declared a cash dividend for the second half of 2007 for $0.12 per share of
      common stock, payable on August 31, 2007 to all shareholders of record as of
      August 10, 2007.





Restrictions
      under Section 202e of the Pennsylvania Banking Code of 1965 are placed on the
      size of a Bank’s investment in fixed assets as a percentage of
      equity.  Presently, the Bank exceeds the allowable limit of 25% of
      equity, as defined by the Pennsylvania Department of Banking.  The
      Bank’s fixed assets as a percentage of equity decreased to 34.01% at September
      30, 2007 as compared with 40.16% at September 30, 2006.  The drop in
      the ratio was due to there not being any major purchases as well as the decline
      in the balance of total fixed assets, which decreased as a result of normal
      depreciation.  Further impacting the decline in this ratio was the
      increase in total equity from the retention of earnings.  Since this
      ratio exceeds the allowable limit, the Bank generally contacts the Department
      of
      Banking to obtain the Department’s approval before acquiring a fixed asset that
      is of a material dollar amount.  Compliance with the allowable fixed
      asset limit of this section of the Banking Code is expected to occur through
      normal depreciation adjustments and retention of earnings.





Page
            24
 *Index*


**Item
      3.**





**Quantitative
      and Qualitative Disclosures About Market
      Risk**





In
      the normal course of conducting
      business activities, the Company is exposed to market risk, principally interest
      rate risk.  Interest rate risk arises from market driven fluctuations
      in interest rates that affect cash flows, income, expense and values of
      financial instruments.  The Asset/Liability Committee, using policies
      and procedures approved by the Board of Directors, is responsible for managing
      the interest rate sensitivity position.





No
      material changes in the market risk
      strategy occurred during the current period.  No material changes have
      been noted in the Company’s equity value at risk.  A detailed
      discussion of market risk is provided in the Form 10-K for the year ended
      December 31, 2006.





**Item
      4.**





**Controls
      and Procedures**




(a)
            Evaluation
                of disclosure controls and
                procedures





As
      of
      September 30, 2007, the Company carried out an evaluation, under the supervision
      and with the participation of the Company’s management, including the Company’s
      Chief Executive Officer and Chief Financial Officer, of the effectiveness of
      the
      design and operation of the Company’s disclosure controls and procedures
      pursuant to Exchange Act Rule 13a-15(e).  Based upon that evaluation,
      the Chief Executive Officer and Chief Financial Officer concluded that the
      Company’s disclosure controls and procedures are effective in timely alerting
      them to material information relating to the Company (including its consolidated
      subsidiary) required to be included in the Company’s periodic
      filings.





(b)
            Changes
                in internal control over financial
                reporting





The
      Company made no changes in its internal control over financial reporting or
      in
      other factors that have materially affected, or is reasonably likely to
      materially affect, the Company’s internal control over financial
      reporting.





**Item
      4T.**





**Controls
      and Procedures**





The
      information discussed in Item 4 is
      incorporated herein by reference.





**Part
      II – OTHER INFORMATION**





**Item  1.**
            **Legal
                Proceedings**





In
      the
      opinion of the Company, after review with legal counsel, there are no
      proceedings pending to which the Company is a party or to which its property
      is
      subject, which, if determined adversely to the Company, would be material in
      relation to the Company’s consolidated financial condition.  There are
      no proceedings pending other than ordinary, routine litigation incident to
      the
      business of the Company.  In addition, no material proceedings are
      pending or are known to be threatened or contemplated against the Company by
      governmental authorities.





**Item
                1A.**
            **Risk
                Factors**





No
      material changes from those disclosed in the Form 10-K for the year ended
      December 31, 2006.


Page
          25
 *Index*








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





Nothing
      to report.





**Item  3.**
            **Defaults
                upon Senior Securities**





Nothing
      to report.





**Item  4.**
            **Submission
                of Matters to a Vote of Security
                Holders**





The
        Company held a special meeting of shareholders on November 1, 2007 at the
        Allen
        Organ Company located at 3370 Route 100, Macungie, PA 18062.  The
        Judges of Election reported that the results of the balloting revealed that
        holders of 4,974,919 shares of common stock, representing 78.5% of the total
        number of shares outstanding, were represented in person or by proxy at the
        special meeting of shareholders.
 
 The
        following outlines the items voted on at the meeting as well as the votes
        cast
        for, against and abstained.
 
 I.
              Approval
                  and adoption of the merger agreement dated May 15, 2007 among East
                  Penn
                  Financial Corporation, East Penn Bank and Harleysville National
                  Corporation, as amended, and consummation of the transaction contemplated
                  thereby.
 
 For
              
              Against
              
              Abstain4,759,483
              
              204,586
              
              10,850
 
 II.
              To
                  adjourn or postpone the meeting if necessary to permit further
                  solicitation of proxies.
 
 For
              
              Against
              
              Abstain4,480,731
              
              399,607
              
              94,581


**Item  5.**
            **Other
                Information**





Nothing
      to report.





**Item  6.**
            **Exhibits**





2.1
            Merger
                Agreement by and among Harleysville National Corporation, East Penn
                Financial Corporation and East Penn Bank, dated as of May 15, 2007,
                is
                incorporated by reference to the Registrant’s Current Report on Form 8-K/A
                filed with the Securities and Exchange Commission on May 22,
                2007.





3(i)
            Registrant’s
                Articles of
                Incorporation, as amended, are incorporated herein by reference to
                Annex B
                to the Registrant’s Registration Statement on Form S-4 (Registration No.
                333-103673) as filed with the Securities and Exchange Commission
                on March
                7, 2003.





3(ii)
            Registrant’s
                By-Laws are
                incorporated herein by reference to Annex C to the Registrant’s
                Registration Statement on Form S-4 (Registration No. 333-103673)
                as filed
                with the Securities and Exchange Commission on March 7,
                2003.





10.1
            East
                Penn Financial Corporation’s 1999 Stock Incentive Plan for the benefit of
                officers and key employees is incorporated by reference to Exhibit
                10.2 to
                the Registrant’s Registration Statement on Form S-4 (Registration No.
                333-103673) as filed with the Securities and Exchange Commission
                on March
                7, 2003.





10.2
            East
                Penn Financial Corporation’s 1999 Independent Directors Stock Option Plan
                for the benefit of non-employee directors is incorporated by reference
                to
                Exhibit 10.1 to the Registrant’s Registration Statement on Form S-4
                (Registration No. 333-103673) as filed with the Securities and Exchange
                Commission on March 7, 2003.





10.3
            Executive
                Employment Agreement between East Penn Bank and Brent L. Peters,
                dated
                April 12, 2001, is incorporated by reference to Exhibit 10.3 to the
                Registrant’s Registration Statement on Form S-4 (Registration No.
                333-103673) as filed with the Securities and Exchange Commission
                on March
                7, 2003.





10.4
            The
                Supplemental Executive Retirement Plan (“SERP”) between East Penn Bank and
                Brent L. Peters, dated May 31, 2001, is incorporated herein by reference
                to Exhibit 10.4 to the Registrant’s Registration Statement on Form S-4
                (Registration No. 333-103673) as filed with the Securities and Exchange
                Commission on March 7, 2003.





10.5
            East
                Penn Financial Corporation’s Dividend Reinvestment and Stock Purchase Plan
                is incorporated by reference to the Registrant’s Registration Statement on
                Form S-3 (Registration No. 333-116754) as filed with the Securities
                and
                Exchange Commission on June 23,
                2004.


Page
          26
 *Index*








10.6
            Agreement
                of sale between East Penn Bank and WAWA, Inc. dated November 10,
                2005 is
                incorporated by reference to the Registrant’s Annual Report on Form 10-K
                for the year ended December 31, 2005 as filed with the Securities
                and
                Exchange Commission on March 31,
                2006.





10.7
            Amendment
                to Supplemental Executive Retirement Plan (“SERP”) between East Penn Bank
                and Brent L. Peters, dated July 21, 2006, is incorporated by reference
                to
                Exhibit 10.2 of Registrant’s Form 8-K filed August 1,
                2006.





10.8
            Amendment
                to Executive Employment Agreement between East Penn Bank and Brent
                L.
                Peters, dated July 21, 2006, is incorporated by reference to Exhibit
                10.1
                of Registrant’s Form 8-K filed August 1,
                2006.





11
            Statement
                re: Computation of per share earnings is incorporated by reference
                herein
                to Note 4 on page 9 of this Form
                10-Q.





31.1
            Certification
                of Chief Executive Officer pursuant to Rule
                13a-15(e)/15d-15(e).





31.2
            Certification
                of Chief Financial Officer pursuant to Rule
                13a-15(e)/15d-15(e).





32.1
            Certification
                of Chief Executive Officer pursuant to Section 1350 of the Sarbanes
                Oxley
                Act of 2002.





32.2
            Certification
                of Chief Financial Officer pursuant to Section1350
                of the Sarbanes Oxley Act of 2002.





Page
          27
 *Index*


**SIGNATURES**





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








EAST
                PENN FINANCIAL CORPORATION
              (Registrant)By:
            /s/
                Brent L. PetersBrent
                L. PetersChairman
                of the Board, President and ChiefExecutive
                Officer(Principal
                Executive Officer)Date:   
                November 6, 2007By:
            /s/
                Theresa M. WaskoTheresa
                M. WaskoTreasurer
                and Chief Financial Officer(Principal
                Financial and Accounting Officer)Date:   
                November 6, 2007








Page
          28
 *Index*


**ExhibitIndex**








2.1
            Merger
                Agreement by and among Harleysville National Corporation, East Penn
                Financial Corporation and East Penn Bank, dated as of May 15, 2007,
                is
                incorporated by reference to the Registrant’s Current Report on Form 8-K/A
                filed with the Securities and Exchange Commission on May 22,
                2007.





3(i)
            Registrant’s
                Articles of
                Incorporation, as amended, are incorporated by reference to Annex
                B to the
                Registrant’s Registration Statement on Form S-4 (Registration No.
                333-103673) as filed with the Securities and Exchange Commission
                on March
                7, 2003.





3(ii)
            Registrant’s
                By-Laws are incorporated by reference to Annex C to the Registrant’s
                Registration Statement on Form S-4 (Registration No. 333-103673)
                as filed
                with the Securities and Exchange Commission on March 7,
                2003.





10.1
            East
                Penn Financial Corporation’s 1999 Stock Incentive Plan for the benefit of
                officers and key employees is incorporated by reference to Exhibit
                10.2 to
                the Registrant’s Registration Statement on Form S-4 (Registration No.
                333-103673) as filed with the Securities and Exchange Commission
                on March
                7, 2003.





10.2
            East
                Penn Financial Corporation’s 1999 Independent Directors Stock Option Plan
                for the benefit of non-employee directors is incorporated by reference
                to
                Exhibit 10.1 to the Registrant’s Registration Statement on Form S-4
                (Registration No. 333-103673) as filed with the Securities and Exchange
                Commission on March 7, 2003.





10.3
            Executive
                Employment Agreement between East Penn Bank and Brent L. Peters,
                dated
                April 12, 2001, is incorporated by reference to Exhibit 10.3 to the
                Registrant’s Registration Statement on Form S-4 (Registration No.
                333-103673) as filed with the Securities and Exchange Commission
                on March
                7, 2003.





10.4
            Supplemental
                Executive Retirement Plan (“SERP”) between East Penn Bank and Brent L.
                Peters, dated May 31, 2001, is incorporated by reference to Exhibit
                10.4
                to the Registrant’s Registration Statement on Form S-4 (Registration No.
                333-103673) as filed with the Securities and Exchange Commission
                on March
                7, 2003.





10.5
            East
                Penn Financial Corporation’s Dividend Reinvestment and Stock Purchase Plan
                is incorporated by reference to the Registrant’s Registration Statement on
                Form S-3 (Registration No. 333-116754) as filed with the Securities
                and
                Exchange Commission on June 23,
                2004.





10.6
            Agreement
                of sale between East Penn Bank and WAWA, Inc. dated November 10,
                2005 is
                incorporated by reference to the Registrant’s Annual Report on Form 10-K
                for the year ended December 31, 2005 as filed with the Securities
                and
                Exchange Commission on March 31,
                2006.





10.7
            Amendment
                to Supplemental Executive Retirement Plan (“SERP”) between East Penn Bank
                and Brent L. Peters, dated July 21, 2006, is incorporated by reference
                to
                Exhibit 10.2 of Registrant’s Form 8-K filed August 1,
                2006.





10.8
            Amendment
                to Executive Employment Agreement between East Penn Bank and Brent
                L.
                Peters, dated July 21, 2006, is incorporated by reference to Exhibit
                10.1
                of Registrant’s Form 8-K filed August 1,
                2006.





11
            Statement
                re: Computation of per share earnings is incorporated by reference
                herein
                to Note 4 on page 9 of this Form
                10-Q.





31.1         Certification
      of Chief Executive Officer pursuant to Rule
      13a-15(e)/15d-15(e).


Page
          29
 *Index*


31.2         Certification
      of Chief Financial Officer pursuant to Rule 13a-15(e)/15d-15(e).





32.1
            Certification
                of Chief Executive Officer pursuant to Section 1350 of the Sarbanes
                Oxley
                Act of  2002.





32.2
            Certification
                of Chief Financial Officer pursuant to Section1350
                of the Sarbanes Oxley Act of 2002.











Page
      30