UNITED STATES
                       SECURITIES AND EXCHANGE COMMISSION
                             Washington, D.C. 20549

                                    FORM 10-K

             [ X ] ANNUAL REPORT PURSUANT TO SECTION 13 or 15(d) OF
                       THE SECURITIES EXCHANGE ACT OF 1934
                   For the fiscal year ended December 31, 2003
                                       or
            [ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF
                       THE SECURITIES EXCHANGE ACT OF 1934

                         Commission file number 0-15786

                [GRAPHIC OMITTED]COMMUNITYBANKS[GRAPHIC OMITTED]

                              COMMUNITY BANKS, INC.
             (Exact name of registrant as specified in its charter)

        Pennsylvania                                       23-2251762
        ------------                                       ----------
(State or other jurisdiction of                         (I.R.S. Employer
 incorporation or organization)                         Identification No.)

  750 East Park Drive, Harrisburg, PA                        17111
  -----------------------------------                        -----
(Address of principal executive offices)                   (Zip Code)

       Registrant's telephone number, including area code: (717) 920-1698

        Securities registered pursuant to Section 12 (b) of the Act: None

          Securities registered pursuant to Section 12 (g) of the Act:
                      Common Stock, par value $5 per share
                      ------------------------------------

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,  and (2) has been subject to such filing  requirements
for the past 90 days.
   Yes   X    No
       -----     ----

Indicate by check mark if disclosure of delinquent  filers  pursuant to Item 405
of Regulation  S-K is not contained  herein,  and will not be contained,  to the
best of registrant's  knowledge,  in definitive proxy or information  statements
incorporated by reference in Part III of the Form 10-K or any amendments to this
Form 10-K. [ ]

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

Aggregate market value of the Common Stock, $5 par value, held by non-affiliates
of the registrant, computed by reference to the closing price as of the close of
business on June 30, 2003: $258,000,000

Number of shares of the Common Stock, $5 par value, outstanding as of the close
of business on March 1, 2004: 11,700,000 shares.

                      Documents Incorporated by Reference:

Portions of the Proxy  Statement for the 2004 Annual Meeting of  Shareholders of
Community Banks, Inc., have been incorporated by reference into Part III.


<PAGE>

<TABLE>
<CAPTION>


                     COMMUNITY BANKS, INC. and SUBSIDIARIES
                                    FORM 10-K
                                      INDEX

PART I                                                                                                                Page

<S>                                                                                                                 <C>
Item 1            Business                                                                                            3-4
Item 2            Properties                                                                                            5
Item 3            Legal Proceedings                                                                                     5
Item 4            Submission of Matters to a Vote of Security Holders                                                   5


PART II

Item 5            Market for Registrant's Common Equity and Related Stockholder Matters                                 6
Item 6            Selected Financial Data                                                                               7
Item 7            Management's Discussion and Analysis of Financial Condition and Results
                    of Operation                                                                                     8-32
Item 7A           Quantitative and Qualitative Disclosures About Market Risk                                        33-35
Item 8            Financial Statements and Supplementary Data                                                       36-63
Item 9            Changes in and Disagreements with Accountants on Accounting and
                    Financial Disclosure                                                                               64
Item 9A           Controls and Procedures                                                                              64


PART III

Item 10           Directors and Executive Officers of the Registrant                                                   65
Item 11           Executive Compensation                                                                               65
Item 12           Security Ownership of Certain Beneficial Owners and Management and
                    Related Stockholder Matters                                                                        65
Item 13           Certain Relationships and Related Transactions                                                       65
Item 14           Principal Accounting Fees and Services                                                               65


PART IV

Item 15           Exhibits, Financial Statement Schedules, and Reports on Form 8-K                                  66-68


SIGNATURES                                                                                                             69

</TABLE>





                                       2
<PAGE>
                                     PART I

Item 1.  Business:
------------------

Community  Banks,  Inc.,  referred  to in this  report as the  "Corporation"  or
"Community,"  is a financial  holding  company that was formed as a Pennsylvania
corporation in 1982. Community's banking subsidiary is Community Banks, referred
to in this  report  as the  "Bank."  Community's  non-banking  subsidiaries  are
Community Bank Investments, Inc. (CBII), Community Banks Life Insurance Company,
Inc.  (CBLIC),  CMTY Capital Trust I, and CMTY Capital  Statutory  Trust II. The
subsidiaries of the Bank are UDNB  Investments,  Inc.; PSB Realty Co., Inc.; The
Sentinel Agency, LLC; Community Banks Insurance Services, LLC; CB Services, LLC;
and Erie Financial Group, LLC.

On  January  1,  2002,  Community  consolidated  the  charters  of  its  banking
subsidiaries under the name Community Banks,  pursuant to regulatory  approvals.
Prior to that time,  Community's  separate  banking  organizations  operated  as
Peoples State Bank (PSB), a state  chartered bank with offices  throughout  York
and Adams Counties; and Community Banks, N.A. (CBNA), a federally chartered bank
headquartered  in  Dauphin  County  with  offices in  central  and  northeastern
Pennsylvania.   The   consolidation   was  designed  to  facilitate  a  regional
operational  focus that would ease  regulatory  burdens while, at the same time,
maintain a philosophy of local decision-making.

Community conducts a full service commercial banking business and provides trust
services through 46 banking offices in Pennsylvania  and Maryland:  3 offices in
Adams County,  2 offices in Cumberland  County,  10 offices in Dauphin County, 3
offices in Luzerne  County,  2 offices in  Northumberland  County,  7 offices in
Schuylkill  County,  1 office in Snyder  County,  and 16 offices in York County,
Pennsylvania  and 2 offices in Carroll  County,  Maryland.  There are nearly 700
offices of commercial banks and savings and loan associations  within its market
area  with  which   Community   competes.   Deposits  of   Community   represent
approximately 5% of the total deposits in the market area.

Like other banking  companies,  Community has been subjected to competition from
credit unions,  brokerage firms, money market funds, consumer finance and credit
card companies and other companies  providing  financial  services and credit to
consumers.

Over the years,  Community has formed  special  purpose  subsidiaries  which are
included in  consolidated  results.  In  December  2003,  Community  formed CMTY
Statutory Capital Trust II to execute a trust preferred issuance of $15 million.
In December  2002,  Community  formed CMTY  Capital  Trust I to execute a pooled
trust  preferred  issuance of $15 million.  In 1986,  Community  formed CBLIC to
provide credit life insurance to its consumer credit  borrowers.  Total premiums
earned were $188,000 for the year ended  December 31, 2003.  In 1985,  Community
formed CBII to make investments  primarily in equity  securities of other banks.
Total assets of CBII at December 31, 2003 were $7.9 million.

Community  and its  subsidiaries  have  approximately  630  full  and  part-time
employees and Community considers its employee relations to be satisfactory.

Supervision and Regulation of Community
---------------------------------------

The banking  industry  is subject to  extensive  state and  federal  regulation.
Proposals  to change laws and  regulations  governing  the banking  industry are
frequently  raised in  Congress,  in state  legislatures,  and in  various  bank
regulatory agencies. The likelihood and timing that any such changes may have on
Community  are  difficult to determine  with any  certainty.  Changes in laws or
regulations, or changes in the interpretation of laws or regulations, may have a
material impact on the business, operations and earnings of Community.

Community  Banks,  Inc. is  registered as a financial  holding  company with the
Federal   Reserve   Board   in   accordance   with  the   requirements   of  the
Gramm-Leach-Bliley  Act  (the  "GLB  Act").  The  GLB  Act  enables  broad-scale
consolidation among banks, securities firms and insurance companies for eligible
bank  holding  companies  that have  elected  and  maintain  "financial  holding
company"  status.  Financial  holding  companies can offer virtually any type of
financial service, including banking,  securities underwriting,  insurance (both
agency and underwriting)  and merchant  banking.  If a bank holding company does
not become a financial  holding company,  it will be limited to those activities
previously  determined  by the Federal  Reserve Board to be  permissible;  i.e.,
"closely  related to banking"  under the  standard set forth in the Bank Holding
Company  Act.  In order to become a  financial  holding  company,  all of a bank
holding  company's bank  subsidiaries  must be well capitalized and well managed
and have a rating under the Community  Reinvestment  Act (the "CRA") of at least
"satisfactory."

                                       3
<PAGE>

Community is subject to regulation  by the Federal  Reserve  Board.  The Federal
Reserve Board requires  regular reports from Community and is authorized to make
regular  examinations of Community and its subsidiaries.  The Bank is subject to
supervision and regulation,  and is examined  regularly,  by the Federal Deposit
Insurance  Corporation and the state banking  departments in the states in which
it operates.  To the extent that the Bank's  subsidiaries are licensed to engage
in the sale of insurance or the mortgage  brokerage  business,  the subsidiaries
are subject to examination by the respective  licensing  authorities.  Community
and its direct  non-banking  subsidiaries are affiliates,  within the meaning of
the GLB Act,  of the Bank and its  subsidiaries.  As a result,  the Bank and its
subsidiaries  are subject to  restrictions  on loans or extensions of credit to,
purchase of assets from, investments in, and transactions with Community and its
direct  non-banking  subsidiaries and on certain other transactions with them or
involving their securities.

Capital Adequacy
----------------

The Federal Reserve Board and the FDIC have adopted  risk-based capital adequacy
guidelines for financial  holding  companies and banks under their  supervision.
Under these guidelines,  "Tier 1 capital" and "Total capital" as a percentage of
risk-weighted  assets and certain off-balance sheet instruments must be at least
4% and 8%,  respectively.  The regulators have also imposed a leverage standard,
which  focuses on the  institution's  ratio of Tier 1 capital  to average  total
assets,  adjusted for goodwill and certain  other  items,  to  supplement  their
risk-based  ratios.  This minimum  leverage  ratio was set at 3% and would apply
only to those banking  organizations  receiving a regulatory composite 1 rating.
Most banking organizations will be required to maintain a leverage ratio ranging
from 1 to 2 percentage points above the minimum standard.

Community and the Bank are subject to various  regulatory  capital  requirements
administered  by federal and state  banking  agencies.  Failure to meet  minimum
capital  requirements  can initiate  certain  mandatory and possibly  additional
discretionary  actions by regulators  that, if  undertaken,  could have a direct
material  effect on Community's  financial  statements.  Under capital  adequacy
guidelines  and the  regulatory  framework for prompt  corrective  action,  each
subsidiary bank must meet specific capital guidelines that involve  quantitative
measures  of  assets,  liabilities,   and  certain  off-balance-sheet  items  as
calculated  under  regulatory  accounting  practices.  The  capital  amounts and
classification are also subject to qualitative judgments by the regulators about
the risk weightings of components, and other factors.

Quantitative  measures  established  by  regulation to ensure  capital  adequacy
require  Community  to maintain  minimum  amounts and ratios of total and Tier 1
capital  to  risk-weighted  assets  and of Tier 1  capital  to  average  assets.
Management  believes,  as of December 31, 2003, that Community and the Bank have
met all capital  adequacy  requirements  to which they are  subject.  For tables
presenting  Community's  capital ratios,  see "Notes to  Consolidated  Financial
Statements - Regulatory Matters" included in Part II, Item 8.

Sarbanes-Oxley Act of 2002
--------------------------

The  Sarbanes-Oxley Act of 2002  (Sarbanes-Oxley),  which was signed into law in
July,  2002,  impacts  all  companies  with  securities   registered  under  the
Securities Exchange Act of 1934, including Community. Sarbanes-Oxley created new
requirements  in the areas of  corporate  governance  and  financial  disclosure
including,  among other things, (i) increased responsibility for Chief Executive
Officers  and Chief  Financial  Officers  with respect to the content of filings
with the  SEC;  (ii)  enhanced  requirements  for  audit  committees,  including
independence  and  disclosure  of expertise;  (iii)  enhanced  requirements  for
auditor  independence  and the types of  non-audit  services  that  auditors can
provide;  (iv) accelerated  filing  requirements for SEC reports;  (v) increased
disclosure and reporting  obligations  for companies,  their directors and their
executive officers;  and (vi) new and increased civil and criminal penalties for
violation of securities laws.

Certifications of the Chief Executive Officer and the Chief Financial Officer as
required  by  Sarbanes-Oxley  and the  resulting  SEC  rules can be found in the
"Exhibits" section of this document.

Other Information
-----------------

Community's  internet address is  www.communitybanks.com.  Electronic  copies of
Annual Reports on Form 10-K,  Quarterly Reports on Form 10-Q and Current Reports
on Form 8-K, and  amendments  to those  reports  filed or furnished  pursuant to
Section 13(a) or 15(d) of the Exchange Act, are available  through the "Investor
Relations"  section of  Community's  website as soon as  reasonably  practicable
after  filing such  material  with,  or  furnishing  it to, the  Securities  and
Exchange Commission. Copies of such reports are also available at no charge.


                                       4
<PAGE>


Item 2. Properties:
-------------------

The following table summarizes the Bank's branch network:
<TABLE>
<CAPTION>

                                                            PSB                                              Total
                                        Bank (1)         Realty(2)         Leased         Term (3)         Branches
                                        -------          --------          ------         -------          --------
In Pennsylvania:
<S>                                        <C>              <C>              <C>            <C>               <C>
    Adams County                           2                1                -                 -               3
    Cumberland County                      1                -                1              2019               2
    Dauphin County                         7                -                3              2018              10
    Luzerne County                         1                -                2              2005               3
    Northumberland County                  2                -                -                 -               2
    Schuylkill County                      7                -                -                 -               7
    Snyder County                          1                -                -                 -               1
    York County                            6                4                6              2020              16
In Maryland:
    Carroll County                         1                -                1              2007               2
                                        -------------------------------------------                       -----------

    Total                                 28                5               13                                46
                                        ===========================================                       ===========
</TABLE>

(1) Properties are owned by the Bank, free and clear of encumbrances.
(2) Properties are owned by PSB Realty Company and are leased to the Bank.
(3) Latest lease term expiration date, excluding renewal options.

From time to time,  the Bank also acquires real estate by virtue of  foreclosure
proceedings,  and such real  estate  is  disposed  of in the usual and  ordinary
course of business as expeditiously as is prudently possible.

The following table summarizes the Corporation's other significant properties:

<TABLE>
<CAPTION>
                                                                                                 Owned/            Lease
         User                             Character of Facility          Location                Leased         Expires(1)
         ----                             ---------------------          --------                ------         ----------

<S>                                       <C>                        <C>                         <C>              <C>
Community Banks, Inc.                     Executive Offices          Harrisburg, PA              Leased           2007
Community Banks                           Operations Center          Halifax, PA                 Owned
Community Banks                           Operations Center          Hanover, PA                 Owned
The Sentinel Agency LLC                   Admin/Sales                Harrisburg, PA              Leased           2004
CB Insurance Services LLC                 Admin                      Mechanicsburg, PA           Leased           2004
Erie Financial Group LLC                  Admin/Sales                York, PA                    Owned

</TABLE>

(1) Latest lease term expiration date, excluding renewal options.


Item 3.  Legal Proceedings:
---------------------------

Various actions and proceedings are presently  pending to which Community or one
or more of its subsidiaries is a party.  These actions and proceedings arise out
of routine  operations  and, in management's  opinion,  will not have a material
adverse effect on Community's consolidated financial position.

Item 4.  Submission of Matters to a Vote of Security Holders:
-------------------------------------------------------------

No  matters  were  submitted  to a vote of  security  holders  during the fourth
quarter of 2003.



                                       5
<PAGE>
                                     PART II

Item 5.  Market for Registrant's Common Equity and Related Stockholder Matters:
-------------------------------------------------------------------------------

Market Information
------------------

The  shares of  Community  are traded on the Nasdaq  National  Market  under the
symbol CMTY and are  transferred  through local and regional  brokerage  houses.
Community had  approximately  3,346  shareholders  as of December 31, 2003.  The
following  table sets forth  dividends  declared  per share and the high and low
prices of Community at which the common  stock has been  transferred  during the
periods indicated.  High and low prices are based solely upon transactions known
to management  of Community  and represent a portion of the actual  transfers of
common stock during the periods in question.

<TABLE>
<CAPTION>
             ------------------------------------------------------------------------------------------------------
                                                   2003                                          2002
             ------------------------------------------------------------------------------------------------------
                                      Price Per Share      Dividends               Price Per Share        Dividends
                                      Low         High      Declared               Low          High      Declared


<S>                                 <C>          <C>          <C>                <C>           <C>          <C>
             First Quarter          $21.83       $23.63       .16                $19.33        $22.02       .13
             Second Quarter          23.22        25.00       .16                 20.28         23.57       .14
             Third Quarter           24.88        27.92       .17                 18.97         21.98       .14
             Fourth Quarter          28.00        33.75       .17                 20.62         23.02       .16
</TABLE>

Holders of the common stock of Community  are entitled to such  dividends as may
be declared  from time to time by the Board of  Directors  out of funds  legally
available  therefore.  Community  currently expects that it will continue to pay
comparable  dividends  in  the  future,  subject  to  regulatory   requirements,
Community's  financial  condition and requirements,  future prospects,  business
conditions and other factors deemed relevant by the Board of Directors. As noted
in  "Capital  Adequacy"  in Part I, Item 1,  Community  is  subject  to  various
regulatory  capital  requirements that limit the amount of capital available for
dividends.

The market  prices listed above are based on historical  market  quotations  and
have been restated to reflect stock dividends and splits.

Equity Compensation Plan Information
------------------------------------
<TABLE>
<CAPTION>

---------------------------------- -------------------------------- -------------------------------- -------------------------------
                                                 (a)                            (b)                               (c)
                                                                                                          Number of securities
                                                                                                        remaining available for
                                     Number of securities to be                                       future issuance under equity
                                       issued upon exercise of         Weighted average exercise     compensation plans (excluding
                                    outstanding options, warrants    price of outstanding options,      securities reflected in
          Plan Category                      and rights                   warrants and rights                 column (a))
---------------------------------- -------------------------------- -------------------------------- -------------------------------
<S>                                            <C>                              <C>                          <C>
Equity compensation plans                      978,376                          $18.80                       1,049,468 (1)
approved by security holders
---------------------------------- -------------------------------- -------------------------------- -------------------------------
Equity compensation plans not
approved by security holders (2)                None                              n/a                             n/a
---------------------------------- -------------------------------- -------------------------------- -------------------------------
              Total                            978,376                          $18.80                         1,049,468
---------------------------------- -------------------------------- -------------------------------- -------------------------------
</TABLE>

     (1)  Includes 80,960 shares available for future issuance under Community's
          Employee Stock  Purchase Plan.
     (2)  Community does not maintain  equity  compensation  plans that have not
          been approved by its stockholders.

Sales of Unregistered Securities
--------------------------------

On December 16, 2003,  Community,  through its subsidiary CMTY Capital Statutory
Trust II,  issued and sold to STI  Investment  Management,  Inc.,  15,000  trust
preferred  securities for an aggregate offering price of $15 million.  The trust
securities were exempt from registration under the private offering exemption in
Section 4(2) of the  Securities  Act of 1933 and Section 506 of  Securities  and
Exchange  Commission  Regulation D.  Community used the proceeds of the sale for
general corporate purposes.

                                       6
<PAGE>



Item 6. Selected Financial Data:
--------------------------------
<TABLE>
<CAPTION>
                                                                         At or for the Year Ended December 31
                                                      --------------------------------------------------------------------------
                                                           2003            2002           2001           2000           1999
                                                      --------------------------------------------------------------------------
                                                                     (dollars in thousands except per share data)
<S>                                                   <C>             <C>            <C>            <C>             <C>
BALANCE SHEET DATA:
At Period End:
Investment securities                                 $    646,961    $    667,801   $    543,901   $    389,819    $    360,540
   Total loans                                           1,078,611         904,568        857,278        814,874         708,016
   Total assets                                          1,860,130       1,679,898      1,509,734      1,308,713       1,151,344
   Total deposits                                        1,230,685       1,132,913      1,003,225        919,241         826,167
   Long-term debt                                          441,422         335,533        322,155        239,613         213,865
   Stockholders' equity                                    143,406         129,162        111,249        103,978          86,309
Average:
   Total assets                                          1,780,171       1,580,046      1,398,521      1,238,870       1,093,262
   Total stockholders' equity                              135,773         119,352        111,381         92,255          92,274

EARNINGS DATA:
Net interest income                                         52,536          50,488         45,935         43,795          40,248
Provision for loan losses                                    2,500           3,350          5,080          2,863           1,588
Net interest income after provision
     for loan losses                                        50,036          47,138         40,855         40,932          38,660
Other income                                                20,441          13,975         12,141          8,148           6,388
Other expense                                               45,718          39,300         36,521         30,463          27,501
Provision for income taxes                                   4,359           3,367          2,879          4,702           4,257
Net income                                                  20,400          18,446         13,596         13,915          13,290

PER SHARE DATA:
Basic earnings per share                                      1.76            1.59           1.17           1.21            1.14
Diluted earnings per share                                    1.71            1.55           1.15           1.19            1.12
Cash dividends                                                 .66             .57            .51            .45             .41
Book value                                                   12.31           11.20           9.50           9.08            7.44
Average diluted shares outstanding                      11,902,259      11,896,495     11,868,567     11,649,436      11,821,835

PROFITABILITY RATIOS:
Return on average assets                                     1.15%           1.17%           .97%          1.12%           1.22%
Return on average stockholders' equity                      15.03%          15.46%         12.21%         15.08%          14.40%
Net interest margin (FTE)                                    3.50%           3.78%          3.83%          4.01%           4.20%
Efficiency ratio                                            60.47%          56.81%         59.77%         55.42%          55.54%

CAPITAL AND LIQUIDITY RATIOS:
Stockholders' equity to total assets                         7.71%           7.69%          7.37%          7.95%           7.50%
Average equity to average assets                             7.64%           7.55%          7.96%          7.45%           8.44%
Dividend payout ratio                                       37.35%          36.07%         43.25%         37.48%          36.70%
Net loans to assets                                         57.28%          53.11%         55.98%         61.48%          60.72%

ASSET QUALITY RATIOS:
Allowance for loan losses to total loans
     outstanding                                             1.22%           1.36%          1.42%          1.27%           1.27%
Allowance for loan losses to non-accrual
     loans                                                    162%            131%           109%           171%            152%
Non-accrual loans to total loans
     outstanding                                              .76%           1.04%          1.29%           .74%            .83%
Non-performing assets to total assets                         .70%            .63%           .78%           .49%            .57%
Net charge-offs to average loans outstanding                  .17%            .35%           .39%           .20%            .18%

</TABLE>



                                       7
<PAGE>
Item 7. Management's  Discussion and Analysis of Financial Condition and Results
--------------------------------------------------------------------------------
     of Operation:
     -------------

    MANAGEMENT'S DISCUSSION OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

This  discussion is being  presented to provide a narrative  explanation  of the
financial  statements  of  Community.  The  purpose of this  presentation  is to
enhance  the  overall  financial  disclosure  and to provide  information  about
historic financial performance as a means to assess whether past performance can
be used to  evaluate  the  prospects  for future  performance.  Throughout  this
presentation,  net income and yield on earning  assets have been  presented on a
tax  equivalent  basis and balances  represent  average  daily  balances  unless
otherwise indicated.  All per share amounts have been restated to give effect to
the stock split,  issued in the form of a 20% stock  dividend,  announced in the
fourth quarter of 2003.  During 2003,  Community  completed the  acquisitions of
several  businesses,  including:  Abstracting  Company of York County (ABCO),  a
title, settlement,  and abstracting company (April, 2003); Erie Financial Group,
Ltd. (Erie), a company providing mortgage origination services (July, 2003); and
Your Insurance  Partnership,  an insurance agency group specializing in personal
insurance  services  (October,  2003).  All  dollar  amounts  are  presented  in
thousands, unless otherwise indicated.

FORWARD-LOOKING STATEMENTS

Periodically,  Community has made and will continue to make  statements that may
include   forward-looking    information.    The   Corporation   cautions   that
forward-looking  information disseminated through financial presentations should
not be  construed  as  guarantees  of future  performance.  Furthermore,  actual
results  may  differ  from  expectations   contained  in  such   forward-looking
information  as  a  result  of  factors  that  are  not  predictable.  Financial
performance can be affected by any number of factors that are not predictable or
are  out of  management's  direct  control.  Examples  include:  the  effect  of
prevailing  economic  conditions;  unforeseen or dramatic changes in the general
interest rate environment; actions or changes in policies of the Federal Reserve
Board  and  other  government  agencies;   business  risk  associated  with  the
management of the credit extension  function and fiduciary  activities.  Each of
these factors could affect estimates,  assumptions,  uncertainties and risk used
to develop forward-looking information, and could cause actual results to differ
materially from management's expectations regarding future performance.

CRITICAL ACCOUNTING POLICY:  ADEQUACY OF ALLOWANCE

Management  believes  that  the  application  of  its  accounting  policies  and
procedures  in the  determination  of the  adequacy  of the  allowance  for loan
losses, and the related provision for loan losses,  should be considered to be a
critical  accounting policy to ensure the fair presentation of the Corporation's
financial  statements.  Community  applies a  systemic  methodology  in order to
estimate  the  allowance  for  loan  losses.  These  methodologies   incorporate
management's  judgments about the credit quality of the loan portfolio through a
disciplined process that is consistently  applied.  This process requires that a
detailed  analysis of the loan portfolio be performed on a quarterly basis. This
analysis  includes a specific  individual loan review for any and all loans that
meet specific  materiality  criteria.  Such loans are  evaluated for  impairment
under the provisions of Statement of Financial  Accounting Standards (SF AS) No.
114,  "Accounting  by Creditors  for  Impairment  of a Loan".  The  portfolio is
further  stratified  to analyze  groups of  homogenous  loans with  similar risk
characteristics.  Such loans are  evaluated  under the  provisions of SFAS No. 5
"Accounting for Contingencies". Management considers all known relevant internal
and external factors that may affect loan collectability,  as well as particular
risks  indigenous to specific types of lending.  The process is further designed
to consolidate the aggregate loss estimates and to ensure that the allowance for
loan  losses is  recorded  in  accordance  with  generally  accepted  accounting
principles. The final results are reviewed and approved by executive management.
Results are  constantly  validated  by a review of trends  associated  with loan
volume,  delinquencies,  potential  concentrations,  or other  factors  that may
influence the methodology used to estimate the allowance for loan losses.

2003 PERFORMANCE OVERVIEW

Community  completed another year of record  performance in 2003,  reporting the
highest  net income and  earnings  per share in its  history.  At the same time,
Community made  significant  progress in its continuing  effort to evolve into a
"community-focused"  financial  services  corporation,  capable of  delivering a
competitive  menu of services to meet the  expanding  needs of  individuals  and
businesses  within its  marketplace.  Community is  committed  to achieving  the
highest  possible return to its  shareholders,  constrained by the need for both
prudent  management  of critical risk factors and the  continuing  investment in
infrastructure to ensure superior customer service and growth of the franchise.

                                       8
<PAGE>
Net income reached $20.4  million,  an 11% increase from the net income of $18.4
million reported in 2002. Similarly, diluted earnings per share reached $1.71, a
10% improvement from the $1.55 reported in 2002.  Return on average assets (ROA)
and  return on average  equity  (ROE)  provide  traditional  benchmarks  used to
compare the relative operating  performance of financial service  companies.  At
the end of 2003, the Corporation  produced an ROA of 1.15% and an ROE of 15.03%,
which were comparable to the performances of 1.17% and 15.46%, respectively,  in
the prior year. Community has established  long-term  performance goals that are
consistent  with its  emergence as a growing and vibrant  competitor  within its
expanding  footprint.  The  performance  during 2003 was  consistent  with these
operating   goals   and   generated   favorable   performance   comparisons   to
similarly-sized  financial  service  companies  operating  within the  northeast
region of the United States.

Performance  for 2003  included  double-digit  growth in loan  volume and steady
deposit  growth that  combined to yield a 5%  increase in net  interest  income.
Non-interest  income was influenced  primarily by the growth in fees  associated
with acquired businesses and with increases in new or existing banking products.
Mortgage origination fees expanded due to demand from the existing bank delivery
network and from the activity  generated as a result of the midyear  acquisition
of Erie. Title and settlement revenues grew at record levels throughout the year
and were influenced by the flurry of origination activity and by the acquisition
of ABCO.  Community  also recorded a $1.1 million gain from the sale of a retail
office,  which  is  included  in other  income,  as part of its  ongoing  office
reconfiguration  effort. These and other factors provided a significant boost to
non-interest revenues.  Aside from increases in the non-interest revenue stream,
a  reduction  in the  provision  for loan losses  also  contributed  to improved
performance.  Community  continues  to monitor and manage its credit  quality to
minimize  losses  from  credit  activities.   Finally,  profitability  was  also
influenced  by growth in expenses  that  occurred as a result of the  additional
costs from acquired  businesses,  expenses  associated with the expansion of the
delivery network, and from other investments in the growth of the Corporation.

Economic Climate

The  year  2003  began  with  the  predictable   uncertainty   that  accompanies
geopolitical discord and the escalation of armed international  conflict.  Since
the tragedies  brought on by the World Trade Center attack in September of 2001,
Americans  have had to adjust  to a new  global  reality  that has made " terror
alerts" and " al Qaeda" a normal part of our national lexicon.  This new reality
has had a dampening  effect on economic  growth.  Beyond this backdrop of global
tensions lie national,  regional,  and local economies  within the United States
that are more  directly  affected  by  international  trends  and  events.  This
vulnerability  was  particularly  evident  in  the  first  half  of  2003,  with
escalation  of  military  involvement  in Iraq and  increased  concern  over the
potential for further terrorist attacks.  The economic malaise in the first half
of 2003 was even more directly affected by the overall business  climate,  which
was  characterized  by lackluster  stock market  returns,  increased  skepticism
associated  with corporate  scandals,  and reduced  capital  spending within the
commercial sector.

The impact of  declining  interest  rates  during 2003 was the most  influential
trend  affecting the financial  services  industry.  For the second  consecutive
year,  interest  rates fell to the lowest levels in the last four decades.  This
trend had its most  significant  impact on growth in net  interest  income,  the
largest  source  of  revenue  for  most  financial  institutions.  The low  rate
environment  was a catalyst  for  borrowing  activity,  particularly  within the
consumer sector. Since the demise of the `bubble economy' of the 1990's,  steady
consumer  confidence  has been an important  constant in sustaining the national
economy. The retail consumer's capacity and appetite for debt to accommodate the
purchase of goods and  services  has helped  forestall a deeper,  more  dramatic
recessionary downturn.

The Federal Reserve Board ("Fed") maintained an accommodative stance on interest
rates throughout most of the year in order to preempt the effect of higher rates
on economic  growth.  The Fed's interest rate posture was also  responsive to an
absence of inflationary concerns,  forestalling the need to raise rates in order
to suppress the adverse consequences of unchecked  inflation.  These lower rates
created unprecedented challenges to achieving growth in interest spread for most
financial  institutions.  The rate  environment  provided a stimulus  for credit
services,  but also produced  challenges  associated  with expanding the deposit
base. As interest rates  declined,  most financial  institutions  were forced to
become less competitive on the pricing of deposit funding products.  Late in the
year, many of these products had reached practical floors, preventing meaningful
downward  repricing of deposit funding.  The pressure on net interest income was
exacerbated  by the  inability  to  achieve  higher  loan  pricing  or  identify
favorable  reinvestment  opportunities  within the bond  markets to enhance  net
interest spread.

                                       9
<PAGE>
While lower interest rates constrained growth in net interest income, this trend
had a positive impact on other areas of financial services industry performance.
The  highest  direct  correlation  between  lower  rates and higher  performance
occurred in the mortgage origination markets. Nationwide, housing starts grew to
over 1.7  million  while  total home sales  reached a record high 5.8 million in
2003. At the same time, the lower mortgage rates spurred another record level of
mortgage  refinancing.  This trend provided consumers with increased  disposable
income  and  helped  sustain  consumer  confidence  during  a period  of  rising
unemployment and stagnant  economic  trends.  Lower interest rates also have the
tendency to reduce the volume and  severity  of losses  from credit  activities.
Affordable  credit tends to mitigate the potential for borrower  default,  which
can be expected to increase during sustained periods of higher interest rates.

Late in the third  and  fourth  quarters  of 2003,  tentative  signs of a modest
economic recovery began to emerge. Unfortunately, some industry sectors continue
to be influenced  adversely by conditions  largely  beyond their  control,  thus
reducing the potential for more robust  improvement in near term  profitability.
Specific   examples  include  the  travel,   airline,   and   telecommunications
industries. Most industries also continued to be hamstrung by their inability to
raise  prices  during a  period  that has been  almost  devoid  of  inflationary
pressure.  Many other  sectors,  such as the  automobile  and home  construction
industries,  remained  strong during the  slowdown,  but are unlikely to achieve
another  layer of  sizeable  gains in the near term,  regardless  of the pace of
economic  improvement.  As a consequence,  the recovery,  although  welcome,  is
expected to be comparatively modest in magnitude.

Community operates within a regional economy, and smaller local economies,  that
traditionally  have been sheltered from major  aftershocks  produced by volatile
swings in specific  industry  sectors or other  subsets of the broader  national
economy. Community's diverse economic underpinnings provide a solid base that is
less  predisposed to broad  expansions or deep slumps caused by the ebb and flow
of global or national  business cycles.  While the local economies are partially
cushioned  from  these  macro-trends,  they  will  never  be  totally  buffered.
Consequently, while Community and the businesses and individual customers within
its  markets  were  affected  by the  overall  downturn  in the  economy,  those
constituencies  experienced only modest deterioration in employment and relative
economic stability.

Strategy

Community's stated operating focus is manifested in its marketing slogan, "Local
People,  Local Decisions".  Its operating  strategy centers around three guiding
factors:  growth,  diversity,  and  profitability.  During 2003,  Community made
substantial progress in each of these areas.

The growth of the Community  franchise was quantified several ways. The absolute
growth in loans and  deposits,  combined with  deepening and expanding  customer
relationships  provided an affirmation of the potential for franchise expansion.
Community  also made  significant  strides  fortifying  its presence in existing
markets in 2003. During the year, Community added three new offices, including a
presence in northern Maryland,  and announced  additional plans to open at least
two  new  offices  in  2004.  At the  same  time,  management  has  consistently
reevaluated the viability of the delivery system, resulting in the sale of three
offices over the last two years. This ongoing  evaluation of the delivery system
has allowed for redeployment of both human and financial capital in more vibrant
markets with higher potential for economic  growth.  During this time, the entry
of larger, less personable financial  institutions into Community's core markets
via bank  acquisitions  has  generated  opportunities  to gain market  share and
expand customer relationships.

Diversity has been a hallmark of Community's  operating  strategy.  Improvements
have been realized through introductions of new products and services, additions
of acquired  businesses,  and  execution  of strategic  partnerships  with other
financial  services  companies.  As an example,  Community  has become a leading
provider of title and settlement services inside its footprint.  In April, 2003,
Community  added to its presence in the York, PA market by acquiring ABCO, a key
provider of title services in this vital  component of Community's  core banking
market.  Later in 2003,  the  acquisition  of Erie added a leading  provider  of
mortgage  origination  services in the York and northern Maryland markets.  This
transaction  has  doubled  the  previous  mortgage  origination  capacity of the
franchise and will provide  efficiencies  with  Community's  legacy  origination
operations.  The  Corporation  also added to its ability to deliver high quality
insurance  services to both commercial and retail customers.  The acquisition of
Your Insurance Partner,  an insurance agency group with two offices in the heart
of Community's geographic footprint,  adds capacity to the Corporation's growing
menu of  insurance  services.  Improvements  to  fee-based  revenues  were  also
achieved  through the introduction of new,  convenience-driven  banking services
such as the "OverdraftHonor" program.

                                       10
<PAGE>
As  another   testimony  to  the  commitment  to  meeting  customer  needs,  the
Corporation announced an innovative  revenue-sharing  arrangement with Bryn Mawr
Trust Company (Bryn Mawr) in late 2003. Bryn Mawr, which is headquartered in the
affluent  "Main Line" area of suburban  Philadelphia,  has been in the trust and
investment  management  services business for over 100 years.  Community,  which
historically  has had a  limited  capability  for  delivery  of these  essential
services to its existing  customer base,  now possesses  access to the expertise
and  experience of a  corporation  that  currently  manages over $1.6 billion in
assets.

The net  result of these  growth  initiatives  and  increased  diversity  of the
revenue stream has been improved profitability.  This improved profitability was
achieved  while   simultaneously   improving   credit  quality  and  making  the
appropriate  investment in the future growth of the franchise.  Such investments
will continue to exert  pressure on the overall cost  structure and will present
challenges into 2004 and beyond.

Emerging Trends

For the foreseeable future, net interest income will remain the most significant
source of revenue for banks. Recent trends have resulted in pricing compression,
creating a major  challenge to future  revenue  expansion.  This  convergence of
trends,  combined  with  increasing  competition  from both  smaller  and larger
rivals,  has constrained  growth in this vital driver of  performance.  Entering
2004,  management had made substantial  efforts to reposition both earning asset
and funding sources to benefit from a gradual, measured rise in overall interest
rates.  The Fed's  stimulative  monetary  policy,  combined with the  increasing
federal budget  deficit,  is beginning to intensify  conditions  that could give
rise to inflationary  pressure and higher interest rates.  Most economists agree
that interest rates will begin to rise, perhaps as early as the third quarter of
2004.  Management has  considered  options to more  aggressively  extend loan or
investment  maturities to achieve higher asset yields, but continues to pursue a
more moderate  approach.  Execution of a more aggressive  approach could lead to
unacceptable  levels of  interest  rate risk to the  long-term  revenue  stream,
particularly  given  the  current  proximity  to a  perceived  low  point in the
interest rate cycle.  Consequently,  the potential for reprieve from the effects
of interest rate compression remains subdued in the near term, placing increased
emphasis on garnering market share and achieving absolute earning asset growth.

Credit  quality  is  vital  to  the  financial  performance  of  community-based
financial  services  companies.  The  diversity of  Community's  markets and the
relative  granularity of its loan portfolio make it somewhat less susceptible to
adverse  credit  quality  conditions  that are systemic in nature.  During 2003,
Community recognized net charge-offs that were at their lowest level since 1999.
The allowance for loan losses,  the Corporation's  reserve to absorb credit risk
within the  existing  loan  portfolio,  is near a five year high in terms of its
coverage of non-accrual  loans.  Absolute levels of non-accrual loans saw marked
reductions  since the end of 2002,  providing  further  evidence  of the  bank's
improving asset quality metrics.

Continuous  improvement  in the level of other  revenue  sources  has  served to
offset the  pressure on net interest  income  experienced  during this  extended
period of declining interest rates.  Community's focus on the integration of new
products and services has fueled this growth.  The  strategic  acquisitions  and
partnerships  completed  during 2003 have  solidified  existing  capabilities in
title insurance and settlement  services,  mortgage  origination,  and insurance
agency  services.  The recently  announced  plan to partner with Bryn Mawr Trust
Company  is  expected  to add  new  capabilities  in  the  arena  of  investment
management for higher net worth  customers.  Growth in these areas in 2004 could
be limited,  however,  depending on the magnitude and velocity of market shifts.
For example,  both title and mortgage  origination  revenues  could be adversely
influenced by a sudden and substantial spike in interest rates.  Similarly,  the
record  level of  refinancing  activity  during  the past two years is likely to
moderate as interest  rates rise.  Increases in revenue  from  delivery of asset
management services through Bryn Mawr is expected to occur gradually over a more
extended time horizon, especially given the challenges associated with garnering
market share in this segment of the financial services market.

The final major aspect of performance that will be influenced by emerging trends
is operating expenses. Community's execution of its growth strategies has driven
steady  increases in  operating  expenses in two major  areas.  First,  expenses
related to the new branch  expansion  over the last several  years  continued to
influence operating expenses,  especially in salaries, benefits and depreciation
expense.  This ongoing  investment in a measured  expansion  plan is critical to
positioning  Community in both its core markets and in  contiguous  markets that
are natural extensions of the franchise.  Secondly, the Corporation's efforts to
expand the mix and  volume of  integrated  services  have also had the impact of
increasing  operating expenses as compared to historical  levels.  These efforts
have been correlated with synchronous  programs designed to increase the revenue
stream from both core  banking and  integrated  services.  Increases in the cost
structure have always been

                                       11
<PAGE>


predicated on management's assessment of market share growth potential, higher
revenues, and improvements in both profitability and return on invested capital.

NET INTEREST INCOME

Community's  major source of revenue is derived from  intermediation  activities
and is reported as net interest  income.  Net interest  income is defined as the
difference  between  interest  income on earning assets and interest  expense on
deposits and borrowed  funds.  Net  interest  margin is a relative  measure of a
financial  institution's ability to efficiently deliver net interest income from
a given  level of earning  assets.  Both net  interest  income and net  interest
margin are  influenced by the frequency,  velocity,  and extent of interest rate
changes  and by the  composition  and  absolute  volumes of  earning  assets and
funding sources.

The  following  table  compares  net  interest  income and net  interest  margin
components between 2003 and 2002 (in thousands):
<TABLE>
<CAPTION>

                                              2003                       2002                      Change
                                    -----------------------     ----------------------      --------------------
                                                     Yield/                     Yield/                    Yield/
                                       Amount         Rate         Amount        Rate         Amount       Rate

<S>                                 <C>              <C>        <C>             <C>         <C>          <C>
Interest income                     $ 101,217        6.02%      $  102,488      6.89%       $ (1,271)    (0.87)%
Interest expense                       42,329        2.89%          46,212      3.60%         (3,883)    (0.71)%
                                    ---------        -----      ----------      -----       ---------    -------
Net interest income                 $  58,888                   $   56,276                  $  2,612

Interest spread                                      3.13%                      3.29%                    (0.16)%
Impact of
  non-interest fund  s                               0.37%                      0.49%                    (0.12)%
                                                     -----                      -----                    -------

Net interest margin                                  3.50%                      3.78%                    (0.28)%
                                                     =====                      =====                    =======
</TABLE>

Interest Rates

Interest rates profoundly  influenced net interest income and profit performance
during  2003.  Since the year 2000,  key interest  rate  indices  began a steady
pattern of decline. In each of the last two years, it was assumed that rates had
declined to levels at, or near, the trough in the interest rate cycle.  By 2002,
such rates had declined to levels not seen since the 1950's. Entering 2003, most
rate forecasts reflected expectations that rates would begin to increase, though
not  dramatically,  sometime  in 2003.  Instead,  buoyed  by Fed  policy,  rates
continued on a descending path throughout most of the year, reaching yet another
level of lows in most key indices. To illustrate, the following graph provides a
comparison  of U.S Treasury  rates for the key maturity  intervals for both 2003
and the prior year: [GRAPH OMITTED]

                          Average U.S. Treasury Curve
                          ---------------------------

         3 Months   6 Months   1 Year   2 Year   3 Year   5 Year   10 Year
         --------   --------   ------   ------   ------   ------   -------

2002       1.64%      1.72%     2.00%    2.64%    3.10%    3.82%    4.61%
2003       1.03%      1.08%     1.24%    1.65%    2.10%    2.97%    4.01%

                                       12
<PAGE>
The various  Treasury  indices,  which are important  interest rate  barometers,
declined  across the board by virtually  the same extent.  This ratable  decline
resulted in little change to the overall slope of the yield curve. Consequently,
both earning asset yields and funding costs  declined  during the year.  General
interest  rate  trends were  crucial to both  interest  income and the  interest
expense results. The incremental pricing of maturing investments,  variable rate
loans,  and new loan  relationships  was  correlated  with the lower  prevailing
interest  rates,  increasing  pressure on asset  yields.  Despite the decline in
earning asset yields,  interest income was stabilized during most of the year as
earning assets were  redeployed  from  lower-yielding,  maturing  investments to
comparatively  higher-yielding  loans.  The increasing  affordability  of credit
created  increased  demand  for both  business  and  consumer  credit  products,
resulting in an overall increase in earning assets. At the same time, most banks
continued  to  benefit  from an  influx  of  deposit  funding.  The  paucity  of
competitive returns in either the equity markets or other investment yields made
bank deposits a viable  short-term  alternative  given consumer  preferences for
liquidity  in  anticipation  of  future  rate  increases.  Most  consumers  were
understandably averse to commit funds into longer maturity instruments given the
expectation of higher rates.  As a  consequence,  many banks were able to secure
increases  in deposit  funding,  despite  that fact that many of the more liquid
deposit  products  were  priced at record  low  levels.  The net impact was that
interest  expense  declined  by 8% while  interest  income  declined by only 1%,
resulting in an increase in net interest income of nearly 5%.

Interest Income /Earning Assets

Interest  income was  $101.2  million in 2003,  only  slightly  below the $102.5
million  recorded in 2002,  despite the fact that earning asset yields  declined
from 6.89% to 6.02% over the  two-year  period.  Earning  asset  growth,  fueled
principally  by loan  growth,  forged a 13.0%  increase  from $1.487  million to
$1.680  million  and  helped to  offset  the  compression  that  would  normally
accompany  lower earning asset yields.  From 2002 to 2003,  earning  assets grew
$193  million,  including  $111  million in loans and $89  million in  portfolio
investment  securities.  Growth  in loans  accelerated  during  the year and was
funded by both runoff in the investment portfolio and by an $86 million increase
in the level of deposits, most of which occurred in Community's successful Power
NOW offering. As interest rates declined, Community also sought opportunities to
"lock  in"  low-cost  term  funding.  With  interest  rates  at  historic  lows,
management  selectively "termed out" certain short-term borrowings to secure the
benefits of the lower, longer term rates available during the year.

Interest Expense / Funding Sources

Interest expense on deposits declined  dramatically  during 2003 and was a major
contributor to the nearly 5% increase in net interest income.  Despite increases
in loan mix and an overall  increase in the level of earning  assets,  Community
was not able to  achieve  improvement  in  interest  income due to the impact of
lower rates.  Fortunately,  that same rate  environment  permitted most banks to
reduce  interest  rates on deposit  funding and enabled  Community to reduce its
overall  funding  costs from $46.2  million in 2002 to $42.3  million in 2003, a
decline of almost $3.9 million or 8%.  Simultaneously,  most banks  continued to
enjoy an influx of  deposit  funding as  consumers  opted for the  security  and
short-term liquidity of bank deposits. It is likely that this trend, at least in
part, could be linked to corporate and mutual fund scandals,  a lackluster stock
market,  low money market rates,  and other  developments  that reduced consumer
interest in these other alternatives. Total deposits grew by nearly $86 million,
the vast  majority of which  occurred in savings,  Power Now and other  accounts
that were responsive to customer  preferences for liquidity.  For the first time
in several years, Community realized no growth in its time deposit categories as
consumers were reluctant to extend  maturities for relatively  unattractive rate
premiums.

Community also made strategic use of other forms of funding in order to meet the
consistent  demand for  credit  extension  that  occurred  throughout  the year.
Incremental  borrowing  rates on  federal  funds,  which are set by the  Federal
Reserve,  influenced  the  pricing of all  short-term  sources of funds and made
these borrowings far less expensive than other funding  sources.  Community made
strategic use of this source of liquidity  within the risk  parameters set forth
in its asset / liability  management (ALCO) policies and procedures.  At various
times during the year, Community also increased its long-term borrowings,  which
are composed principally of term funding available through the Federal Home Loan
Bank programs. The Corporation  experienced a 17% increase in long-term funding,
which included the first full year of $15 million in trust preferred instruments
issued under a pooled  arrangement  in December of 2002.  Community  executed an
additional  $15 million in these  instruments  at the end of 2003,  bringing its
total  issuances  to $30  million.  The  issuances  were  integrated  with,  and
responsive to, the overall  capital  management  policy  discussed later in this
presentation.

                                       13
<PAGE>
Interest Spread and Net Interest Margin

A financial  institution's  ability to effectively  blend the impact of changing
rates,  shifting rate indices,  customer  preferences,  and product  development
initiatives  can be measured by the  performance  of interest  spread,  which is
defined as the  difference  between  earning asset yield and the cost of funding
sources.  Net interest  margin  combines the impact of interest spread with both
investment of non-interest bearing funding sources and management of non-earning
assets.  As a result of rate trends and other  dynamics  specific to Community's
balance sheet,  the  Corporation  reported a decline in net interest spread from
3.29% in 2002 to 3.13% in 2003, and a decline in net interest  margin from 3.78%
to 3.50% over the same  period.  The  decline  in margin was also  linked to the
impact of reduced contribution from non-interest funding sources, which declined
from  0.49%  to  0.37%.   During  periods  of  declining   interest  rates,  the
contribution  from  non-interest  funds to net interest  margin is reduced since
funds are invested at progressively lower rates. During periods of rising rates,
these  funds can be expected  to  contribute  to  improvements  in net  interest
margin.

Quarterly Performance

The following  table  provides a comparison  of earning  asset  yields,  funding
costs, and other information for each of the four quarters of 2003 and 2002.
<TABLE>
<CAPTION>
                                                                     2003
                                            -----------------------------------------------------
                                            Fourth          Third         Second            First
                                            Quarter        Quarter        Quarter          Quarter
                                            -----------------------------------------------------
<S>                                          <C>           <C>            <C>             <C>
                Asset yield                    5.81%         5.88%          6.05%           6.38%
                Funding cost                   2.76%         2.80%          2.94%           3.10%
                                            -----------------------------------------------------
                  Interest spread              3.05%         3.08%          3.11%           3.28%
                                            -----------------------------------------------------
                  Net interest margin          3.41%         3.45%          3.49%           3.68%
                                            -----------------------------------------------------

                Net interest margin          $14,795       $14,884        $14,618         $14,591
                                            =====================================================
</TABLE>

<TABLE>
<CAPTION>
                                                                     2002
                                            -----------------------------------------------------
                                            Fourth          Third        Second             First
                                            Quarter        Quarter       Quarter           Quarter
                                            -----------------------------------------------------
<S>                                          <C>            <C>           <C>             <C>
                Asset yield                    6.54%          6.80%         7.01%           7.26%
                Funding cost                   3.35%          3.51%         3.74%           3.82%
                                            -----------------------------------------------------
                  Interest spread              3.19%          3.29%         3.27%           3.44%
                                            -----------------------------------------------------
                  Net interest margin          3.65%          3.78%         3.76%           3.96%
                                            -----------------------------------------------------

                Net interest margin          $14,180       $14,394       $13,757          $13,946
                                            =====================================================
</TABLE>

Continuing  a trend which has  corresponded  to the general  decline in interest
rates,  quarterly net interest margin exhibited a steady decline throughout both
2002  and  2003.   Throughout  2003,  Community  experienced  a  steady,  almost
consistent  decline in earning  asset  yields  despite  the  benefits  of a more
concentrated  mix of loans,  whose  yields  normally  exceed  those of portfolio
investments  with comparable  maturities.  The increase in the mix and volume of
higher yielding loans tended to offset the overall  reduction of interest income
from lower  offering  rates  since  2002.  This  improved  mix had the impact of
offsetting  some of the  adverse  consequences  of a lower rate  environment  on
interest income. Funding costs also declined during 2003, and such declines were
more directly  responsible  for the  improvement in net interest  income for the
first  nine  months of the year.  Community's  ability  to  improve  either  net
interest income or net interest margin through further reductions in incremental
pricing of deposits or other funding sources was minimized in the fourth quarter
of 2003,  as a  significant  portion of the funding  pool reached all time lows.
Pricing of both loans and deposits is also subject to  competitive  pressures in
the  marketplace.  Consequently,  the  short-term  potential  for  improving net
interest  margin or net interest  income through  further  reductions in funding
costs seems less likely in the current environment.

                                       14
<PAGE>
PROVISION FOR CREDIT LOSSES

For the second  consecutive year,  Community reported a decline in the provision
for loan losses,  which  reflected the steady  improvement  in the overall asset
quality metrics of its loan portfolio.  The provision declined from $3.4 million
in 2002 to $2.5 million in 2003,  while the  relationship  of the  allowance for
loan losses to loans  declined  from 1.36% at December  31, 2002 to 1.22% at the
end of 2003. The provision,  and the level of the allowance,  were responsive to
the  changing  credit  quality   conditions  of  both  seasoned  loans  and  the
incremental  risk inherent in a growing loan portfolio.  Net charge-offs  during
2003 were  only  $1.7  million,  or 0.17% of  average  loans,  and  reflected  a
significant  decline  from charge off levels of the past two years.  Non-accrual
loans aggregated $8.2 million,  the lowest absolute level since the beginning of
2001. The coverage of these loans provided by the allowance reached 162%, nearly
equal to the 171% high recorded at the end of 2000.  See the section  addressing
the  allowance  for  loan  losses  and  asset  quality  of this  discussion  for
additional information.

NON-INTEREST INCOME

This  increasingly  vital  component  of the revenue  stream grew  substantially
during  2003  as  important   steps  were  undertaken  to  solidify  and  expand
Community's integrated businesses and complementary banking services.  Excluding
the impact from sales of investment  securities,  non-interest revenue grew 43%,
from $12.9  million in 2002 to over $18.5 million in 2003.  The income  recorded
during 2003,  however,  included two nonrecurring  gains without which Community
would still have  recorded  an  increase of 37%, as adjusted  for these items in
both years.  Amounts  recorded in 2003 included a gain from the curtailment of a
legacy,  defined benefit plan in the third quarter and the recognition of a gain
from the sale of an office,  inclusive of both loans and deposits, in the fourth
quarter.  Community  had  recognized a similar gain from the sale of two offices
and related deposits in 2002.

The following is a summary of the various components of non-interest  income for
both 2003 and 2002, including the year over year increases related thereto:

<TABLE>
<CAPTION>
                                                                                                         Change
                                                                 2003           2002            Amount             %
                                                             --------------------------------------------------------
<S>                                                          <C>             <C>               <C>                <C>
Investment management and trust services                     $    1,326      $     993         $     333          34%
Service charges on deposit accounts                               5,128          3,440             1,688          49%
Other service charges, commissions and fees                       2,958          2,471               487          20%
Insurance premium income and commissions                          2,822          2,016               806          40%
Mortgage banking activities                                       2,532          1,221             1,311         107%
Other income                                                      3,748          2,800               948          34%
                                                             --------------------------------------------------------

                                                                 18,514         12,941             5,573          43%

Investment security gains                                         1,927          1,034               893          86%
                                                             --------------------------------------------------------

           Total                                             $   20,441      $  13,975         $   6,466          46%
                                                             ========================================================
</TABLE>

Investment  management and trust revenues  include fees derived from the sale of
various retail investment products (annuities, brokerage services, mutual funds,
etc) and other fees related to Community's limited trust department  activities.
Sales  of  investment  products  are  facilitated  under an  arrangement  with a
national  provider of these services.  Consultative  sales are conducted through
the community office network.  This arrangement  provides  convenient  access to
alternative  investment vehicles through licensed employees who live and work in
the communities  where  customers  conduct their normal banking  business.  This
service has  facilitated  a more  holistic  approach  to meeting  the  expanding
financial  service  needs of customers  who live within  Community's  footprint.
Customers are increasingly  comfortable with using trusted,  competent employees
who work within their primary  financial  institutions  for this vital  service.
While  traditional  trust fees showed a  meaningful  increase in 2003,  the vast
majority  of the  increase  in  this  category  was  derived  from  the  sale of
additional  investment  products  to  new  and  existing  customers.  Near  term
increases in this category  will continue to be weighted  toward sales of retail
investment  products.  In the future, the affiliated  arrangement with Bryn Mawr
Trust Company is expected to provide more competitive services to high net worth
individuals as these product offerings are made available.

                                       15
<PAGE>


The most substantial increase in fees occurred in the area of service charges on
deposits.  In the first quarter of 2003,  Community provided a new service known
as  "OverdraftHonor".  Under this carefully  designed program,  customers who so
choose  now have  access to a  service  that  facilitates  payment  of  periodic
overdraft  items while  simultaneously  avoiding  adverse credit history events.
Fees  from  these  services,  which  were  not  provided  prior  to  2003,  were
responsible for virtually all of the increase in this category.

Other service charges include interchange fees from Community's vast ATM network
and debit card  transactions.  Community  continues  to boast an ATM  network of
nearly 100 ATMs,  including  those in place  under a  relationship  with a local
convenience store chain operating within the Corporation's geographic footprint.
Fees  associated  with  non-customer  use  of  these  convenient   locations  to
facilitate cash withdrawal needs grew by more than 23% since 2002. A more robust
increase of 42% was  realized in the  interchange  fees  associated  with retail
transactions  conducted via the use of debit or credit cards.  Nearly all of the
increases in these sources of fee income  resulted from increased  usage and the
consumer's  growing acceptance of electronic mediums as a substitute for cash or
check-based transactions.

Insurance  premiums  and  commissions  include  agency-based   commissions  from
commercial and personal lines, fees from credit  reinsurance  activities related
to  consumer  lending,  and the  revenue  from title  insurance  and  settlement
activities conducted through Community's title insurance subsidiary. These fees,
which rose by a total of $806 thousand  from 2002 to 2003,  included an increase
of over $530 thousand related to title-based  activities  alone.  Such increases
were related to both the overall increase in mortgage loan originations,  and to
the  addition of the ABCO  franchise at the  beginning of the second  quarter of
2003.  The  remainder  of the increase  was related to the  acquisitions  of the
insurance   agencies   during   the  year.   Community   continues   to  explore
opportunities,  through either acquisitions or strategic  alliances,  which will
help develop a meaningful critical mass in this important financial service.

The single  largest  percentage  increase  in  revenues  occurred in income from
mortgage banking  activities.  The increase was related both to volume increases
in purchase mortgages and refinancings, and to new volumes generated through the
midyear acquisition of the Erie subsidiary.  Community has more than doubled its
capacity to originate  mortgages  with the  acquisition of Erie and has become a
more  significant  and efficient  competitor  in its core and extended  Maryland
markets.

Other income  included  gains from the sales of offices in both 2003 and 2002. A
gain in excess of $1 million  was  recorded  in the  fourth  quarter of 2003 and
related to the sale of the loans,  deposits  and  physical  location of a single
community office. In 2002,  Community had recorded a $500 thousand gain from the
sale of two smaller  offices.  Both sales coincided with entry into markets with
more favorable  growth  demographics.  Other income also included a nonrecurring
gain from the  curtailment of a legacy  pension plan in the third quarter.  With
this action,  Community has made substantial  progress toward uniform retirement
benefit  programs for current and  prospective  employees  while  simultaneously
forestalling increased expenses from higher-cost defined benefit plans.

Security gains  increased by nearly $900 thousand from 2002 as efforts were made
to  identify  opportunities  to improve  the  duration  or average  yield of the
portfolio  at various  times  during the year.  The total gains of $1.9  million
recorded in 2003 included  nearly $1.5 million of gains related to sales of bank
equity holdings.

NON-INTEREST EXPENSES

Total  non-interest  expenses  reached $45.7 million in 2003 and reflected a 16%
increase,  or $6.4 million,  from the $39.3 million recorded in 2002. The growth
was influenced by two major  factors.  Over 25% of the increase of $6.4 million,
or $1.7 million,  was directly related to increased expenses from the integrated
businesses  acquired at different points during 2003.  These increases  included
the  expenses  from ABCO,  Erie,  and  incremental  insurance  agency  activity.
Excluding  the  portion of the  increase  related to acquired  businesses,  2003
operating expenses increased $4.7 million or 12% over 2002 expenses. This second
component of the increase was more directly related to the costs associated with
expansion of the core banking franchise.



                                       16
<PAGE>
The following is a summary of the various components of change in operating
expenses:

<TABLE>
<CAPTION>
                                                                             Change From            Total Change
                                                                         --------------------      ---------------
                                                                         Integrated
                                                  2003          2002     Businesses    Other        Amount       %
                                                  ----          ----     ----------    -----       -------       -

<S>                                            <C>           <C>          <C>         <C>          <C>          <C>
Salaries and employee benefits                 $ 25,397      $ 21,636     $ 1,265     $ 2,496      $ 3,761      17%
Net occupancy expense                             7,200         6,051         119       1,030        1,149      19%
Marketing expense                                 2,018         1,090          20         908          928      85%
Telecommunications expense                        1,302           995          39         268          307      31%
Other operating expenses                          9,801         9,528         237          36          273       3%
                                               --------      --------     -------     -------      -------      ---

              Total                            $ 45,718      $ 39,300     $ 1,680     $ 4,738      $ 6,418      16%
                                               ========      ========     =======     =======      =======      ===
</TABLE>

Excluding  that portion of the increase  related to the  additional  expenses of
businesses acquired in 2003, Community reflected significant increases in salary
and employee benefits costs (12%), occupancy expenses (17%), and other operating
expenses,  including  marketing and  telecommunications  (10%). Since the end of
2001,  Community  has added a total of seven new  banking  facilities  in new or
existing  markets while selling three offices in markets with less robust growth
characteristics.  This selective  expansion of the Community Banks franchise has
had a significant  influence on the  operating  expense  structure.  At the same
time, this expansion has also been an important  catalyst for the growth in loan
and deposit balances since the end of 2001.

The single largest component of costs is salary and benefits,  as these expenses
represent nearly 56% of total operating costs.  Excluding the impact of salaries
added from the acquired businesses, salary and benefit expenses grew nearly $2.5
million from 2002 to 2003. Of this  increase,  over $1 million was attributed to
the  effect of the 3%  average  salary  increase  and to a heavier  reliance  on
employee  incentives for sales of certain financial product  offerings.  Payroll
taxes and employee  insurance  costs,  which  increased by nearly $600 thousand,
were influenced by personnel added in both banking and acquired businesses,  and
by increases in health insurance rates. The remainder of the increase, less than
$1 million,  was  affected by personnel  added as a result of the new  community
offices,  the increased cost of the customer service center, and by the addition
of new lenders for certain key growth markets.

As would be expected, occupancy expenses were also influenced by increased costs
associated with community office expansion and rose by just over $1 million. The
costs for  offices  added  since the end of 2001 grew by almost  $400  thousand.
Another $250 thousand of increased  costs were related to the first full year of
operation of the southern operations center and by the expansion of the customer
service  center.  These  initiatives  had been undertaken in 2002 to improve the
level of customer service to new and existing customers.

Within  the  overall  category  of  other  operating  expenses,   marketing  and
promotional increased over $900 thousand.  In its 2002 annual report,  Community
announced  its  intention to increase its 2003  spending to  accommodate  a more
significant  level  of  marketing  and  advertising   costs.  These  costs  were
undertaken in order to increase  Community's  market share in new markets and to
preserve and expand share in its legacy  communities.  Expenses  were related to
expanded awareness, image and lead product advertising,  especially in the first
half  of  2003.  Community  also  reflected  a  $300  thousand  increase  in its
communications and data connection expenses during the year, which included cost
for upgrades of existing  systems and the increased costs for its growing office
network.  Other operating  expenses increased $300 thousand and were principally
related to the acquired businesses.

INCOME TAXES

Income taxes grew from $3.4 million in 2002 to $4.4 million in 2003, an increase
of nearly 30%. The increase was commensurate  with the increase in pretax income
and resulted in an effective tax rate of over 17%, only slightly higher than the
15% tax rate recorded in 2002. The relative mix of tax exempt income, which grew
during 2003,  influences the level of effective income tax rates and remains the
primary  reason  for the  difference  between  the  effective  tax  rate and the
statutory federal tax rate for corporations.



                                       17
<PAGE>


STATEMENT OF CONDITION:  OVERVIEW

At December 31, 2003,  Community's  total assets  reached  almost $1.9  billion,
reflecting  a change  of  almost  11% from the  nearly  $1.7  billion  of assets
recorded at the end of 2002.  Average  assets grew to $1.8  billion for 2003 and
grew almost 13% from 2002 average  assets.  Average  balances of earning assets,
loans and deposits grew 13%, 13% and 8%, respectively.  Community benefited from
increased demand for credit in both the consumer and commercial  sectors.  While
consumer  demand for credit was influenced by both low rates and steady consumer
confidence,  growth  in the  commercial  sector  was more  directly  related  to
Community's  ability to garner market share from larger,  less nimble  financial
institutions.  The  growth  trends  experienced  in 2003 and in  previous  years
continue to  demonstrate  Community's  commitment  to staying  close to its core
markets and to using its local  presence  and  responsiveness  as a  competitive
advantage.

INVESTMENTS

Community has  established  corporate  investment  policies that address various
aspects of portfolio  management,  including  quality  standards,  liquidity and
maturity  limits,  investment  concentrations  and  regulatory  guidelines.  The
Corporation's   objective  with  respect  to  investment   management   includes
maintenance of appropriate  asset  liquidity,  facilitation  of  asset/liability
strategy  and  maximization  of return.  Compliance  with  investment  policy is
regularly reported to the Board of Directors.

Community actively manages its investment portfolio and, accordingly, classifies
all investment  securities as "available  for sale".  Under current  policy,  if
management has the intent and the Corporation has the ability to hold securities
until maturity,  securities are classified as "held-to-maturity"  investments at
the time of purchase and carried at amortized historical cost.  Securities to be
held for  indefinite  periods of time are  classified  as available for sale and
carried  at fair  value.  Such  securities  are  intended  to be used as part of
Community's  asset/liability management strategy, and may be sold in response to
changes in interest rates,  prepayment risk and other factors  affecting overall
investment strategy.

During 2003,  the average  balance in the  investment  portfolio  grew from $585
million to $674 million, a growth rate of 15% that, though substantial,  was far
less than the investment  portfolio growth of 29% that was experienced from 2001
to  2002.  During  2002,   Community  had  experienced  robust  deposit  growth,
particularly  early in that year.  Unfortunately,  loan growth did not keep pace
with deposit generation growth rates,  creating additional liquidity that fueled
growth in the investment  portfolio  throughout 2002. As Community entered 2003,
loan demand for both commercial and consumer credits  increased  coincident with
the demand created by steadily  declining  interest rates.  While deposit inflow
remained  significant  into 2003, it was less robust growth than  experienced in
2002.  The  combination  of investment  runoff and the  increasing  deposit base
provided  more than  adequate  funding  to keep  pace with the 2003 loan  growth
rates. Consequently,  Community continued to experience growth in its investment
portfolio between the two years.

The pretax  unrealized net gain within the investment  portfolio at December 31,
2003 was $13.3 million. As required, this fair value adjustment was reflected in
other  comprehensive  income  (adjusted for income  taxes) in the  stockholders'
equity  section  of the  statement  of  condition.  Near the end of 2003,  a new
accounting  pronouncement was issued that requires additional disclosures in the
footnotes to the financial  statements.  Such disclosures  relate to declines in
the market  value of specific  securities  that may be  considered  "temporarily
impaired"   pursuant  to   newly-established   criteria  for  identifying   such
securities.  Of the total of $674 million of investments included in Community's
portfolio at year end, securities  aggregating over $148 million were identified
as having met the criteria  necessary for disclosure.  The aggregate  unrealized
loss  disclosed in the  footnotes  to the  financial  statements  is slightly in
excess of $3.8  million,  nearly all of which was  related to the  extraordinary
decline in interest rates on certain  securities and its impact on the valuation
of  those  securities.  Such  declines  were  not  attributed  to any  perceived
deterioration  in  an  individual   issuer's  ability  to  meet  the  terms  and
obligations of the issuance and were more than offset by gross  unrealized gains
of just over $17  million.  Community  has the  ability  and intent to hold such
investments  until their original maturity and fully expects that any unrealized
losses will be recovered over the term of the investments.



                                       18
<PAGE>

The following  tables  summarize  amortized  cost and  estimated  fair values at
December 31, 2003,  2002,  and 2001 and maturity  distribution  of securities at
December 31, 2003 (in thousands).

<TABLE>
<CAPTION>

                                                            2003                       2002                        2001
                                                   -----------------------------------------------------------------------------
                                                   Amortized      Fair        Amortized       Fair        Amortized      Fair
                                                      Cost        Value          Cost         Value          Cost        Value
                                                   -----------------------------------------------------------------------------
<S>                                                <C>          <C>           <C>          <C>            <C>          <C>
Mortgage-backed U.S. government agencies           $ 121,853    $ 123,395     $ 206,450    $ 210,825      $  74,403    $  74,370
U.S. Government corporations and agencies            173,651      173,292       130,947      134,334        144,640      142,544
Obligations of states and political sub-
   divisions                                         177,546      184,481       172,391      177,135        172,223      169,993
Corporate securities                                  95,461       97,987        95,022       93,094         99,561       98,405
Equity  securities                                    65,070       67,806        50,610       52,413         57,846       58,589
                                                   ---------    ---------     ---------    ---------      ---------    ---------
   Total                                           $ 633,581    $ 646,961     $ 655,420    $ 667,801      $ 548,673    $ 543,901
                                                   =========    =========     =========    =========      =========    =========
</TABLE>

<TABLE>
<CAPTION>

                MATURITY DISTRIBUTION OF SECURITIES (Fair Value)



                                                             One         Five                                               Weighted
                                              Within       Through      Through       After                   Average       Average
                                             One Year     Five Years   Ten Years    Ten Years      Total      Maturity      Yield(a)
                                             ---------------------------------------------------------------------------------------

<S>                                          <C>           <C>         <C>          <C>         <C>          <C>   <C>        <C>
       U.S. Government agencies              $ 18,433      $ 20,495    $ 157,165    $ 100,594   $ 296,687    10yr. 13 mos.    4.33%
       Obligations of states and political
          subdivisions                            ---         1,589       12,382      170,510     184,481    16yr.  3 mos.    7.17%
       Other                                    5,039        23,332       27,271      110,151     165,793    15yr.  5 mos.    4.90%
                                             --------      --------    ---------    ---------   ---------

             Total                           $ 23,472      $ 45,416    $ 196,818    $ 381,255   $ 646,961    13yr.  2 mos.    5.29%
                                             ========      ========    =========    =========   =========

       Percentage of total                      3.63%         7.02%       30.42%       58.93%      100.0%
                                                ====          ====        =====        =====       =====

       Weighted average yield (a)               2.21%         4.99%        4.80%        5.76%       5.29%
                                                ====          ====         ====         ====        ====
</TABLE>

     (a)  Weighted  average yields were computed on a tax equivalent basis using
          a federal tax rate of 35%.

The  Corporation  monitors  investment  performance  and valuation on an ongoing
basis to evaluate  investment  quality.  An investment  which has  experienced a
decline in market value considered to be other than temporary is written down to
its net realizable  value and the amount of the write down is accounted for as a
realized loss.

LOANS

Average  loans  reached $997 million at the end of 2003, a 12% increase over the
$887 million of average loans recorded in 2002. The composition of loans between
the two years was influenced by a number of factors,  including the influence of
lower interest  rates.  The following  presentation  of loans at December 31 for
each of the  past  two  years  is an  indication  of the  relative  mix of loans
included in the portfolio (in thousands):

<TABLE>
<CAPTION>
                                                                                  Change
                                                2003          2002          Amount        %
                                                ----          ----          ------        -

<S>                                       <C>             <C>            <C>             <C>
Commercial                                $   367,444     $  295,506     $  71,938       24 %
Commercial real estate                        283,662        246,533        37,129       15 %
Residential real estate                        97,178        109,497       (12,319)     (11)%
Consumer                                      330,327        253,032        77,295       31 %
                                          ---------------------------------------------------
          Total                           $ 1,078,611     $  904,568     $ 174,043       19 %
                                          ===================================================
</TABLE>



                                       19
<PAGE>

Following a year of less robust  commercial  loan  activity in 2002,  commercial
borrowing began to increase  dramatically during the second quarter of 2003, and
growth  continued  well into the second  half of the year.  After the end of the
first  quarter,  the  steady  declines  in  interest  rate  trends  caused  many
borrowers,   including  those  with  prior  relationships  with  competitors  of
Community,  to  reevaluate  their  existing  credit  arrangements  in  search of
improved funding terms and more responsive credit  relationships.  Community has
consistently  made efforts to position  itself in the  marketplace to ensure its
ability to compete  with large and small  competitors  alike.  As a result,  the
Corporation  was able to increase both its commercial and commercial real estate
portfolios by nearly $109 million on an aggregate  basis.  Much of the growth in
the commercial sector was attributed to Community's  ability to acquire existing
market  share since  business  lending has been  constrained  on both a national
level and in certain  segments of Community's  market.  A portion of this growth
also can be  attributed  to the addition of certain key lending  personnel  made
available  as  a  result  of  mergers  of  local   financial   institutions   by
out-of-market acquirers.

The single most significant  source of loan growth occurred in consumer lending,
particularly home equity lending, which grew by $77 million between December 31,
2002  and the  end of  2003.  As part of  Community's  effort  to  increase  its
visibility  in core  markets,  a  concerted  effort  was  made to  become a more
effective  consumer  lender,  including  substantial  increases in marketing and
advertising  efforts.  Historically,   Community  has  been  more  widely  known
throughout its market as a lender to small and medium-size  businesses,  with an
emphasis on commercial mortgages and commercial loans secured by real estate. In
2003, Community sought to leverage its office network as a channel for expanding
consumer  lending  and  to  fulfill  the  consumer's  appetite  for  convenient,
accessible retail lending services. Consumer demand for credit was also aided by
the high  levels  of  consumer  confidence  and  improved  credit  affordability
experienced in the current  interest rate  environment.  These efforts were also
aided by the growth  achieved as a result of the expansion of the office network
and sales efforts over the last several years.

Residential  real  estate  lending,  which  is  composed  primarily  of loans to
single-family  creditors,  has  experienced a steady  decline as a result of the
increasing  accessibility of secondary market liquidity through mortgage banking
activities.  Community-based  banks continue to provide a convenient  avenue for
consumers  to access  funding  for  residential  lending,  but most new  credits
continue  to be sold in the  secondary  market.  This  strategy  has reduced the
interest rate risk  associated with consumer  preferences  for long-term,  fixed
rate  lending,  and continues to provide  valuable  liquidity for other forms of
relationship lending.

ALLOWANCE FOR LOAN LOSSES AND CREDIT QUALITY

The following sets forth activity within the allowance for credit losses for the
last three years.

<TABLE>
<CAPTION>
                                                             2003              2002              2001
                                                             ----              ----              ----

<S>                                                       <C>              <C>               <C>
                  Balance at January 1,                   $    12,343      $    12,132       $    10,328
                     Loans charged off                         (2,839)          (4,180)           (3,776)
                     Recoveries                                 1,174            1,041               500
                     Provision charged to operations            2,500            3,350             5,080
                                                          ----------------------------------------------
                  Balance at December 31,                 $    13,178      $    12,343       $    12,132
                                                          ==============================================

Allowance for credit losses to loans                            1.22%            1.36%             1.42%

</TABLE>


                                       20
<PAGE>

The  period  between  January  1,  2001 and  December  2002  marked a period  of
adjustment in the credit quality  profile of Community  Banks,  Inc. In the last
three  quarters of 2002,  emerging  trends  suggested  that the risk  profile of
Corporation's  loan portfolio would experience  steady  improvement in 2003. The
decline  in both  non-accrual  loans  and in loans  "90 days or more  past  due"
provided indications of an improving picture of credit quality, despite dramatic
increases in the overall loan  balances.  During 2003,  further  indications  of
these favorable trends continued to emerge,  resulting in dramatic reductions in
both net charge-offs and additional  reductions in the level of problem credits.
Net charge-offs  were reduced to $1.7 million,  or 0.17% of average  outstanding
loans, and compared favorably to the net charge-offs of $ 3.1 million, or 0.35%,
in the prior  year.  Non-accrual  loans,  the most  severe  category  of problem
credits,  declined  13% from $9.4  million in 2002 to $8.2 million at the end of
2003 while  loans 90 days or more past due  declined  from $961  thousand to $90
thousand  over the same period.  Despite a decline in the ratio of the allowance
for  credit  losses to loans  from 1.36% at year end 2002 to 1.22% at the end of
2003, the coverage of non-accrual loans provided by the allowance increased from
131% to 162%  over the two year  period.  As a  consequence  of these  and other
critical  factors,  management  was able to reduce the provision for loan losses
from $3.4 million in 2002 to $2.5 million in 2003.

The following sets forth loan loss experience for the last five years (in
thousands):
<TABLE>
<CAPTION>

                                                         2003               2002          2001           2000           1999
                                                         ----               ----          ----           ----           ----

<S>                                                  <C>                 <C>           <C>            <C>            <C>
       Loans at year-end, net of unearned income     $ 1,078,611         $ 904,568     $ 857,278      $ 814,874      $ 708,016
                                                     ===========         =========     =========      =========      =========

       Average loans balance                         $   997,190         $ 886,808     $ 838,178      $ 768,204      $ 665,422
                                                     ===========         =========     =========      =========      =========
       Balance, allowance for loan losses,
                 January 1                           $    12,343         $  12,132     $  10,328      $   8,976      $   8,608

       Loans charged off:
          Commercial, financial and agricultural             253             1,878         2,275            303            489
          Real estate-mortgage                             1,548             1,447           484            521            190
          Consumer and other                               1,038               855         1,017          1,101            984
                                                     -----------         ---------     ---------      ---------      ---------
       Total                                               2,839             4,180         3,776          1,925          1,663
                                                     -----------         ---------     ---------      ---------     ----------

       Loans recovered:
          Commercial, financial and agricultural             240               644           120             23            140
          Real estate-mortgage                               689                25           108             83             43
          Consumer and other                                 245               372           272            308            260
                                                     -----------         ---------     ---------      ---------      ---------

       Total                                               1,174             1,041           500            414            443
                                                     -----------         ---------     ---------      ---------      ---------

       Net charge-offs                                    (1,665)           (3,139)       (3,276)        (1,511)        (1,220)

       Provision for loan losses                           2,500             3,350         5,080          2,863          1,588
                                                     -----------         ---------     ---------      ---------      ---------

       Balance, allowance for loan losses,
                 December 31                         $    13,178         $  12,343     $  12,132      $  10,328      $   8,976
                                                     ===========         =========     =========      =========      =========

       Net charge-offs to loans at year end                 .15%              .35%          .38%           .19%           .17%

       Net charge-offs to average loans                     .17%              .35%          .39%           .20%           .18%

       Balance of allowance for loan losses
                 to loans at year end                      1.22%             1.36%         1.42%          1.27%          1.27%

</TABLE>


                                       21
<PAGE>
The allowance for loan losses is based upon management's  continuing  evaluation
of the loan  portfolio.  A review  as to loan  quality,  current  macro-economic
conditions  and  delinquency  status is  performed  on a  quarterly  basis.  The
provision for loan losses is adjusted  quarterly based upon current review.  The
following  table presents an allocation by loan  categories of the allowance for
loan losses at December 31 for the last five years (in thousands).

<TABLE>
<CAPTION>
                                                         2003           2002           2001           2000          1999
                                                         ----           ----           ----           ----          ----
<S>                                                   <C>            <C>            <C>            <C>            <C>
       Loans:
           Commercial, financial and agricultural     $   7,090      $   6,305      $   9,285      $   5,268      $  3,030
           Real estate-construction                         ---            ---             10             14             9
           Real estate-mortgage                           2,313          1,936            965          1,593         1,509
           Installment                                    2,184          1,767          1,030          1,748         1,575
           Unallocated                                    1,591          2,335            842          1,705         2,853
                                                      ---------      ---------      ---------      ---------      --------
       Balance                                        $  13,178      $  12,343      $  12,132      $  10,328      $  8,976
                                                      =========      =========      =========      =========      ========
</TABLE>

The amount of the allowance  assigned to each component of the loan portfolio is
derived from a combination of factors.  Estimation  methods and assumptions used
in the process are reviewed  periodically  by both  management  and the Board of
Directors.

The  percentage of loans in each category above is included in the "Loan Account
Composition"  table in Appendix A to  Management's  Discussion  and  Analysis of
Financial Condition and Results of Operation, Part II Item 7.

The Corporation's allowance for loan losses is based upon management's quarterly
review of the loan portfolio utilizing a consistent valuation  methodology.  The
purpose  of the  review is to assess  loan  quality,  identify  impaired  loans,
analyze delinquencies, ascertain loan growth, evaluate potential charge-offs and
recoveries, and assess general economic conditions in the markets its affiliates
serve.  Commercial  and real  estate  loans are  individually  risk rated by the
Corporation's loan officers and periodically reviewed by independent loan review
personnel.  Consumer and residential real estate loans are generally analyzed in
homogeneous pools utilizing historical loan charge-off information.

To determine the allowance and corresponding  loan loss provision,  an amount is
allocated to specific loans. For certain commercial and construction loans, this
amount is based upon specific borrower data and supporting collateral determined
by reviewing  individual  non-performing,  delinquent,  or potentially  troubled
credits.  For the  majority  of the loans  that are  individually  reviewed  for
impairment, this analysis is based on a comparison of the loan's carrying amount
to the net  realizable  value of the  collateral.  The portion of the  allowance
attributable to specific  impaired loans was $546 thousand at December 31, 2003.
The remaining commercial as well as consumer,  and residential real estate loans
are evaluated as part of various pools. These pool reserves, generally are based
upon  historic  charge-offs  and  delinquency  history,  other known  trends and
expected  losses  over  the  remaining  lives  of  these  loans,  as well as the
condition  of local,  regional  and  national  economies  and other  qualitative
factors.

To ensure adequacy to a higher degree of confidence,  a portion of the allowance
for loan  losses is  considered  unallocated.  The  unallocated  portion  of the
allowance  is  intended to provide for  probable  losses that are not  otherwise
identifiable,  for possible imprecise estimates in assessing potential losses on
commercial loans or in the calculation of pool reserves, and for the extenuating
influence of current factors, such as economic  uncertainties.  This unallocated
portion  is  available  to absorb  losses  sustained  anywhere  within  the loan
portfolio.  The combined  allocated  and  unallocated  portions  bring the total
allowance to an amount deemed prudent and reasonable by management at that time.

Risk Elements

The following  sets forth  information  regarding  various  segments of the loan
portfolio,  collectively  referred to as risk elements.  These segments  include
both  nonperforming  assets  and  those  loans  past  due for 90  days or  more.
Non-performing assets include non-accrual loans, restructurings,  and other real
estate. Non-accrual loans are loans for which interest income is not accrued due
to concerns  about the  collection of interest  and/or  principal.  Restructured
loans may involve renegotiated interest rates, repayment terms, or both, because
of  deterioration in the financial  condition of the borrower.  The only credits
that would have  qualified as  restructured  loans at the end of both years were
already classified in the more severe non-accrual category.  The following table
provides a comparative  summary of nonperforming  assets and total risk elements
at the end of each of the last five years (in thousands).

                                       22
<PAGE>

<TABLE>
<CAPTION>


                                                     2003              2002              2001             2000            1999
                                                     ----              ----              ----             ----            ----
<S>                                           <C>              <C>               <C>              <C>              <C>
     Loans on which accrual of interest has
     been discontinued:
          Commercial, financial and agricultural  $    3,066       $    2,257        $    3,783       $    2,042       $    2,231
          Mortgages                                    4,054            6,609             6,952            3,445            3,203
          Other                                        1,031              527               355              356              222
                                                  ----------       ----------        ----------       ----------       ----------

                                                       8,151            9,393            11,090            5,843            5,656
                                                  ----------       ----------        ----------       ----------       ----------

     Loans renegotiated with borrowers                  ---               ---               ---              205              254
                                                  ----------       ----------        ----------       ----------       ----------

     Total non-accrual loans                           8,151            9,393            11,090            6,048            5,910

     Foreclosed real estate                            4,865            1,183               631              416              615
                                                  ----------       ----------        ----------       ----------       ----------

     Total non-performing assets                      13,016           10,576            11,721            6,464            6,525
     Loans past due 90 days or more:
        Commercial, financial and agricultural             4               97             1,002                8              146
        Mortgages                                         40              770               405              495              147
        Consumer and other                                46               94               252              109               85
                                                  ----------       ----------        ----------       ----------       ----------

                                                          90              961             1,659              612              378
                                                  ----------       ----------        ----------       ----------       ----------

     Total risk elements                          $   13,106       $   11,537        $   13,380       $    7,076       $    6,903
                                                  ==========       ==========        ==========       ==========       ==========

     Ending allowance for loan losses             $   13,178       $   12,343        $   12,132       $   10,328       $    8,976
                                                  ==========       ==========        ==========       ==========       ==========

     Ending allowance to non-accrual loans              162%             131%              109%             171%             152%

</TABLE>

Despite  improvement  in  most  categories  of  problem  credits,  there  was  a
substantial increase in foreclosed real estate from 2002 to 2003. The balance in
this category grew from $1.2 million at December 31, 2002 to $4.9 million at the
end of 2003. Nearly all of the increase was related to the  reclassification  of
two large  credits  that had been  made to a single  borrower.  Pursuant  to the
provisions of the original loan  agreements,  Community  took  possession of two
collateral  properties in the fourth quarter of 2003, due to borrower default. A
new,  unrelated  borrower  purchased  one of the  properties  in January,  2004,
resulting  in the return of nearly  $2.6  million  of loans to  accrual  status.
Amounts  included in  foreclosed  real estate are stated at the lower of cost or
market  and  no  losses  are  expected  from  the  final  disposition  of  these
properties.

The determination to discontinue the accrual of interest on non-performing loans
is made on the individual case basis.  Such factors as the character and size of
the loan, quality of the collateral and the historical  creditworthiness  of the
borrower  and/or  guarantors  are  considered  by  management  in assessing  the
collectibility of such amounts.

The  approximate  amount  that would have been  accrued on those loans for which
interest was discontinued in 2003 was $350,000.

Overall Assessment

Community  has assessed  all of the above  factors in the  establishment  of the
allowance for loan losses. The determination as to the adequacy of the allowance
reflects  management's  judgment,  and was based upon  collateral,  local market
conditions,  various estimates,  and other information that requires  subjective
analysis.  These factors, which are prone to change, are monitored by management
to evaluate their potential impact on management's assessment of the adequacy of
the allowance. Based on its evaluation of loan quality, management believes that
the  allowance  for loan  losses at  December  31,  2003 was  adequate to absorb
probable losses within the loan portfolio.


                                       23
<PAGE>
DEPOSITS

Deposit balances remain the primary source of funding for financial institutions
and  Community   recognized  steady  growth  of  nearly  8%  in  this  important
core-funding source, summarized as follows (in thousands):

<TABLE>
<CAPTION>
                                                                                           Change
                                                 2003              2002             Amount          %
                                                 ----              ----             ------          -

<S>                                      <C>                <C>                 <C>                 <C>
Demand                                   $      167,315     $     163,434       $    3,881          2%
Savings & NOW accounts                          401,805           322,632           79,173         25%
Time                                            498,005           498,159             (154)        --%
Time $100,000 or more                           110,231           107,523            2,708          3%
                                         -------------------------------------------------------------
                                         $    1,177,356     $   1,091,748       $   85,608          8%
                                         =============================================================
</TABLE>

Deposit growth in 2003 occurred  almost  exclusively in savings  deposits,  more
specifically   Community's   Power  Now  account.   This   account,   which  has
characteristics  of both a money  market and  checking  account,  grew  steadily
throughout the year. At the same time, longer term time deposit growth was flat.
Consumer  preferences  were clearly  weighted in favor of  maintaining  adequate
liquidity in anticipation of a gradual rise in rates. Despite the fact that most
interest rates declined  steadily  throughout the period,  most  depositors were
reluctant to extend time deposit  maturities  to obtain only  marginally  higher
rates.  The  consistent  downward  pressure  on  rates,  combined  with  lack of
confidence  in  other  more  risky  investment   vehicles,   increased  consumer
preference  for the  flexibility,  liquidity and guaranteed  return  provided by
these accounts.

The following  table  summarizes the maturity  distribution  of time deposits of
$100,000 or more as of December 31, 2003 (in thousands).
<TABLE>
<CAPTION>
<S>                                                                                         <C>
                       Remaining to Maturity:
                          Less than three months                                            $   24,791
                          Three months to six months                                            21,735
                          Six months to twelve months                                           33,076
                          More than twelve months                                               34,403
                                                                                            ----------
                                                                                            $  114,005
                                                                                            ==========
</TABLE>

BORROWED FUNDS

Community makes tactical use of Federal Home Loan Bank (FHLB) advances and other
borrowed funds to augment its funding needs. Strategic capital leverage efforts,
including share repurchase and various investment initiatives, have affected the
volume and composition of non-deposit funding. The largest component of borrowed
funds comes from FHLB advances.  FHLB borrowings,  which are  collateralized  by
residential mortgages or other qualified securities, include a variety of credit
products  available to Community through its membership in the Federal Home Loan
Bank.

CAPITAL ADEQUACY

Capital  strength  is an  important  measure  with  which to judge  the  overall
stability of a financial  institution.  A strong  capital base is a prerequisite
for sustaining  franchise  growth through both internal  expansion and strategic
acquisition   opportunities.   Regulatory  authorities  impose  constraints  and
restrictions  on bank  capital  levels  that are  designed  to help  ensure  the
vitality of the nation's banking system.

Community  believes that capital is a valuable,  albeit  limited  resource whose
availability  moderates with changes in the business cycle.  The Corporation has
developed  an  extensive  capital  management  policy  designed to consider  all
aspects of capital management. This policy is mindful of the responsibilities to
Community's  shareholders,  employees,  regulators,  and other constituencies to
ensure that capital is well-managed. The policy considers the impact of numerous
capital management issues,  including:  the maintenance of key financial ratios;
the need for an adequate return to shareholders in terms of both dividend payout
and  capital  appreciation;  the  flexibility  to  apply  techniques  that  will
accommodate  either equity expansion or contraction;  and the restraint required
to avoid accumulation of unsustainable  levels of intangible  assets.  Community
also continuously  examines its options with regard to capital management in the
context of intrinsic factors,  including its prospects for growth, the potential
for earnings disruption, and others. Maintenance of appropriate capital levels

                                       24
<PAGE>
may require the  application  of techniques  designed to help  Community meet or
exceed regulatory  guidelines and to correlate capital levels with a given asset
growth rate.  The  Corporation's  capital  management  and  planning  process is
reviewed and approved by its Board of Directors.

In addition to internal  guidelines,  regulators have established  standards for
the  monitoring and  maintenance of appropriate  levels of capital for financial
institutions.  All regulatory capital guidelines are now based upon a risk-based
supervisory  approach that has been designed to ensure  effective  management of
capital  levels and associated  business risk. The following  table provides the
risk-based  capital positions of Community and its principal banking  subsidiary
at the end of 2003, along with an indication of the various  regulatory  capital
requirements.
<TABLE>
<CAPTION>

                                                         December 31,        "Well          Regulatory
                                                            2003          Capitalized"       Minimums
                                                            ----          ------------       --------
<S>                                                          <C>              <C>               <C>
                  Leverage ratio
                      Community Banks, Inc.                   8.8%            n/a               4%
                      Bank only                               7.7%             5%               4%

                  Tier 1 capital ratio
                      Community Banks, Inc.                  11.6%            n/a               4%
                      Bank only                              10.1%             6%               4%

                  Total risk-based capital ratio
                      Community Banks, Inc.                  12.6%            n/a               8%
                      Bank only                              11.1%            10%               8%
</TABLE>

The most fundamental source of capital is earnings and earnings retention.  This
cornerstone  of  capital  adequacy  can be  augmented  by a  number  of  capital
management strategies,  many of which were utilized during 2003. As it has for a
number of years,  the Board  approved the issuance of a 5% stock dividend in the
first  quarter.  In the fourth  quarter,  the Board  announced the approval of a
stock split issued in the form of a 20% stock dividend, which has been accounted
for on a pro forma basis throughout this presentation.  Throughout the year, the
Corporation's  strong  earnings  supported  a  return  of  capital  to  existing
shareholders  in the  form of an  increase  in the  traditional  cash  dividend.
Community also  continues to make  strategic use of share  repurchase as another
efficient  means of  returning  capital to  shareholders.  In  December of 2003,
management  executed  another pooled trust preferred  issuance of $15 million in
order to increase  the amount of  qualifying  regulatory  capital  through  this
relatively  inexpensive funding source.  Community previously had executed a $15
million issuance at the end of 2002, bringing the total trust preferred balances
to $30 million at December 31, 2003.  Such amounts are  classified  as long-term
debt  for  financial  statement  purposes.  It is  anticipated  that  additional
regulatory guidance is forthcoming  regarding the suitability of trust preferred
issuances  as "Tier 1 capital" on a going  forward  basis.  Community  places no
significant   reliance  on  these   instruments  to  meet   regulatory   capital
requirements  and  anticipates  no  material  change  in  its  accounting  as  a
consequence of this new guidance. In the aggregate, these various strategies and
techniques  have  allowed   management  to  maintain   capital  at  levels  that
represented an efficient use of this valuable resource.

ASSET/LIABILITY MANAGEMENT AND LIQUIDITY

The process by which  financial  institutions  manage earning assets and funding
sources under different  interest rate  environments  is called  asset/liability
management.  The primary goal of  asset/liability  management is to increase net
interest income through the prudent control of market risk, liquidity,  interest
rate risk and capital.  Two important barometers of performance are net interest
margin and  liquidity.  Net interest  margin is  increased by widening  interest
spread while controlling interest rate sensitivity. The adequacy of liquidity is
determined by the ability to meet the cash flow  requirements of both depositors
and customers  requesting bank credit.  The Board of Directors (the "Board") and
the Audit Committee of the Board governs and monitors asset/liability management
processes  as part of the overall  risk  management  process and  delegates  the
responsibility   for   management   of   these   processes   to  the   corporate
Asset/Liability Management Committee (ALCO).



                                       25
<PAGE>
Liquidity is defined as the ability to meet maturing  obligations and customers'
demand for funds on a  continuous  basis.  Liquidity is sustained by stable core
deposits,  a diversified  mix of liabilities,  strong credit  perception and the
presence of  sufficient  assets  convertible  to cash without  material  loss or
disruption of normal  operations.  Community actively manages liquidity within a
defined range and has developed reasonable liquidity contingency plans, ensuring
availability of alternate funding sources to maintain adequate liquidity under a
variety of  business  conditions.  The  Corporation's  investing  and  financing
activities  are  conducted  within  the  overall  constraints  of its  liquidity
management policy and practices.

Community utilizes a variety of techniques to assist management and the Board of
Directors in the  management  and  monitoring of interest rate risk. In order to
quantify  the impact of changes in interest  rates on net interest  income,  the
Corporation  conducts a quarterly  interest rate shock  simulation that projects
the impact of interest  rate changes on net interest  income over the next year.
These  simulations  are utilized to assess whether  management  should  consider
corrective actions in order to minimize Community's exposure or vulnerability to
a particular  trend in interest  rates.  Management has  established  acceptable
tolerance  limits for the impact of changes in interest  rates on the volatility
of net interest  income,  and is authorized to pursue  mitigating  strategies in
order  to  minimize  unfavorable  impact  under a  variety  of  scenarios.  Such
simulations are conducted under a variety of assumptions that require  estimates
of the velocity and extent of interest rate changes,  including an assessment of
the  impact  of  such  changes  on  those  assets  and  liabilities   that  have
indeterminate maturity or repricing  characteristics.  Simulation of earnings is
used  primarily to measure  Community's  earning  exposure for the ensuing year.
Current policy limits  unfavorable  exposure of simulated net interest income to
10% of the base case net  interest  income in  either a rising or  falling  rate
"shock" scenario  (immediate  repricing) of 200 basis points. The following is a
summary of the rate "shock" results conducted under these various assumptions as
December 31, 2003:

                                           Annual
            Simultaneous                   Change
               Rate                    in Net Interest                  %
              "Shock"                      Income                    Change
              -------                      ------                    ------

               +300bp                  -$1.3 million                 -2.30%
               +200bp                  -$1.0 million                 -1.70%
               +100bp                  -$0.4 million                 -0.60%
              - 100bp                  -$2.5 million                 -4.20%

Management  augments  its  simulation  process  with two other  techniques,  GAP
analysis and economic  value of equity (EVE)  computations.  The most  practical
tool for  day-to-day  management of interest  rate risk is GAP  analysis,  which
provides an array of various  timeframes during which earning assets and funding
sources can be expected to mature or reprice.  This  information  is  ordinarily
examined in the context of the results  derived  from the  quarterly  rate shock
simulations.  Management uses such  information to identify  specific "cause and
effect"  relationships that can be reviewed,  analyzed,  managed,  or changed to
ensure  maximization  of  net  revenue  from  intermediation   activities.   The
combination  of GAP  analysis  and  rate  shock  simulations  provides  the most
practical measurement tools for monitoring and managing of the largest source of
revenue  for  community  banks.  As with the  simulation  or  "shock"  analysis,
Community has established a policy limit for the cumulative  twelve month GAP of
"plus or minus" 15% of total assets.  At December 31, 2003, the twelve month GAP
fell well within this policy limit for each of the time  intervals less than one
year, as shown in the following summary:

                                                         Cumulative GAP
                       Interval                      Expressed as % of Assets)
                       --------                      -------------------------

                      0 - 90 days                        +        2.60%

                      91 - 180 days                      +        2.97%

                      181 - 365 days                     +        1.67%

EVE computations provide a longer-term assessment of interest rate risk, but are
more practical for evaluating long-term,  strategic planning  alternatives.  EVE
has  several  limitations,   including:   the  intrinsic  value  of  assets  and
liabilities  does  not  necessarily   represent  the  fair  value  of  financial
instruments since it does not include credit risk and liquidity;  estimated cash
flows are  required  for  nonmaturity  financial  instruments  and are, by their
nature, inexact and; the future structure of

                                       26
<PAGE>
Community's   balance  sheet  does  not  consider  increased  loan  and  deposit
activities from core business within its present value  assessment.  The results
derived  from EVE  computations,  however,  provide  a  valuable  framework  for
managing  longer-term  balance  sheet  exposures  and interest  rate  volatility
trends.  At the end of 2003,  all measures of EVE fell within the policy  limits
established via the asset/liability  management policy, as approved by the Board
of Directors.

CONTRACTUAL OBLIGATIONS

Significant contractual obligations at December 31, 2003 are summarized in the
following table:
<TABLE>
<CAPTION>

                                                               Less than         1-3            3-5          More than
          Dollars in thousands                   Total           1 year         years          years          5 years
          -----------------------------------------------------------------------------------------------------------

<S>                                          <C>               <C>           <C>            <C>             <C>
          Long-term debt                     $   411,422       $  42,140     $  69,280      $  67,640       $ 232,362
          Operating lease obligations             10,095           1,117         1,872          1,228           5,878
          Trust preferred securities              30,000             ---           ---            ---          30,000
          Time Deposits                          608,823         341,538       171,427         94,542           1,316
          Defined benefit pension payments           889             889           ---            ---             ---
          -----------------------------------------------------------------------------------------------------------

          Total                              $ 1,061,229       $ 385,684     $ 242,579      $ 163,410       $ 269,556
          -----------------------------------------------------------------------------------------------------------
</TABLE>

OFF-BALANCE-SHEET COMMITMENTS

As of December 31, 2003,  the  Corporation  had  unfunded  commitments  totaling
$432.7 million. For details of these off-balance-sheet  commitments,  see "Notes
to Consolidated  Financial Statements - Commitments and Contingencies"  included
in Part II, Item 8.

REGULATORY MATTERS

Community and its affiliates are subject to periodic examinations by the various
regulatory  agencies.  These  examinations  include,  but  are not  limited  to,
procedures  designed  to  review  lending  practices,  risk  management,  credit
quality,   liquidity,   compliance  and  capital  adequacy.   During  2003,  the
Pennsylvania  State  Department  of  Banking,   the  Federal  Deposit  Insurance
Corporation,  and the Federal  Reserve Bank performed  various  examinations  of
Community  and its  banking  subsidiaries  pursuant to their  regular,  periodic
regulatory  reviews.  No comments were  received from these various  bodies that
would  have  a  material  adverse  effect  on  Community's  liquidity,   capital
resources, or operations.

INFLATION

Community's ability to cope with the impact of inflation is best measured by its
ability to respond to changing interest rates and manage non-interest income and
expense. Within its ALCO processes,  the Corporation manages the mix of interest
rate-sensitive  assets and  liabilities in order to limit the impact of changing
interest  rates on net interest  income.  Inflation  also has a direct impact on
non-interest income and expense such as service fee income,  salary and benefits
expenses,  and other  overhead  expenses.  Inflationary  pressures over the last
several  years have been modest but this trend is subject to change.  Management
will  continue  to monitor the  potential  for  inflation  and its impact on the
pricing of products and services.

PERFORMANCE REVIEW: 2002 VS. 2001

Against a backdrop of an uncertain economy, increasing global tensions, a series
of unfortunate  corporate scandals,  and the lowest interest rate environment in
the last four decades,  Community Banks, Inc. recorded  substantial  performance
improvement  in 2002.  Net income  reached  $18.5 million and earnings per share
grew to $1.55,  reflecting  an increase of 36% and 35%,  respectively,  over the
results  achieved  in 2001.  Performance  in 2001 had been  reduced  by  charges
incurred  in  connection  with the  merger of Glen Rock  State  Bank,  which was
combined into Community  Banks at the end of the first quarter of 2001.  Results
for 2002 translated  into a ROA of 1.17% and a ROE of 15.46%,  and represented a
substantial  improvement  over the ROA of 0.97% and ROE of 12.21 %  reported  in
2001.  Performance in 2002  represented a realization  of Community's  strategic
efforts to provide its customers  with expanded  financial  services  within the
framework of a convenient and efficient "community banking" model.


                                       27
<PAGE>
Interest Income

Interest  income  was  $102.5  million  in 2002,  virtually  equal to the $102.4
million  recorded in 2001,  despite the fact that earning asset yields  declined
from 7.81% to 6.89% over the two-year period.  At the same time,  earning assets
grew 13.6%,  from nearly $1.310 billion to $1.487 billion,  and helped to offset
the compression that would normally  accompany lower earning asset yields.  From
2001 to 2002,  earning assets grew $178 million,  including $52 million in loans
and $132 million in portfolio investment securities. This reflected growth rates
of 6.2 % in loans and 29.0% in investments.  During 2002, Community  experienced
11.8% growth in total  deposits,  which  increased by nearly $115  million,  and
clearly  outpaced  the level of demand for  increased  credit  facilities.  This
excess  funding was then  utilized to fund  increases  in the level of portfolio
investments  throughout  the year.  Community  seeks to maintain  an  investment
portfolio  that both  maximizes  return and  provides  an  additional  source of
liquidity as demand for more profitable loan relationships increases.

Interest Expense

Interest  expense on deposits and other funding  sources  declined  dramatically
during 2002 and was the primary  driver of the 12%  improvement  in net interest
income.  While  interest  income was stable during 2002,  Community  achieved an
11.4% reduction in interest expense, even as total deposits increased 11.8 % and
total interest bearing liabilities grew 14.2%. Total interest expense dropped to
$46.2 million, a decline of $5.9 million,  representing  substantial improvement
from the interest  expense of $52.1 million  recorded in 2001.  Deposits grew by
$115 million,  which  included  growth of $ 44 million in core  transaction  and
saving accounts and $71 million in time deposits.  Growth in deposit funding was
attributable  to a number  of  factors,  including  the  safety,  soundness  and
convenience of bank deposit  products as contrasted with the volatility and risk
of loss that has  characterized  other investment and savings  alternatives over
the last several years.

Community also grew its funding from long-term debt, which consists primarily of
collateralized  borrowings  from the  Federal  Home Loan  Bank,  by  almost  $30
million,  or 11% to  selectively  augment  growth  in  the  deposit  categories.
Throughout  2002,  the  steady  decline in  prevailing  interest  rates  allowed
Community to reduce pricing on time deposits. In the fourth quarter of the year,
most banks were forced to reexamine the pricing on more core sources of funds as
rates  declined  to the lowest  levels in  decades.  As a  consequence  of these
trends, the overall cost of funds declined 103 basis points,  from 4.63% in 2001
to 3.60% in 2002.

Net Interest Income

Net interest  income  reached $56.3 million in 2002 compared to $50.2 million in
2001, an increase of $6.0 million or 12%.  Virtually all of the  improvement was
related to the decline in the cost of funding,  which  declined by $5.9 million.
This  improvement was achieved  despite a drop in net interest margin from 3.83%
in 2001 to 3.78% in 2002. As in 2003,  Community benefited from increases in the
absolute volume of earning assets and from its ability to lower funding costs in
declining rate environment.

Provision for Credit Losses

The  provision  for credit  losses  declined  from $5.1  million in 2001 to $3.4
million in 2002,  while the ratio of the allowance for loan losses to loans also
reflected a modest  decline from 1.42% at the end of 2001 to 1.36% at the end of
2002.  When  comparing  asset  quality  trends from 2001 to those  during  2002,
Community  reported  significant  improvements  in the metrics  commonly used to
assess the overall credit quality of the loan portfolio.

Non-interest Income

Income from  non-interest  sources grew to $12.9  million from $10.4 in 2001, an
increase of nearly 24%.  Results in 2002  included  over $500  thousand in gains
from the sale of two branches,  but  improvement  in year over year  performance
still would have reached 20%,  exclusive of these gains.  Community  experienced
growth  in  almost  all  categories  of  non-interest  income.  Income  from the
commissions  earned on sales of mutual  funds and annuity  products  grew 34% as
2002 was the first full year, bank-wide rollout of these product offerings.  The
increase of 14 % in deposit  service  charges was driven by both the increase in
the volume of personal and business accounts and by the continuous evaluation of
the fee structure to ensure that Community is fairly compensated for the cost of
providing these deposit  services.  Other service charges,  commissions and fees


                                       28
<PAGE>

reflect  revenues  received from customers who utilize the various cash exchange
and payment systems that are accessible  through  Community's bank network,  and
grew 39%.  Insurance fees were increased by the fees from the first full year of
operation  of The  Sentinel  Agency.  On the credit  insurance  side,  Community
actually  experienced  a  reduction  in the  fees  earned  through  its  captive
insurance business, which partially offset the increase in title insurance fees.
Revenues from mortgage origination  activities were strong in both 2001 and 2002
due to the favorable effect of low interest rates on both purchase mortgages and
refinancings.

Non-interest Expenses

Non-interest  expenses  grew 8% to $39.3  million in 2002 versus  $36.5 in 2001,
resulting in an increase of $2.7 million in year-over-year expenses. Expenses in
2001 had  included  nearly $2.0  million in  nonrecurring  expenses  incurred in
connection  with the  merger  of Glen  Rock  State  Bank at the end of the first
quarter of 2001. Excluding these charges, non-interest expenses grew nearly $4.7
million and  reflected an increase in core  operating  expenses of 14%. The vast
majority of the increase in recurring  expenses  occurred in salary and benefits
expense,  which grew from $18.5  million  in 2001 to $21.6  million in 2002,  an
increase  of 17%.  Of the  total  increase  from  2001 to  2002,  nearly  4% was
attributed  to the average  2002 salary  increase  of 4%. An  additional  4% was
ascribed to increases in the Corporation's  discretionary  variable compensation
plans,   employee  benefit  plan  contributions,   sales  incentives  and  other
performance-driven  compensation  plans.  The  impact of annual  merit  increase
combined with  performance-driven  compensation accounted for almost one half of
the 17% increase in salary and benefit costs.  The remaining 8% of the total 17%
increase in salary and benefit expenses was driven by several factors, including
the  following:  the full year impact of staffing of offices added in 2001 along
with the partial  year impact of those added in 2002;  the increase in personnel
added in  nontraditional  banking  services,  most notably  those added from the
merger  of The  Sentinel  Agency;  and the  increased  cost of  providing  group
insurance benefits to employees. Occupancy expenses increased $784 thousand and,
like salary and benefit expenses,  were influenced by offices added in both 2001
and 2002.  Other  expense  exhibited a more modest  increase  from 2001 to 2002.
During 2001, Community had incurred incremental costs associated with new branch
openings,  the  acquisition of Glen Rock State Bank and the  convergence of bank
charters.

Income Taxes

Income tax  expense  grew to $3.4  million in 2002,  reflecting  an  increase of
nearly 17% over the income tax of $2.9 million  recorded in 2001.  The effective
tax rate for 2002 was nearly 16% and was comparable to the 17% rate  experienced
in 2001.





APPENDIX A - ADDITIONAL STATISTICAL DISCLOSURE BY BANK HOLDING COMPANIES

The following tables are provided as a supplement to Management's Discussion and
Analysis of Financial Condition and Results of Operation:

Distribution of Assets, Liabilities and Stockholders' Equity; Interest Rates and
Interest Differential

Rate/Volume Analysis - Tax Equivalent Basis

Loan Account Composition as of December 31, 2003, 2002, 2001, 2000, and 1999.

Maturities and Sensitivity to Changes in Interest Rates for Commercial,
Financial, and Agricultural Loans as of December 31, 2003.



                                       29
<PAGE>
<TABLE>
<CAPTION>

 Distribution of Assets, Liabilities and Stockholders' Equity; Interest rates and Interest Differential

 Income and Rates on a Tax Equivalent Basis (b) for the Years Ended December 31, 2003, 2002, and 2001
                             (dollars in thousands)

                                             2003                               2002                             2001
                              -----------------------------------------------------------------------------------------------------
                                                      Average                            Average                          Average
                                           Interest    Rates                  Interest    Rates                 Interest   Rates
                                Average     Income/   Earned/     Average      Income/    Earned/    Average     Income    Earned/
                               Balance(c)  Expense(a)  Paid (a)  Balance(c)    Expense    Paid (a)  Balance(c)  Expense(a) Paid(a)
                              -----------------------------------------------------------------------------------------------------
Assets:
<S>                           <C>           <C>         <C>     <C>            <C>          <C>    <C>            <C>       <C>
   Cash and due from banks    $    36,451                       $    36,982                        $    36,129
                              -----------                       -----------                        -----------
   Earning assets:
      Interest-bearing deposits
       in other banks               1,160   $      9      .78%        1,742    $      26    1.49%        2,126   $    103   4.84%
                              -----------                       -----------                        -----------
      Investment securities:
         Taxable                  466,316     18,607     3.99       384,097       19,602    5.10       300,040     20,075   6.69
         Tax-exempt (b)           207,627     15,957     7.69       200,419       14,955    7.46       152,960     11,034   7.21
                              -----------                       -----------                        -----------
      Total investment
       securities                 673,943                           584,516                            453,000
                              -----------                       -----------                        -----------
      Federal funds sold            4,015         40     1.00        11,126          193    1.73        16,221        800   4.93
                              -----------                       -----------                        -----------
    Loans (b)                   1,001,086     66,604     6.65       889,912       67,712    7.61       838,178     70,339   8.39
                              -----------   --------    -----   -----------    ---------    ----   -----------   --------   ----
       Total earning assets     1,680,204   $101,217     6.02     1,487,296    $ 102,488    6.89     1,309,525   $102,351   7.81
                              -----------   --------    -----   -----------    ---------    ----   -----------   --------   ----
  Allowance for loan losses       (13,016)                          (12,689)                           (11,745)
      Premises, equipment, and
         other assets              76,532                            68,457                             64,612
                              -----------                       -----------                        -----------
         Total assets         $ 1,780,171                       $ 1,580,046                        $ 1,398,521
                              ===========                       ===========                        ===========

Liabilities:
   Demand deposits            $   167,315                       $   163,434                        $   150,218
                              -----------                       -----------                        -----------
   Interest-bearing liabilities:
      Savings deposits            164,207        690      .42       149,066        1,864    1.25        71,346      2,816   3.95
      Money market deposits        74,156        624      .84        82,793        1,289    1.56        85,126      2,582   3.03
      NOW accounts                163,442      2,006     1.23        90,773          998    1.10       135,715      1,422   1.05
      Time deposits
         $100,000 or greater      110,231                           107,523                             77,321
         Other                    498,005                           498,159                            457,196
                              -----------                       -----------                        -----------
      Total time deposits         608,236     19,777     3.25       605,682       24,498    4.04       534,517     28,731   5.38
                              -----------                       -----------                        -----------
      Total interest-bearing
         deposits               1,010,041                           928,314                           826,704
      Short-term borrowings        97,837      1,243     1.27        54,178          977    1.80        12,344        240   1.94
      Long-term debt              355,209     17,989     5.06       302,406       16,586    5.48       286,569     16,349   5.71
                              -----------   --------    -----   -----------    ---------    ----   -----------   --------   ----
         Total interest-bearing
            liabilities         1,463,087   $ 42,329     2.89     1,284,898    $  46,212    3.60     1,125,617   $ 52,140   4.63
                              -----------   --------    -----   -----------    ---------    ----   -----------   --------   ----
   Accrued interest, taxes and
      other liabilities            13,996                            12,362                             11,305
                              -----------                       -----------                        -----------
         Total liabilities      1,644,398                         1,460,694                          1,287,140
   Stockholders' equity           135,773                           119,352                            111,381
                              -----------                       -----------                        -----------
         Total liabilities and
            stockholders'
            equity            $ 1,780,171                       $ 1,580,046                        $ 1,398,521
                              ===========                       ===========                        ===========

Interest income to earning
   assets                                                6.02%                              6.89%                           7.81%
Interest expense to earning
   assets                                                2.52                               3.11                            3.98
                                                        -----                               ----                            ----

      Effective interest
         differential                       $ 58,888     3.50%                 $  56,276    3.78%                $ 50,211   3.83%
                                            ========    =====                  =========    ====                 ========   ====
</TABLE>
(a)  Loan fees are included in interest income and rate calculations.
(b)  Interest income on all tax-exempt securities and loans have been adjusted
     to tax equivalent basis utilizing a Federal tax rate of 35% in 2003, 2002,
     and 2001. Loans includes loans held for sale.
(c)  Averages are a combination of monthly and daily averages.

                                       30
<PAGE>


<TABLE>
<CAPTION>


                  Rate/Volume Analysis-Tax Equivalent Basis (a)
                 For the Years Ended December 31, 2003 and 2002
                             (dollars in thousands)



                                                 --------------------------------------------------------------------
                                                           2003 vs 2002                        2002 vs 2001
                                                 --------------------------------------------------------------------
                                                   Volume      Rate         Total       Volume      Rate       Total
                                                 --------------------------------------------------------------------
                                                                        Favorable (Unfavorable)
<S>                                              <C>         <C>          <C>          <C>         <C>        <C>
Increase (decrease) in interest income:
    Loans                                        $   7,935   $ (9,042)    $ (1,107)    $  4,169    $(6,796)   $(2,627)
    Investment securities:
       Taxable                                       3,734     (4,729)        (995)       4,906     (5,379)      (473)
       Tax exempt                                      545        457        1,002        3,527        394      3,921
                                                 ---------   --------     --------     --------    -------   --------

          Total                                      4,279     (4,272)           7        8,433     (4,985)     3,448
    Federal funds sold                                 (92)       (61)        (153)        (198)      (409)      (607)
    Interest-bearing deposits in other
      banks                                             (7)       (10)         (17)         (16)       (61)       (77)
                                                 ---------   --------     --------     --------    -------   --------
       Total                                        12,115    (13,385)      (1,270)      12,388    (12,251)       137
                                                 ---------   --------     --------     --------    -------   --------


(Increase) decrease in interest expense:
    Savings deposits                                 ( 877)     1,708          831         (645)     3,314      2,669
    Time deposits                                     (102)     4,823        4,721       (3,516)     7,749      4,233
    Short-term borrowings                             (615)       349         (266)        (755)        18       (737)
    Long-term debt                                  (2,731)     1,328       (1,403)        (899)       662       (237)
                                                 ---------   --------     --------     --------    -------   --------
       Total                                        (4,325)     8,208        3,883       (5,815)    11,743      5,928
                                                 ---------   --------     --------     --------    -------   --------


    Increase (decrease) in effective
     interest differential                        $  7,790   $ (5,177)    $  2,613     $  6,573    $  (508)  $  6,065
                                                  ========   ========     ========     ========    =======   ========

</TABLE>




(a) Table shows  approximate  effect on the effective  interest  differential of
volume and rate  changes for the years 2003 and 2002.  The effect of a change in
average volume has been  determined by applying the average yield or rate in the
earlier period to the change in average volume during the period.  The effect of
a change in rate has been  determined  by applying the change in rate during the
period to the average  volume of the prior  period.  Any  resulting  unallocated
amount was allocated ratably between the volume and rate components. Non-accrual
loans have been included in the average volume of each period. Tax-exempt income
is shown on a tax equivalent  basis assuming a federal income tax rate of 35% in
2003, 2002, and 2001.





                                       31
<PAGE>
<TABLE>
<CAPTION>
                            LOAN ACCOUNT COMPOSITION
                             (dollars in thousands)
                                as of December 31
                                -----------------

                                             2003                2002               2001               2000             1999
                                    ------------------------------------------------------------------------------------------------
                                       Amount   Percent    Amount   Percent   Amount    Percent   Amount Percent   Amount   Percent
                                       ------   -------    ------   -------   ------    -------   --------------   ------   -------
<S>                                 <C>           <C>     <C>         <C>    <C>          <C>    <C>       <C>    <C>        <C>
Commercial, financial and
    agricultural                    $   367,444   34.1%   $295,506    32.7%  $158,223     18.4%  $135,612  16.6%  $107,419   15.2%
Real estate-construction                  7,338    0.7       2,615     0.3     21,225      2.5     22,403   2.7     17,003    2.4
Real estate-commercial mortgage         283,662   26.3     246,533    27.2    554,354*    64.7    540,639* 66.4    464,680*  65.6
Real estate-retail mortgage              89,840    8.3     106,882    11.8        ---      0.0        ---   0.0        ---    0.0
Consumer-home equity                     38,298    3.5      28,169     3.1        ---      0.0        ---   0.0        ---    0.0
Consumer-installment and other          292,029   27.1     224,863    24.9    123,476     14.4    116,220  14.3    118,914   16.8
                                    -----------  -----    --------   -----   --------    -----   -------- -----   --------  -----
                                      1,078,611  100.0%    904,568   100.0%   857,278    100.0%   814,874 100.0%   708,016  100.0%
                                                 =====               =====               =====            =====             =====
Less:
    Reserve for loan losses             (13,178)           (12,343)           (12,132)            (10,328)          (8,976)
                                    -----------           --------           --------            --------         --------

                                    $ 1,065,433           $892,225           $845,146            $804,546         $699,040
                                    ===========           ========           ========            ========         ========
</TABLE>
* Prior breakouts of historical  information could not be readily  reconstructed
from  predecessor  banks'  records.  Breakouts  from 1999 to 2001 are assumed to
approximate current mix trends.

The Corporation's loan activity is principally with customers located within its
local market area.  The  Corporation  continues to maintain a  diversified  loan
portfolio and has no  significant  loan  concentration  in any economic  sector.
Commercial,  financial, and agricultural loans consist principally of commercial
lending secured by financial assets of businesses including accounts receivable,
inventories  and  equipment,  and, in most cases,  include liens on real estate.
Real  estate  construction  and  mortgage  loans  are  primarily  1 to 4  family
residential  loans secured by  residential  properties  within the bank's market
area.  Personal-installment loans consist principally of secured loans for items
such as automobiles,  property improvement,  household and other consumer goods.
The Corporation  continues to sell fixed rate mortgages in the secondary  market
to manage interest rate risk. Historically,  relative credit risk of commercial,
financial and  agricultural  loans has generally been greater than that of other
types of loans.

<TABLE>
<CAPTION>
                MATURITIES AND SENSITIVITY TO CHANGES IN INTEREST
                RATES FOR COMMERCIAL, FINANCIAL AND AGRICULTURAL
                       AND REAL-ESTATE CONSTRUCTION LOANS
                             (dollars in thousands)
                             as of December 31, 2003
                             -----------------------

                              Maturity Distribution
                              ---------------------

                                                   One Year          One to          Over Five
                                                   Or Less         Five Years          Years            Total
                                                   -------         ----------          -----            -----
<S>                                              <C>               <C>              <C>              <C>
       Commercial, financial and
            agricultural                         $    68,447       $  125,035       $   173,962      $   367,444
         Real estate-construction                      3,454              241             3,643            7,338
         Real estate-commercial mortgage              40,643           92,697           150,322          283,662
                                                 -----------       ----------       -----------      -----------
                                                 $   112,544       $  217,973       $   327,927      $   658,444
                                                 ===========       ==========       ===========      ===========
</TABLE>
<TABLE>
<CAPTION>
                              Interest Sensitivity
                              --------------------

                                                   Variable           Fixed            Total
                                                   --------           -----            -----

<S>                                              <C>               <C>              <C>
         Due in one year or less                 $    57,010       $   55,534       $   112,544
         Due after one year                          346,142          199,758           545,900
                                                 -----------       ----------       -----------
                                                 $   403,152       $  255,292       $   658,444
                                                 ===========       ==========       ===========
</TABLE>

                                       32
<PAGE>
Item 7A.  Quantitative and Qualitative Disclosures About Market Risk
--------------------------------------------------------------------

A portion of the information related to quantitative and qualitative disclosures
about market risk is included under Management's  Discussion and Analysis (MD&A)
under the heading of  Asset/Liability  Management and Liquidity.  The purpose of
this presentation is to augment the discussion contained in the MD&A.

Market risk is defined as the exposure to economic loss that arises from changes
in the values of certain financial  instruments  pursuant to factors arising out
of the various  categories  of market risk.  Market risk can include a number of
categories,  including interest rate risk, foreign currency risk,  exchange rate
risk, commodity price risk, etc. For domestic,  community-based  banks, the vast
majority of market risk is related to interest rate risk. Financial institutions
use a number of  techniques  to attempt to measure the impact of  interest  rate
risk which includes GAP analysis,  interest rate "shock simulation" and economic
value of equity.  Each of these  techniques is used to help quantify market risk
attributable  to the inherent  sensitivity  of both interest  earning assets and
interest bearing liabilities.

Interest rate  sensitivity  results when the maturity or repricing  intervals of
interest-earning  assets,  interest-bearing  liabilities,  and off-balance sheet
financial  instruments are different,  creating a risk that changes in the level
of market  interest rates will result in  disproportionate  changes in the value
of, and the net earnings  generated  from,  the  Corporation's  interest-earning
assets,   interest-bearing   liabilities,   and   off-balance   sheet  financial
instruments.  The Corporation's exposure to interest rate sensitivity is managed
primarily through the Corporation's strategy of selecting the types and terms of
interest-earning   assets  and   interest-bearing   liabilities  which  generate
favorable earnings,  while limiting the potential negative effects of changes in
market   interest   rates.   Since   the   Corporation's   primary   source   of
interest-bearing  liabilities  is customer  deposits,  its ability to manage the
types and terms of such deposits may be somewhat limited by customer preferences
in the market areas in which it operates. Borrowings, which include Federal Home
Loan Bank (FHLB) advances and short-term  loans,  subordinated  notes, and other
short-term  and long-term  borrowings,  are generally  structured  with specific
terms  which in  management's  judgment,  when  aggregated  with the  terms  for
outstanding  deposits and matched  with  interest-earning  assets,  mitigate the
Corporation's exposure to interest rate sensitivity.

The rates, terms and interest rate indices of the Corporation's interest-earning
assets result  primarily  from its strategy of investing in loans and securities
(a  substantial  portion of which have  adjustable-rate  terms) which permit the
Corporation  to limit its exposure to interest rate  sensitivity,  together with
credit risk,  while at the same time  achieving a positive  interest rate spread
compared to the cost of interest-bearing liabilities.

The following  table  provides a measure of interest rate  sensitivity  for each
category of interest earning assets and interest bearing liabilities at December
31, 2003.

<TABLE>
<CAPTION>
         Interest Rate Sensitivity
         ---------------------------------------------------------------------------------------------------------------------
         At December 31, 2003                  1-90              90-180          180-365           1 year
         Dollars in thousands                  days               days             days            or more            Total
         ---------------------------------------------------------------------------------------------------------------------

<S>                                         <C>               <C>               <C>              <C>              <C>
         Assets
         Federal funds sold                 $    17,097       $       ---       $      ---       $       ---      $     17,097
         Interest-bearing deposits in
            other banks                           3,301               ---              ---               ---             3,301
         Loans held for sale(1)                      97                97              193             3,906             4,293
         Investment securities                  127,390            48,912           48,758           421,901           646,961
         Loans(2)                               366,158            62,793           99,823           549,837         1,078,611
         ---------------------------------------------------------------------------------------------------------------------
         Earning assets                         514,043           111,802          148,774           975,644         1,750,263
         Non-earning assets                       1,775               ---              ---           108,092           109,867
         ---------------------------------------------------------------------------------------------------------------------
         Total Assets                       $   515,818       $   111,802       $  148,774       $ 1,083,736      $  1,860,130
          --------------------------------------------------------------------------------------------------------------------
</TABLE>



                                       33
<PAGE>


<TABLE>
<CAPTION>

<S>                                         <C>               <C>               <C>              <C>              <C>
         Liabilities
         Savings                            $   309,026       $       ---       $      ---       $   147,662      $    456,688
         Time                                    71,610            56,467          136,277           230,464           494,818
         Time in denominations of
            $100,000 or more                     24,791            21,735           33,075            34,404           114,005
         Short-term borrowings                   27,764               ---              ---               ---            27,764
         Long-term debt                          11,785            26,785            3,570           369,282           411,422
         Subordinated debentures                 22,500               ---              ---             7,500            30,000
         ----------------------------------------------------------------------------------------------------------------------
         Interest bearing liabilities           467,476           104,987          172,922           789,312         1,534,697
         Other liabilities and equity               ---               ---              ---           325,433           325,433
         ---------------------------------------------------------------------------------------------------------------------
         Total liability and equity         $   467,476       $   104,987       $  172,922       $ 1,114,745      $  1,860,130
         ---------------------------------------------------------------------------------------------------------------------

         Interest Sensitivity GAP
         Periodic                           $    48,342       $     6,815       $  (24,148)      $   (31,009)
         Cumulative                                                55,157           31,009               ---
         Cumulative GAP as a percentage
           of total assets                        2.60%             2.97%            1.67%                0%
</TABLE>

         (1) Only education loans held for sale are included in earning assets.
         (2) Includes non-accrual loans.


Community seeks to maximize net interest income and minimize earnings volatility
by managing the level of interest rate sensitivity. Interest rate sensitivity is
influenced by the repricing  characteristic  of both assets and  liabilities and
includes the volume of assets and liabilities repricing, the timing of repricing
and the relative magnitude of the repricing.  While GAP measurement  provides an
important tool to quantify the level of interest rate  sensitivity at a specific
point in time,  its utility is  constrained  by the inherent  limitations of GAP
measurement  for a number of  reasons.  First,  changes in the level of interest
rates cannot be expected to affect all assets and  liabilities  equally nor will
they all be impacted at the same time.  Second,  assets and liabilities that are
eligible to be repriced  within a specific time frame may, in fact,  not reprice
or may  not  reprice  to the  same  extent.  Third,  the  measurement  of GAP is
inherently  limited  in that  it  provides  a  representation  of the  repricing
characteristics  of assets and  liabilities  at a  specific  point in time while
actual  sensitivity of assets and  liabilities are undergoing  constant  change.
Finally, much of the presentation of GAP is, by necessity,  based upon estimates
and assumptions for certain assets and liabilities.  For example,  savings,  NOW
accounts,  and other forms of core  deposits do not have defined  maturities  or
repricing dates and therefore require estimates to be made based upon historical
deposit decay rate analysis or other forms of approximation.

Interest rate sensitivity,  and the measurement  thereof, are also influenced by
the optionality of certain earning assets and interest bearing liabilities.  For
example, a substantial  portion of the Corporation's  loans and  mortgage-backed
securities and residential  mortgage loans contain significant embedded options,
which permit the borrower to prepay the  principal  balance of the loan prior to
maturity  ("prepayments") without penalty. A loan's propensity for prepayment is
dependent  upon a number of factors,  including  the current  interest  rate and
interest rate index (if any) of the loan, the financial  ability of the borrower
to refinance, the economic benefit to be obtained from refinancing, availability
of  refinancing  at attractive  terms,  as well as economic and other factors in
specific geographic areas which affect the sales and price levels of residential
property.  In a changing interest rate environment,  prepayments may increase or
decrease on fixed and  adjustable-rate  loans  pursuant to the current  relative
levels and expectations of future short and long-term interest rates.

Investment  securities,  other than  mortgage-backed  securities  and those with
early call provisions  generally do not have  significant  embedded  options and
repay  pursuant to specific  terms until  maturity.  While  savings and checking
deposits  generally may be withdrawn upon the customer's  request  without prior
notice, a continuing  relationship with such customers is generally  predictable
resulting in a  dependable  and  uninterrupted  source of funds.  Time  deposits
generally  have  early  withdrawal  penalties,  while term FHLB  borrowings  and
subordinated  notes  have  prepayment   penalties,   which  discourage  customer
withdrawal of time deposits and prepayment by the Corporation of FHLB borrowings
and subordinated notes prior to maturity.



                                       34
<PAGE>


In  addition   to   periodic   GAP  reports   comparing   the   sensitivity   of
interest-earning assets and interest-bearing  liabilities to changes in interest
rates,  management  also  utilizes a report  which  measures the exposure of the
Corporation's  economic  value of  equity  to  interest  rate  risk.  The  model
calculates  the  present  value of  assets,  liabilities  and  equity at current
interest  rates,  and at  hypothetically  higher and lower interest rates at one
percent  intervals.  The  present  value of each  major  category  of  financial
instruments  is  calculated  by the model  using  estimated  cash flows based on
prepayments,  early withdrawals,  weighted average  contractual rates and terms,
and discount  rates for similar  financial  instruments.  The resulting  present
value of longer term  fixed-rate  financial  instruments  are more  sensitive to
change  in a higher  or lower  interest  rate  scenario,  while  adjustable-rate
financial   instruments   largely   reflect  only  a  change  in  present  value
representing  the difference  between the contractual and discounted rates until
the next  interest  rate  repricing  date.  The  information  provided  by these
analyses provides some indication of the potential for interest rate adjustment,
but does not  necessarily  mean that the rate  adjustment  will occur or that it
will  occur  in  accordance  with  the   assumptions.   Despite  these  inherent
limitations,  Community  believes  that the tools  used to  manage  its level of
interest rate risk provide an appropriate measure of market risk exposure.

The following table reflects the estimated present value of assets,  liabilities
and equity  using the model for  Community  as of  December  31, 2003 at current
interest  rates and  hypothetically,  higher and lower interest rates of one and
two percent.


<TABLE>
<CAPTION>

                                                                                    Base
                                                  -2%              -1%          Present Value         +1%               +2%
                                            ------------------------------------------------------------------------------------
<S>                                         <C>               <C>                <C>             <C>               <C>
      Assets:                                                            (dollars in thousands)
       Cash, interest-bearing time deposits,
           and federal funds sold           $       63,188    $      63,188      $     63,188    $      63,188     $      63,188
       Loans held for sale (1)                       4,480            4,480             4,293            4,112             3,941
       Investment securities                       686,968          665,929           646,961          623,851           602,812
       Loans                                     1,097,279        1,085,786         1,065,433        1,052,653         1,033,591
       Other assets                                 80,255           80,255            80,255           80,255            80,255
                                            --------------    -------------       -----------    -------------     -------------

            Total assets                    $    1,932,170    $   1,899,638      $  1,860,130    $   1,824,059     $   1,783,787
                                            ==============    =============      ============    =============     =============


       Liabilities:
       Deposits                             $    1,252,523    $   1,245,181      $  1,230,685    $   1,229,886     $   1,222,517
       Short-term borrowings                        27,764           27,764            27,764           27,764            27,764
       Long-term debt                              461,533          440,266           411,422          401,565           383,960
       Trust preferred securities                   30,000           30,000            30,000           30,000            30,000
       Other liabilities                            16,853           16,853            16,853           16,853            16,853
                                            --------------    -------------      ------------    -------------     -------------

            Total liabilities                    1,788,673        1,760,064         1,716,724        1,706,068         1,681,094
                                            --------------    -------------      ------------    -------------     -------------

            Total stockholders' equity             143,497          139,574           143,406          117,991           102,692
                                            --------------    -------------      ------------    -------------     -------------
            Total liabilities and
               stockholders' equity         $    1,932,170    $   1,899,638      $  1,860,130    $   1,824,059     $   1,783,786
                                            ==============    =============      ============    =============     =============

</TABLE>

         (1) Only education loans held for sale are included in earning assets.



                                       35
<PAGE>

Item 8.  Financial Statements and Supplementary Data:
-----------------------------------------------------
<TABLE>
<CAPTION>

         Community Banks, Inc. and Subsidiaries
         CONSOLIDATED BALANCE SHEETS
         At December 31, 2003 and 2002
         (Dollars in thousands except per share data)
                                                                       ---------------------------------
                                                                           2003                  2002
                                                                       ---------------------------------
         ASSETS

<S>                                                                    <C>                   <C>
         Cash and due from banks                                       $    42,790           $    36,137
         Federal funds sold                                                 17,097                   ---
                                                                       -----------           -----------
              Cash and cash equivalents                                     59,887                36,137
         Interest-bearing time deposits in other banks                       3,301                   951
         Investment securities, available for sale                         646,961               667,801
         Loans held for sale                                                 6,067                11,483
         Loans                                                           1,078,611               904,568
              Less: Allowance for loan losses                              (13,178)              (12,343)
                                                                       -----------           -----------
                  Net loans                                              1,065,433               892,225
         Premises and equipment, net                                        24,153                24,209
         Goodwill and identifiable intangible assets                         4,773                 1,760
         Accrued interest receivable and other assets                       49,555                45,332
                                                                       -----------           -----------
    Total assets                                                       $ 1,860,130           $ 1,679,898
                                                                       ===========           ===========

         LIABILITIES

         Deposits:
              Non-interest bearing                                     $   165,174           $   168,277
              Interest bearing                                           1,065,511               964,636
                                                                       -----------           -----------
                Total deposits                                           1,230,685             1,132,913
         Short-term borrowings                                              27,764                69,125
         Long-term debt                                                    411,422               320,533
         Trust preferred securities                                         30,000                15,000
         Accrued interest payable and other liabilities                     16,853                13,165
                                                                       -----------           -----------
                Total liabilities                                        1,716,724             1,550,736
                                                                       -----------           -----------

         STOCKHOLDERS' EQUITY

         Preferred stock, no par value;
              500,000 shares authorized;
              no shares issued and outstanding                                 ---                   ---
         Common stock - $5.00 par value; 20,000,000 shares
              authorized;  11,851,000 and 9,410,000 shares
              issued at 2003 and 2002                                       59,256                47,053
         Surplus                                                            57,563                46,418
         Retained earnings                                                  24,297                35,344
         Accumulated other comprehensive income,
              net of tax                                                     6,596                 6,538
         Treasury stock; 203,000 and 258,000 shares
              in 2003 and 2002, at cost                                     (4,306)               (6,191)
                                                                       -----------           -----------
                Total stockholders' equity                                 143,406               129,162
                                                                       -----------           -----------
                Total liabilities and stockholders' equity             $ 1,860,130           $ 1,679,898
                                                                       ===========           ===========
</TABLE>


          The  accompanying  notes  are an  integral  part  of the  consolidated
          financial statements.



                                       36
<PAGE>


<TABLE>
<CAPTION>

Community Banks, Inc. and Subsidiaries
CONSOLIDATED STATEMENTS OF INCOME
For the Years Ended December 31, 2003, 2002, and 2001
(dollars in thousands except per share data)
                                                            ---------------------------------------
                                                               2003           2002           2001
                                                            ---------------------------------------
<S>                                                         <C>            <C>            <C>
INTEREST INCOME:
     Loans, including fees                                  $  65,837      $  67,158      $  69,925
     Investment securities:
         Taxable                                               17,532         18,478         17,750
         Tax exempt                                             8,957          8,457          7,172
         Dividends                                              2,490          2,388          2,325
     Other                                                         49            219            903
                                                            ---------      ---------      ---------
         Total interest income                                 94,865         96,700         98,075
                                                            ---------      ---------      ---------

INTEREST EXPENSE:
     Deposits                                                  23,097         28,649         35,551
     Short-term borrowings                                      1,243            977            240
     Long-term debt                                            17,256         16,560         16,349
     Trust preferred securities                                   733             26            ---
                                                            ---------      ---------      ---------
         Total interest expense                                42,329         46,212         52,140
                                                            ---------      ---------      ---------
         Net interest income                                   52,536         50,488         45,935
Provision for loan losses                                       2,500          3,350          5,080
                                                            ---------      ---------      ---------
         Net interest income after provision for
           loan losses                                         50,036         47,138         40,855
                                                            ---------      ---------      ---------

NON-INTEREST INCOME:
     Investment management and trust services                   1,326            993            740
     Service charges on deposit accounts                        5,128          3,440          3,023
     Other service charges, commissions and fees                2,958          2,471          1,783
     Investment security gains, net                             1,927          1,034          1,704
     Insurance premium income and commissions                   2,822          2,016          1,483
     Mortgage banking activities                                2,532          1,221          1,367
     Other                                                      3,748          2,800          2,041
                                                            ---------      ---------      ---------
         Total non-interest income                             20,441         13,975         12,141
                                                            ---------      ---------      ---------

NON-INTEREST EXPENSES:
     Salaries and employee benefits                            25,397         21,636         18,528
     Net occupancy and equipment                                7,200          6,051          5,267
     Marketing expense                                          2,018          1,090            707
     Telecommunications expense                                 1,302            995            940
     Merger and restructuring related                            ---             ---          1,968
     Other                                                      9,801          9,528          9,111
                                                            ---------      ---------      ---------
         Total non-interest expenses                           45,718         39,300         36,521
                                                            ---------      ---------      ---------

         Income before income taxes                            24,759         21,813         16,475
Income taxes                                                    4,359          3,367          2,879
                                                            ---------      ---------      ---------
         Net income                                         $  20,400      $  18,446      $  13,596
                                                            =========      =========      =========


Basic earnings per share                                    $    1.76      $    1.59      $    1.17
                                                            =========      =========      =========

Diluted earnings per share                                  $    1.71      $    1.55      $    1.15
                                                            =========      =========      =========
</TABLE>

The accompanying notes are an integral part of the consolidated financial
statements.



                                       37
<PAGE>


<TABLE>
<CAPTION>

Community Banks, Inc. and Subsidiaries
CONSOLIDATED STATEMENTS OF CHANGES IN STOCKHOLDERS' EQUITY
For the Years Ended December 31, 2003, 2002, and 2001
(dollars in thousands except per share data)

                                                -----------------------------------------------------------------------
                                                                                  Accumulated
                                                                                     Other                      Total
                                                Common                Retained   Comprehensive  Treasury     Stockholders'
                                                 Stock     Surplus    Earnings   Income (Loss)    Stock         Equity
                                                -----------------------------------------------------------------------

<S>                                             <C>        <C>        <C>          <C>           <C>           <C>
Balance, December 31, 2000                      $42,726    $29,155    $38,723      $  (694)      $(5,932)      $103,978
Comprehensive income:
         Net income                                                    13,596                                    13,596
         Change in unrealized gain (loss) on
           securities, net of reclassification
           adjustment and tax effect                                                (2,408)                      (2,408)
         Change in unfunded pension liability,
           net of tax effect                                                          (922)                        (922)
                                                                                                               --------
     Total comprehensive income                                                                                  10,266
Cash dividends ($.51 per share)                                        (5,880)                                   (5,880)
5% stock dividend  (426,000 shares)               2,130      6,773     (8,903)
Purchase of treasury stock (28,000 shares)                                                          (689)          (689)
Issuance of additional shares (209,000 net
    shares of treasury stock reissued and
    3,000 shares of common stock canceled)          (17)       (22)      (613)                     4,226          3,574
                                                -----------------------------------------------------------------------

Balance, December 31, 2001                       44,839     35,906     36,923       (4,024)       (2,395)       111,249
Comprehensive income:
         Net income                                                    18,446                                    18,446
         Change in unrealized gain (loss) on
           securities, net of reclassification
           adjustment and tax effect                                                11,151                       11,151

         Change in unfunded pension liability,
           net of tax effect                                                          (589)                        (589)
                                                                                                               --------
     Total comprehensive income                                                                                  29,008
Cash dividends ($.57 per share)                                        (6,654)                                   (6,654)
5% stock dividend (440,000 shares)                2,241     10,177    (12,418)
Purchases of treasury stock (224,000 shares)                                                      (5,828)        (5,828)
Issuance of additional shares (93,000 net
   shares of treasury stock reissued and
   5,000 shares of common stock canceled)           (27)       335       (953)                     2,032          1,387
                                                -----------------------------------------------------------------------

Balance, December 31, 2002                       47,053     46,418     35,344        6,538        (6,191)       129,162
Comprehensive income:
         Net income                                                    20,400                                    20,400
         Change in unrealized gain (loss) on
           securities, net of reclassification
           adjustment and tax effect                                                   626                          626
         Change in unfunded pension liability,
           net of tax effect                                                          (568)                        (568)
                                                                                                               --------
Total comprehensive income                                                                                       20,458
Cash dividends ($.66 per share)                                        (7,619)                                   (7,619)
5% stock dividend  (470,000 shares)               2,346     10,612    (12,984)                                      (26)
 Stock split payable in the form of a 20%
stock dividend (1,975,000 shares)                 9,876                (9,876)
Purchases of treasury stock (125,000 shares)                                                      (3,627)        (3,627)
Issuance of additional shares (224,000 net
shares of treasury stock reissued and
4,000 shares of common stock canceled)              (19)       533       (968)                     5,512          5,058
                                                -----------------------------------------------------------------------

Balance, December 31, 2003                      $59,256    $57,563    $24,297      $ 6,596      $ (4,306)      $143,406
                                                =======================================================================
</TABLE>

The  accompanying  notes  are an  integral  part of the  consolidated  financial
statements.



                                       38
<PAGE>


<TABLE>
<CAPTION>

Community Banks, Inc. and Subsidiaries
CONSOLIDATED STATEMENTS OF CASH FLOWS
For the Years Ended December 31, 2003, 2002, and 2001
(in thousands)


                                                                       --------------------------------------------
                                                                         2003              2002              2001
                                                                       --------------------------------------------
<S>                                                                    <C>              <C>               <C>
Operating Activities:
     Net income                                                        $  20,400        $  18,446         $  13,596
     Adjustments to reconcile net income to net
         cash provided by operating activities:
         Provision for loan losses                                         2,500            3,350             5,080
         Deferred income taxes                                              (152)            (192)             (906)
         Depreciation and amortization                                     3,075            2,541             2,127
         Amortization of security premiums and discounts, net              2,431              779             1,960
         Investment security gains, net                                   (1,927)          (1,034)           (1,704)
         Loans originated for sale                                       (66,976)         (66,158)          (94,933)
         Proceeds from sales of loans                                     73,957           66,375            88,540
         Gains on loan sales                                              (1,565)          (1,221)           (1,367)
         Earnings on investment in life insurance                         (1,455)          (1,476)           (1,100)
         Pension curtailment gain                                           (497)             ---               ---
         Change in other assets, net                                       2,480           (5,523)            2,249
         Change in accrued interest payable and other
           liabilities, net                                                3,275             (527)            4,237
                                                                       ---------        ---------         ---------
              Net cash provided by operating activities                   35,546           15,360            17,779
                                                                       ---------        ---------         ---------

Investing Activities:
     Net (increase) decrease in interest-bearing time
       deposits in other banks                                            (2,350)             421             1,196
     Proceeds from sales of investment securities                        165,513          147,610           124,490
     Proceeds from maturities of investment securities                   145,221           83,605           134,308
     Purchases of investment securities                                 (289,398)        (337,706)         (418,685)
     Net increase in total loans                                        (180,725)         (54,094)          (46,343)
     Net additions to premises and equipment                              (2,677)          (4,037)           (3,532)
     Other                                                                (2,717)            (880)             (335)
                                                                       ---------        ---------         ---------
              Net cash used in investing activities                     (167,133)        (165,081)         (208,901)
                                                                       ---------         --------         ---------

Financing Activities:
     Net increase in deposits                                             97,773          129,688            83,984
     Net increase (decrease) in short-term borrowings                    (41,361)           9,123            23,909
     Proceeds from issuance of long-term debt                             98,751           34,767            83,236
     Proceeds from issuance of trust preferred securities                 15,000           15,000               ---
     Repayment of long-term debt                                          (7,862)         (36,389)             (694)
     Cash dividends                                                       (7,645)          (6,654)           (5,880)
     Purchases of treasury stock                                          (3,627)          (5,828)             (689)
     Proceeds from issuance of common stock                                4,308            1,387             3,574
                                                                       ---------        ---------         ---------
              Net cash provided by financing activities                  155,337          141,094           187,440
                                                                       ---------        ---------         ---------
              Increase (decrease) in cash and cash equivalents            23,750           (8,627)           (3,682)

Cash and cash equivalents at beginning of year                            36,137           44,764            48,446
                                                                       ---------        ---------         ---------
Cash and cash equivalents at end of year                               $  59,887        $  36,137         $  44,764
                                                                       =========        =========         =========

Cash paid during the year for:
     Interest                                                          $  42,311        $  46,617         $  52,112
                                                                       =========        =========         =========
     Income taxes                                                      $   4,170        $   4,304         $   3,610
                                                                       =========        =========         =========
</TABLE>

The accompanying notes are an integral part of the consolidated financial
statements.



                                       39
<PAGE>
Community Banks, Inc. and Subsidiaries
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

1.     ORGANIZATION AND BASIS OF PRESENTATION:

Community Banks, Inc.  ("Community" or the "Corporation") is a financial holding
company whose wholly-owned  subsidiaries include Community Banks, Community Bank
Investments,  Inc. (CBII),  Community Banks Life Insurance Company (CBLIC), CMTY
Capital  Trust  I  and  CMTY  Capital   Statutory   Trust  II.  All  significant
intercompany transactions have been eliminated in consolidation. The Corporation
operates through its executive office in Harrisburg,  Pennsylvania,  and through
46 branch  banking  offices  located  in Adams,  Cumberland,  Dauphin,  Luzerne,
Northumberland,  Schuylkill,  Snyder,  and York  Counties in  Pennsylvania,  and
Carroll  County in Maryland.  Community  Banks provides a wide range of services
through its network of offices.  Lending  services include secured and unsecured
commercial  loans,  residential  and  commercial  mortgages and various forms of
consumer lending. Deposit services include a variety of checking,  savings, time
and money market deposits.  The Corporation also provides  specialized  services
through  its  wholly-owned  subsidiaries.  Community  and its  subsidiaries  are
subject to the  regulations  of certain  Federal and state  agencies and undergo
periodic examinations by such regulatory authorities.

2.     SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES:

                                USE OF ESTIMATES:
The preparation of financial statements in accordance with accounting principles
generally  accepted in the United States of America requires  management to make
estimates  and  assumptions  that  affect  the  reported  amounts  of assets and
liabilities  and disclosure of contingent  assets and liabilities at the date of
the financial  statements and reported  amounts of revenues and expenses  during
the reporting  period.  Actual  results could differ from those  estimates.  The
principal  material  estimate that is  particularly  susceptible  to significant
change in the near term relates to the  determination  of the allowance for loan
losses.

                             CASH FLOWS INFORMATION:
Cash and cash  equivalents  include  cash and due from banks and  federal  funds
sold. Noncash transactions included the issuance of $750,000 of common stock for
an acquisition in 2003.

                 SIGNFICANT GROUP CONCENTRATIONS OF CREDIT RISK:
Most of the Corporation's activities are with customers located within Northeast
/ Central  Pennsylvania  and Northern  Maryland.  Note 3 discusses  the types of
securities  in which the  Corporation  invests.  Note 4  discusses  the types of
lending  engaged  in by the  Corporation.  The  Corporation  does  not  have any
significant concentrations to any one industry or customer.

                             INVESTMENT SECURITIES:
The   Corporation    classifies   debt   and   equity   securities   as   either
"held-to-maturity,"  "available-for-sale,"  or "trading."  Investments for which
management  has the intent,  and the  Corporation  has the  ability,  to hold to
maturity are carried at cost adjusted for  amortization of premium and accretion
of discount.  Amortization  and  accretion  are  calculated  principally  on the
interest method. Securities bought and held primarily for the purpose of selling
them in the near term are  classified  as trading  and  reported  at fair value.
Changes in unrealized  gains and losses on trading  securities are recognized in
the Consolidated Statements of Income. At December 31, 2003 and 2002, there were
no securities  identified as held-to-maturity  or trading.  All other securities
are  classified  as  available-for-sale  securities  and reported at fair value.
Changes in unrealized gains and losses on available-for-sale  securities, net of
applicable  taxes, are recorded as a component of stockholders'  equity.  Quoted
market  values,  when  available,  are  used to  determine  the  fair  value  of
available-for-sale  securities.  If quoted market prices are not available, then
fair values are  estimated  using  quoted  prices of  instruments  with  similar
characteristics.

Securities classified as available-for-sale include those investments management
intends to use as part of its  asset/liability  management  strategy  and may be
sold in response to changes in interest  rates,  resultant  prepayment  risk and
other factors. Declines in the fair value of available-for-sale securities below
their cost that are  deemed to be other  than  temporary  are  reflected  in the
Consolidated   Statements   of  Income  as  realized   losses.   In   estimating
other-than-temporary  impairment losses,  management considers independent price
quotations, projected target prices of investment analysts within the short term
and the financial condition of the issuer. Realized gains and losses on the sale
of securities are recognized  using the specific  identification  method and are
included in Non-Interest Income in the Consolidated Statements of Income.

                                       40
<PAGE>
Equity  securities  include  Federal Home Loan Bank (FHLB) stock at December 31,
2003 and 2002 of $21.2 million and $18.9 million, and represent equity interests
in the FHLB. Such  securities,  which are carried at cost, do not have a readily
determinable  fair value because  ownership is  restricted  and can be sold back
only to the  FHLB or to  another  member  institution.  The  FHLB  requires  the
Corporation  to maintain  certain  amounts of FHLB stock based on its balance of
FHLB advances.

                              LOANS HELD FOR SALE:
Loans held for sale, consisting primarily of fixed rate mortgages and education
loans, are valued at the lower of cost or fair value, determined on an aggregate
basis.

                         LOANS AND REVENUE RECOGNITION:
Loans are stated at their principal amount outstanding  adjusted for charge-offs
and certain  origination fees or costs.  Interest income on loans is recorded on
the  interest  method.  Non-accrual  loans  are those on which  the  accrual  of
interest  has ceased and where all  previously  accrued  and unpaid  interest is
reversed.  Loans,  other than consumer loans,  are placed on non-accrual  status
when principal or interest is past due 90 days or more and the collateral may be
inadequate to recover principal and interest, or immediately,  if in the opinion
of management,  full  collection is doubtful.  Generally,  the  uncollateralized
portions of consumer  loans past due 90 days or more are  charged-off.  Interest
accrued but not collected as of the date of placement on  non-accrual  status is
reversed and charged against current income.  Subsequent cash payments  received
are applied either to the outstanding  principal balance or recorded as interest
income, depending upon management's assessment of the ultimate collectibility of
principal and interest. Nonaccrual loans are restored to accrual status when all
delinquent  principal  and  interest  become  current or the loan is  considered
secured and in the  process of  collection.  Delinquency  status is based on the
contractual  terms  of the  loan.  Loan  origination  fees  and  certain  direct
origination  costs  are  being  deferred  and the  net  amount  amortized  as an
adjustment of the yield on the related loan under the interest method, generally
over the contractual life.

                           ALLOWANCE FOR LOAN LOSSES:
The  allowance  for loan losses is  established  as losses are estimated to have
occurred  through a provision for loan losses  charged to earnings.  Loan losses
are charged against the allowance when management believes the  uncollectibility
of a loan balance is confirmed.  Subsequent recoveries,  if any, are credited to
the allowance.

The  allowance  for loan losses is evaluated on a quarterly  basis by management
using a systemic methodology that incorporates  management's judgments about the
credit  quality of the loan  portfolio  through a  disciplined  process  that is
consistently  applied.  Management  considers  all known  relevant  internal and
external  factors  that may affect loan  collectibility,  as well as  particular
risks indigenous to specific types of lending.  The final results of the process
are  reviewed  and  approved by  executive  management.  Results  are  regularly
validated by a review of trends associated with loan volume, delinquencies,  and
other factors that may influence the methodology  used to estimate the allowance
for loan  losses.  This  evaluation  is  inherently  subjective  as it  requires
estimates that are susceptible to significant revision as additional information
becomes  available.  An unallocated  component is maintained in the allowance to
cover uncertainties that could affect management's  estimate of probable losses.
The  unallocated  component of the allowance  reflects the margin of imprecision
inherent in the underlying  assumptions used in the methodologies for estimating
specific and general losses in the portfolio.

A loan is considered  impaired when, based on current information and events, it
is  probable  that the  Corporation  will be unable  to  collect  the  scheduled
payments of principal or interest when due,  according to the contractual  terms
of  the  loan  agreement.   Factors  considered  by  management  in  determining
impairment  include payment  status,  collateral  value,  and the probability of
collecting  scheduled  principal  and  interest  payments  when due.  Loans that
experience insignificant payment delays and payment shortfalls generally are not
classified as impaired. Management determines the significance of payment delays
and payment shortfalls on a case-by-case basis, taking into consideration all of
the circumstances surrounding the loan and the borrower, including the length of
the delay, the reasons for the delay,  the borrower's prior payment record,  and
the amount of the  shortfall in relation to the  principal  and  interest  owed.
Impairment is measured on a loan-by-loan  basis for commercial and  construction
loans over  $250,000 by either the present  value of expected  future cash flows
discounted at the loan's effective  interest rate, the loan's  obtainable market
price, or the fair value of the collateral if the loan is collateral dependent.


                                       41
<PAGE>
Community Banks, Inc. and Subsidiaries
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (Continued):

Large groups of smaller balance homogeneous loans are collectively evaluated for
impairment. Accordingly, the Corporation does not separately identify individual
consumer and residential loans for impairment disclosures.

Loans  continue  to be  classified  as impaired  unless  they are brought  fully
current and the  collection  of scheduled  interest and  principal is considered
probable.  When an impaired loan or portion of an impaired loan is determined to
be  uncollectible,  the  portion  deemed  uncollectible  is charged  against the
related valuation allowance, and subsequent recoveries,  if any, are credited to
the valuation allowance.

                             PREMISES AND EQUIPMENT:
Premises and equipment are stated at cost,  less  accumulated  depreciation  and
amortization.  Depreciation is calculated  using  accelerated and  straight-line
methods  over the  estimated  useful  lives of the  related  assets as  follows:
banking premises, 20 to 40 years,  furniture,  fixtures,  and equipment,  3 to 5
years.  Leasehold  improvements are amortized over the shorter of the lease term
or 20 years.  Long-lived  assets are reviewed for impairment  whenever events or
changes in business  circumstances indicate the carrying value of the assets may
not be recovered.  Maintenance and repairs are expensed as incurred, while major
additions  and  improvements  are  capitalized.  Gain or loss on  retirement  or
disposal of individual  assets is recorded as income or expense in the period of
retirement or disposal.

                  GOODWILL AND IDENTIFIABLE INTANGIBLE ASSETS:
The costs of  acquired  companies  in excess of the fair  value of net assets at
acquisition date is recorded as goodwill.  Through  December 31, 2001,  goodwill
was amortized on a straight-line basis over 15 years. Subsequent to December 31,
2001,  goodwill is not amortized but,  instead,  is tested at least annually for
impairment.  Identifiable  intangible  assets relate to  acquisitions  of branch
offices from other banks and  customer  lists and other  intangibles  related to
acquisitions   of  insurance   agencies  and  mortgage   origination   entities.
Identifiable  intangible assets are amortized over their estimated useful lives.
Goodwill amortization was $289,000 for 2001.  Amortization for other intangibles
was $94,000, $73,000, and $73,000 for 2003, 2002, and 2001, respectively.

                             FORECLOSED REAL ESTATE:
Real estate  acquired  through  foreclosure is initially  carried at fair value,
typically  derived from the current  appraised value of the property at transfer
date less estimated  selling cost. Prior to foreclosure,  the recorded amount of
the loan is written  down,  if  necessary,  to the  appraised  value of the real
estate to be acquired by charging the  allowance  for loan losses.  During 2003,
2002,  and 2001  transfers  from  loans to  foreclosed  real  estate  totaled $5
million, $3.7 million, and $663,000, respectively.

Subsequent  to  foreclosure,  gains or losses  on the sale of and  losses on the
periodic  revaluation of foreclosed real estate are credited or charged to other
expense.  Costs of maintaining and operating foreclosed property are expensed as
incurred.

                                RETIREMENT PLANS:
The  Corporation  has a  noncontributory  defined  benefit pension plan covering
current and former  employees of a  predecessor  bank.  Pension costs are funded
currently  subject to the full funding  limitation  imposed under federal income
tax  regulations.  The defined  benefit  pension plan was amended during 2001 to
discontinue the admittance of any future  participants into the plan. During the
third  quarter  of 2003,  the plan was  amended to  curtail  future  eligibility
services and affected participants will no longer accrue benefits in the future.
Community uses a September 30 measurement date for its plan.

The  Corporation  maintains a 401(k)  savings plan  covering  substantially  all
employees  which  allows  employees to invest a  percentage  of their  earnings,
matched to a certain amount specified by the Corporation. The expense related to
this savings plan was $1.1 million in 2003,  $1.3 million in 2002,  and $938,000
in 2001, and has been included in salaries and benefits expense.



                                       42
<PAGE>
The Corporation maintains  supplemental  retirement plans and life insurance for
selected  executives.  The  supplemental  life  insurance  plans  replaced other
insurance  coverage.  The expense  associated with these plans was approximately
$181,000  for 2003,  $277,000  for 2002,  and  $367,000  for 2001.  The  accrued
liability  was $1.6 million at December  31, 2003,  and $1.5 million at December
31, 2002.  Investment in bank owned life insurance  policies was used to finance
the supplemental benefit plans, and provide a tax-exempt return to Community.

                                  INCOME TAXES:
Deferred  income  taxes  are  accounted  for by the  liability  method,  wherein
deferred tax assets and liabilities  are calculated on the  differences  between
the basis of assets and liabilities for financial  statement purposes versus tax
purposes (temporary  differences) using enacted tax rates in effect for the year
in which the differences are expected to reverse.

                               EARNINGS PER SHARE:
Basic  earnings per share  represents  income  available to common  stockholders
divided by the  weighted-average  number of common shares outstanding during the
period.  Diluted earnings per share reflects additional common shares that would
have been outstanding if dilutive  potential  common shares had been issued,  as
well as any  adjustment  to income that would result from the assumed  issuance.
Potential  common shares that may be issued by the Corporation  relate solely to
outstanding  stock options,  and are determined using the treasury stock method.
All  share  and per share  amounts  are  restated  for  stock  splits  and stock
dividends that occur prior to the issuance of the financial statements.

                            STOCK-BASED COMPENSATION:
At December 31, 2003, the Corporation has a stock-based compensation plan, which
is described more fully in Note 12. The Corporation accounts for this plan under
the recognition and measurement  principle of APB No. 25,  "Accounting for Stock
Issued to Employees," and related  Interpretations.  No stock-based compensation
cost is reflected in net income,  as all options  granted under this plan had an
exercise price equal to the market value of the  underlying  common stock on the
date of grant.  The  following  table  illustrates  the effect on net income and
earnings  per share if the  Corporation  had applied the fair value  recognition
provisions  of FASB No.  123,  "Accounting  for  Stock-Based  Compensation,"  to
stock-based compensation.

<TABLE>
<CAPTION>

                                                                                 Years Ended December 31,
                                                                          (In Thousands, Except Per Share Data)
                                                                     ----------------------------------------------
                                                                         2003             2002              2001
                                                                     ----------------------------------------------
                                                                                     (in thousands)

<S>                                                                  <C>              <C>               <C>
             Net income, as reported                                 $    20,400      $    18,446       $    13,596
             Deduct:  Total stock-based
              compensation expense determined under fair
              value based method for all awards, net of
              related tax effects                                           (822)            (644)             (557)
                                                                     ------------     -----------       -----------

             Pro forma net income                                    $    19,578      $    17,802       $    13,039
                                                                     ===========      ===========       ===========

             Earnings per share:
              Basic-as reported                                      $      1.76      $      1.59       $      1.17
                                                                     ===========      ===========       ===========
              Basic-pro forma                                        $      1.69      $      1.53       $      1.12
                                                                     ===========      ===========       ===========

              Diluted-as reported                                    $      1.71      $      1.55       $      1.15
                                                                     ===========      ===========       ===========
              Diluted-pro forma                                      $      1.64      $      1.50       $      1.10
                                                                     ===========      ===========       ===========

</TABLE>






                                       43
<PAGE>
Community Banks, Inc. and Subsidiaries
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES: (continued)

                              COMPREHENSIVE INCOME:
The  Corporation  reports  comprehensive  income in accordance with Statement of
Financial  Accounting  Standard No. 130, "Reporting  Comprehensive  Income." The
components of other comprehensive income and related tax effects for years ended
December 31 are as follows:

<TABLE>
<CAPTION>
                                                                         2003             2002              2001
                                                                     ---------------------------------------------
                                                                                    (in thousands)
<S>                                                                  <C>              <C>               <C>
             Unrealized holding gains (losses)
                   on available-for-sale securities                  $     2,891      $    18,189       $   (5,409)
             Reclassification adjustments for
                   (gains) included in net income                         (1,927)          (1,034)          (1,704)
                                                                     -----------      -----------       ----------
             Net unrealized gains (losses)                                   964           17,155           (3,705)
             Tax effect                                                     (338)          (6,004)           1,297
                                                                     -----------      -----------       ----------
                  Net-of-tax amount                                          626           11,151           (2,408)
                                                                     -----------      -----------       ----------

             Increase in unfunded pension liability                         (874)            (906)          (1,419)
             Tax effect                                                      306              317              497
                                                                     -----------      -----------       ----------
                  Net-of-tax amount                                         (568)            (589)            (922)
                                                                     -----------      -----------       ----------

                                                                     $        58      $    10,562       $   (3,330)
                                                                     ===========      ===========       ==========
</TABLE>

The components of accumulated other comprehensive income, included in
stockholders' equity, are as follows at December 31:
<TABLE>
<CAPTION>
                                                                         2003             2002
                                                                     ----------------------------
                                                                             (in thousands)
<S>                                                                  <C>              <C>
             Net unrealized gain (loss) on
                  available-for-sale securities                      $    13,347      $    12,381
             Tax effect                                                   (4,672)          (4,332)
                                                                     -----------      -----------
                  Net-of-tax amount                                        8,675            8,049
                                                                     -----------      -----------

             Unfunded pension liability                                   (3,199)          (2,325)
             Tax effect                                                    1,120              814
                                                                     -----------      -----------
                  Net-of-tax amount                                       (2,079)          (1,511)
                                                                     -----------      -----------

               Accumulated other comprehensive income                $     6,596      $     6,538
                                                                     ===========      ===========

</TABLE>


                               SEGMENT REPORTING:
The Corporation has determined its only reportable segment is community banking.
The   Corporation's   non-banking   activities   have  been   determined  to  be
insignificant and do not require separate disclosure.

                         TRANSFERS OF FINANCIAL ASSETS:
Transfers of financial assets are accounted for as sales,  when control over the
assets has been  surrendered.  Control over  transferred  assets is deemed to be
surrendered when (1) the assets have been isolated from the Corporation, (2) the
transferee  obtains the right (free of conditions  that constrain it from taking
advantage of that right) to pledge or exchange the transferred  assets,  and (3)
the Corporation does not maintain  effective control over the transferred assets
through an agreement to repurchase them before their maturity.



                                       44
<PAGE>

                        RECENT ACCOUNTING PRONOUNCEMENTS:
In  January  2003,  the  Financial   Accounting   Standards  Board  issued  FASB
Interpretation No. (FIN) 46,  "Consolidation of Variable Interest  Entities,  an
Interpretation  of ARB No.  51."  FIN 46 was  revised  in  December  2003.  This
interpretation  provides new guidance for the consolidation of variable interest
entities  (VIEs) and requires such entities to be  consolidated by their primary
beneficiaries  if the entities do not  effectively  disperse  risk among parties
involved.  The  interpretation  also adds disclosure  requirements for investors
that are involved with unconsolidated VIEs. The disclosure requirements apply to
all  financial  statements  issued after  December 31, 2003.  The  consolidation
requirements apply to companies that have interests in special-purpose  entities
for periods ended after December 15, 2003.  Consolidation of other types of VIEs
is required in financial statements for periods ending after March 15, 2004.

Community  has  evaluated  the impact of FIN 46 on CMTY Capital Trust I and CMTY
Statutory  Capital Trust II, VIEs  currently  consolidated  by the  Corporation.
Management  has   determined   that  the  provisions  of  FIN  46  will  require
de-consolidation of the trusts,  which issued mandatorily  redeemable  preferred
capital securities to third-party investors. Upon adoption of FIN 46 as of March
31, 2004, the trusts will be de-consolidated and the trust preferred  securities
of the  Corporation  will be  reported  in the  Consolidated  Balance  Sheets as
"Long-Term   Debt"  rather  than  the  trust  preferred   securities  line  item
representing preferred shares in the trusts.  Community's equity interest in the
trusts,  which is not  significant,  will be  reported  in "Other  Assets."  For
regulatory reporting purposes,  the Federal Reserve Board has indicated that the
preferred  securities  will  continue  to qualify  as Tier 1 capital  subject to
previously specified limitations,  until further notice.  Additional information
on the trusts is summarized in Note 8. The adoption of this  interpretation  did
not have and is not expected to have a material impact on results of operations,
financial position, or liquidity.

SFAS No. 149, "Amendment of Statement 133 on Derivative  Instruments and Hedging
Activities,"  was issued in April 2003. SFAS 149 amends and clarifies  financial
accounting  and  reporting  for  derivatives   instruments,   including  certain
derivative instruments embedded in other contracts  (collectively referred to as
"derivatives")  and for  hedging  activities  under  SFAS 133,  "Accounting  for
Derivative  Instruments  and Hedging  Activities."  SFAS 149 was  effective  for
contracts  entered into or modified  after June 30,  2003.  The adoption of this
standard  did not have a material  impact on results  of  operations,  financial
position, or liquidity.

SFAS No. 150, "Accounting for Certain Financial Instruments with Characteristics
of Both  Liabilities and Equity," was issued in May 2003. SFAS 150 requires that
an  issuer  classify  a  financial  instrument  that is  within  its  scope as a
liability.  Many of these instruments were previously classified as equity. SFAS
150 was effective for financial  instruments  entered into or modified after May
31, 2003 and  otherwise was effective  beginning  July 1, 2003.  The adoption of
this  standard  did not have any  impact on  results  of  operations,  financial
position, or liquidity.

                               RECLASSIFICATIONS:

Certain amounts  reported in prior years have been  reclassified to conform with
the 2003 presentation.  These reclassifications did not impact the Corporation's
financial condition or results of operations.



                                       45
<PAGE>
Community Banks, Inc. and Subsidiaries
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

3.    INVESTMENT SECURITIES:

The amortized cost and fair value of investment securities at December 31, 2003
and 2002 are as follows:

<TABLE>
<CAPTION>
                                                            2003                                         2002
                                         -----------------------------------------------------------------------------------------
                                                     Gross        Gross                             Gross     Gross
                                         Amortized Unrealized  Unrealized     Fair    Amortized  Unrealized Unrealized      Fair
                                           Cost      Gains       Losses      Value       Cost       Gains     Losses       Value
                                         -----------------------------------------------------------------------------------------
                                                                              (in thousands)
<S>                                      <C>        <C>         <C>        <C>        <C>         <C>        <C>         <C>
U.S. Treasury and federal agencies       $ 173,651  $  1,923    $ (2,282)  $ 173,292  $ 130,947   $  3,391   $     (4)   $ 134,334
Mortgage-backed U.S. government agencies   121,853     1,817        (275)    123,395    206,450      4,375        ---      210,825
Obligations of states and political
  subdivisions                             177,546     7,217        (282)    184,481    172,391      5,252       (508)     177,135
Corporate securities                        95,461     3,283        (757)     97,987     95,022      2,003     (3,931)      93,094
Equity securities                           65,070     2,961        (225)     67,806     50,610      1,858        (55)      52,413
                                         ---------  --------    --------    --------  ---------    -------   --------    ---------

       Total                             $ 633,581  $ 17,201    $ (3,821)  $ 646,961  $ 655,420   $ 16,879   $ (4,498)   $ 667,801
                                         =========  ========    ========   =========  =========   ========   ========    =========
</TABLE>

The following table shows gross unrealized losses and fair value, aggregated by
investment category and length of time that individual securities have been in a
continuous unrealized loss position, at December 31, 2003.
<TABLE>

                                                  Less Than 12 Months         12 Months or More                   Total
                                                 -------------------------------------------------------------------------------
                                                             Unrealized                  Unrealized                    Unrealized
                                                 Fair Value    Losses       Fair Value     Losses        Fair Value      Losses
                                                 -------------------------------------------------------------------------------
<S>                                              <C>          <C>           <C>           <C>            <C>           <C>
U.S. Treasury and federal agencies               $  79,564    $ (2,282)     $     ---     $    ---       $   79,564    $ (2,282)
Mortgage-backed U.S. government agencies            44,710        (275)           ---          ---           44,710        (275)
Obligations of states and political subdivisions    15,580        (256)         1,256          (26)          16,836        (282)
Corporate securities                                 1,245          (5)        19,691         (752)          20,936        (757)
                                                 ---------    --------      ---------     --------       ----------    ---------
       Subtotal of debt securities                 141,099      (2,818)        20,947         (778)         162,046      (3,596)
Equity securities                                      ---         ---          1,275         (225)           1,275        (225)
                                                 ---------    --------      ---------     --------       ----------    ---------
       Total temporarily impaired securities      $141,099     $(2,818)     $  22,222      $(1,003)      $  163,321    $ (3,821)
                                                 =========    ========      =========     ========       ==========    =========
</TABLE>

The above table represents 67 investment securities where the current fair value
is less than the related amortized cost. Management believes that the unrealized
losses  reflect  changes in interest  rates  subsequent  to the  acquisition  of
specific  securities  and  do  not  reflect  any  deterioration  of  the  credit
worthiness of the issuing  entities.  Generally,  securities  with an unrealized
loss are debt  securities  of  investment  grade.  Therefore  the  bonds  have a
maturity  date and are  generally  expected  to  pay-off  at par,  substantially
eliminating any market value losses at that time.

The amortized cost and fair value of all  investment  securities at December 31,
2003, by contractual maturity,  are shown below. Expected maturities will differ
from contractual maturities because obligors may have the right to call or repay
obligations with or without call or prepayment penalties.

<TABLE>
<CAPTION>
                                                                          Amortized              Fair
                                                                             Cost                Value
                                                                         -------------------------------
                                                                                  (in thousands)
<S>                                                                      <C>                  <C>
                      Due in one year or less                            $    23,416          $   23,472
                      Due after one year through five years                   41,923              43,445
                      Due after five years through ten years                 159,135             161,407
                      Due after ten years                                    222,184              227,436
                                                                         -----------          -----------
                                                                             446,658             455,760
                      Mortgage-backed securities                             121,853             123,395
                      Equity securities                                       65,070              67,806
                                                                         -----------          ----------
                                                                         $   633,581          $  646,961
                                                                         ===========          ==========
</TABLE>

Gross  investment  security  gains and  losses  of $2.8  million  and  $907,000,
respectively were recognized in 2003. Gross gains and losses of $1.9 million and
$865,000,  respectively, were recognized in 2002. Gross gains and losses of $2.1
million and $360,000,  respectively  were  recognized in 2001. The tax provision
applicable to these net realized gains amounted to $674,000 in 2003, $362,000 in
2002 and $596,000 in 2001.

At December 31, 2003 and 2002,  investment  securities with carrying  amounts of
approximately $296.3 million and $222.2 million,  respectively,  were pledged to
collateralize public deposits and for other purposes as provided by law.

                                       46
<PAGE>
4.   LOANS AND ALLOWANCE FOR LOAN LOSSES:

The composition of loans outstanding by lending classification as of December 31
is as follows (in thousands):
<TABLE>
<CAPTION>
                                                               2003             2002
                                                          ----------------------------
<S>                                                        <C>              <C>
              Commercial                                   $   367,444      $  295,506
              Real estate - construction                         7,338           2,615
              Real estate - mortgage:
                 Residential                                    89,840         106,882
                 Commercial                                    283,662         246,533
              Consumer                                         330,327         253,032
                                                           -----------      ----------
                                                           $ 1,078,611      $  904,568
                                                           ===========      ==========
</TABLE>

Changes in the allowance for loan losses for years ended December 31 are as
follows (in thousands):
<TABLE>
<CAPTION>
                                                                2003            2002           2001
                                                             ----------------------------------------
<S>                                                          <C>             <C>             <C>
              Balance, January 1                             $  12,343       $  12,132       $ 10,328
              Provision for loan losses                          2,500           3,350          5,080
              Loan charge-offs                                  (2,839)         (4,180)        (3,776)
              Recoveries                                         1,174           1,041            500
                                                             ---------       ---------       --------
              Balance, December 31                           $  13,178       $  12,343       $ 12,132
                                                             =========       =========       ========
</TABLE>

The following table summarizes risk elements as of December 31 (in thousands):
<TABLE>
<CAPTION>
                                                                2003            2002
                                                              ------------------------
 <S>                                                          <C>             <C>
              Loans on which accrual of interest has
                  been discontinued                          $   8,151       $   9,393
              Foreclosed real estate                             4,865           1,183
                                                             ---------       ---------

              Total non-performing assets                       13,016          10,576

              Loans past due 90 days or more and
                  still accruing interest                           90             961
                                                             ---------       ---------

                  Total risk elements                        $  13,106       $  11,537
                                                             =========       =========
</TABLE>

The following is a summary of information pertaining to impaired loans as of
December 31 (in thousands):
<TABLE>
<CAPTION>
                                                                                2003             2002
                                                                             --------------------------
<S>                                                                          <C>              <C>
              Impaired loans without a valuation allowance                   $   3,644        $   5,894
              Impaired loans with a valuation allowance                          2,112            1,100
                                                                             ---------        ---------
              Total impaired loans                                           $   5,756        $   6,994
                                                                             =========        =========

              Valuation allowance related to impaired loans                  $     546        $     326
                                                                             =========        =========
</TABLE>

              Impaired  loans  are included in nonaccrual  loans.  For the years
              ended  December 31,  2003,  2002 and 2001,  the  average  recorded
              investment  in impaired  loans  approximated  $7.8  million,  $6.6
              million,  and $7.3 million.  Interest recognized on impaired loans
              on  the cash basis for the years ending  December 31, 2003,  2002,
              and 2001 was not significant.

Certain  directors  and their  business  affiliates  (defined as the  beneficial
ownership  of at least a 10  percent  interest),  executive  officers  and their
families are indebted to Community  Banks for loans made in the ordinary  course
of business. In the opinion of management,  such loans are consistent with sound
banking practices and are within applicable regulatory lending limitations.  The
aggregate  dollar  amount of these loans was $14.3  million and $13.3 million at
December 31, 2003 and 2002.  During 2003, $7.4 million of new advances were made
and repayments totaled $6.4 million.

                                       47
<PAGE>
Community Banks, Inc. and Subsidiaries
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

5. PREMISES AND EQUIPMENT:

Premises and equipment are comprised of the following as of December 31:
<TABLE>
<CAPTION>
                                                                     ------------------------
                                                                       2003            2002
                                                                     ------------------------
                                                                         (in thousands)

<S>                                                                  <C>             <C>
                     Banking premises                                $ 25,279        $ 23,224
                     Furniture, fixtures, and equipment                20,310          19,993
                     Leasehold improvements                             1,793           1,485
                     Construction-in-progress                             279           1,813
                                                                     --------        --------
                                                                       47,661          46,515
                     Less accumulated depreciation
                        and amortization                              (23,508)        (22,306)
                                                                     --------        --------

                                                                     $ 24,153        $ 24,209
                                                                     ========        ========
</TABLE>


Depreciation and amortization  expense related to premises and equipment charged
to operations  amounted to approximately  $3.0 million,  $2.5 million,  and $2.1
million in 2003, 2002, and 2001, respectively.

Certain branch offices and equipment are leased under agreements which expire at
varying  dates  through  2024.  Most leases  contain  renewal  provisions at the
Corporation's  option.  Total rental expense was  approximately  $1.1 million in
2003,  $853,000 in 2002 and  $865,000  in 2001.  Future  minimum  payments as of
December  31,  2003 under  noncancelable  operating  leases  are as follows  (in
thousands):


                     2004                                        $      1,117
                     2005                                               1,015
                     2006                                                 857
                     2007                                                 694
                     2008                                                 534
                     Thereafter                                         5,878
                                                                 ------------

                                                                 $     10,095
                                                                 ============



                                       48
<PAGE>

6.  DEPOSITS

Deposits consisted of the following as of December 31:

<TABLE>
<CAPTION>
                                                                 -------------------------------
                                                                     2003               2002
                                                                 -------------------------------
                                                                         (in thousands)

<S>                                                              <C>                <C>
                  Non-interest bearing deposits                  $    165,174       $    168,277
                  Savings deposits                                    162,908            153,679
                  Money market deposits                                72,778             78,508
                  NOW accounts                                        221,002            113,411
                  Time deposits                                       608,823            619,038
                                                                 ------------       ------------

                  Total                                          $  1,230,685       $  1,132,913
                                                                 ============       ============
</TABLE>


The aggregate amount of time deposits with minimum  denominations of $100,000 or
more  totaled  approximately  $114 million and $112 million at December 31, 2003
and 2002.


At December 31, 2003  scheduled  maturities of time deposits were as follows (in
thousands):
<TABLE>
<CAPTION>

<S>                                                                                 <C>
                  2004                                                              $    341,538
                  2005                                                                   121,998
                  2006                                                                    49,429
                  2007                                                                    67,176
                  2008                                                                    27,366
                  Thereafter                                                               1,316
                                                                                    ------------

                                                                                    $    608,823
                                                                                    ============
</TABLE>



                                       49
<PAGE>

Community Banks, Inc. and Subsidiaries
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

7.  SHORT-TERM BORROWINGS AND LONG-TERM DEBT:

Short-term borrowings consist of the following as of December 31:
<TABLE>
<CAPTION>
                                                                        -------------------------------------------
                                                                          2003       Rate        2002         Rate
                                                                        -------------------------------------------
                                                                                  (dollars in thousands)

<S>                                                                     <C>          <C>       <C>            <C>
         Securities sold under agreements to repurchase                 $ 23,732     0.75%     $ 31,694       1.73%
         Treasury tax and loan note                                        2,032     0.76%        1,891       1.02%
         Other                                                             2,000     2.42%          ---        ---
         FHLB borrowings                                                     ---      ---        35,540       1.31%
                                                                        --------               --------
                                                                        $ 27,764               $ 69,125
                                                                        ========               ========
</TABLE>

The maximum short-term FHLB borrowings  outstanding at any month-end during 2003
and 2002 was $139.3 million and $35.5 million;  the average amounts  outstanding
during the year were $73.1 million and $16.2 million;  and the weighted  average
interest rate during the year approximated 1.35% and 1.82%.

  At December 31, 2003, additional amounts available for borrowing under these
arrangements totaled approximately $50.0 million.

  Long-term debt consists of the following as of December 31:
<TABLE>
<CAPTION>
                                                                                                  -------------------------
                                                                                                     2003            2002
                                                                                                  -------------------------
                                                                                                        (in thousands)
<S>                                                                                                <C>            <C>
     Outstanding  advances from the FHLB of Pittsburgh are currently  fixed rate
and mature from 2004 to 2016.  The  advances are  collateralized  by FHLB stock,
certain first mortgage loans and both agency and mortgage-backed securities. The
advance rates range from 1.14% to 6.66%,  with a weighted  average interest rate
of 4.44%. Advances totaling $289.5 million are convertible  advances.  Under the
terms of these arrangements, the FHLB retains the option to convert the advances
from  fixed  to  variable  rate.  If the FHLB  were to  convert  their  options,
Community  has the ability to prepay the advances at no penalty.  At the current
time no advances  have been  converted,  and remain at a fixed rate of interest.
Additional amounts available for borrowing at the FHLB totaled $87.7 million and
$123.2 million at December 31, 2003 and 2002, respectively.                                       $ 411,117       $ 320,222

     Other long-term debt has an interest rate of 4% and matures in 2017.                               305             311
                                                                                                  ---------       ---------
                                                                                                  $ 411,422       $ 320,533
                                                                                                  =========       =========
</TABLE>


              Maturities on long-term debt at December 31, 2003 are as follows
(in thousands):

                     2004                                 $       42,140
                     2005                                         42,140
                     2006                                         27,140
                     2007                                          6,886
                     2008                                         60,754
                     Thereafter                                  232,362
                                                          --------------
                                                          $      411,422
                                                          ==============



                                       50
<PAGE>

8.  TRUST PREFERRED SECURITIES:

In December  2002,  the  Corporation  issued $15 million of floating rate junior
subordinated deferrable interest debentures to CMTY Capital Trust I (the Trust),
a  Delaware  Business  Trust,  in which the  Corporation  owns all of the common
equity.  The  debentures  are the sole asset of the Trust.  The Trust issued $15
million  of  preferred  securities  to  a  single  investor.  The  Corporation's
obligations  under  the  debentures  and  related  documents,   taken  together,
constitute a full and unconditional  guarantee by the Corporation of the Trust's
obligations  under  the  preferred  securities.  The  junior  subordinated  debt
securities  pay  interest  quarterly  at 3 month  LIBOR + 3.35%.  The  preferred
securities are redeemable by the Corporation on or after January 7, 2008 at 100%
of principal plus accrued  interest.  The preferred  securities must be redeemed
upon  maturity  of the  debentures  on January 7, 2033.  All $15  million of the
debentures currently qualify as Tier 1 capital for regulatory purposes.

In December  2003,  the  Corporation  issued $15 million of floating rate junior
subordinated  deferrable  interest debentures to CMTY Statutory Capital Trust II
(the Trust II), a Connecticut  Business Trust, in which the Corporation owns all
of the common equity.  The debentures are the sole asset of the Trust. The Trust
issued $15 million of preferred securities to a single accredited investor.  The
Corporation's  obligations  under the  debentures and related  documents,  taken
together,  constitute a full and  unconditional  guarantee by the Corporation of
the Trust's obligations under the preferred securities.  The junior subordinated
debt securities pay interest  quarterly at 3 month LIBOR + 2.84%.  The preferred
securities  are  redeemable by the  Corporation on or after December 16, 2008 at
100% of principal  plus  accrued  interest.  The  preferred  securities  must be
redeemed upon maturity of the  debentures on December 16, 2033.  All $15 million
of the debentures currently qualify as Tier 1 capital for regulatory purposes.



9.  PENSION PLAN:

Community   maintains  a  defined  benefit  pension  plan  for  employees  of  a
predecessor  bank. As of September 30, 2003,  this plan covered less than 25% of
the aggregate employee base.  Effective at the end of the third quarter of 2003,
the Board of Directors of Community  approved a curtailment of this pension plan
and,  in  connection  therewith,  recorded  a gain of  $497,000  related  to the
recognition  of a  previously  unrecognized  prior  service  benefit,  which was
recorded as other income.  In addition,  the Corporation also recorded  periodic
pension expense of $280,000 for 2003. The  determination  of pension expense for
each of the last three years is provided as follows:
<TABLE>
<CAPTION>
         ----------------------------------------------------------------------------------------------------------------
         (dollars in thousands)                                                 2003              2002             2001
         ----------------------------------------------------------------------------------------------------------------
<S>                                                                          <C>               <C>              <C>
         Components of net periodic benefit cost:
              Service cost benefit earned during year                        $     115         $     107        $     130
              Interest cost on projected benefit obligation                        428               401              373
              Actual return on plan assets                                        (549)             (453)            (477)
              Net amortization and deferral:
                Net transition asset                                             ---                  (4)              (9)
                Prior service benefit                                             (103)             (103)            (110)
                Net loss                                                           239               156              130
                Gain deferred                                                      150               ---              ---
                                                                             ---------         ---------        ---------
         Pension cost                                                        $     280         $     104        $      37
                                                                             =========         =========        =========

         Increase in minimum liability included in other
         comprehensive income                                                $     874         $     906        $   1,419
                                                                             =========         =========        =========

</TABLE>



                                       51
<PAGE>



Community Banks, Inc. and Subsidiaries
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

9. PENSION PLAN - (Continued):

The following table sets forth the pension plan's funded status at September 30,
2003 and 2002:
<TABLE>
<CAPTION>
         -----------------------------------------------------------------------------------------------
         (dollars in thousands)                                                2003               2002
         -----------------------------------------------------------------------------------------------
<S>                                                                          <C>               <C>
         Obligations and funded status:
         Change in benefit obligation:
           Projected benefit obligation, beginning of year                   $   6,238         $   5,842
              Service cost                                                         115               107
              Interest cost                                                        428               401
              Benefits paid                                                       (314)             (269)
              Change in assumptions                                                662                93
              Experience loss                                                      156                64
              Curtailment                                                         (478)              ---
                                                                             ---------         ---------
           Projected benefit obligation, end of year                         $   6,807         $   6,238
                                                                             =========         =========
           Change in plan assets:
           Fair value of plan assets, beginning of year                      $   4,511         $   5,083
              Actual return on plan assets                                         549              (454)
              Employer contributions                                               158               151
              Benefits paid                                                       (314)             (269)
                                                                             ---------         ---------
           Fair value of plan assets, end of year                            $   4,904         $   4,511
                                                                             =========         =========

           Funded status, end of year                                        $  (1,903)        $  (1,727)
           Unrecognized prior service benefit                                      ---              (600)
           Unrecognized net cost                                                 3,199             3,248
           Recognition of additional minimum liability                          (3,199)           (2,325)
                                                                             ---------         ---------
         Accrued pension liability                                           $  (1,903)        $  (1,404)
                                                                             =========         =========

         Amounts recognized in the consolidated balance sheet
         consist of:
           Prepaid benefit cost                                              $   1,296         $     921
           Accumulated other comprehensive income adjustment                    (3,199)           (2,325)
                                                                             ---------         ---------
         Net accrued pension liability                                       $  (1,903)        $  (1,404)
                                                                             =========         =========

         The accumulated benefit obligation for the pension plan was $6.8 million and $5.9 million at December 31, 2003 and 2002.
</TABLE>

Assumptions  used in the  determination  of the  funded  status  of the  plan at
December 31, 2003 and 2002 and pension  expense for each of the last three years
were as follows:
<TABLE>
<CAPTION>

                                                                                 2003               2002             2001
                                                                             --------------------------------------------
<S>                                                                              <C>                <C>              <C>
           Discount rate                                                         6.25%              7.0%             7.0%
           Expected long-term return on plan assets                               9.0%              9.0%             9.0%
           Rate of compensation increase                                          4.0%              4.0%             4.0%
</TABLE>

Community  maintains a pension investment policy which addresses the assumptions
required for the various  aspects of plan management and plan  accounting.  Such
policy has been designed to be responsive to changing  conditions  affecting its
pension plan,  including overall  investment style,  targeted annual returns and
asset allocation.  Plan assumptions are determined by management pursuant to the
guidance  provided by the investment  policy and through  consultation with plan
actuaries.


                                       52
<PAGE>



Targeted  allocations  of plan assets have been  developed as a component of the
investment  policy and are responsive to the investment  goals,  risk management
practices and the relationship between plan assets and benefit obligations.  The
current  investment  style favors an emphasis on growth given that a substantial
portion of the benefited  employees are not  receiving  pension  benefits at the
current time.  During the last three years,  the  performance of plan assets has
given rise to an  increase in the  minimum  liability,  which is included in the
financial  statements  as  a  component  of  other  comprehensive   income.  The
development  of a targeted  allocation  of plan  assets has  facilitated  a more
disciplined investment approach that seeks to more closely coordinate investment
goals with benefit obligations.  Pursuant to that policy, the following targeted
allocations,   including  an  acceptable  range  of  allocations  under  varying
conditions,  and  actual  asset  allocations  at the end of each of the last two
years are provided.
<TABLE>
<CAPTION>

                                                           Target                             At December 31,
                                                            Asset                            -----------------
                                                         Allocation          Range           2003         2002
                                                         ----------          -----           -----------------
<S>                                                          <C>             <C>              <C>          <C>
                      Equity                                 60%             50-70%           64%          41%
                      Fixed income                           35%             25-45%           28%          38%
                      Cash and/or equivalents                 5%              2-10%            8%          21%
                                                           ----

                                                            100%
                                                           ====
</TABLE>

The expected  long-term  rate of return on plan assets is based upon  historical
returns of  specified  benchmark  investment  categories  that are  weighted  by
targeted  allocations  of plan assets.  Such returns are then compared to actual
returns achieved during the most recent ten and fifteen year periods in order to
ascertain the  reasonableness  of the assumptions  utilized for the current plan
year.  The  following  presentation  provides an  indication  of targeted  asset
allocation, which is specified within the investment policy, and a comparison to
historical annualized returns that provide support for the assumed expected long
term rate of return on plan assets.
<TABLE>
<CAPTION>

                                  Targeted                                          10yrs (12/31/03)     15yrs (12/31/03)
                                    Asset                                              Annualized           Annualized
                                  Allocation            Benchmarks                       Returns             Returns
                                  ----------            ----------                       -------             -------
<S>                                   <C>                                                 <C>                 <C>
         Equities                     60%            S&P 500                              11.06%              12.21%
         Fixed income                 35%            Lehman Bros Aggregate                 6.95%               8.37%
         Cash equivalents              5%            3 mo T-Bill                           4.33%               4.81%
                                    -----                                                ------               -----

         Total pension               100%                                                  9.29%              10.50%
                                    =====                                                ======               =====

</TABLE>

The plan currently  maintains no investment in the common stock of Community and
contributions  to the plan during 2004 are  currently  estimated to be $889,000.
The Corporation  anticipates no adverse funding issues associated with the plan.
The  curtailment  of the plan is expected to limit  future  increases in pension
expense as eligible  employees are no longer accruing  benefits  associated with
future service.


                                       53
<PAGE>

Community Banks, Inc. and Subsidiaries
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

10.   EARNINGS PER SHARE:

The following table sets forth the calculation of Basic and Diluted Earnings Per
Share for the years ended below.
<TABLE>
<CAPTION>

                                                     2003                          2002                          2001
                                      -------------------------------------------------------------------------------------------
                                                            Per-Share                       Per-Share                   Per-Share
                                       Income       Shares   Amount    Income     Shares     Amount   Income    Shares    Amount
                                       ------       ------   ------    ------     ------     ------   ------    ------    ------
                                                                 (in thousands except  per share data)
Basic EPS:
<S>                                   <C>           <C>      <C>       <C>        <C>        <C>      <C>       <C>       <C>
  Income available to common
     stockholders                     $ 20,400      11,561   $ 1.76    $18,446    11,624     $1.59    $13,596   11,634    $1.17
                                      ========               ======    =======               =====    =======             =====

Effect of Dilutive Securities:

  Incentive stock options
     outstanding                                       341                           272                           235
                                                    ------                        ------                        ------

Diluted EPS:

  Income available to common
     stockholders and assumed
     conversion                       $ 20,400      11,902   $ 1.71    $18,446    11,896     $1.55    $13,596   11,869    $1.15
                                      ========      ======   ======    =======    ======     =====    =======   ======    =====
</TABLE>

Per share and share data have been adjusted to reflect a 5% stock  dividend paid
to  shareholders  of record April 16, 2003,  and a stock split to be paid in the
form of a 20% stock  dividend  to  shareholders  of  record  January  16,  2004.
Antidilutive options excluded from the above earnings per share calculations for
2003, 2002 and 2001 were not significant.


                                       54
<PAGE>

11.   INCOME TAXES:

The provision for income taxes for the years ended December 31 consists of the
following:
<TABLE>
<CAPTION>

                                                                              ---------------------------------------
                                                                                2003           2002            2001
                                                                              ---------------------------------------
                                                                                          (in thousands)

<S>                                                                           <C>            <C>             <C>
              Current                                                         $  4,511       $  3,559        $  3,785
              Deferred                                                            (152)          (192)           (906)
                                                                              --------       --------        --------
                                                                              $  4,359       $  3,367        $  2,879
                                                                              ========       ========        ========
</TABLE>

A reconciliation of income tax expense and the amounts which would have been
recorded based upon statutory rates (35%) is as follows:
<TABLE>
<CAPTION>
                                                                              ---------------------------------------
                                                                                2003           2002            2001
                                                                              ---------------------------------------
                                                                                          (in thousands)

<S>                                                                           <C>            <C>             <C>
              Provision on pre-tax income at statutory rate                   $  8,666       $  7,635        $  5,766
              Tax-exempt interest income                                        (3,284)        (2,939)         (2,379)
              Earnings on investment in insurance                                 (473)          (481)           (364)

              Other, net                                                          (550)          (848)           (144)
                                                                              --------       --------        --------

              Total provision for income taxes                                $  4,359       $  3,367        $  2,879
                                                                              ========       ========        ========
</TABLE>


The components of the net deferred tax asset as of December 31, were as follows:
<TABLE>
<CAPTION>
                                                                              -----------------------
                                                                                2003           2002
                                                                              -----------------------
                                                                                   (in thousands)
<S>                                                                           <C>            <C>
              Deferred tax assets:
                  Allowance for loan losses                                   $  4,542       $  4,197
                  Non-accrual loan interest income                                 230            235
                  Unfunded pension adjustment                                    1,120            814
                  Deferred loan fees                                               211            240
                  Deferred compensation                                            586            539
                  Alternative minimum tax                                          250            ---
                  Other                                                             35             74
                                                                              --------       --------
                      Total deferred tax assets                                  6,974          6,099
                                                                              --------       --------

              Deferred tax liabilities:
                  Depreciation                                                $  1,053       $    934
                  Unrealized gain on available for sale securities               4,672          4,332
                  Pension expense                                                  647            351
                  Life insurance company reserves                                  404            410
                  Other                                                             28             20
                                                                              --------       --------
                      Total deferred tax liabilities                             6,804          6,047
                                                                              --------       --------

                      Net deferred tax asset                                  $    170       $     52
                                                                              ========       ========
</TABLE>

As of December  31,  2003 and 2002,  the  Corporation  had not  established  any
valuation  allowance  against  deferred  tax assets since these tax benefits are
realizable either through carry-back  availability  against prior years' taxable
income or the reversal of existing deferred tax liabilities.


                                       55
<PAGE>
Community Banks, Inc. and Subsidiaries
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

12. STOCK-BASED COMPENSATION:

The  Corporation  has a Long-term  Incentive  Plan (the  "Plan") that allows the
Corporation to grant to employees, executive officers and directors stock awards
in the form of Incentive  Stock  Options,  Nonqualified  Stock  Options or Stock
Appreciation  Rights.  The stock  options can be granted at prices not less than
the fair market value in the case of Incentive  Stock  Options and not less than
80% of the fair market  value in the case of  Nonqualified  Stock  Options.  The
Corporation has elected to follow  Accounting  Principles  Board Opinion No. 25,
"Accounting   for  Stock   Issued  to   Employees"   ("APB  25"),   and  related
interpretations  in accounting for its stock-based  compensation  and to provide
the  disclosures  required  under  SFAS No.  123,  "Accounting  for Stock  Based
Compensation"  ("SFAS 123"). All options to date have been issued at fair value.
Accordingly,  no  compensation  expense has been  recognized  for stock  options
issued under the Plan.

In electing to follow APB 25 for expense recognition  purposes,  the Corporation
is obliged to provide the expanded  disclosures  required under SFAS No. 123 for
stock-based  compensation  granted.  The weighted average fair values at date of
grant for options  granted during fiscal years 2003,  2002, and 2001 were $8.29,
$5.94,  and $6.25,  respectively,  and were  estimated  using the  Black-Scholes
option valuation model with the following weighted average assumptions for 2003,
2002, and 2001, respectively: dividend yield of 2.0%, 2.6%, and 2.6%; volatility
of 22%, 26%, and 26%;  risk free interest  rates of 3.9%,  3.8%,  and 5.5%;  and
expected life in years of 7.9, 8.4, and 8.7.

As of December 31, 2003, shares totaling 968,508 were authorized but not awarded
under the Plan. The stock options generally vest from one to five years from the
date of grant,  and expire no later than ten years after the date of grant.  The
changes in outstanding options are as follows:
<TABLE>
<CAPTION>
                                                                                                Weighted
                                                                                                Average
                                                                          Shares Under       Exercise Price
                                                                            Option             Per Share
                ---------------------------------------------------------------------------------------
<S>                                                                        <C>                  <C>
                Balance December 31, 2000                                   923,363             $ 12.63
                Issued                                                      145,530               19.95
                Exercised                                                  (125,296)               9.62
                Forfeited                                                      (558)              14.87
                ---------------------------------------------------------------------------------------
                Balance December 31, 2001                                   943,039             $ 14.17
                Issued                                                      157,500               22.11
                Exercised                                                  (105,076)              11.78
                Forfeited                                                    (4,603)              17.19
                ---------------------------------------------------------------------------------------
                Balance December 31, 2002                                   990,860             $ 15.70
                Issued                                                      162,000               31.92
                Exercised                                                  (165,081)              12.92
                Forfeited                                                    (9,403)              18.76
                ---------------------------------------------------------------------------------------
                Balance December 31, 2003                                   978,376             $ 18.80
                ---------------------------------------------------------------------------------------
</TABLE>

The following table provides certain information about stock options outstanding
and exercisable at December 31, 2003:
<TABLE>
<CAPTION>
                                                        Options Outstanding                      Options Exercisable
                                        --------------------------------------------------------------------------------
                                                             Weighted        Weighted                           Weighted
                                                             Average         Average                            Average
                                                             Exercise       Remaining                           Exercise
         Range of exercise prices          Number             Price        Contractual           Number          Price
            per share                   Outstanding         Per Share     Life in Years        Exercisable     Per Share
         -----------------------------------------------------------------------------------------------------------------
<S>            <C>                         <C>               <C>               <C>               <C>            <C>
         Under $9.58                       96,601            $  7.83           2.2               96,601         $  7.83
         $9.59-$12.77                      31,117            $ 10.28           1.9               31,117         $ 10.28
         $12.78-$15.96                    326,342            $ 14.81           5.1              272,529         $ 14.88
         $15.97-$19.15                     73,409            $ 16.55           3.7               73,409         $ 16.55
         $19.16-$22.34                    288,907            $ 21.10           8.4              131,147         $ 20.93
         $22.35-$31.92                    162,000            $ 31.92           9.9                  ---         $   ---
         -----------------------------------------------------------------------------------------------------------------
         $6.42-$31.92                     978,376            $ 18.80           6.4              604,803         $ 15.03
         ------------------------------------------------------------------------- ---------------------------------------
</TABLE>

                                       56
<PAGE>
13. CONDENSED FINANCIAL INFORMATION OF COMMUNITY BANKS, INC. (PARENT ONLY):
<TABLE>
<CAPTION>
                                                                           ------------------------
                                                                               2003         2002
                                                                           ------------------------
                                                                                  (in thousands)
<S>                                                                        <C>           <C>
Condensed Balance Sheets:
     Cash                                                                  $     1,241   $      658
     Interest bearing time deposits in other banks                                  64          ---
     Investment securities, available for sale                                  17,130        8,494
     Investment in banking subsidiary                                          150,688      130,412
     Investment in nonbank subsidiaries                                          6,446        4,355
     Other assets                                                                  986          774
                                                                           -----------   ----------
       Total assets                                                        $   176,555   $  144,693
                                                                           ===========   ==========

     Short-term borrowings                                                 $     2,000   $      ---
     Long term debt                                                             30,928       15,464
     Other liabilities                                                             221           67
     Stockholders' equity                                                      143,406      129,162
                                                                           -----------   ----------
       Total liabilities and stockholders' equity                          $   176,555   $  144,693
                                                                           ===========   ==========
</TABLE>
<TABLE>
<CAPTION>
                                                                              ----------------------------------
                                                                                2003         2002         2001
                                                                              ----------------------------------
                                                                                        (in thousands)
<S>                                                                           <C>          <C>          <C>
Condensed Statements of Income:
     Dividends from:
           Banking subsidiary                                                 $    ---     $  5,000     $  4,396
     Other income (expense)                                                       (830)        (354)        (686)
                                                                              --------     --------     --------
Income (loss) before equity in undistributed earnings of subsidiaries             (830)       4,646        3,710
                                                                              --------     --------     --------
Equity in undistributed earnings of:
     Banking subsidiary                                                         20,118       13,416        9,205
     Nonbank subsidiaries                                                        1,112          384          681
                                                                              --------     --------     --------
                                                                                21,230       13,800        9,886
                                                                              --------     --------     --------
Net income                                                                    $ 20,400     $ 18,446     $ 13,596
                                                                              ========     ========     ========

Condensed Statements of Cash Flows:
   Operating activities:
     Net income                                                               $ 20,400      $18,446      $13,596
Adjustments to reconcile net cash provided by operating activities:
         Undistributed earnings of:
              Banking subsidiary                                               (20,118)     (13,416)      (9,205)
              Nonbank subsidiaries                                              (1,112)        (384)        (681)
         Other, net                                                               (181)      (1,768)       1,548
                                                                              --------     --------     --------
              Net cash provided by (used in) operating activities               (1,011)       2,878        5,258
                                                                              --------     --------     --------
Investing activities:
         Purchases of investment securities                                    (17,304)      (8,494)         ---
         Proceeds from maturities and sales of investment securities             8,862          ---          ---
         Investment in subsidiary                                                 (464)        (464)         ---
                                                                              --------     --------     --------
              Net cash used in investment activities                            (8,906)      (8,958)         ---
                                                                              --------     --------     --------
Financing Activities:
     Net increase in short-term borrowings                                       2,000          ---          ---
     Proceeds from issuance of long term debt                                   15,464       15,464          ---
     Proceeds from issuance of common stock                                      4,308        1,387        3,574
     Purchases of treasury stock                                                (3,627)      (5,828)        (689)
     Cash dividends                                                             (7,645)      (6,654)      (5,880)
                                                                              --------     --------     --------
              Net cash provided by (used in) financing activities               10,500        4,369       (2,995)
                                                                              --------     --------     --------

              Net change in cash and cash equivalents                              583       (1,711)       2,263
     Cash and cash equivalents at beginning of year                                658        2,369          106
                                                                              --------     --------     --------
     Cash and cash equivalents at end of year                                 $  1,241     $    658     $  2,369
                                                                              ========     ========     ========
</TABLE>
                                       57
<PAGE>
Community Banks, Inc. and Subsidiaries
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

14.  REGULATORY MATTERS:

The dividends that may be paid by Community  Banks,  the subsidiary bank, to the
Corporation are subject to certain legal and regulatory limitations.  Under such
limitations,  the total amount  available  for payment of dividends by Community
Banks was approximately $134 million at December 31, 2003.

Under current  Federal  Reserve  regulations,  Community Banks is limited in the
amount it may loan to affiliates,  including the Corporation.  Loans to a single
affiliate may not exceed 10%, and the aggregate of loans to all  affiliates  may
not exceed 20% of bank  capital and surplus.  At December 31, 2003,  the maximum
amount  available for transfer from  Community  Banks to the  Corporation in the
form of loans was approximately $31 million.

Community Banks and the Corporation  are subject to various  regulatory  capital
requirements administered by banking regulators. Failure to meet minimum capital
requirements   can  initiate  certain   mandatory  -  and  possibly   additional
discretionary - actions by regulators  that, if undertaken,  could have a direct
material  effect  on  the  Corporations'  financial  statements.  Under  capital
adequacy  guidelines and the regulatory  framework for prompt corrective action,
Community Banks must meet specific capital guidelines that involve  quantitative
measures of the bank's assets, liabilities,  and certain off-balance-sheet items
as calculated under  regulatory  accounting  practices.  Community Banks capital
amounts and  classification  are also  subject to  qualitative  judgments by the
regulators about components, risk weightings and other factors.

Quantitative  measures  established by  regulations  to ensure capital  adequacy
require  Community  Banks and the  Corporation to maintain  minimum  amounts and
ratios  of total  and Tier 1  capital  to  risk-weighted  assets,  and of Tier 1
capital to average assets (as defined in the regulations).  Management believes,
as of December 31,  2003,  that  Community  Banks and the  Corporation  meet the
capital adequacy requirements to which they are subject.

As of December 31, 2003 and 2002,  Community Banks was "well  capitalized" under
the regulatory framework for prompt corrective action based on its capital ratio
calculations. In order to be "well capitalized",  the bank must maintain minimum
total risk-based,  Tier 1 risk-based, and Tier 1 leverage ratios as set forth in
the following  table.  There are no conditions or events since December 31, 2003
that management believes have changed the bank's classification.

The following tables present the total risk-based, Tier 1 risk-based and Tier 1
leverage requirements for the Corporation and Community Banks.
<TABLE>
<CAPTION>
                                                                     As of December 31, 2003
                                                -------------------------------------------------------------------
                                                       Actual          Regulatory Minimum        "Well Capitalized"
                                                       ------          ------------------        ------------------
                                                 Amount      Ratio     Amount      Ratio         Amount      Ratio
                                                 ------      -----     ------      -----         ------      -----
<S>                                             <C>           <C>     <C>            <C>        <C>           <C>
            Leverage ratio
                 Community Banks, Inc.          $159,958      8.8%    $ 72,736       4%              n/a      n/a
                 Bank only                      $138,569      7.7%    $ 72,295       4%         $ 90,369       5%

              Tier 1 capital ratio
                 Community Banks, Inc.          $159,958     11.6%    $ 55,176       4%              n/a      n/a
                 Bank only                      $138,569     10.1%    $ 54,956       4%         $ 82,434       6%

              Total risk-based capital ratio
                 Community Banks, Inc.          $174,367     12.6%    $110,352       8%              n/a      n/a
                 Bank only                      $152,605     11.1%    $109,912       8%         $137,390      10%

</TABLE>



                                       58
<PAGE>
<TABLE>
<CAPTION>


                                                                     As of December 31, 2002
                                                -------------------------------------------------------------------
                                                       Actual          Regulatory Minimum        "Well Capitalized"
                                                       ------          ------------------        ------------------
                                                 Amount      Ratio     Amount      Ratio         Amount      Ratio
                                                 ------      -----     ------      -----         ------      -----
<S>                                             <C>           <C>     <C>            <C>        <C>           <C>
              Leverage ratio
                 Community Banks, Inc.          $134,354      8.2%    $ 65,284       4%              n/a      n/a
                 Bank only                      $121,281      7.5%    $ 65,037       4%         $ 81,297       5%

              Tier 1 capital ratio
                 Community Banks, Inc.          $134,354     11.2%    $ 48,093       4%              n/a      n/a
                 Bank only                      $121,281     10.1%    $ 47,996       4%         $ 71,994       6%

              Total risk-based capital ratio
                 Community Banks, Inc.          $147,508     12.3%    $ 96,186       8%              n/a      n/a
                 Bank only                      $133,980     11.2%    $ 95,992       8%         $119,990      10%
</TABLE>

Under  current  Federal  Reserve  guidelines,  the  Corporation  includes  trust
preferred  securities  in  Tier  1  capital.  As  noted  in  "Recent  Accounting
Pronouncements" in the Summary of Significant  Accounting Policies section, FASB
Interpretation   No.  46  may  require  the  Corporation  to  deconsolidate  its
investment in its subsidiary trusts. If trust preferred securities are no longer
included in regulatory  capital,  the Corporation will still meet all regulatory
capital requirements.

Community  Banks  is  required  to  maintain  reserves,  in the form of cash and
balances with the Federal  Reserve Bank,  against its deposit  liabilities.  The
amounts of such  reserves  totaled  $6.2  million at December  31, 2003 and $2.3
million at December 31, 2002.

15.  COMMITMENTS AND CONTINGENCIES:

In the  normal  course of  business,  the  Corporation  is a party to  financial
instruments  with  off-balance-sheet  risk to meet  the  financing  needs of its
customers  and to reduce its own  exposure to  fluctuations  in interest  rates.
These financial  instruments  include commitments to originate loans and standby
letters of credit,  which involve,  to varying  degrees,  elements of credit and
interest  rate risk in  excess  of the  amount  recognized  in the  Consolidated
Balance Sheets.

Financial instruments with  off-balance-sheet risk at December 31 are as follows
(in thousands):
<TABLE>
<CAPTION>
                                                                                   Contract Amount
                                                                             ---------------------------
                                                                                 2003             2002
                                                                             ---------------------------
<S>                                                                          <C>              <C>
                  Commitments to fund loans                                  $   76,499       $   63,199
                  Unused lines of credit                                     $  292,813       $  194,877
                  Standby letters of credit                                  $   34,974       $   23,060
                  Unadvanced portions of construction loans                  $   28,443       $   22,177
</TABLE>

Substantially all of the Corporation's unused commitments to originate loans and
unused  lines  of  credit  are at  variable  rates  or will be  provided  at the
prevailing fixed rate when the loans are originated or the lines are used.

Commitments to extend credit are agreements to lend to a customer provided there
is no  violation  of any  condition  established  in the  contract.  Commitments
generally  have fixed  expiration  dates or other  termination  clauses  and may
require  payment of a fee.  Lines of credit are similar to  commitments  as they
have fixed expiration dates and are driven by certain criteria  contained within
the loan  agreement.  Lines of credit  normally do not extend beyond a period of
one year. The  Corporation  evaluates  each  customer's  credit  worthiness on a
case-by-case  basis. The amount of collateral  obtained,  if deemed necessary by
the  Corporation  upon  extension  of credit,  is based on  management's  credit
evaluation  of the  borrower.  Collateral  held varies but may include  accounts
receivable, inventory, and plant and equipment and personal guarantees.



                                       59
<PAGE>
Community Banks, Inc. and Subsidiaries
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

15. COMMITMENTS AND CONTINGENCIES: (continued)

Standby letters of credit are conditional  commitments  issued by the subsidiary
bank to guarantee  the  financial or  performance  obligation of a customer to a
third party.  Community's exposure to credit loss in the event of nonperformance
by the other party to the financial  instrument for standby letters of credit is
represented by the contractual amount of those instruments.  The subsidiary bank
uses the same credit policies in making  conditional  obligations as it does for
on-balance  sheet  instruments.  The majority of these standby letters of credit
expire  within the next  twelve  months.  The credit  risk  involved  in issuing
letters of credit is  essentially  the same as that involved in extending  other
loan  commitments.   The  subsidiary  bank  requires   collateral  and  personal
guarantees  supporting these letters of credit as deemed  necessary.  Management
believes that the proceeds obtained through a liquidation of such collateral and
the enforcement of personal  guarantees would be sufficient to cover the maximum
potential amount of future payments required under the corresponding guarantees.
The current amount of the liability as of December 31, 2003 for guarantees under
standby letters of credit issued is not material.

Since a portion of the  commitments  are expected to expire  without being drawn
upon, the total  commitment  amount does not necessarily  represent  future cash
requirements.

From time to time, the  Corporation  and its  subsidiaries  may be defendants in
legal proceedings relating to the conduct of their business.  Most of such legal
proceedings  are a normal part of doing business,  and in management's  opinion,
the financial position and results of operations of the Corporation would not be
affected materially by the outcome of such legal proceedings.

16.  QUARTERLY RESULTS OF OPERATIONS (UNAUDITED):

The following is a summary of the quarterly  results of operations for the years
ended December 31, 2003 and 2002:

<TABLE>
<CAPTION>

                                                                            Three Months Ended
                                         ---------------------------------------------------------------------------------------
                                                              2003                                        2002
                                         ---------------------------------------------------------------------------------------
                                           Mar.31     June 30    Sept. 30    Dec. 31    Mar. 31    June 30   Sept. 30    Dec. 31
                                         ---------------------------------------------------------------------------------------
                                                                (dollars in thousands except per share data)
<S>                                      <C>         <C>         <C>        <C>        <C>        <C>        <C>        <C>
Interest income                          $  23,771   $  23,723   $ 23,769   $ 23,602   $ 24,107   $ 24,215   $ 24,413   $ 23,965
Interest expense                            10,698      10,694     10,515     10,422     11,638     11,876     11,465     11,233
                                         ---------   ---------   --------   --------   --------    -------   --------   --------
Net interest income                         13,073      13,029     13,254     13,180     12,469     12,339     12,948     12,732
Provision for loan losses                      400         600        900        600       1,600       650        500        600
                                         ---------   ---------   --------   --------   --------   --------   --------   --------
Net interest income after provision for
     loan losses                            12,673      12,429     12,354     12,580     10,869     11,689     12,448     12,132
Investment security gains, net               1,047         500        302         78        518         18         64        434
Mortgage banking activities                    426         445        936        725        385        101        310        425
Other income                                 2,916       4,061      4,263      4,742      2,779      3,544      2,602      2,795
Other expenses                              10,789      11,389     11,578     11,962      9,423     10,027      9,563     10,287
                                         ---------   ---------   --------   --------   --------   --------   --------   --------
Income before income taxes                   6,273       6,046      6,277      6,163      5,128      5,325      5,861      5,499
Income taxes                                 1,172       1,070      1,130        987        677        706      1,121        863
                                         ---------   ---------   ---------  --------   --------   --------   --------   --------
Net income                               $   5,101   $   4,976   $  5,147   $  5,176    $ 4,451   $  4,619   $  4,740   $  4,636
                                         =========   =========   ========   ========   ========   ========   ========   ========


Basic earnings per share                 $     .44   $     .43   $    .44   $    .45   $    .38   $    .40   $    .41   $    .40
Diluted earnings per share               $     .43   $     .42   $    .43   $    .43   $    .37   $    .39   $    .40   $    .39
Dividends declared                       $     .16   $     .16   $    .17   $    .17   $    .13   $    .14   $    .14   $    .16

</TABLE>

Per share and share data have been adjusted to reflect a 5% stock  dividend paid
to  shareholders  of record April 16, 2003,  and a stock split to be paid in the
form of a 20% stock dividend to shareholders of record January 16, 2004.




                                       60
<PAGE>
17.  FAIR VALUES OF FINANCIAL INSTRUMENTS:

The following  methodologies  and  assumptions  were used by the  Corporation to
estimate its fair value disclosures:

CASH AND DUE FROM BANKS, INTEREST-BEARING TIME DEPOSITS, AND FEDERAL FUNDS SOLD:
The fair values for cash and due from banks, interest-bearing time deposits, and
federal funds sold is deemed to be the same as those assets' carrying amounts.

                             INVESTMENT SECURITIES:
Fair values for investment  securities are based on quoted market prices,  where
available.  If quoted market prices are not available,  fair values are based on
quoted market prices of comparable instruments.

                    ACCRUED INTEREST RECEIVABLE AND PAYABLE:
The fair values of accrued  interest  receivable and payable  approximate  their
carrying amounts.

                                     LOANS:
For variable-rate  loans that reprice  frequently with no significant  change in
credit risk,  fair value equals  carrying  amount.  The fair values of all other
loans held in portfolio are estimated by discounting the future cash flows using
comparable  current rates at which similar loans would be made to borrowers with
similar  credit  risk.  The fair value of loans held for sale is based on quoted
market prices for similar loans sold in securitization transactions.

                              DEPOSIT LIABILITIES:
The fair values of demand and savings deposits equal their carrying values.  The
carrying amounts for variable rate money market accounts  approximate their fair
values at the reporting date. Fair values for fixed-rate certificates of deposit
are estimated by discounting  expected  future cash flows using rates  currently
offered for similar deposits.

              SHORT-TERM BORROWINGS AND TRUST PREFERRED SECURITIES:
The  fair  values  of  short-term  borrowings  and  trust  preferred  securities
approximate their carrying amounts.

                                 LONG-TERM DEBT:
The fair values of the  Corporation's  long-term  borrowings are estimated using
discounted cash flows analyses,  based on rates available to the Corporation for
similar types of borrowings.

                         OFF-BALANCE-SHEET INSTRUMENTS:
Fair values for  off-balance-sheet,  credit-related  financial  instruments  are
based on fees currently  charged to enter into similar  agreements,  taking into
account the remaining  terms of the  agreements and the  counterparties'  credit
standing.

The following table summarizes the carrying amounts and fair values of financial
instruments at December 31, 2003 and 2002:
<TABLE>
<CAPTION>

                                                                             2003                            2002
                                                                  ----------------------------------------------------------
                                                                                  Estimated                       Estimated
                                                                    Carrying        Fair           Carrying         Fair
                                                                     Amount         Value           Amount          Value
                                                                  ----------------------------------------------------------
                                                                                        (in thousands)
<S>                                                               <C>            <C>             <C>             <C>
              Financial assets:
                Cash and due from banks, interest-bearing
                  time deposits, and federal funds sold           $    63,188    $    63,188     $    37,088     $    37,088
                Investment securities                                 646,961        646,961         667,801         667,801
                Loans held for sale                                     6,067          6,067          11,483          11,483
                Net loans                                           1,065,433      1,070,977         892,225         911,547
                Interest receivable                                     8,819          8,819           9,999           9,999

              Financial liabilities:
                Deposits                                          $ 1,230,685    $ 1,237,438     $ 1,132,913     $ 1,144,891
                Short-term borrowings                                  27,764         27,764          69,125          69,125
                Long-term debt                                        411,422        420,306         320,533         344,236
                Trust preferred securities                             30,000         30,000          15,000          15,000
                Interest payable                                        3,289          3,289           3,271           3,271
                Off-balance-sheet instruments                             ---            ---             ---             ---
</TABLE>



                                       61
<PAGE>
Community Banks, Inc. and Subsidiaries
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS



18.  COMPLETED ACQUISITIONS:

In April 2003,  Community  completed the  acquisition of Abstracting  Company of
York County (ABCO), a title insurance abstracting company.  Shareholders of ABCO
received  25,760 shares for the 96,920 shares of outstanding  ABCO common shares
in a tax-free exchange.

The following cash acquisitions  were completed during 2003: In June,  Community
acquired The Shultz Agency,  an insurance  agency  providing both commercial and
personal lines of insurance;  in July,  Community acquired Erie Financial Group,
LTD., a company  providing  mortgage  origination  services;  and in  September,
Community  acquired  Your  Insurance  Partnership,  an  insurance  agency  group
specializing in personal insurance services.

All of the above acquisitions were accounted for as purchases,  and accordingly,
the  results  of  operations   of  each  entity  are  included  in   Community's
consolidated statement of income from the date of acquisition. The acquisitions,
individually  and in the  aggregate,  are  immaterial to  Community's  financial
position and results of operations.  Goodwill arising from the acquisitions will
be  subject  to  periodic  impairment  testing  and  other  intangibles  will be
amortized over their estimated useful lives.


                                       62
<PAGE>

[GRAPHIC OMITTED]
Beard Miller Company LLP
Certified Public Accountants
[GRAPHIC OMITTED]


                        Report of Independent Accountants
                        ---------------------------------



The Board of Directors and Stockholders
Community Banks, Inc.
Harrisburg, Pennsylvania

We have audited the accompanying  consolidated balance sheet of Community Banks,
Inc. and  subsidiaries  as of December 31,  2003,  and the related  consolidated
statements of income,  changes in stockholders'  equity,  and cash flows for the
year then ended. These consolidated  financial statements are the responsibility
of the  Company's  management.  Our  responsibility  is to express an opinion on
these  consolidated  financial  statements  based on our audit. The consolidated
financial  statements of Community Banks,  Inc. for the years ended December 31,
2002 and 2001 were audited by other  auditors,  whose  report dated  January 24,
2003, expressed an unqualified opinion on those statements.

We conducted our audit in accordance with auditing standards  generally accepted
in the  United  States of  America.  Those  standards  require  that we plan and
perform the audit to obtain  reasonable  assurance  about  whether the financial
statements are free of material misstatement.  An audit includes examining, on a
test basis,  evidence  supporting  the amounts and  disclosures in the financial
statements.  An audit also includes assessing the accounting principles used and
significant  estimates  made by  management  as well as  evaluating  the overall
financial  statement  presentation.   We  believe  that  our  audit  provides  a
reasonable basis for our opinion.

In our opinion,  the 2003 consolidated  financial  statements  referred to above
present fairly, in all material  respects,  the financial  position of Community
Banks,  Inc. and  subsidiaries  as of December 31, 2003 and the results of their
operations and their cash flows for the year ended in conformity with accounting
principles generally accepted in the United States of America.

                                    /S/ Beard Miller Company LLP
Harrisburg, Pennsylvania
January 19, 2004




                                       63
<PAGE>
Item 9.  Changes  in  and  Disagreements  With  Accountants  on  Accounting  and
--------------------------------------------------------------------------------
Financial Disclosure:
---------------------

On   June  4,   2003,   Community   dismissed   its   independent   accountants,
PricewaterhouseCoopers LLP  (PricewaterhouseCoopers)  and appointed Beard Miller
Company  LLP  (Beard)  as  its  new  independent  accountants,   each  effective
immediately. The decisions to dismiss PricewaterhouseCoopers and to engage Beard
were approved by Community's Audit Committee.

PricewaterhouseCoopers'  report on Community's consolidated financial statements
for 2002 and 2001  contained  no  adverse  opinion or  disclaimer  of opinion or
qualification  or  modification  as to  uncertainty,  audit scope or  accounting
principles.

During the fiscal years 2002 and 2001 and subsequent interim periods, there were
no  disagreements  or  reportable  events  relating to any matter of  accounting
principles and practices,  financial statements  disclosure or auditing scope or
procedure,  which  PricewaterhouseCoopers  would have  referred to in connection
with its  report  if the  disagreement  was not  resolved  to its  satisfaction.
Community acknowledges that disagreements required to be reported in response to
the preceding  sentence  include both those resolved to  PricewaterhouseCoopers'
satisfaction  and those not  resolved to  PricewaterhouseCoopers'  satisfaction.
Community further acknowledges that disagreements  contemplated by this rule are
those which  occurred at the  decision-making  level,  i.e.,  between  Community
personnel  responsible  for the  presentation  of its financial  statements  and
PricewaterhouseCoopers  personnel  responsible  for rendering its report.  There
have been no reportable events within the meaning of Item 304 of Regulation S-K.


Item 9A. Controls and Procedures:
---------------------------------

Under the supervision and with the  participation  of the Company's  management,
including its Chief Executive Officer and Chief Financial  Officer,  the Company
has evaluated the effectiveness of its disclosure  controls and procedures as of
December 31, 2003. Based upon this evaluation,  the Chief Executive  Officer and
Chief Financial  Officer have concluded that the Company's  disclosure  controls
and  procedures  are adequate and effective to ensure that material  information
relating to the Company and its consolidated  subsidiaries is made known to them
by others within those  entities,  particularly  during the period in which this
report was prepared.  There have not been any changes in the Company's  internal
control over financial reporting (as such term is defined in Rules 13a-15(f) and
15d-15(f)  under the Exchange  Act) during the most recent  fiscal  quarter that
have materially  affected,  or are reasonably likely to materially  affect,  the
Company's internal control over financial reporting.



                                       64
<PAGE>

                                    PART III

Item 10. Directors and Executive Officers of the Registrant:
------------------------------------------------------------

Incorporated by reference to the  Corporation's  definitive  Proxy Statement for
its 2004 Annual Meeting of Shareholders,  which will be filed on or before April
29, 2004.

Copies  of  Community's  Code of  Ethics  for the Chief  Executive  Officer  and
Financial     Professionals    are    available    on    Community's    website,
www.communitybanks.com,  or by  writing to Donald F.  Holt,  EVP/CFO,  Community
Banks, Inc., 750 East Park Drive, Harrisburg, PA 17111.

Item 11. Executive Compensation:
--------------------------------

Incorporated by reference to the  Corporation's  definitive  Proxy Statement for
its 2004 Annual Meeting of Shareholders,  which will be filed on or before April
29, 2004.

Item 12.  Security  Ownership of Certain  Beneficial  Owners and  Management and
--------------------------------------------------------------------------------
Related Stockholder Matters:
----------------------------

Incorporated by reference to the  Corporation's  definitive  Proxy Statement for
its 2004 Annual Meeting of Shareholders,  which will be filed on or before April
29, 2004.

Item 13. Certain Relationships and Related Transactions:
--------------------------------------------------------

Incorporated by reference to the  Corporation's  definitive  Proxy Statement for
its 2004 Annual Meeting of Shareholders,  which will be filed on or before April
29, 2004.

Item 14. Principal Accounting Fees and Services:
------------------------------------------------

Information concerning the fees billed by our independent auditor and the nature
of services  comprising the fees for each of the two most recent fiscal years in
each of the  following  categories:  (i) audit fees,  (ii) audit - related fees,
(iii) tax fees and (iv) all  other  fees,  is set  forth in the Audit  Committee
Report  segment of the  Corporation's  definitive  Proxy  Statement for its 2004
Annual  Meeting  of  Shareholders  and  is  incorporated  herein  by  reference.

Information  concerning our Audit Committee's policies and procedures pertaining
to  pre-approval  of audit and non-audit  services  rendered by our  independent
auditor  is set  forth  in the  Audit  Committee  segment  of the  Corporation's
definitive  Proxy Statement for its 2004 Annual Meeting of  Shareholders  and is
incorporated herein by reference.



                                       65
<PAGE>


                                     PART IV

Item 15.  Exhibits, Financial Statements Schedules and Reports on Form 8-K:
---------------------------------------------------------------------------

(a) The following documents are filed as part of this report:

     1.   Financial Statements - The following consolidated financial statements
          of Community Banks,  Inc. and Subsidiaries are incorporated  herein by
          reference in response to Item 8 above:

     (i)  Consolidated Balance Sheets at December 31, 2003 and 2002
     (ii) Consolidated  Statements  of Income for the Years Ended  December  31,
          2003, 2002 and 2001 (
     iii) Consolidated  Statements  of Changes in  Stockholders'  Equity for the
          Years Ended December 31, 2003, 2002 and 2001.
     (iv) Consolidated Statements of Cash Flows for the Years Ended December 31,
          2003, 2002 and 2001.
     (v)  Notes to Consolidated Financial Statements
     (vi) Report of Beard Miller Company LLP, Independent Accountants

     2.   Financial  Statement Schedules - All financial statement schedules for
          which  provision is made in the applicable  accounting  regulations of
          the  Securities  and Exchange  Commission  are not required  under the
          related  instructions  or are  inapplicable  and have  therefore  been
          omitted.

     3.   Exhibits

          3(i) Amended Articles of  Incorporation  (Incorporated by reference to
               Exhibit 3.1,  attached to Community's  registration  on Form 8-A,
               filed on May 13, 2002)
          3(ii)Amended  By-Laws  (Incorporated  by  reference  to  Exhibit  3.2,
               attached  to  Community's  Quarterly  Report on Form 10-Q for the
               quarter  ended March 31, 2003,  filed with the  Commission on May
               15, 2003)
          4    Instruments  defining the rights of the holders of trust  capital
               securities and sold by Community in December 2002 and in December
               2003 are not attached,  as the amount of such  securities is less
               than  10%  of  the  consolidated  assets  of  Community  and  its
               subsidiaries,  and  the  securities  have  not  been  registered.
               Community agrees to provide copies of such instruments to the SEC
               upon request.
          10.1 2000 Directors'  Stock Option Plan,  incorporated by reference to
               Exhibit 4 to Community's  registration  on Form S-8, filed on May
               17,  2000   (Incorporated   by   reference  to  Exhibit  10.1  to
               Community's  Annual  Report  on  Form  10-K  for the  year  ended
               December 31, 2002, filed with the Commission on March 28, 2003)
          10.2 1998  Long-Term  Incentive  Plan,  incorporated  by  reference to
               Exhibit 4 to Community's  registration on Form S-8, filed on June
               18, 1998(Incorporated by reference to Exhibit 10.2 to Community's
               Annual Report on Form 10-K for the year ended  December 31, 2002,
               filed with the Commission on March 28, 2003)
          10.3 Form of Stock  Option  Agreement  - Directors  Stock  Option Plan
               (Incorporated by reference to Exhibit 10.3 to Community's  Annual
               Report on Form 10-K for the year ended  December 31, 2002,  filed
               with the Commission on March 28, 2003)
          10.4 Form  of  Stock  Option  Agreement  -  Long-Term  Incentive  Plan
               (Incorporated by reference to Exhibit 10.4 to Community's  Annual
               Report on Form 10-K for the year ended  December 31, 2002,  filed
               with the Commission on March 28, 2003)
          10.5 Employment  Agreement of Eddie L.  Dunklebarger  (Incorporated by
               reference to Exhibit 10.5 to  Community's  Annual  Report on Form
               10-K  for the  year  ended  December  31,  2002,  filed  with the
               Commission on March 28, 2003)*
          10.6 Employment Agreement of Donald F. Holt (Incorporated by reference
               to Exhibit 10.6 to Community's Annual Report on Form 10-K for the
               year ended December 31, 2002,  filed with the Commission on March
               28, 2003) *
          10.7 Employment Agreement,  and amendment thereto, of Robert W. Lawley
               (Incorporated by reference to Exhibit 10.7 to Community's  Annual
               Report on Form 10-K for the year ended  December 31, 2002,  filed
               with the Commission on March 28, 2003)*
          10.8 Employment  Agreement,  and amendment thereto,  of Anthony N. Leo
               (Incorporated by reference to Exhibit 10.8 to Community's  Annual
               Report on Form 10-K for the year ended  December 31, 2002,  filed
               with the Commission on March 28, 2003) *
          10.9 Employment  Agreement,  and  amendment  thereto,  of  Jeffrey  M.
               Seibert (Incorporated by reference to Exhibit 10.9 to Community's
               Annual Report on Form 10-K for the year ended  December 31, 2002,
               filed with the Commission on March 28, 2003) *



                                       66
<PAGE>

         10.10 Salary  Continuation  Agreement,  and amendment thereto, of Eddie
               L.  Dunklebarger  (Incorporated  by reference to Exhibit 10.10 to
               Community's  Annual  Report  on  Form  10-K  for the  year  ended
               December 31, 2002, filed with the Commission on March 28, 2003) *
         10.11 Salary Continuation  Agreement,  and amendment thereto, of Robert
               W.  Lawley   (Incorporated  by  reference  to  Exhibit  10.11  to
               Community's  Annual  Report  on  Form  10-K  for the  year  ended
               December 31, 2002, filed with the Commission on March 28, 2003) *
         10.12 Salary Continuation Agreement,  and amendment thereto, of Anthony
               N. Leo (Incorporated by reference to Exhibit 10.12 to Community's
               Annual Report on Form 10-K for the year ended  December 31, 2002,
               filed with the Commission on March 28, 2003) *
         10.13 Salary Continuation Agreement,  and amendment thereto, of Jeffrey
               M.  Seibert  (Incorporated  by  reference  to  Exhibit  10.13  to
               Community's  Annual  Report  on  Form  10-K  for the  year  ended
               December 31, 2002, filed with the Commission on March 28, 2003) *
         10.14 Rights  Agreement  between  Community  Banks,  Inc. and Community
               Banks,  dated  February  28, 2002,  incorporated  by reference to
               Exhibit  1 to  Community's  registration  on Form  8-A,  filed on
               February 27, 2002
         10.15 Community Banks,  Inc. 401(k) Plan  (Incorporated by reference to
               Exhibit 10.15 to  Community's  Annual Report on Form 10-K for the
               year ended December 31, 2002,  filed with the Commission on March
               28, 2003)
         10.16 Survivor Income  Agreement,  with Split Dollar Addendum  thereto,
               of Eddie L.  Dunklebarger  (Incorporated  by reference to Exhibit
               3.2,  attached to Community's  Quarterly  Report on Form 10-Q for
               the quarter ended September 30, 2003) *
         10.17 Survivor Income  Agreement,  with Split Dollar Addendum  thereto,
               of Robert W. Lawley  (Incorporated  by  reference to Exhibit 3.2,
               attached  to  Community's  Quarterly  Report on Form 10-Q for the
               quarter ended September 30, 2003) *
         10.18 Survivor Income  Agreement,  with Split Dollar Addendum  thereto,
               of Anthony N. Leo  (Incorporated  by  reference  to Exhibit  3.2,
               attached  to  Community's  Quarterly  Report on Form 10-Q for the
               quarter ended September 30, 2003) *
         10.19 Survivor Income  Agreement,  with Split Dollar Addendum  thereto,
               of Jeffrey M. Seibert  (Incorporated by reference to Exhibit 3.2,
               attached  to  Community's  Quarterly  Report on Form 10-Q for the
               quarter ended September 30, 2003) *
         14    Code of Ethics (for the Chief  Executive  Officer  and  Financial
               Professionals)
         16    Letter  re:  Change In  Certifying  Accountant  (Incorporated  by
               reference to Exhibit 16,  attached to Community's  Current Report
               on Form 8-K, filed with the Commission on June 9, 2003)
         21    Subsidiaries of the Registrant (See Item 1, page #3)
         23.1  Consent of Independent Accountants - Beard Miller Company LLP
         23.2  Consent of Independent Accountants - PricewaterhouseCoopers LLP
         31.1  Rule 13a-14(a)/15d-14(a) Certification (Chief Executive Officer)
         31.2  Rule 13a-14(a)/15d-14(a) Certification (Chief Financial Officer)
         32.1  Section 1350 Certification (Chief Executive Officer)
         32.2  Section 1350 Certification  (Chief Financial Officer)
         99    Report of Independent Accountants - PricewaterhouseCoopers LLP

           *identifies a management contract or compensatory plan or arrangement

     b)  The  registrant  filed the  following  reports  on  Form 8-K during the
         fourth calendar quarter of the year ended December 31, 2003:

         Report Dated  October 16, 2003
         ------------------------------
         Registrant  announced its earnings for the period ended  September 30,
         2003.

         Report Dated November 3, 2003
         -----------------------------
         Registrant  announced its  intentions to enter into  an agreement  with
         Bryn   Mawr  Trust  Co.  pursuant  to  which  registrant's  subsidiary,
         CommunityBanks,  will  engage  Bryn Mawr Trust  to  provide  investment
         management services to its trust and asset management department.

         Report Dated November 4, 2003
         -----------------------------
         Registrant  released information pursuant to Regulation FD with respect
         to  presentation materials, which were made available to the investment
         community by Community Banks, Inc.

         Report Dated November 4, 2003
         -----------------------------

         Registrant   announced  a  cash  dividend  payable  January  2,  2004.
         Registrant  also  announced a stock split payable in the form of a 20%
         stock dividend payable January 30, 2004.

         Report Dated December 16, 2003
         ------------------------------
         Registrant  announced  the issuance of $15 million of trust  preferred
         securities.

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<PAGE>


     (c)  Exhibits - The  exhibits  required  to be filed as part of this report
          are submitted as a separate section of this report.

     (d)  Financial Statement Schedules - None required.


                                       68
<PAGE>

                                   SIGNATURES

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

                              Community Banks, Inc.

                        By: /S/ (Eddie L. Dunklebarger)
                            ---------------------------
                             (Eddie L. Dunklebarger)
     Chairman of the Board, President, Chief Executive Officer and Director

Date:  March 10, 2004

Pursuant to the requirements of the Securities Exchange Act of 1934, this report
has been signed below by the following  persons on behalf of the  registrant and
in the capacities and on the dates indicated.

<TABLE>
<CAPTION>
<S>                                         <C>                                                 <C>
/S/      (Donald F. Holt)                   Ex. Vice President and                              03/10/04
------------------------------------        Chief Financial Officer                             --------
         (Donald F. Holt)                   (Principal Accounting Officer)


/S/      (Ronald E. Boyer)                  Director                                            03/10/04
------------------------------------                                                            --------
         (Ronald E. Boyer)

/S/      (Samuel E. Cooper)                 Director                                            03/10/04
------------------------------------                                                            --------
         (Samuel E. Cooper)

/S/      (Kenneth L. Deibler)               Director                                            03/10/04
------------------------------------                                                            --------
         (Kenneth L. Deibler)

/S/      (Peter Desoto)                     Director                                            03/10/04
------------------------------------                                                            --------
         (Peter DeSoto)

/S/      (Thomas W. Long)                   Director                                            03/10/04
------------------------------------                                                            --------
         (Thomas W. Long)

/S/      (Donald L. Miller)                 Director                                            03/10/04
------------------------------------                                                            --------
         (Donald L. Miller)

/S/      (Thomas L. Miller)                 Director                                            03/10/04
------------------------------------                                                            --------
         (Thomas L. Miller)

/S/      (Earl L. Mummert)                  Director                                            03/10/04
------------------------------------                                                            --------
         (Earl L. Mummert)

/S/      (Wayne H. Mummert)                 Director                                            03/10/04
------------------------------------                                                            --------
         (Wayne H. Mummert)

/S/      (Scott J. Newkam)                  Director                                            03/10/04
------------------------------------                                                            --------
         (Scott J. Newkam)

/S/      (Robert W. Rissinger)              Director                                            03/10/04
------------------------------------                                                            --------
         (Robert W. Rissinger)

/S/      (Allen Shaffer)                    Director                                            03/10/04
------------------------------------                                                            --------
         (Allen Shaffer)

/S/      (John W. Taylor, Jr.)              Director                                            03/10/04
------------------------------------                                                            --------
         (John W. Taylor, Jr.)

/S/      (James A. Ulsh)                    Director                                            03/10/04
------------------------------------                                                            --------
         (James A. Ulsh)

</TABLE>

                                       69