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, 2004
                                       or
            [ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF
                       THE SECURITIES EXCHANGE ACT OF 1934

                         Commission file number 0-15786
                                                -------
                [GRAPHIC OMITTED]COMMUNITY BANKS[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, 2004: $326,000,000

Number of shares of the Common Stock, $5 par value,  outstanding as of the close
of business on February 28, 2005: 12,301,000 shares.


Documents Incorporated by Reference:  None
                                      ----

<PAGE>








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                                       2
<PAGE>



<TABLE>
<CAPTION>

                              COMMUNITY BANKS, INC.
                                    FORM 10-K
                                      INDEX



PART I                                                                                                      Page
<S>                                                                                                          <C>

Item 1                 Business                                                                              4-7
Item 2                 Properties                                                                            7-8
Item 3                 Legal Proceedings                                                                      8
Item 4                 Submission of Matters to a Vote of Security Holders                                    8


PART II

Item 5                 Market for Registrant's Common Equity, Related Stockholder Matters and Issuer
                           Purchases of Equity Securities                                                     9
Item 6                 Selected Financial Data                                                               10
Item 7                 Management's Discussion and Analysis of Financial Condition and Results
                           of Operations                                                                    11-38
Item 7A                Quantitative and Qualitative Disclosures About Market Risk                           39-41
Item 8                 Financial Statements and Supplementary Data                                          42-71
Item 9                 Changes in and Disagreements with Accountants on Accounting and Financial
                           Disclosure                                                                        72
Item 9A                Controls and Procedures                                                               72
Item 9B                Other Information                                                                     72


PART III

Item 10                Directors and Executive Officers of the Registrant                                   73-75
Item 11                Executive Compensation                                                               75-86
Item 12                Security Ownership of Certain Beneficial Owners and Management                       86-88
Item 13                Certain Relationships and Related Transactions                                        88
Item 14                Principal Accounting Fees and Services                                                89


PART IV

Item 15                Exhibits, Financial Statement Schedules                                              90-91


SIGNATURES                                                                                                   92

</TABLE>





                                       3
<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) and Community  Banks Life  Insurance
Company, Inc. (CBLIC). 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. At December 31,
2004 no non-bank  subsidiaries  have total assets that exceed 1% of consolidated
total assets.  With the exception of Community Bank  Investments,  Inc. and UDNB
Investments, Inc., each of whose net income was approximately 5% of consolidated
net  income,  for 2004 no non-bank  subsidiary  has net income  exceeding  1% of
consolidated net income.

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 and retail  banking  business and
provides  limited trust services  through 48 banking offices in Pennsylvania and
Maryland:  3 offices in Adams County, 3 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 17
offices in York County,  Pennsylvania and 2 offices in Carroll County, Maryland.
At December  31, 2004 there were four  additional  offices in varying  stages of
completion  including 2 additional  offices in  Cumberland  County and 1 each in
Dauphin and York  counties.  There are  approximately  700 offices of commercial
banks and  savings  and loan  associations  within  its  market  area with which
Community competes.  Community currently has a 7% share of the deposit market in
the primary metropolitan  statistical areas (MSA) in which it conducts business.
In addition to traditional banking business, we conduct business through various
direct or indirect,  non-bank  subsidiaries.  These  subsidiaries are engaged in
activities related to the business of banking.

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.  The competition is especially fierce with the credit union industry,
particularly in certain segments of Community's markets. The expansion of credit
union activity, now permitted by so-called "community-based" charters, continues
to create mounting competitive pressure. The expansion of "fields of membership"
and credit  union  activity  is thought by most banks to be  contributing  to an
increasingly  unfair  competitive  situation,  largely because of the tax-exempt
status  afforded  credit  unions.  Initiatives  to further  expand the powers of
credit  unions to conduct  business  in areas  that go far  beyond the  original
intent of credit  union  charters  continue  to be pressed at both the state and
federal levels.

Over the years, Community has formed special purpose wholly-owned  subsidiaries.
In 1986, Community formed CBLIC to provide credit life insurance to its consumer
credit borrowers.  In 1985, Community formed CBII to make investments  primarily
in equity securities of other banks. In December 2003, Community had formed CMTY
Statutory Capital Trust II to execute a trust preferred issuance of $15 million.
In  December  2002,  Community  had  formed  CMTY  Capital  Trust I to execute a
previous  pooled trust  preferred  issuance of $15 million.  In 2004,  Community
deconsolidated  these  subsidiary  trusts  from  its  financial  statements.  in
accordance  with provisions of FASB  Interpretation  No. 46,  "Consolidation  of
Variable  Interest  Entities,  as  Interpretation  of ARB No.  51" See "Notes to
Consolidated Financial Statements-Subordinated Debt" included in Part II, Item 8
for more information on the deconsolidation

Community and its  subsidiaries  have  approximately  634  full-time  equivalent
employees as of December, 2004 and Community considers its employee relations to
be satisfactory.

                                       4
<PAGE>

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   Gramm-Leach-Bliley   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  of  at  least
"satisfactory."

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
applicable  banking laws and regulations 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, 2004, 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.

                                       5
<PAGE>
Sarbanes-Oxley Act of 2002
--------------------------

The series of business failures and corporate  scandals that began with Enron in
2001 caused an abrupt decline in the level of investor confidence in the capital
markets. In response to these  developments,  Congress passed the Sarbanes-Oxley
Act of 2002  (Sarbanes-Oxley),  which was  signed  into law in July,  2002,  and
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.

Various  elements  of  Sarbanes-Oxley  require  compliance  under a  "phased-in"
approach to allow  affected  companies a  sufficient  amount of time to meet the
far-reaching provisions of this legislation. For 2004, some of the more sweeping
changes  related to the Section 404  provisions  of  Sarbanes-Oxley,  which were
mandated  to be in  place  by the  end of  that  year.  Under  the  Section  404
provisions,  management  is now required to perform an annual  assessment of the
effectiveness  of its system of internal  control over financial  reporting.  In
addition,  the  company's  independent  registered  public  accounting  firm  is
required to issue a report on internal  control over  financial  reporting  that
includes both an opinion on  managements'  assessment,  and their own opinion on
the  effectiveness of the company's  internal control over financial  reporting.
Pursuant  to the  related  SEC  rules  and  Auditing  Standard  No 2,  which was
established by the Public Company  Accounting  Oversight  Board,  the procedures
required of a company's independent  registered public accounting firm are to be
performed  in  conjunction  with the  audit of the  company's  annual  financial
statements.  The  objectives  of the  Section  404  procedures  and the audit of
internal  control over financial  reporting are to obtain  reasonable  assurance
about whether any material  weaknesses in internal control exists as of the date
of  managements'  assessment.  Community and its independent  registered  public
accounting   firm  have  complied   with  the   provisions  of  Section  404  of
Sarbanes-Oxley  and  the  reports can be found at pages 70 and 71.

Merger Activity
---------------

On March 30, 2001, Community completed a merger of the Glen Rock State Bank into
Community's  bank subsidiary  (then known as Peoples State Bank). As a result of
the Glen Rock merger,  Community acquired an additional 5 branch offices located
in York and  Adams  Counties,  Pennsylvania  and  assets of  approximately  $190
million.

On November 16, 2004,  Community announced the signing of a definitive agreement
pursuant to which it will combine with PennRock Financial Services Corp., parent
company of Blue Ball  National  Bank.  PennRock is a financial  holding  company
headquartered  in  Lancaster  County,  Pennsylvania,  and  its  current  banking
franchise is directly east of Community's  existing geographic  footprint.  Blue
Ball, which is PennRock's primary operating  subsidiary,  has over $1 billion in
assets and 19 banking offices in its network. Following consummation,  the joint
banking and financial  services franchise will operate nearly 70 banking offices
in 11 counties  throughout  the center of  Pennsylvania.  The  combination  will
dramatically  increase  Community's  presence in the south central  Pennsylvania
market, including significant coverage of the vibrant Harrisburg,  Lancaster and
York  regions,  with  combined  assets  totaling  over  $3  billion.  After  the
combination,  Community  is  expected  to become the 8th  largest  bank  holding
company  headquartered  in  Pennsylvania.  Under  the  terms  of the  definitive
agreement,  each shareholder of PennRock will receive 1.4 shares of Community in
exchange for each share of PennRock common stock. Based upon Community's ten-day
average  share  price of  $29.89  prior to the  announcement,  the  value of the
transaction  will  approximate  $326  million.  The  completion of the merger is
subject  to  various  regulatory  approvals  as  well  as  the  approval  of the
shareholders of both Community and PennRock.  Community  urges its  shareholders
and the  shareholders  of PennRock  Financial  Services  Corp., as well as other
investors, to read the proxy  statement/prospectus  that will be included in the
registration  statement  on Form S-4 which  Community  will file with the SEC in
connection  with the  proposed  merger.  This  proxy  statement/prospectus  will
contain important information about Community, PennRock, the merger, the persons
soliciting  proxies in the merger and their  interests in the merger and related
matters.
                                       6
<PAGE>

Operating Segments
------------------

All of the  operations  of  Community  operate  and are  reported  under its one
reportable segment, community banking.

Concentrations, Seasonality
---------------------------

No portions  of  Community's  businesses  are  dependent  on a single or limited
number of customers,  the loss of which would have a material  adverse effect on
our business.  No substantial  portions of loans or investments are concentrated
within a single industry or group of related industries,  although a significant
amount  of  loans  are  secured  by  real  estate   located  in  south   central
Pennsylvania. Community's businesses are not seasonal in nature.

Environmental Compliance
------------------------

Community's  compliance with federal,  state and local environmental  protection
laws had no material  effect on capital  expenditures,  earnings or  competitive
position  in  2004,  and is not  expected  to  have a  material  effect  on such
expenditures, earnings or competitive position in 2005.

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.

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                -              2             2019            3
              Dauphin County                           7                -              3             2015            10
              Luzerne County                           1                -              2             2014            3
              Northumberland County                    2                -              -              -              2
              Schuylkill County                        7                -              -              -              7
              Snyder County                            1                -              -              -              1
              York County                              6                4              7             2020            17
          In Maryland:
              Carroll County                           1                -              1             2007            2
                                                 ----------------------------------------------                 -------------

          Total                                        28               5              15                            48
                                                 ==============================================                 =============
</TABLE>

(1)  Properties  are owned by the Bank,  free and  clear of  encumbrances.
(2)  Properties are owned by PSB Realty  Company,  a wholly-owned  subsidiary of
     Community, and are leased to the Bank.
(3)  Latest lease term expiration date, excluding renewal options.
(4)  In  addition to the above,  two branches in  progress  are subject to lease
     agreements extending through 2024.


                                       7
<PAGE>

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 Community'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          2005
         CB Insurance Services LLC           Admin                    Mechanicsburg, PA           Leased          2005
         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 and/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 or results of
operations.

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 2004.



                                       8
<PAGE>

                                     PART II

Item 5. Market for Registrant's  Common Equity,  Related Stockholder Matters and
--------------------------------------------------------------------------------
Issuer Purchases of Equity Securities:
--------------------------------------

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  3,426  shareholders  of record as of December 31,
2004. The following table sets forth  dividends  declared per share and the high
and low closing  prices for Community  common stock as reported by NASDAQ during
the periods indicated.

<TABLE>
<CAPTION>

         ----------------------------------------------------------------------------------------------------------------
                                                 2004                                            2003
         ----------------------------------------------------------------------------------------------------------------
                                    Price Per Share          Dividends              Price Per Share          Dividends
         ----------------------------------------------------------------------------------------------------------------
                                   Low           High         Declared             Low           High         Declared
         ----------------------------------------------------------------------------------------------------------------

         ----------------------------------------------------------------------------------------------------------------
<S>                             <C>            <C>            <C>               <C>            <C>            <C>
         First Quarter          $   28.41      $   34.52      $  0.16           $   20.79      $   22.51      $  0.15
         ----------------------------------------------------------------------------------------------------------------
         Second Quarter         $   27.02      $   31.58      $  0.17           $   22.11      $   23.81      $  0.16
         ----------------------------------------------------------------------------------------------------------------
         Third Quarter          $   25.35      $   29.73      $  0.17           $   23.69      $   26.59      $  0.16
         ----------------------------------------------------------------------------------------------------------------
         Fourth Quarter         $   27.77      $   31.47      $  0.17           $   26.67      $   32.14      $  0.16
         ----------------------------------------------------------------------------------------------------------------
</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  therefor.  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.

Issuer Purchases of Equity Securities
-------------------------------------

No  shares  were  purchased  during  the  fourth  quarter  of  2004  as  part of
Community's Share Repurchase Program.



                                       9
<PAGE>

Item 6.  Selected Financial Data:
---------------------------------
<TABLE>
<CAPTION>

                                                                     At or for the Year Ended December 31,
                                                ---------------------------------------------------------------------------------
                                                     2004             2003            2002            2001             2000
                                                ---------------------------------------------------------------------------------
                                                                (dollars in thousands except for per share data)
BALANCE SHEET DATA
<S>                                             <C>              <C>             <C>             <C>              <C>
At Period End:
   Investment securities                        $      619,110   $      646,961  $      667,801  $       543,901  $      389,819
   Total loans                                       1,215,951        1,078,611         904,568          857,278         814,874
   Total assets                                      1,954,799        1,861,063       1,680,362        1,509,734       1,308,713
   Total deposits                                    1,305,537        1,230,685       1,132,913        1,003,225         919,241
   Long-term debt                                      404,662          411,422         320,533          322,155         239,613
   Stockholders' equity                                152,341          143,406         129,162          111,249         103,978
Average:
   Total assets                                      1,941,096        1,780,679       1,580,046        1,398,521       1,238,870
   Total stockholders' equity                          145,750          135,773         119,352          111,381          92,225

EARNINGS DATA:
Net interest income                                     56,557           52,514          50,488           45,935          43,795
Provision for loan losses                                3,100            2,500           3,350            5,080           2,863
Net interest  income after  provision for loan
     losses                                             53,457           50,014          47,138           40,855          40,932
Other income                                            23,213           20,463          13,975           12,141           8,148
Other expense                                           49,993           45,718          39,300           36,521          30,463
Provision for income taxes                               4,879            4,359           3,367            2,879           4,702
Net income                                              21,798           20,400          18,446           13,596          13,915

PER SHARE DATA:
Basic earnings per share                                  1.78             1.68            1.51             1.11            1.15
Diluted earnings per share                                1.73             1.63            1.48             1.09            1.14
Cash dividends declared                                   0.67             0.63            0.54             0.48            0.43
Book value                                               12.45            11.73           10.67             9.05            8.65
Average diluted shares outstanding                  12,574,908       12,497,372      12,491,320       12,461,996      12,231,908

PROFITABILITY RATIOS:
Return on average assets                                 1.12%            1.15%           1.17%            0.97%           1.12%
Return on average stockholders' equity                  14.96%           15.03%          15.46%           12.21%          15.08%
Net interest margin (FTE)                                3.44%            3.50%           3.78%            3.83%           4.01%
Efficiency ratio                                        60.22%           60.47%          56.81%           59.77%          55.42%

CAPITAL AND LIQUIDITY RATIOS:
Stockholders' equity to total assets                     7.79%            7.71%           7.69%            7.37%           7.95%
Average equity to average assets                         7.51%            7.62%           7.55%            7.96%           7.45%
Dividend payout ratio                                   37.69%           37.35%          36.07%           43.25%          37.48%
Net loans to assets                                     61.47%           57.25%          53.10%           55.98%          61.48%

ASSET QUALITY RATIOS:
Allowance for loan losses to total loans
     outstanding                                         1.19%            1.22%           1.36%            1.42%           1.27%
Allowance for loan losses to non-accrual loans            266%             162%            131%             109%            171%
Non-accrual loans to total loans outstanding             0.45%            0.76%           1.04%            1.29%           0.74%
Non-performing assets to total assets                    0.38%            0.70%           0.63%            0.78%           0.49%
Net charge-offs to average loans outstanding             0.16%            0.17%           0.35%            0.39%           0.20%

</TABLE>




                                       10
<PAGE>
Item 7. Management's  Discussion and Analysis of Financial Condition and Results
--------------------------------------------------------------------------------
of Operations:
-------------

    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  to what  extent  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 dollar  amounts,  except  per share
information, 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.  Community 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:

     o    the effect of prevailing economic conditions;
     o    unforeseen   or  dramatic   changes  in  the  general   interest  rate
          environment;
     o    actions or changes in policies of the Federal  Reserve Board and other
          government agencies; and
     o    business risk associated  with the management of the credit  extension
          function and fiduciary activities.

Each of these factors could affect  estimates,  assumptions,  uncertainties  and
risks  used to  develop  forward-looking  information,  and could  cause  actual
results to differ  materially from  management's  expectations  regarding future
performance.

CRITICAL ACCOUNTING POLICIES

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) and in the evaluation of "other than
temporary"  impairment  of  investment  securities  should be  considered  to be
critical  accounting  policies to ensure the fair  presentation  of  Community's
financial statements.

     o  Community  applies  a  systemic  methodology  in order to  estimate  the
allowance for loan losses. This methodology incorporates  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  (SFAS) 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 collectibility,  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.

     o Investment securities are written down to their net realizable value when
there is an impairment in value that is considered to be "other than temporary."
The determination of whether or not other than temporary  impairment exists is a
matter of judgment. Management reviews these investment securities regularly for
possible  impairment  that is "other than  temporary" by analyzing the facts and
circumstances  of each  investment and the  expectations  for that  investment's
performance. "Other than temporary" impairment in the value of an investment may
be indicated by the
                                       11
<PAGE>

length of time and the extent to which market value has been less than cost; the
financial  condition  and near term  prospects of the issuer;  or the intent and
ability of Community to retain its investment for a period of time sufficient to
allow for any anticipated recovery in market value.

A summary of the review and application of these critical accounting policies is
included  later in this  discussion  and in the notes to the  audited  financial
statements.

2004 PERFORMANCE SUMMARY

The year 2004 is  destined  to go down as a  milestone  period in the history of
Community. The reliable delivery of strong profit performance, combined with the
execution of critical efforts to facilitate  meaningful franchise expansion,  is
expected to  distinguish  Community  among its  competitors  and provide a solid
foundation for future growth and expansion.

Net income reached $21.8  million,  a 7.0% increase from the net income of $20.4
million  reported  in 2003.  Similarly,  earnings  per share  reached $ 1.73 per
share, a 6.1%  improvement  from the $1.63  reported in 2003.  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 2004, Community produced an ROA of 1.12% and an ROE of
14.96%,   which  was  comparable  to  the  performances  of  1.15%  and  15.03%,
respectively, in the prior year.

Community  produced  improved  levels of  profitability  during  2004 by driving
higher loan and deposit volumes,  increased fees,  strong asset quality and more
modest  growth in  operating  expenses.  Across the broader  financial  services
spectrum,  profit  performance  was directly and  indirectly  influenced  by the
depressed level of interest rates and an unsettled national economy.  Rates have
remained  lodged near their lowest  levels in decades and,  when  combined  with
competitive  pressures,  produced  enduring  margin  compression  and  lingering
constraints on net interest income growth. Net interest income, which is defined
as the  difference  between  interest  income from  earning  assets and interest
expense on funding  sources,  remains the largest  single  source of revenue for
most community  banks. The strain on net interest income growth placed a premium
on  increasing  market  share,   maintaining  pristine  asset  quality  metrics,
developing  new and  improved  sources of service  fee income,  and  unrelenting
vigilance on the  achievement  of operating  efficiencies.  All of these factors
contributed to  Community's  improved  profit  performance in 2004. The progress
achieved in these areas served to offset the impact of interest rate compression
on revenue  expansion and facilitated  earnings growth in an uncertain  economic
environment.

At the same time, Community continued to make strategic  investments in expanded
operating  platforms and delivery  channels to support and serve a larger,  more
profitable financial services operation. Identifying opportunities for franchise
expansion continued to be a primary objective for Community throughout the year.
On November 16, 2004,  Community announced its pending combination with PennRock
Financial   Services  Corp.,  the  parent  of  Blue  Ball  National  Bank.  This
affiliation will be the single largest merger in Community's history.  PennRock,
with assets in excess of $1 billion,  serves three important counties within the
south  central  region of  Pennsylvania  through its 19 office  locations.  On a
combined  basis,  the  Community  /  PennRock  affiliation  will have a combined
network of nearly 70 offices and over $3 billion in assets and will serve twelve
counties containing over 1.2 million households. Operations will extend from the
Pocono region of northern  Pennsylvania to just across the Maryland border, with
an enviable  presence in the vibrant south central region of  Pennsylvania.  The
combined  franchise is expected to become the 8th largest  bank holding  company
headquartered in Pennsylvania.  The future for this new and exciting partnership
will be built on a mutual  history of sustained  profitability  and  responsible
leadership, both of which were aptly demonstrated during 2004.

FUTURE PERFORMANCE COMPARISONS

Assuming  that the companies  complete the merger after  receiving the necessary
regulatory and shareholder approvals,  Community will be recording the merger of
PennRock  under the purchase  method of  accounting  for business  combinations,
which is now required under generally  accepted  accounting  principles  (GAAP).
Traditional  measures of performance,  like net income,  earnings per share, and
return on assets  will  continue  to be  presented,  but  comparability  between
post-consummation  results and prior years will require  careful  scrutiny.  The
most noticeable effect will be that Community's historical operating results and
statements  of  condition  will not be restated  for the impact of the

                                       12
<PAGE>

PennRock  acquisition for periods prior to  consummation.  PennRock results will
only be included on a prospective basis, commencing at the date of consummation,
which is expected to occur in mid-2005.

The comparability of other measures,  such as ROE, will be dramatically affected
due to the  introduction  of concepts which are unique to the application of the
purchase method of accounting for business combinations.  For example, Community
will  recognize  certain  intangible  assets to the extent that the value of the
common stock exchanged with former PennRock  shareholders exceeds the book value
of net tangible assets  acquired in the  transaction.  The  introduction of more
substantial  levels of intangibles  arising from the PennRock  acquisition  will
make historic  comparisons  of ROE between 2005 and prior periods more difficult
to interpret and assess.

Many of Community's  peers and competitors have also experienced  growth through
acquisitions  that  were  completed  after  the  mandatory   imposition  of  the
"purchase" method of accounting.  In response to these comparability challenges,
many financial  institutions have adjusted certain  performance  measurements in
order to facilitate  meaningful  comparisons of performance within the financial
services industry.  Future  presentations of Community's  financial  performance
will consider these adjusted  measures.  For example,  earnings  results will be
reported in both the  traditional  "net income" format as well as the "operating
income" format.  The operating  income format will measure earnings by excluding
certain non-operating expenses such as core deposit intangible  amortization and
merger-related  expenses.  Additionally,  traditional  ROE  comparisons  will be
augmented  with a measure  called "return on average  tangible  equity"  (ROTE),
which seeks to eliminate the  distortion in  comparability  that arises from the
accounting  implications  of  acquired  intangible  assets.  To the extent  such
measures are considered  "non-GAAP"  measures of performance,  Community will be
required to provide reconciliations designed to highlight and explain the nature
of the  differences  between  traditional  "GAAP"  measures  and those  that are
considered "non-GAAP".

The  presentations  provided  in this 2004  discussion  will  require  no GAAP /
non-GAAP  reconciliations.  The scarcity of significant  acquisition activity at
Community since the mandated  imposition of the purchase accounting method would
yield few noticeable differences between "GAAP" and "non-GAAP" measures in 2004,
or in comparable earlier periods. Consequently,  most results and comparisons in
this analysis are presented on a GAAP basis, unless otherwise indicated.

2004 PERFORMANCE REVIEW

The primary driver of performance in 2004 was growth;  more  specifically,  loan
and deposit  growth.  While the  opportunity  for improved  pricing and expanded
interest spread was undermined by the compression of interest rates, Community's
ability to achieve  organic  growth,  which includes  market share  penetration,
resulted in an  expansion  of net  interest  income.  Community  benefited  from
marketing efforts in its core markets and from its position as one of the larger
franchises  to  sustain  a  deliberate   and   concentrated   focus  on  central
Pennsylvania.  Community's  customers,  as well as  new,  influential  employees
formerly  associated with larger  competitors  have been attracted to its "local
people...local  decisions"  philosophy.  That  operating  principle was in stark
contrast to larger  competitors,  which often appear less  intensely  focused on
local markets or seem  distracted by the potential for  opportunities  in new or
acquired  markets.  Average  loans grew 15.7% and  deposits  rose 10.1% and such
growth contributed substantially to a 7.2% increase in net interest income.

The continued  expansion of banking service  offerings also provided an increase
to revenue in the form of higher  non-interest  income.  For  example,  the more
widespread  acceptance of the "OverdraftHonor"  program and the success of other
fee-based product distribution  initiatives,  including annuity sales, brokerage
services  and   insurance-related   commissions,   provided  measurable  revenue
expansion and income stream diversification.  During the first half of the year,
Community  also  recorded  substantial  increases  in  gains  from  the  sale of
portfolio securities,  primarily gains from the sale of bank stocks. These gains
reflected  opportunities to benefit from the favorable valuations of bank equity
securities,   particularly  early  in  2004.  Recognition  of  these  gains  was
coordinated  with expanded  marketing  efforts to increase the visibility of the
Community  franchise.  In the third quarter,  Community also decided to sell its
credit card portfolio and  recognized a gain of $725  thousand.  The maturity of
the mono-line  credit card industry,  combined with the relatively small size of
Community's portfolio,  created overwhelming competitive and scale disadvantages
that precipitated the sale.

                                       13
<PAGE>
Lessening  the  effect  of these  gains and other  revenue  expansion  trends in
non-interest  income was the impact of subdued  mortgage  refinancing  activity.
Industry-wide,  gains  and fees  from  home  mortgage  refinancing  declined  as
previous pent-up demand was largely satisfied in recent years. At the same time,
purchase  activity  waned in the wake of a tepid  economy and the  concern  over
higher interest rates. As a result of these external factors, growth in mortgage
banking  revenue  was not as great as in prior  years.  Growth in  complementary
fee-based activities,  such as title and settlement services, also lessened, due
in some measure to the outsized  mortgage  origination  activity  experienced in
previous  years.  The net effect of all of these  trends was a 12%  increase  in
income from non-interest sources (excluding security gains), and an 18% increase
excluding nonrecurring gains from both years.

Two  highlights  of 2004  performance  related to asset quality and control over
non-interest  expenses.  Community has now experienced two consecutive  years of
steadily  improving metrics in loan quality,  including net charge-offs to loans
of only  0.16% in 2004.  At the same  time,  the  coverage  of  problem  credits
provided by the allowance  reached 266%.  As a  consequence  of these  favorable
trends, the provision for loan losses grew modestly,  despite substantial growth
in loan balances.

Non-interest  expenses were adversely  impacted by increased  marketing efforts,
including  both  image  and  product  specific  advertising,  each of which  was
designed to increase Community's visibility within its core markets.  Community,
like  most  publicly-traded   companies,   also  experienced  another  layer  of
regulatory   burden  in  the  form  of  compliance  costs  arising  out  of  the
Sarbanes-Oxley Act of 2002 (SOX). The most recent wave of requirements  resulted
in increased costs  associated with Section 404 of SOX, which mandated  detailed
review, documentation and testing of internal controls over financial reporting,
and required  completion by the end of 2004.  Despite these challenges,  overall
operating  expenses  grew  only  modestly  as a result  of close  management  of
incremental spending during 2004. Concern over the impact of a compressed margin
and less robust non-interest  revenue projections in areas like mortgage banking
necessitated  more  proactive  and  strategic  cost control  efforts,  including
temporary delays of office openings originally planned for 2004.

Economic Climate

In many ways,  economic  conditions  in 2004  reflected  an extended  version of
issues that had  influenced  2003 results.  A "new reality" has evolved from the
increased global and domestic threats of terrorism.  It began with the attack of
September 11, 2001 and continued  with the current  occupation of Iraq,  and the
seemingly  endless  hostility  in that  region of the world.  This new  reality,
combined  with  a  sluggish  domestic   economy,   became  the  dominant  issues
confronting  the country  during the 2004  presidential  election year. For most
businesses,  the  fallout  from these  challenges  was  exacerbated  by previous
corporate  scandals that ultimately gave rise to the  compliance,  testing,  and
oversight  provisions of SOX. The nation continues to recover and build upon the
progress  that has been made in coping  with  these  external  factors,  but the
economy in many parts of the country remains uninspiring.

The Federal Reserve  maintained its accommodative  posture on interest rates for
most of 2004,  although  subtle  changes  began to emerge over the course of the
year.   Productivity   improvements,   from  both  technological   advances  and
inexpensive labor costs from the new, more  globally-driven  economy,  served to
restrain inflationary pressures and supported a stance of continued low interest
rates.  The  Federal  Reserve's  posture was also a  reflection  of its focus on
providing "ongoing support to economic  activity".  Despite the precipitous rise
in energy prices and a steadily  weakening dollar, the Federal Reserve pursued a
restrained  mid-year reversal to its accommodative  monetary policy. The Federal
Reserve  began the year with a federal  funds  target of 1 percent and ended the
year with an  increase of 125 basis  points to 2.25  percent by the end of 2004.
This tightening, while directionally significant, did not dramatically alter the
interest rate landscape for most financial  institutions as most long-term rates
experienced little or no upward pressure.  Since the end of 2003, interest rates
have moved  gradually from low rates and a steep yield curve to slightly  higher
rates and a flatter yield curve. This steady flattening of the yield curve often
has been viewed as an  unfavorable  bellwether for financial  institutions.  The
relatively low rate  environment  experienced in both 2003 and 2004 continued to
provide a healthy stimulus for credit services,  while consumer expectations for
higher deposit rates supported a continuous  flow of liquidity into  transaction
accounts.  This trend corresponded with consumer  resistance to locking up funds
in longer term certificates of deposit that provided only modest rate incentives
for  customers to extend  maturities.  The  pressure on net interest  income was
exacerbated by the inability to achieve  significantly higher loan pricing or to
incrementally  reduce  funding  costs  to  expand  net  interest  spread.  As  a
consequence,  overall interest spreads  remained  substantially  comparable with
2003.
                                       14
<PAGE>

In summary,  the economic climate during 2004 was mixed,  yielding no definitive
or compelling arguments for either an imminent,  robust expansion or a near-term
recessionary slowdown. Community operates within a regional economy, and smaller
local  economies,  that have performed with comparative  consistency,  seemingly
less vulnerable to major "boom or bust" cycles that often influence other,  more
cycle-dependent  regions  of  the  country.  The  mature  yet  diverse  economic
underpinnings  of Community's  service area have been less  predisposed to broad
expansions or deep slumps  triggered by national or  international  economic and
political trends.  While these local economies have been  characterized by their
reliability,  the existence of  overarching  trends will always have some causal
effect on regional  economies.  The businesses and individual  customers  within
Community's markets remain exposed to these pervasive economic developments, but
are characterized most often by their comparative stability.  That stability has
been  attributed  to many  factors,  including  an  absence  of single  industry
concentrations,  relatively  modest deviations in local employment  trends,  and
steady  profitability  performance.  In recent  years,  the  influence  of these
factors on local economies has  contributed  considerably to the sound financial
performance of Community Banks.

Emerging Issues for 2005

The single  dominant  internal issue for 2005 will be the planning and execution
of the  successful  integration  of the Community and PennRock  operations.  The
first half of 2005 will be dedicated to the  coordination  and  harmonization of
policies,  procedures and  practices,  and to the  construction  of an operating
platform that will facilitate the combination of these  historically  successful
franchises.  During this process,  both  entities  will maintain a  concentrated
focus on the  creation of an overall  operating  platform  capable of serving an
even  larger,  more  diverse  franchise.  This  effort  will  culminate  in  the
consolidation   of  most   "back-office"   operations,   including   information
technology,  loan  and  deposit  operations,  and  an  array  of  administrative
functions.  Prior to consummation  and throughout  much of 2005,  Community will
incur and recognize certain  non-operating  expenses that will arise as a direct
consequence  of the merger.  These  expenses  will  include  various  retention,
conversion and severance benefits to be incurred by Community to ensure fair and
equitable  remuneration for employees who are displaced or inconvenienced by the
efforts to combine and integrate the two  companies.  Community  will also incur
certain other merger-based  expenses directly related to the overall combination
initiative.  Appropriate  accounting  recognition  will  be  made  in  order  to
segregate  the impact of each of these items on 2005 results and provide a clear
picture  of the  operating  performance  of  the  newly-formed  Community  Banks
franchise.

During 2005, however, the highest priority will be placed on the following:

     o    minimizing  the impact of the  combination  effort on the  convenient,
          effective,  and efficient  delivery of products and service to new and
          existing customers, and;

     o    maintaining the highest possible levels of profitability and operating
          efficiency  for  all  of our  stakeholders,  including  both  existing
          shareholders  and  those   shareholders  added  through  our  PennRock
          affiliation.


While a great deal of management attention will be devoted to the combination of
the  Community  and  PennRock  franchises,  these  two  priorities  will  remain
corporate imperatives for 2005 and beyond.

NET INTEREST INCOME

Community's major source of revenue continues to be derived from  intermediation
activities  through its bank subsidiary 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.


                                       15
<PAGE>

The  following  table  compares  net  interest  income and net  interest  margin
components between 2004 and 2003:
<TABLE>
<CAPTION>

                                                2004                      2003                    Change
                                      ----------------------------------------------------------------------------
                                                     Yield /                   Yield /                  Yield /
                                        Amount        Rate        Amount        Rate        Amount       Rate
                                      ----------------------------------------------------------------------------

<S>                                   <C>              <C>      <C>              <C>      <C>           <C>
         Interest income              $   106,338      5.80%    $   101,217      6.02%    $   5,121     (0.22)%
         Interest expense                  43,242      2.70%         42,351      2.89%          891     (0.19)%
                                      ----------------------------------------------------------------------------
         Net interest income          $    63,096               $    58,866               $   4,230

         Interest spread                               3.10%                     3.13%                  (0.03)%
         Impact of non-interest
         funds                                         0.34%                     0.37%                  (0.03)%
                                                   ------------              ------------             ------------

         Net interest margin                           3.44%                     3.50%                  (0.06)%
                                                   ============              ============             ============
</TABLE>

Interest Rates

For the first time since 2000,  average interest rates rose. When examined on an
average  basis,  such  increases  were  comparatively  modest and slightly  more
conspicuous at the short end and middle  segments of the yield curve. In each of
the last three  years,  it was assumed  that rates had declined to levels at, or
near,  the trough in the interest  rate cycle.  In each of those years,  despite
predictions for a gradual rise in interest rates,  downward  pressure  remained.
For most of that three year  period,  declines in short term rates  outpaced the
declines in the long end of the curve,  producing  an  increasingly  steep yield
curve.  During  2004,  such trends  began to reverse,  producing  modest  upward
pressure  on short term  rates and a  comparatively  flatter  yield  curve.  The
following graph provides a comparison of average U.S. Treasury rates for the key
maturity intervals for both 2004 and the preceding year.


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

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

2003      1.028%     1.075%    1.241%   1.651%   2.105%   2.966%   4.014%
2004      1.399%     1.614%    1.888%   2.382%   2.780%   3.426%   4.271%


A more  perceptible  change in the  direction of interest  rates  emerges from a
comparison  of the one-day  interest  rates in effect at December 31 for each of
the past two years.  This comparison,  unlike the presentation of average rates,
displays rates in place at discrete  points in time.  Such  comparisons  tend to
provide a less revealing  overview of trends,  largely  because they exclude the
more inclusive  influence of average rate  comparisons and because rates are, by
definition,  vulnerable to one-day swings.  The following graph demonstrates the
comparative  results provided by a presentation of the yield curve at the end of
both 2004 and 2003.


                                       16
<PAGE>


                       Year-Over-Year U.S. Treasury Curve
                       ----------------------------------


         3 Months   6 Months   2 Year   3 Year   5 Year   10 Year   30 Year
         --------   --------   ------   ------   ------   -------   -------

2003      0.917%     1.012%    1.819%   2.302%   3.247%   4.246%    4.826%
2004      2.212%     2.577%    3.065%   3.219%   3.607%   4.218%    5.073%


Despite its inherent  limitations,  the above graph does provide an illustration
of the incremental pricing challenges that emerged during 2004 and the impending
challenges  likely to be confronted by financial  institutions  into 2005.  This
presentation reveals the comparatively modest interest rate premium available at
the long end of the curve.  When coupled  with the  flatness of the curve,  this
trend tends to diminish the bank's  appetite for extending  maturities on credit
facilities  or  portfolio  investments  in order to  improve  yields.  Extending
maturities or granting favorable, long-term pricing concessions close to the low
end of the rate cycle may prove to be  problematic  if  long-term  rates were to
subsequently tighten, thus restoring a steeper yield curve. On the funding side,
the consumer's enthusiasm for extending maturities into longer term certificates
of deposits is also  diminished  near the apparent  bottom of the interest  rate
cycle.  Most  importantly,  if a flat  yield  curve is in place for an  extended
period of time,  it has the  potential to yield  additional  compression  in net
interest spread and net interest margin.

Despite these challenges,  Community  reported little volatility in net interest
margin and actually  recorded  overall  improvement in net interest  income when
comparing 2004 and 2003 results.  Interest  income from earning assets grew 5.1%
while  interest  expense  from the various  funding  sources  increased by 2.1%,
resulting in an increase in net interest income of 7.2%.

Interest Income /Earning Assets

Interest  income was $106.3 million in 2004 and grew by $5.1 million as compared
to the $101.2 million recorded in 2003. This represented  growth of 5.1% and was
achieved  despite the fact that earning asset yields declined from 6.02% in 2003
to  5.80% in 2004.  From  2003 to 2004,  earning  assets  grew  $151.7  million,
including $155.0 million in loans. Such growth was offset by a slight decline in
investment  portfolio balances.  Growth in loans accelerated during the year and
was funded by normal runoff in the investment  portfolio and by a $118.6 million
increase in the level of deposits,  primarily in  Community's  successful  Power
Checking offering. As in recent years, loan growth was focused in the commercial
and commercial real estate categories and was augmented by continued penetration
of the consumer home equity market.


                                       17
<PAGE>

Interest Expense / Funding Sources

Interest  expense grew  modestly  during the year despite the overall  growth in
funding sources. The overall cost of funding,  like the yield on earning assets,
declined from 2.89% in 2003 to 2.70% in 2004.  This decline in the relative cost
of funds substantially offset the impact of increased funding levels on interest
expense growth.  Interest  expense rose from $42.4 million in 2003 to just $43.2
million in 2004, a modest  change of only $0.9 million.  Total  interest-bearing
funding grew by $139.5  million and,  combined  with the growth in  non-interest
funds,  provided  substantially all of the funding needed for the $155.0 million
in loan growth. As was the case in 2003, Community's  longer-term,  time deposit
growth  patterns were  relatively  flat  throughout most of the year as consumer
preferences  were  weighted  in  favor  of  maintaining  adequate  liquidity  in
anticipation  of an impending rise in interest rates.  Consumer  preferences for
liquidity and flexibility  resulted in an increase in Community's  popular Power
Checking  account  offering,  which grew by $102.5  million  and was the primary
driver of overall deposit growth.

Community  continued to make strategic use of other forms of funding in order to
meet the consistent  demand for credit  extension  that occurred  throughout the
year.  During the year,  Community  made  efforts to  strategically  realign its
balance sheet composition in preparation for the onset of higher interest rates.
To this end, Community  gradually reduced its dependence on selected  short-term
funding sources,  such as overnight fed funds,  which are sensitive to increases
in short term interest rates.  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,  an important
source of liquidity  that is accessed  pursuant to risk  parameters set forth in
Community's asset / liability  management  (ALCO) policies and procedures.  This
strategy  permitted  Community  to  "lock  in"  longer-term  funds  at or near a
potential  trough in the  interest  rate cycle.  Community  experienced  a 19.7%
increase in long-term  funding,  which  totaled $436 million at the end of 2004,
and included two $15.5 million  subordinated  debt  instruments  issued in equal
amounts at the end of both 2002 and 2003.  The issuances were  integrated  with,
and responsive to, the overall capital management policy discussed later in this
presentation.

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,  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,
Community reported a modest decline in net interest spread from 3.13% in 2003 to
3.10% in 2004, and a decline in net interest margin from 3.50% to 3.44% 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 0.37% to
0.34%.  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.


                                       18
<PAGE>
Quarterly Performance

The following  table  provides a comparison  of earning  asset  yields,  funding
costs, and other information for each of the four quarters of 2004 and 2003.
<TABLE>
<CAPTION>

                                                                    2004
                                          ---------------------------------------------------------
                                              Fourth         Third        Second         First
                                              Quarter       Quarter       Quarter       Quarter
                                          ---------------------------------------------------------
<S>                                            <C>           <C>           <C>            <C>
            Asset yield                        5.90%         5.79%         5.75%          5.77%
            Funding cost                       2.75%         2.68%         2.64%          2.70%
                                          ---------------------------------------------------------
               Interest spread                 3.15%         3.11%         3.11%          3.07%
                                          ---------------------------------------------------------
               Net interest margin             3.51%         3.43%         3.44%          3.40%
                                          ---------------------------------------------------------

            Net interest margin              $16,285        $15,906       $15,843        $15,062
                                          =========================================================
</TABLE>

<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%         3.44%         3.49%          3.68%
                                          ---------------------------------------------------------

            Net interest margin              $14,789        $14,878       $14,613        $14,586
                                          =========================================================
</TABLE>

Quarterly net interest  income and net interest  margin trends for both 2004 and
2003 reflected many of the same characteristics noted in the comparisons of full
year  performance.  Since the beginning of 2003,  interest rates continued their
steady  pattern  of  decline   through  the  midpoint  of  2004.  This  drove  a
corresponding  compression of net interest margin, and a practical constraint on
Community's ability to reflect more substantial increases in net interest income
to accompany its impressive balance sheet growth.  For the most part,  Community
experienced relatively modest improvement in net interest income on a sequential
quarter basis  throughout  most of 2003 and 2004.  Near mid-year  2004,  the Fed
began to slowly  reverse  its  accommodative  monetary  policy.  The pace of the
policy  reversal  was slowly  reflected  in the  increases  in yields on earning
assets and cost of funding  sources  in the third and fourth  quarters  of 2004,
though both net interest spread and net interest margin remained compressed.  By
the end of the year, a more measurable improvement in pricing began to emerge as
both net interest  spread and net interest  margin  appeared to recover,  albeit
modestly,  from the nadir of performance  reported in the first quarter of 2004,
when  margin  reached  only  3.40%.  In the fourth  quarter  of 2004,  Community
recorded  its highest  quarterly  net  interest  margin  (3.51%) in the two year
period.

PROVISION FOR CREDIT LOSSES

One of the high points for the banking industry, and specifically for Community,
was the ongoing  stability of the credit quality picture  throughout 2004. These
trends have been largely sustained over a two year period, even as Community has
continued  to  experience  dramatic  loan  growth  over  that same  period.  The
provision for loan losses was $3.1 million,  which was only slightly higher than
the  provision  of $2.5  million  recorded  in  2003.  The  relationship  of the
allowance to loan losses declined,  albeit modestly, from 1.22% in 2003 to 1.19%
in 2004.  The  provision  and the  allowance  are  recorded at levels  which are
responsive to both the ebb and flow of general credit quality patterns and, more
specifically,  to the risks  inherent in both seasoned  loans and in incremental
additions to Community's  growing portfolio.  Community undergoes a rigorous and
consistently  applied  process on a  quarterly  basis in order to  evaluate  the
allowance for loan losses and the  determination of the quarterly  provision for
credit losses.  Net  charge-offs  during 2004 were only $1.9 million or 0.16% of
average loans. Non-accrual loans aggregated just $5.4 million, and remained near
the lowest levels in Community's more recent history.  One of the more important
measures of credit quality is the coverage of non-accrual  loans provided by the
allowance. At December 31, 2004, this ratio reached 266% compared to 162% at the
end of 2003. See the section of this  discussion  which  addresses the allowance
for loan losses and asset quality for additional information.
                                       19
<PAGE>

NON-INTEREST INCOME

Generation  of  increased  levels  of  non-interest  income  continues  to be an
integral  component  of  Community's  operating  strategy.  The  development  or
acquisition of new financial  service  offerings,  combined with the enhancement
and expansion of traditional fee-based banking services, have been the catalysts
for steady growth in this vital revenue  source.  Results for both 2004 and 2003
were influenced by the impact of gains from security transactions and by certain
non-recurring transactions.

Total  non-interest  revenues  grew 13% from  2003 to 2004.  Aggregate  revenues
reached $23.2  million  versus $20.5  million,  inclusive of gains from sales of
securities.   Excluding  the  financial   impact  of  both  security  gains  and
non-recurring revenues, comparisons of non-interest income between 2004 and 2003
resulted in a 18% increase in adjusted non-interest income.  Non-interest income
adjusted  for  these  items now  accounts  for 24% of total  revenues,  which is
defined  as the sum of  tax-equivalent  net  interest  income  and  non-interest
income. The following presentation provides a comparative summary,  adjusted for
security gains and non-recurring  items, of non-interest income between 2003 and
2004:

<TABLE>
<CAPTION>
                                                                                               Change
                                                                                      -------------------------
                                                               2004         2003        Amount          %
                                                            ---------------------------------------------------
<S>                                                         <C>          <C>          <C>              <C>
         Investment management and trust services           $   1,510    $   1,326    $     184        14%
         Service charges on deposit accounts                    7,120        5,128        1,992        39%
         Other service charges, commissions and fees            3,357        2,958          399        13%
         Insurance premium income and commissions               3,260        2,822          438        16%
         Mortgage banking activities                            2,665        2,532          133         5%
         Earnings on investment in life insurance               1,593        1,455          138         9%
         Other income (excluding non-recurring)                   513          674         (161)      (24)%
                                                           ---------------------------------------------------

                                                               20,018       16,895        3,123        18%

         Other income--non-recurring:
               Gain on branch sale                                ---        1,144       (1,144)
               Pension curtailment                                ---          497         (497)
               Gain on sale of credit card portfolio              725          ---          725
                                                            ---------------------------------------------------
                     Subtotal                                  20,743       18,536        2,207        12%

         Investment security gains                              2,470        1,927          543        28%
                                                            ---------------------------------------------------

         Total non-interest income                          $  23,213    $  20,463    $   2,750        13%
                                                            ===================================================
</TABLE>

Investment  management and trust revenues  include fees derived from the sale of
various retail investment products (annuities, brokerage services, mutual funds,
etc) as well as fees related to Community's 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  comprehensive  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 under the umbrella of their  primary  financial  institutions  for this
vital service.  Trust revenues,  which are primarily driven by fees derived from
the  administration  of personal trust accounts,  also  experienced more vibrant
growth during 2004. Late in 2003 Community announced its affiliated  arrangement
with Bryn Mawr Trust Company,  pursuant to which a more  competitive  investment
management  product  menu  could  be  offered  to new  customers.  A  number  of
initiatives  were  executed in 2004 in  furtherance  of  leveraging  this unique
relationship and will continue into 2005.


                                       20
<PAGE>
In the first quarter of 2003,  Community began to provide a new product offering
which was branded as  "OverdraftHonor".  Under the benefits  provided  from this
service,  demand deposit customers can avoid the adverse credit  implications of
the occasional  inadvertent  overdraft  situation and simultaneously  facilitate
timely  payment  of  overdraft  items.  Since its  introduction,  Community  has
experienced steady increases in the fees derived from this service with a modest
increase  in related  credit  losses.  Such  growth  was  related to a number of
factors:  the  heightened  consumer  awareness of the benefits of this  service;
increased  product  utilization;  and the overall growth in the number of demand
deposit  accounts.  While Community expects to continue to record increased fees
from this  service  in 2005,  it is  anticipated  that the pace of  growth  will
moderate from current levels as the product  matures and is more fully saturated
within the core customer base. The vast majority of the $2.0 million increase in
service  charges on deposit  accounts was derived from fees associated with this
service.  The  remainder  was due to increases in the fee structure for this and
more traditional overdraft fees.

Other service  charges  include letter of credit fees,  credit card  interchange
income and safe deposit  rentals.  The most  significant  volume of fees in this
category,  however,  are derived  from  interchange  fees from  Community's  ATM
network and from debit card  transactions,  which  together  provide  nearly two
thirds of the total of $3.4 million in fees.  Community continues to maintain an
ATM network of nearly 100 ATMs,  including  those in place under a  relationship
with a local  convenience  store chain operating within  Community's  geographic
footprint.  Transaction counts for non-customer use of the network have remained
constant  despite a full-year  increase in the  standard fee charged for foreign
transactions. The more substantial increase was realized in the interchange fees
associated with retail transactions  conducted via the use of debit cards. These
charges  aggregated  nearly  $1.1  million in annual  fees,  resulting  in a 42%
increase  over 2003.  Nearly all of the increases in these sources of fee income
resulted from increased usage and the consumer's  continuing acceptance of these
electronic  mediums to augment cash or check-based  transactions.  Community has
conducted  promotional campaigns to encourage the use of debit card transactions
versus traditional check 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,   The
Sentinel Agency, LLC (Sentinel). During 2003, Community consummated acquisitions
of ABCO (April,  2003), which is now a division of Sentinel,  and Your Insurance
Partner  (October,  2003), an insurance  agency.  The year 2004  represented the
first full year of combined  operations from these acquisitions and fueled a 16%
increase in commissions.  Growth in commissions  was  constrained,  however,  as
title activity declined in a manner that correlated with the decline in mortgage
refinancing  activity,  an important  catalyst for increases in title  insurance
services.

Mortgage  banking  activities in 2004 were adversely  impacted by the decline in
mortgage  refinancing,  which had experienced a dramatic upturn for the last two
to three years.  The steady  decline in the rates offered on  fixed-rate  single
family  homes  had  spurred  an  extraordinary  level of  refinancing  activity.
Although 2004  represented the first full year of activity since the acquisition
of Erie Financial  Group,  Ltd.  (Erie),  such activity was hampered by the fact
that much of the pent-up demand for mortgage  refinancing  had been satisfied in
previous  years.  Revenues  from mortgage  banking  activities,  primarily  from
brokerage  activities,  grew to just $2.7  million  compared to $2.5  million in
2003,  a  rather  modest  increase  of 5% in the  first  full  year of  combined
operations of Erie and Community.

Earnings on investment in life insurance represent the increase in cash value of
Bank Owned Life Insurance  (BOLI)  policies.  The BOLI policies of Community are
designed to offset costs of supplemental retirement plans and life insurance for
selected  executives and to partially offset the costs of employee benefit plans
including health, group life and disability insurance.  Income from BOLI totaled
$1.6 million in 2004 and $1.5 million in 2003.  The  investment  in BOLI totaled
$35.5 million and $28.8 million at December 31, 2004 and 2003.  Earnings on BOLI
are affected by  fluctuations in interest rates and provide a tax-free return to
Community.

The comparison of non-recurring income provided in the chart on page 20 isolates
the financial  impact of the pension  curtailment and branch sale which occurred
in 2003 and the gain from the sale of the credit card portfolio in 2004.  During
2004,  Community  analyzed the competitive  issues  surrounding the viability of
maintaining its credit card portfolio in a business line increasingly  driven by
the  advantages  of scale.  Such  analysis was  considerate  of the  competitive
challenges  presented by the large  mono-line  credit card providers  versus the
potential  for  meaningful  expansion  of  Community's  current  customer  base.
Although  credit cards will continue to be offered to customers via an outsource
arrangement,  Community  sold its  portfolio  in the third  quarter  of 2004 and
realized  a gain of  $725,000.
                                       21
<PAGE>
Gains from the sale of investment  securities totaled $2.5 million and increased
by nearly $543 thousand  between 2003 and 2004. The majority of gains related to
sales of equity  holdings in bank stocks,  the majority of which occurred in the
first half of the year.  During  that time,  Community  had also  embarked  on a
simultaneous  marketing  campaign that focused on increasing  its  visibility in
core markets and certain product-specific  advertising.  This resulted in higher
marketing expenditures, particularly in the second quarter of 2004.

NON-INTEREST EXPENSES

Aggregate  non-interest expenses grew to $50.0 million in 2004 compared to $45.7
in 2003,  an  increase  of $4.3  million  or nearly  10%.  The pace of growth in
non-interest   expenses  was  influenced  by  additional   expenses  from  those
businesses acquired in 2003 that were integrated with existing financial service
activities. Because 2004 represented the first full year of operations for these
businesses  (ABCO,  Your  Insurance  Partner,  Erie),  half  of  the  growth  in
non-interest  expenses was directly  attributable to the incremental expenses of
these  businesses  incurred  from 2003 (partial  year) to 2004 (full year).  The
following table  summarizes the expenses  incurred during the last two years and
isolates  the  year-over-year  changes into its two  components;  those from new
businesses and those from on-going operations (dollars in thousands):

<TABLE>
<CAPTION>

                                                                                $ Change                       % Change
                                           -----------------------    ------------------------------   --------------------------
                                              2004        2003          New      Other      Total        New     Other    Total
                                           ----------- -----------    ------------------------------   --------------------------

<S>                                        <C>         <C>            <C>       <C>       <C>             <C>      <C>       <C>
        Salaries and employee benefits     $  28,337   $  25,397      $  1,635  $  1,305  $  2,940        7%       5%        12%
        Net occupancy expense                  7,980       7,200           229       551       780        3%       8%        11%
        Marketing expense                      2,325       2,018            14       293       307        1%      14%        15%
        Telecommunications expense             1,285       1,302            16       (33)      (17)       1%      (2)%      (1)%
        Other operating expense               10,066       9,801           243        22       265        3%     ---          3%
                                           -----------------------    ------------------------------   --------------------------

             Total                         $  49,993   $  45,718      $  2,137  $  2,138  $  4,275        5%       5%        10%
                                           =======================    ==============================   ==========================
</TABLE>

Bifurcation  of  the  increases  in  non-interest  expenses  into  two  distinct
categories  facilitated  identification  of  the  sources  of the  $4.3  million
increase by isolating the impact of acquired businesses. Changes in the absolute
dollar  amount  were found to be equally  influenced  by the impact of  acquired
businesses  and  the  annual  increases  in  the  on-going   operating   expense
categories.  Excluding  the growth  attributed  to the full year  absorption  of
expenses associated with acquired businesses,  adjusted year-over year increases
totaled  $2.1  million,  reflecting  a more  modest 4.7%  increase in  operating
expenses from 2003.

The single largest component of costs is salary and benefits,  as these expenses
represent nearly 57% of total operating costs.  Excluding the impact of salaries
added from the  acquired  businesses,  salary  and  benefit  expenses  grew $1.3
million  during  2004.  During  2004,  the average  increase  for merit  bonuses
approximated  3%.  However,  a number of other  factors  influenced  significant
changes in the composition of salary and benefit expenses.

     o    Migratory  changes  have  occurred  in  the  compensation   structure,
          particularly  in   sales-related   positions,   whereby   portions  of
          individual  compensation  have become  more  heavily  weighted  toward
          incentive-based  pay.  This  approach,  particularly  in areas such as
          mortgage  banking,  reduced the dependence on guaranteed  compensation
          and  increased  reliance  on  a   "pay-for-performance"   compensation
          structure.

     o    Increases  in group  insurance  costs for 2004 were less  severe  than
          national trends,  primarily due to unusual competitive  pressures from
          insurance  carriers  operating  within  Community's   markets.  It  is
          expected that conditions that gave rise to these favorable  conditions
          will abate  during 2005,  and are likely to result in  increases  more
          consistent with national trends.

     o    Participation  by  acquired  employees  in  Community's  discretionary
          incentive and retirement  programs fueled a disproportionate  increase
          in benefits  expense.  Combined benefit costs related to incentive and
          retirement  programs rose to $3.3 million in 2004, a 22% increase from
          2003 and included a more generous  discretionary  contribution  to the
          employee  retirement plan and the impact of expanded  participation in
          the management bonus pool.  Amounts provided under each of these plans
          are dependent on the achievement of pre-defined performance goals.

                                       22
<PAGE>

Excluding the impact of acquired businesses,  the increase in the total count of
full-time equivalent  employees by the end of 2004 was negligible,  nearly equal
to the number in place at the end of 2003.  More focused  efforts to monitor and
manage  staffing  increases  yielded  substantial  control over staff  additions
during the year.

Community has  historically  followed the intrinsic value  accounting  method of
Accounting  Principles  Board  Opinion No. 25,  "Accounting  for Stock Issued to
Employees"  (APB 25),  which was permitted  under SFAS No 123,  "Accounting  for
Stock Based  Compensation" (SFAS 123). All options issued by Community have been
issued  at fair  value  and,  accordingly,  no  compensation  expense  has  been
recognized in the financial  statements  for stock options  issued to employees,
executive  officers or  directors  through the end of 2004.  As discussed in the
Notes to the  Consolidated  Financial  Statements,  Community  has  provided the
required pro forma disclosures of the impact of stock compensation on net income
and earnings per share by applying the fair value recognition provisions of SFAS
123. In December of 2004,  the FASB issued SFAS No 123R,  "Share-Based  Payment"
(SFAS 123R),  which  amended SFAS 123 and will now require  financial  statement
recognition of compensation cost for stock options and other stock-based  awards
for fiscal periods beginning after June 15, 2005.

Community is currently  evaluating  the various  provisions of SFAS 123R and the
optional  transition  methods  that  may  be  applied  when  adopting  this  new
accounting  standard.  It is expected  that  Community  will adopt the  modified
prospective method,  which requires  recognition of compensation expense for the
unvested  portion of  existing  awards and new  grants,  but does not  require a
restatement of prior periods. Additionally, it is also expected that the Company
and its Board of Directors,  through its Compensation Committee, will review and
evaluate  the  continuing  role  of  stock-based  compensation  in  its  overall
compensation  structure  in light of these  changes  in  prescribed  accounting.
Pending the decisions of the Compensation Committee, the ability to estimate the
impact of any new options  grants to be issued in periods  beginning  after June
15,  2005 will be affected  by the  outcome of those  decisions.  The vesting of
existing  option  grants  will  not  have a  material  impact  on the  financial
statements in the last half of 2005 or in years beyond 2005.

As would be expected,  occupancy  expenses were also influenced by the full year
impact of offices added during 2003.  Community delayed the opening of a limited
number of offices that were scheduled to be opened in 2004. Delays in new office
openings  were  affected  by a number of factors  related to the  approvals  and
timing of new office construction. Increased rentals included carrying costs for
land leases  executed in advance of the completion of office  construction  that
enabled Community to secure prime locations  expected to go on line in 2004. The
increase  in  occupancy   expense  was  also  influenced  by  service  contracts
associated with technology-related initiatives.

During the last two years, Community expanded its marketing expenditures and the
communication  channels used to reach its base of customers  and  non-customers.
These efforts have  complemented the introduction of new office locations within
core markets in past years.  These efforts also  coincided  with a more cohesive
and strategic  branding  approach  designed to take  advantage of the disruption
caused by the acquisitions of several well-known,  local financial  institutions
that compete with Community on a day-to-day basis. This elevated marketing focus
has  contributed  to an increase in overall  visibility  and has  generated  the
momentum needed for core franchise growth and an increased share of market.

Telecommunications  expenses  were elevated in 2003 due to the costs of upgrades
for  communications and data connectivity  improvements for Community's  growing
office  network.  During 2004,  Community  underwent an intensive  study with an
outside  vendor  specializing  in the review and analysis of  telecommunications
strategy.    These   efforts    identified    cost   savings   which   moderated
telecommunications  expense in 2004 and are  expected  to continue to do so into
2005.

Other  operating  costs  remained  relatively  stable  between  2003  and  2004.
Increases  were  almost  entirely  related  to the first  full year of  expenses
associated with acquired businesses during 2003.

INCOME TAXES

Income taxes grew from $4.4 million in 2003 to $4.9 million in 2004, an increase
of nearly 12%. The increase was commensurate with the increase in pretax income,
resulting  in an  effective  tax rate of  approximately  18% in both years.  The
relative rate of tax exempt income  influences the reported income tax rates and
remains the primary reason for the difference between the effective tax rate and
the statutory federal tax rate for corporations.

                                       23
<PAGE>

BALANCE SHEET: OVERVIEW

At December 31, 2004, Community's total assets reached $1.95 billion, reflecting
a change of 5% from the $1.86  billion  of assets  recorded  at the end of 2003.
Average  assets  reached  $1.94  billion for 2004  compared to $1.78 billion for
2003,  resulting in growth of 9% from 2003.  Growth in average assets was fueled
by a nearly 16% increase in average loans.  The disparity in growth from average
loans versus the growth in average assets was influenced by investment balances,
which  actually  declined  between the two periods.  The  liquidity  provided by
runoff of the investment  portfolio  combined with a 10% increase in deposits to
provide  the  funding  necessary  to absorb the  accelerated  growth in the loan
portfolio.  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 sustained  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 each of the last two years provide a validation of 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.
Community'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 Community has the ability to hold securities until
maturity,  securities  are classified as  "held-to-maturity"  investments at the
time of purchase and carried at adjusted 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.

Over the last year, balance sheet dynamics have reflected only modest changes in
the  investment  portfolio as  liquidity  from  scheduled  maturity or cash flow
runoff was often  redeployed  into the loan  portfolio  in order to satisfy  the
steady demand for credit  facilities.  During 2004,  the average  balance in the
investment  portfolio was reduced from $674 million to $666 million,  a decrease
of 1%. This decrease  followed two consecutive  years of double-digit  growth in
investment portfolio balances when the generation of funding sources,  including
increases in deposit  balances,  provided funding in excess of amounts needed to
keep pace with loan  demand.  As loan  demand  continued  to  increase  in 2004,
scheduled  runoff in the  investment  portfolio  was  utilized  to  provide  the
additional  liquidity needed to meet customer credit needs,  forestalling growth
in the investment portfolio.  From 2003 to 2004, the relative mix of investments
to earning  assets  dropped  from 40% to 36%,  while the mix of loans to earning
assets  grew from 60% to 63%.  This shift also served to bolster  earning  asset
yields as the loan  portfolio  provided a higher yield  premium by comparison to
alternate investment portfolio yields.

The pretax  unrealized net gain within the investment  portfolio at December 31,
2004 was $8.5 million.  As required,  this fair value adjustment was recorded in
other  comprehensive  income  (adjusted for income  taxes) in the  stockholders'
equity  section of the statement of  condition.  As  previously  discussed,  all
securities  included in  Community's  investment  portfolio  are  classified  as
"available  for sale".  Securities  totaling $407 million have a fair value that
exceeded the adjusted  historical  cost, with  unrealized  pretax gains totaling
$11.7  million.  Alternatively,  the  portfolio  also  included  $212 million of
investments  that have a fair  value  less than the  adjusted  historical  cost,
including unrealized losses of $3.2 million.  Special consideration was given to
those securities  which were affected by unrealized  losses to ensure the losses
were temporary.

In early 2003,  the  Emerging  Issues Task Force (EITF)  addressed  the issue of
accounting for impairments of certain  investments in debt and equity securities
in EITF 03-1. This authoritative guidance sought to clarify existing recognition
and measurement  principles to be applied to valuation impairments of securities
for reporting  periods  beginning after June 15, 2004. In December of 2004, this
new  guidance  was  temporarily  deferred  to enable  the

                                       24
<PAGE>
Financial   Accounting   Standards  Board  (FASB)  additional  time  to  further
deliberate on the impact of this guidance. In concert with the delay,  companies
holding   investments   were   encouraged   to  apply   existing   guidance  for
"other-than-temporary"   impairments  in  evaluating  the  realizable  value  of
investments with unrealized losses.  Specifically,  companies were encouraged to
perform an assessment  for those  securities in an unrealized  loss position and
were  to  determine  whether  that  impairment  was  "other-than-temporary".  In
performing  this  assessment,  it was suggested  that  companies  review several
factors in assessing the  possibility of an  "other-than-temporary"  impairment.
Factors to be considered included, but were not limited to, the following:

     o    The length of time and the extent to which  market value has been less
          than cost;
     o    The financial condition and near term prospects of the issuer;
     o    The intent and  ability of the holder to retain its  investment  for a
          period of time  sufficient  to allow for any  anticipated  recovery in
          market value.

In those instances whereby  Community had identified  securities which reflected
unrealized  losses, a systematic  methodology was applied in order to perform an
assessment of the potential for "other-than-temporary" impairment. The aggregate
portfolio of $619 million  included $212 million of investment  securities  with
unrealized  losses  totaling  $3.2  million.  Of that  amount,  $54  million  of
securities,  with an unrealized  loss of $1.9  million,  had been impaired for a
period exceeding one year. Management believes that these unrealized losses were
entirely  attributable to changes in interest rates in periods subsequent to the
acquisition of the specific securities, and did not reflect any deterioration of
the credit worthiness of the issuing entities.  Generally, those securities with
unrealized  loss  included  in  Community's  portfolio  are debt  securities  of
investment  grade  or  are  equity  securities  with   characteristics  of  debt
securities, including a specific repricing date. In all cases, it was determined
that  investments   that  were  to  be  considered  for   "other-than-temporary"
impairment:  (1) had a specified  maturity or repricing date; (2) were generally
expected to be redeemed at par,  and (3) were  expected to achieve a recovery in
market value within a reasonable period of time.  Consequently,  the impairments
identified  and  subjected to the  assessment  were deemed to be  temporary  and
required no further adjustment to the financial statements.

The following  tables  summarize  amortized  cost and  estimated  fair values at
December 31, 2004,  2003,  and 2002 and maturity  distribution  of securities at
December 31, 2004.

<TABLE>
<CAPTION>

                                                 ----------------------------------------------------- --------------------------
                                                            2004                       2003                      2002
                                                  Amortized         Fair       Amortized       Fair      Amortized       Fair
                                                     Cost          Value          Cost        Value         Cost         Value
                                                 --------------------------------------------------------------------------------

<S>                                              <C>           <C>           <C>           <C>         <C>           <C>
U.S. government  and  federal agency             $    126,056  $    125,541  $    173,651  $  173,292  $   130,947   $  134,334
Mortgage-backed, primarily federal agency             178,437       179,314       121,853     123,395      206,450      210,825
State and municipal                                   180,110       186,366       177,546     184,481      172,391      177,135
Corporate                                              58,928        60,043        95,461      97,987       95,022       93,094
Equity                                                 67,085        67,846        65,070      67,806       50,610       52,413
                                                 --------------------------------------------------------------------------------
   Total                                         $    610,616  $    619,110  $    633,581  $  646,961  $   655,420   $  667,801
                                                 ================================================================================
</TABLE>

<TABLE>
<CAPTION>

                       MATURITY DISTRIBUTION OF SECURITIES

                                                      One           Five                                                 Weighted
                                    Within One      Through       Through         After                     Average       Average
                                       Year       Five Years     Ten Years      Ten Years       Total      Maturity      Yield(a)
                                    ---------------------------------------------------------------------------------------------
<S>                                 <C>          <C>            <C>           <C>            <C>          <C>   <C>        <C>
U.S. Government and federal         $     3,077  $     25,339   $    156,704  $    119,373   $   304,493  11yr. 1 mos.     4.50%
  agencies
State and municipal                         ---           829         12,451       166,830       180,110  15yr. 6 mos.     4.89%
Other                                     4,999        14,149         11,172        28,608        58,928  13yr. 11mos.     5.72%
                                    ---------------------------------------------------------------------
    Total                           $     8,076  $     40,317   $    180,327  $    314,811   $   543,531  12yr. 11mos.     4.77%
                                    =====================================================================
Percentage of total                       1.49%         7.42%         33.18%        57.92%        100.0%
                                    =====================================================================

Weighted average yield (a)                6.00%         4.83%          4.47%         4.89%         4.77%
                                    =====================================================================
</TABLE>

(a) Weighted  average  yields,  based on amortized  cost, were computed on a tax
equivalent basis using a federal tax rate of 35%.
                                       25
<PAGE>

LOANS

Average  loans grew  15.7% to nearly  $1.2  billion  for 2004  compared  to $1.0
billion for 2003. The following table provides a summary of the increases in the
various categories of loans (dollars in thousands).

<TABLE>
<CAPTION>
                                                                                           Change
                                                 2004              2003            Amount            %
                                           -------------------------------------------------------------------

<S>                                        <C>               <C>               <C>                   <C>
        Commercial                         $      404,653    $      338,907    $     65,746          19%
        Commercial real estate                    310,769           268,470          42,299          16%
        Residential real estate                    95,547           102,545          (6,998)         (7)%
        Consumer                                  342,964           287,268          55,696          19%
                                           -------------------------------------------------------------------
             Total                         $    1,153,933    $      997,190    $    156,743          16%
                                           ===================================================================
</TABLE>


For the last several years,  Community has focused on leveraging its position as
one of the larger financial  institutions that remains  headquartered in central
Pennsylvania.  Community  has improved its  visibility  within its core markets,
particularly in the commercial and commercial real estate sectors.  The addition
of experienced lenders with long-term ties to the business  communities in these
markets has enhanced  Community's profile and increased its access to commercial
lending  opportunities.  Brisk  activity in  construction  and land  development
lending  as well as  traditional  consumer  real  estate  financing  fueled  the
substantial increases in these categories. Commercial lending activity continues
to be driven almost  exclusively by in-market  transactions.  Community has also
increased the volume of lending to various governmental bodies within its market
as the creation of a  governmental  banking unit has increased its focus in this
sector.

At the same time,  efforts were also made to become a more competitive  consumer
lender within Community's footprint.  During 2004, promotions for revolving home
equity lines of credit with preferential terms created significant  interest and
generated  substantial increases in consumer lending opportunities and expansion
of  customer  relationships.  Increases  were also  noted in the  volume of home
equity loans with specified terms.  Community has centralized the administration
and oversight of consumer lending activities which has produced a more strategic
approach to expansion of activity in the consumer lending sector.

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  fixed-rate,
conforming  mortgages 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 provided valuable liquidity for other forms
of relationship lending.


ALLOWANCE FOR LOAN LOSSES AND CREDIT QUALITY

The following sets forth activity within the allowance for loan losses for the
last three years (dollars in thousands).
<TABLE>
<CAPTION>
                                                          ------------------------------------------------
                                                               2004             2003            2002
                                                          ------------------------------------------------

<S>                                                       <C>              <C>             <C>
              Balance at January 1,                       $     13,178     $      12,343   $      12,132
                   Loans charged off                            (2,910)           (2,839)         (4,180)
                   Recoveries                                    1,053             1,174           1,041
                   Provision charged to operations               3,100             2,500           3,350
                                                          ------------------------------------------------
              Balance at December 31,                     $     14,421     $      13,178   $      12,343
                                                          ================================================

              Allowance for credit losses to loans               1.19%             1.22%           1.36%
</TABLE>


                                       26
<PAGE>


For the last two years,  the credit quality profile of Community Banks has shown
substantial  improvement  despite  significant growth in loans,  growth that was
particularly  evident in the commercial and commercial real estate sectors.  The
ratio  of net  charge-offs  to  loans  for  2003 and 2004 was 0.17 % and 0.16 %,
respectively.  In the two years prior to 2003, net  charge-off  levels were more
than double those amounts.  This  performance was  particularly  notable because
aggregate  loan balances  increased  15.7% in 2004 and 12.4% in 2003,  providing
some  indication  of the relative  quality of loans being added to the portfolio
over  these  periods.  Community  also  monitors  the level of the  coverage  of
non-accrual  loans  provided by the allowance  for loan losses.  At December 31,
2004,  the  allowance  provided 2.66 times  coverage of those loans  included as
non-accrual  loans.  At the end of 2003,  this same ratio was 1.62 times.  These
measures,  as well as a number of other key measures,  serve to demonstrate  the
continuing  improvement  in the  overall  credit  quality  profile  of the  loan
portfolio.

The following sets forth loan loss experience for the last five years:
<TABLE>
<CAPTION>
                                                     ----------------------------------------------------------------------------
                                                          2004            2003           2002           2001           2000
                                                     ----------------------------------------------------------------------------
<S>                                                  <C>             <C>             <C>            <C>            <C>
      Loans at year-end                              $  1,215,951    $  1,078,611    $    904,568   $    857,278   $   814,874
                                                     ============================================================================

      Average loans balance                          $  1,153,933    $    997,190    $    886,808   $    838,178   $   768,204
                                                     ============================================================================
      Balance, allowance for loan losses,  January
            1                                        $     13,178    $     12,343    $     12,132   $     10,328   $     8,976

      Loans charged off:
          Commercial, financial and agricultural              300             253           1,878          2,275           303
          Real estate-commercial mortgage                   1,087           1,336           1,337            484*          521*
          Real estate-retail mortgage                         160             212             110            ---           ---
          Consumer and other                                1,363           1,038             855          1,017         1,101
                                                     ----------------------------------------------------------------------------

      Total                                                 2,910           2,839           4,180          3,776         1,925
                                                     ----------------------------------------------------------------------------

      Loans recovered:
          Commercial, financial and agricultural              324             240             644            120            23
          Real estate-commercial mortgage                     240             606               7            108*           83*
          Real estate-retail mortgage                          17              83              18            ---           ---
          Consumer and other                                  472             245             372            272           308
                                                     ----------------------------------------------------------------------------

      Total                                                 1,053           1,174           1,041            500           414
                                                     ----------------------------------------------------------------------------

      Net charge-offs                                      (1,857)         (1,665)         (3,139)        (3,276)       (1,511)

      Provision for loan losses                             3,100           2,500           3,350          5,080         2,863
                                                     ----------------------------------------------------------------------------

      Balance,  allowance for loan losses,
            December 31                              $     14,421    $     13,178    $     12,343   $     12,132   $    10,328
                                                     ============================================================================

      Net charge-offs to loans at year end                 0.15%           0.15%           0.35%          0.38%          0.19%

      Net charge-offs to average loans                     0.16%           0.17%           0.35%          0.39%          0.20%

      Balance of allowance for loan losses
            to loans at year end                           1.19%           1.22%           1.36%          1.42%          1.27%
</TABLE>

     *  Prior  breakouts  of  historical   information   could  not  be  readily
     reconstructed from predecessor banks' records.  Breakouts from 2000 to 2001
     are assumed to approximate current mix trends.

The ratio of the allowance to loans  declined  modestly from 1.22% at the end of
2003 to 1.19 % at the end of 2004. This decline  occurred despite a $1.2 million
increase in the absolute balance of the allowance, which grew from $13.2 million
at the end of 2003 to $14.4 million at the end of 2004. The decline in the ratio
of the allowance to loans was primarily attributed to the rapid increase in loan
balances.  This  increase  influenced  the  increase in the  provision  for loan
losses,  which  rose  from $2.5  million  to $3.1  million  even as the level of
identified problem loans declined.

                                       27
<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.

<TABLE>
<CAPTION>

                                                       ------------------------------------------------------------------------
                                                           2004           2003          2002           2001           2000
                                                       ------------------------------------------------------------------------
<S>                                                    <C>            <C>           <C>             <C>           <C>
        Loans:
            Commercial, financial and agricultural     $      7,899   $      7,090  $      6,305    $     9,285   $      5,268
            Real estate-construction                            ---            ---           ---             10             14
            Real estate-mortgage                              2,099          2,313         1,936            965          1,593
            Installment                                       3,202          2,184         1,767          1,030          1,748
            Unallocated                                       1,221          1,591         2,335            842          1,705
                                                       ------------------------------------------------------------------------

        Balance                                        $     14,421   $     13,178  $     12,343   $     12,132   $     10,328
                                                       ========================================================================
</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.

Community'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  served.
Commercial  and  commercial  real estate loans are  individually  risk-rated  by
Community'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 $593 thousand at December 31, 2004.
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.

                                       28
<PAGE>

<TABLE>
<CAPTION>
                                                    -----------------------------------------------------------------------
                                                        2004           2003           2002          2001          2000
                                                    -----------------------------------------------------------------------
<S>                                                 <C>            <C>            <C>            <C>          <C>
      Loans on which accrual of interest has
        been discontinued:

          Commercial, financial and agricultural    $      1,748   $      3,066   $      2,257   $     3,783  $     2,042
          Mortgages                                        2,894          4,054          6,609         6,952        3,445
          Other                                              786          1,031            527           355          356
                                                    -----------------------------------------------------------------------
                                                           5,428          8,151          9,393        11,090        5,843
                                                    -----------------------------------------------------------------------

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

      Total non-accrual loans                              5,428          8,151          9,393        11,090        6,048

      Foreclosed real estate                               2,094          4,865          1,183           631          416
                                                    -----------------------------------------------------------------------

      Total non-performing assets                          7,522         13,016         10,576        11,721        6,464
      Loans past due 90 days or more:
          Commercial, financial and agricultural             ---              4             97         1,002            8
          Mortgages                                          ---             40            770           405          495
          Consumer and other                                 ---             46             94           252          109
                                                    -----------------------------------------------------------------------

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

      Total risk elements                           $      7,522   $     13,106   $     11,537   $    13,380  $     7,076
                                                    =======================================================================

      Ending allowance for loan losses              $     14,421   $     13,178   $     12,343   $    12,132  $    10,328
                                                    =======================================================================

      Ending allowance to non-accrual loans               266%             162%          131%          109%         171%
</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 2004 was $360,000.

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,  2004 was  adequate to absorb
probable losses within the loan portfolio.

                                       29
<PAGE>
DEPOSITS

Deposit balances remain the primary source of funding for financial institutions
and  Community  recognized  steady  growth  of  nearly  10%  in  this  important
core-funding source, with average balances summarized as follows:
<TABLE>
<CAPTION>
                                                                                             Change
                                                                                             ------
                                                    2004              2003            Amount           %
                                                    ----              ----            ------           -

<S>                                           <C>               <C>               <C>                   <C>
            Demand                            $      178,084    $       167,315   $     10,769          6%
            Savings & NOW accounts                   495,968            401,805         94,163         23%
            Time                                     510,046            498,005         12,041          2%
            Time $100,000 or more                    111,879            110,231          1,648          1%
                                              ----------------------------------------------------------------
                                               $   1,295,977    $     1,177,356   $    118,621         10%
                                              ================================================================
</TABLE>

As  in  2003,  deposit  trends  were  influenced  by  consumer  preferences  for
liquidity.  The scarcity of opportunities available to achieve higher returns by
extending  maturities  stunted growth in most time deposit  categories.  Deposit
growth  in  2004  was  concentrated  in  savings  deposits,   more  specifically
Community's Power Checking account.  This account,  which has characteristics of
both a money market and checking  account,  has grown steadily  throughout  both
2004  and  2003.  Consumer   preferences  were  clearly  weighted  in  favor  of
maintaining  adequate  liquidity in  anticipation of a future increase in rates.
This was influenced, in part, by concerns over the presidential election and any
possible  impact  that may have on  expectations  for the pace and  velocity  of
chances in interest  rates.  Despite the fact that most interest  rates declined
steadily through mid-year, 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, 2004.

<TABLE>
<CAPTION>

<S>                                                                             <C>
                            Remaining Time to Maturity:
                              Less than three months                            $        19,365
                              Three months to six months                                 12,157
                              Six months to twelve months                                20,506
                              More than twelve months                                    53,980
                                                                                -----------------
                                                                                $       106,008
                                                                                =================
</TABLE>

BORROWED FUNDS

Community makes tactical use of Federal Home Loan Bank (FHLB) advances and other
borrowed funds to augment its funding needs.  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.  At December 31,  2004,  the amount  available  for  borrowing  under FHLB
arrangements totaled $158.3 million. The use of advances and borrowed funds is a
by-product of Community's  overall asset / liability  management strategy and is
influenced by a number of factors, which are discussed more fully in the section
titled "Asset / Liability Management and Liquidity".

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.  Community  has
developed  an  extensive  capital  management  policy  designed to consider  all
aspects of
                                       30
<PAGE>

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
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. Community'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 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 bank subsidiary at the end of
2004, along with an indication of the various regulatory capital requirements.

<TABLE>
<CAPTION>
                                                  December 31,           "Well              "Regulatory
                                                     2004             Capitalized"            Minimums"
                                                     ----             ------------            ---------
<S>                                                  <C>                  <C>                   <C>
           Leverage ratio
                Community Banks, Inc.                8.80%                 n/a                  4%
                Bank only                            8.22%                  5%                  4%

           Tier 1 capital ratio
                Community Banks, Inc.               11.62%                 n/a                  4%
                Bank only                           10.85%                  6%                  4%

           Total risk-based capital ratio
                Community Banks, Inc.               12.62%                 n/a                  8%
                Bank only                           11.83%                 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.   Throughout  the  year,  Community's  earnings  trends
supported  a return  of  capital  to  existing  shareholders  in the form of the
traditional cash dividend. Community also made strategic use of share repurchase
as another efficient means of returning  capital to shareholders.  At the end of
both 2002 and 2003,  Community  executed separate  issuances of $15.5 million of
subordinated  debentures and the total subordinated debentures balances remained
at $30.9 million as of the end of 2004. Community places no significant reliance
on these instruments to meet regulatory capital requirements.  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.
Community  does not  presently  have any  commitments  for  significant  capital
expenditures.

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.  Community's  Board of Directors and the
Audit  Committee  of the Board  govern and  monitor  asset/liability  management
processes  and  liquidity  as part of the overall  risk  management  process and
delegate the  responsibility  for management of these processes to the corporate
Asset/Liability Management Committee (ALCO).

Liquidity is defined as the ability to meet maturing  obligations and customers'
demand for funds on a continuous basis. Good liquidity exists when an entity can
meet its potential cash obligations  without  liquidating its franchise  assets.
Poor liquidity exists when a company lacks the liquid assets to cover short term
liabilities.  Liquidity is sustained by

                                       31
<PAGE>
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.  Bank liquidity could contract from current
comparatively   strong   positions  if  there  were  reversals  in  trends  that
contributed to recent  deposit  growth.  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.  Community'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,
Community  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, 2004:

<TABLE>
<CAPTION>
                                                              Annual
                               Simultaneous                   Change
                                   Rate                  in Net Interest                  %
                                 "Shock"                      Income                    Change
                      --------------------------------------------------------------------------------

<S>                                <C>                     <C>                           <C>
                                  +300bp                  +$5.0 million                 +8.35%
                                  +200bp                  +$3.5 million                 +5.84%
                                  +100bp                  +$1.8 million                 +2.98%
                                  -100bp                  -$3.2 million                 -5.26%
</TABLE>

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, 2004, 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:

<TABLE>
<CAPTION>
                                                                        Cumulative GAP
                                     Interval                     (Expressed as % of Assets)
                      ---------------------------------------------------------------------------

<S>                              <C>                                         <C>
                                 0-90 days                                 + 11.18%

                                 91-180 days                               + 10.94%

                                 181-365 days                              + 10.28%
</TABLE>

EVE computations provide a longer-term assessment of interest rate risk, but are
more  practical for evaluating  long-term,  strategic  decision-making.  EVE has
several  limitations,   including:   (1)  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;

                                       32
<PAGE>

(2) estimated cash flows are required for non-maturity financial instruments and
are, by their  nature,  inexact;  and (3) the future  structure  of  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 2004,
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, 2004 are summarized in the
following table:

<TABLE>
<CAPTION>

                                                                            Payments due by period
                                                -------------------------------------------------------------------------------
                                                                  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                          $      404,662  $       42,243  $       69,229  $       32,878  $      260,312
        Operating lease obligations                     11,350           1,223           1,833           1,261           7,033
        Subordinated debt                               30,928             ---             ---             ---          30,928
        Time deposits                                  623,803         275,992         257,143          89,716             952
        -----------------------------------------------------------------------------------------------------------------------

        Total                                    $   1,070,743  $      319,458  $      328,205  $      123,855  $      299,225
        -----------------------------------------------------------------------------------------------------------------------
</TABLE>


OFF-BALANCE SHEET COMMITMENTS

As of December 31, 2004,  Community  had unfunded  commitments  totaling  $484.2
million.  For  details of these  off-balance  sheet  commitments,  see "Notes to
Consolidated  Financial Statements - Commitments and Contingencies"  included in
Part II, Item 9

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  2004,  the
Pennsylvania  State  Department  of  Banking,   the  Federal  Deposit  Insurance
Corporation, and the Federal Reserve 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,  Community  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  relatively  modest but more recent  trends  suggest the
potential  for  emerging  inflationary  pressure.  Management  will  continue to
monitor the  potential  for  inflation and its impact on the pricing of products
and services.

PERFORMANCE REVIEW: 2003 VERSUS 2002

Community completed a year of record performance in 2003,  reporting the highest
net income and earnings  per share in its history up to that point.  At the same
time,  Community made  significant  progress in its continuing  effort to evolve
into a "community-focused"  and integrated financial services  corporation.  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 $1.63, a
10% improvement  from the $1.48 reported in 2002. At the end of 2003,  Community
produced  an ROA of 1.15% and an ROE of  15.03%,  which were  comparable  to the
performances of 1.17% and 15.46% in the prior year.

                                       33
<PAGE>
Interest Income

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%  between  the two  years.  Earning  asset  growth,  fueled
principally by loan growth,  forged a 13.0% increase from $1.49 billion to $1.68
billion 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 Checking
offering.

Interest Expense

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 $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.  Total  deposits grew by $86 million.  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  in 2003.  Incremental
borrowing  rates on federal  funds  influenced  the  pricing  of all  short-term
sources of funds and made these borrowings far less expensive than other funding
sources.  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.  Community  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.

Net Interest Income

Despite the decline in earning asset yields,  interest income  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.  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% , from $56.3  million in 2002 to $58.9  million in
2003.

As a result of rate trends and other dynamics  specific to  Community's  balance
sheet, Community 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.

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,  was responsive to
the

                                       34
<PAGE>

changing credit quality  conditions.  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.

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.

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.  Since the end of 2001,  Community had
added a total of seven new banking  facilities  while  selling  three offices in
markets with less robust growth characteristics. This selective expansion of the
Community Banks franchise had a significant  influence on the operating  expense
structure.  At the same time, this expansion had also been an important catalyst
for the growth in loan and deposit balances since the end of 2001.

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.  Payroll  taxes and employee
insurance  costs 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 branch offices,  the increased cost of the customer service center,  and
by the addition of new lenders for certain key growth markets.

Expenses not related to  employee-related  costs also grew.  Occupancy  expenses
were influenced by increased costs  associated with community  office  expansion
and rose by just over $1 million.  Marketing and promotional  expenses increased
over $900 thousand. 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.  Marketing campaigns were undertaken to expand 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.


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

     *    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, 2004,  2003,  2002, 2001,
          and 2000.
     *    Maturities   and   Sensitivity   to  Changes  in  Interest  Rates  for
          Commercial, Financial, and Agricultural Loans as of December 31, 2004.


                                       35
<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, 2004, 2003, and 2002

                                            2004                                 2003                                 2002
                           ---------------------------------------------------------------------------------------------------------
                                                      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(a)  Paid (a)  Balance(c)   Expense(a)  Paid (a)
                           ---------------------------------------------------------------------------------------------------------
<S>                          <C>         <C>           <C>    <C>            <C>          <C>     <C>            <C>         <C>
Assets:
 Earning assets:
  Interest-bearing
  deposits in other banks    $    2,325  $       20    0.86%  $     1,160    $      9     0.78%   $     1,742    $     26    1.49%
  Investment securities:
     Taxable                    456,478      19,624    4.30       466,316      18,607     3.99        384,097      19,602    5.10
     Tax-exempt (b)             209,170      15,856    7.58       207,627      15,957     7.69        200,419      14,955    7.46
                             -----------                      -----------                         -----------
      Total investment
      securities                665,648                           673,943                             584,516
                             -----------                      -----------                         -----------
  Federal funds sold              7,801         117    1.50         4,015          40     1.00         11,126         193    1.73
  Loans (b) (d)               1,156,107      70,721    6.12     1,001,086      66,604     6.65        889,912      67,712    7.61
                           ---------------------------------------------------------------------------------------------------------
    Total earning assets      1,831,881     106,338    5.80     1,680,204     101,217     6.02      1,487,296     102,488    6.89
                           ---------------------------------------------------------------------------------------------------------
Cash and due from banks          37,316                            36,451                              36,982
Allowance for loan losses       (14,156)                          (13,016)                            (12,689)
Premises, equipment,
  and other assets               86,055                            77,040                              68,457
                             -----------                      -----------                         -----------
      Total assets           $1,941,096                       $ 1,780,679                         $ 1,580,046
                             ===========                      ===========                         ===========

Liabilities:
 Interest-bearing
 liabilities:
  Savings deposits           $  167,428         413    0.25   $   164,207         690     0.42    $   149,066       1,864    1.25
  Money market deposits          62,591         377    0.60        74,156         624     0.84         82,793       1,289    1.56
  NOW accounts                  265,949       3,484    1.31       163,442       2,006     1.23         90,773         998    1.10
  Time deposits:
     $100,000 or greater        111,879                           110,231                             107,523
     Other                      510,046                           498,005                             498,159
                             -----------                      -----------                         -----------
       Total time deposits      621,925      18,249    2.93       608,236      19,777     3.25        605,682      24,498    4.04
                             -----------                      -----------                         -----------
      Total interest-bearing
       deposits               1,117,893                         1,010,041                             928,314
                             -----------                      -----------                         -----------
  Short-term borrowings          59,303         739    1.25        97,837       1,243     1.27         54,178         977    1.80
  Long-term debt                394,944      18,382    4.65       339,564      17,256     5.08        301,922      16,560    5.48
  Subordinated debt              30,928       1,598    5.17        16,148         755     4.68            484          26    5.37
                           ---------------------------------------------------------------------------------------------------------
     Total interest-bearing
       liabilities            1,603,068      43,242    2.70     1,463,590      42,351     2.89      1,284,898      46,212    3.60
                           ---------------------------------------------------------------------------------------------------------
Demand deposits                 178,084                           167,315                             163,434
Accrued interest, taxes
  and other liabilities          14,194                            14,001                              12,362
                             -----------                      -----------                         -----------
     Total liabilities        1,795,346                         1,644,906                           1,460,694
                             -----------                      -----------                         -----------
Stockholders' equity            145,750                           135,773                             119,352
                             -----------                      -----------                         -----------
     Total liabilities and
  stockholders' equity       $1,941,096                       $ 1,780,679                         $ 1,580,046
                             ===========                      ===========                         ===========

Interest income to earning assets                      5.80%                              6.02%                              6.89%
Interest expense to earning assets                     2.36                               2.52                               3.11
                                                       -----                              -----                              -----

     Effective interest differential       $ 63,096    3.44%                 $ 58,866     3.50%                  $ 56,276    3.78%
                                           =================                 ==================                  =================
</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 a tax  equivalent  basis  utilizing  a Federal  tax rate of 35% in 2004,
     2003, and 2002.
(c)  Averages are a combination of monthly and daily averages.
(d)  Includes  non-accrual loans and  interest-earning  education loans held for
     sale.

                                       36
<PAGE>


<TABLE>
<CAPTION>

                  Rate/Volume Analysis-Tax Equivalent Basis (a)
                 For the Years Ended December 31, 2004 and 2003

                                             ---------------------------------------------------------------------------------------
                                                           2004 vs 2003                                2003 vs 2002
                                             ---------------------------------------------------------------------------------------
                                                Volume         Rate          Total         Volume          Rate           Total
                                             ---------------------------------------------------------------------------------------

                                                                            Favorable (Unfavorable)
<S>                                          <C>           <C>            <C>           <C>           <C>             <C>
Increase (decrease) in interest income:
     Loans                                   $     9,767   $   (5,650)    $    4,117    $    7,935       $ (9,043)    $    (1,108)
     Investment securities:
         Taxable                                    (399)       1,416          1,017         3,734          (4,729)          (995)
         Tax exempt                                  118         (219)          (101)          545             457          1,002
                                             ---------------------------------------------------------------------------------------
            Total                                   (281)       1,197            916         4,279          (4,272)             7
     Federal funds sold                               50           27             77           (92)            (61)          (153)
     Interest-bearing deposits in other
       banks                                          10            1             11            (7)            (10)           (17)
                                             ---------------------------------------------------------------------------------------
         Total                                     9,546       (4,425)         5,121        12,115         (13,386)        (1,271)
                                             ---------------------------------------------------------------------------------------


(Increase) decrease in interest expense:
     Savings deposits                               (806)        (148)          (954)         (877)          1,708            831
     Time deposits                                  (437)       1,965          1,528          (102)          4,823          4,721
     Short-term borrowings                           480           24            504          (615)            349           (266)
     Long-term debt                               (2,658)       1,532         (1,126)       (1,959)          1,263           (696)
     Subordinated debt                              (757)         (86)          (843)         (732)              3           (729)
                                             ---------------------------------------------------------------------------------------
         Total                                    (4,178)       3,287           (891)       (4,285)          8,146          3,861
                                             ---------------------------------------------------------------------------------------

Increase (decrease) in effective interest
differential                                 $     5,368   $   (1,138)    $    4,230    $    7,830       $ (5,240)    $     2,590
                                             =======================================================================================
</TABLE>

(a) Table shows  approximate  effect on the effective  interest  differential of
volume and rate  changes for the years 2004 and 2003.  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
2004, 2003, and 2002.



                                       37
<PAGE>
<TABLE>
<CAPTION>

                            LOAN ACCOUNT COMPOSITION
                                as of December 31
                                -----------------

                                       2004                2003                 2002                 2001                2000
                               -----------------------------------------------------------------------------------------------------
                                 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                $  409,105   33.7% $  367,444    34.1%  $ 295,506     32.7%  $ 158,223      18.4% $ 135,612     16.6%
Real estate-construction            8,703    0.7       7,338     0.7       2,615      0.3      21,225       2.5     22,403      2.7
Real estate-commercial            356,871   29.3     283,661    26.3     246,533     27.2     554,354 *    64.7    540,639 *   66.4
   mortgage
Real estate-retail mortgage        83,979    6.9      91,485     8.5     106,882     11.8         ---      ---         ---      ---
Consumer-home equity               53,921    4.4      38,299     3.5      28,169      3.1         ---      ---         ---      ---
Consumer-installment and other    303,372   25.0     290,384    26.9     224,863     24.9     123,476      14.4    116,220     14.3
                               -----------------------------------------------------------------------------------------------------
   Total loans                  1,215,951  100.0%  1,078,611   100.0%    904,568    100.0%    857,278     100.0%   814,874    100.0%
                                           =====               ======               ======                ======              ======

Allowance for loan losses         (14,421)           (13,178)            (12,343)             (12,132)             (10,328)
                               ----------         ----------           ---------            ---------            ---------

   Loans, net                  $1,201,530         $1,065,433           $ 892,225            $ 845,146            $ 804,546
                               ==========         ==========           =========            =========            =========
</TABLE>

* Prior breakouts of historical  information could not be readily  reconstructed
from  predecessor  banks'  records.  Breakouts  from 2000 to 2001 are assumed to
approximate current mix trends.

Community's loan activity is principally with customers located within its local
market area.  Community  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.
Community  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
                             as of December 31, 2004
                             -----------------------

                                                                               Maturity Distribution
                                                                               ---------------------
                                                               One Year        One to       Over Five
                                                                or Less      Five Years       Years          Total
                                                             ----------------------------------------------------------

<S>                                                          <C>            <C>           <C>            <C>
               Commercial, financial and agricultural        $     72,248   $    159,420  $    177,437   $    409,105
               Real estate-construction                               593            606         7,504          8,703
               Real estate-commercial mortgage                     34,991        137,266       184,614        356,871
                                                             ----------------------------------------------------------
                                                             $    107,832   $    297,292  $    369,555   $    774,679
                                                             ==========================================================
</TABLE>
<TABLE>
<CAPTION>

                                                                        Interest Sensitivity
                                                                        --------------------

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

<S>                                                          <C>            <C>           <C>
               Due in one year or less                       $     57,947   $     49,885  $    107,832
               Due after one year                                 391,511        275,336       666,847
                                                             -------------------------------------------
                                                             $    449,458   $    325,221  $    774,679
                                                             ===========================================
</TABLE>

                                       38
<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 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,  Community's  interest-earning  assets,
interest-bearing  liabilities,  and  off-balance  sheet  financial  instruments.
Community's  exposure to interest rate sensitivity is managed  primarily through
Community'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  Community'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  Community's exposure to interest rate
sensitivity.

The rates,  terms and  interest  rate  indices of  Community'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
Community  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, 2004.




                                       39
<PAGE>

<TABLE>
<CAPTION>

         Interest Rate Sensitivity
         -------------------------------------------------------------------------------------------------------------
         At December 31, 2004                 1-90           90-180         180-365         1 year
         Dollars in thousands                 days            days            days         or more         Total
         -------------------------------------------------------------------------------------------------------------
<S>                                       <C>            <C>             <C>             <C>            <C>
         Assets
         Interest-bearing deposits in
            other banks                   $       1,787  $          ---  $          ---  $        ---   $       1,787
         Loans held for sale                        ---             ---            ---          1,269           1,269
         Investment securities                  134,452          18,755         29,018        436,885         619,110
         Loans (a)                              453,673          64,579         98,057        599,642       1,215,951
         -------------------------------------------------------------------------------------------------------------
         Earning assets                         589,912          83,334        127,075      1,037,796       1,838,117
         Non-earning assets                         236             ---            ---        116,446         116,682
         -------------------------------------------------------------------------------------------------------------
         Total assets                    $      590,148  $       83,334  $     127,075   $  1,154,242  $    1,954,799
         -------------------------------------------------------------------------------------------------------------

         Liabilities
         Savings                         $      209,550  $          ---  $         ---   $    287,825  $      497,375
         Time                                    70,633          64,185         90,687        292,290         517,795
         Time in denominations of
            $100,000 or more                     19,265          12,157         20,506         54,080         106,008
         Short-term borrowings                   47,116             ---            ---            ---          47,116
         Long-term debt                           1,812          11,812         28,624        362,414         404,662
         Subordinated debt                       23,196             ---            ---          7,732          30,928
         -------------------------------------------------------------------------------------------------------------
         Interest bearing liabilities           371,572          88,154        139,817      1,004,341       1,603,884
         Other liabilities and equity               ---             ---            ---        350,915         350,915
         -------------------------------------------------------------------------------------------------------------
         Total liabilities and equity     $     371,572  $       88,154  $     139,817   $  1,355,256  $    1,954,799
         -------------------------------------------------------------------------------------------------------------

         Interest Sensitivity GAP
         Periodic                        $      218,576  $       (4,820) $     (12,742)  $   (201,014)
         Cumulative                                             213,756        201,014            ---
         Cumulative GAP as a
            percentage of total assets
                                                 11.18%          10.93%         10.28%             0%
</TABLE>
         (a) 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  Community'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

                                       40
<PAGE>

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 Community of FHLB  borrowings and
subordinated notes prior to maturity.

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
Community'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 is 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, 2004 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%
                                                   -------------------------------------------------------------------------------
         Assets:                                                               (dollars in thousands)
<S>                                                <C>             <C>             <C>               <C>             <C>
         Cash, interest-bearing time deposits,

             and federal funds sold                $       45,273  $       45,273  $        45,273   $      45,273   $     45,273
         Loans held for sale                                1,967           1,572            1,269           1,037            858
         Investment securities                            659,156         638,739          619,110         597,907        577,490
         Loans                                          1,233,854       1,219,788        1,201,530       1,175,453      1,152,107
         Other assets                                      87,617          87,617           87,617          87,617         87,617
                                                   -------------------------------------------------------------------------------

             Total assets                          $    2,027,867  $    1,992,989  $     1,954,799   $   1,907,287   $  1,863,345
                                                   ===============================================================================

         Liabilities:
         Deposits                                  $    1,323,663  $    1,314,529  $     1,305,537   $   1,296,675   $  1,288,089
         Short-term borrowings                             47,116          47,116           47,116          47,116         47,116
         Long-term debt                                   448,801         427,813          404,662         389,766        372,519
         Subordinated debt                                 30,928          30,928           30,928          30,928         30,928
         Other liabilities                                 14,215          14,215           14,215          14,215         14,215
                                                   -------------------------------------------------------------------------------

             Total liabilities                          1,864,723       1,834,601        1,802,458       1,778,700      1,752,867
                                                   -------------------------------------------------------------------------------

             Total stockholders' equity                   163,144         158,388          152,341         128,587        110,478
                                                   -------------------------------------------------------------------------------
             Total liabilities and stockholders'
               equity                              $    2,027,867  $    1,992,989  $     1,954,799   $   1,907,287   $  1,863,345
                                                   ===============================================================================
</TABLE>

                                       41
<PAGE>

Item 8.  Financial Statements and Supplementary Data:
-----------------------------------------------------

Community Banks, Inc. and Subsidiaries
CONSOLIDATED BALANCE SHEETS
At December 31, 2004 and 2003
(Dollars in thousands except per share data)

<TABLE>
<CAPTION>

                                                                           -------------------------------------------------
                                                                                    2004                        2003
                                                                           -------------------------------------------------
        ASSETS

<S>                                                                          <C>                          <C>
        Cash and due from banks                                              $          43,486            $       42,790
        Federal funds sold                                                                ---                     17,097
                                                                           ----------------------       --------------------
          Cash and cash equivalents                                                     43,486                    59,887
        Interest-bearing deposits in other banks                                         1,787                     3,301
        Investment securities, available for sale                                      619,110                   646,961
        Loans held for sale                                                              1,505                     6,067
        Loans, net of allowance for loan losses of $14,421 and $13,178               1,201,530                 1,065,433
        Premises and equipment, net                                                     25,517                    24,153
        Accrued interest receivable and other assets                                    61,864                    55,261
                                                                           ----------------------       --------------------
                Total assets                                                 $       1,954,799            $    1,861,063
                                                                           ======================       ====================

        LIABILITIES

        Deposits:
          Non-interest bearing                                               $         184,359            $      165,174
          Interest bearing                                                           1,121,178                 1,065,511
                                                                           ----------------------       --------------------
                Total deposits                                                       1,305,537                 1,230,685
        Short-term borrowings                                                           47,116                    27,764
        Long-term debt                                                                 404,662                   411,422
        Subordinated debt                                                               30,928                    30,928
        Accrued interest payable and other liabilities                                  14,215                    16,858
                                                                           ----------------------       --------------------
                Total liabilities                                                    1,802,458                 1,717,657
                                                                           ----------------------       --------------------

        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;  12,421,000  and 11,851,000 shares issued                          62,107                    59,256
        Surplus                                                                         73,304                    57,563
        Retained Earnings                                                               18,134                    24,297
        Accumulated other comprehensive income , net of tax                              3,211                     6,596
        Treasury stock; 185,000 and 203,000 shares, at cost                             (4,415)                   (4,306)
                                                                           ----------------------       --------------------
               Total stockholders' equity                                              152,341                   143,406
                                                                           ----------------------       --------------------
               Total liabilities and stockholders' equity                    $       1,954,799            $    1,861,063
                                                                           ======================       ====================
</TABLE>

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



                                       42
<PAGE>

<TABLE>
<CAPTION>

Community Banks, Inc. and Subsidiaries
CONSOLIDATED STATEMENTS OF INCOME
For the Years Ended December 31, 2004, 2003, and 2002
(dollars in thousands except per share data)



                                                              ---------------------------------------------------
                                                                   2004              2003               2002
                                                              ---------------------------------------------------
   INTEREST INCOME:
<S>                                                           <C>               <C>                <C>
      Loans, including fees                                   $      69,732     $     65,837       $     67,158
      Investment securities:
          Taxable                                                    18,999           17,532             18,478
          Tax exempt                                                  8,847            8,957              8,457
          Dividends                                                   2,084            2,490              2,388
     Other                                                              137               49                219
                                                              --------------    ---------------    --------------
          Total interest income                                      99,799           94,865             96,700
                                                              --------------    ---------------    --------------

   INTEREST EXPENSE:
      Deposits                                                       22,523           23,097             28,649
      Short-term borrowings                                             739            1,243                977
      Long-term debt                                                 18,382           17,256             16,560
      Subordinated debt                                               1,598              755                 26
                                                              --------------    ---------------    --------------
          Total interest expense                                     43,242           42,351             46,212
                                                              --------------    ---------------    --------------
          Net interest income                                        56,557           52,514             50,488
   Provision for loan losses                                          3,100            2,500              3,350
                                                              --------------    ---------------    --------------
          Net interest income after provision for loan               53,457           50,014             47,138
             losses
                                                              --------------    ---------------    --------------

   NON-INTEREST INCOME:
      Investment management and trust services                        1,510            1,326                993
      Service charges on deposit accounts                             7,120            5,128              3,440
      Other service charges, commissions and fees                     3,357            2,958              2,471
      Investment security gains                                       2,470            1,927              1,034
      Insurance premium income and commissions                        3,260            2,822              2,016
      Mortgage banking activities                                     2,665            2,532              1,221
      Earnings on investment in life insurance                        1,593            1,455              1,476
      Other                                                           1,238            2,315              1,324
                                                              --------------    ---------------    --------------
          Total non-interest income                                  23,213           20,463             13,975
                                                              --------------    ---------------    --------------

   NON-INTEREST EXPENSES:
      Salaries and employee benefits                                 28,337           25,397             21,636
      Net occupancy                                                   7,980            7,200              6,051
      Marketing expense                                               2,325            2,018              1,090
      Telecommunications expense                                      1,285            1,302                995
      Other                                                          10,066            9,801              9,528
                                                              --------------    ---------------    --------------
          Total non-interest expenses                                49,993           45,718             39,300
                                                              --------------    ---------------    --------------

          Income before income taxes                                 26,677           24,759             21,813
   Income taxes                                                       4,879            4,359              3,367
                                                              --------------    ---------------    --------------
          Net income                                          $      21,798     $     20,400       $     18,446
                                                              ==============    ===============    ==============

   EARNINGS PER SHARE:
      Basic                                                   $        1.78     $       1.68       $       1.51
      Diluted                                                 $        1.73     $       1.63       $       1.48
</TABLE>

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

                                       43
<PAGE>

<TABLE>
<CAPTION>

Community Banks, Inc. and Subsidiaries
CONSOLIDATED STATEMENTS OF CHANGES IN STOCKHOLDERS' EQUITY
For the Years Ended December 31, 2004, 2003, and 2002
(dollars in thousands except per share data)

                                                                                              Accumulated
                                                                                                 Other
                                         Outstanding     Common                Retained      Comprehensive   Treasury        Total
                                            Shares       Stock      Surplus    Earnings      Income (Loss)     Stock         Equity
                                         -------------------------------------------------------------------------------------------
<S>                                          <C>       <C>         <C>        <C>            <C>            <C>           <C>
Balance, December 31, 2001                   8,849     $  44,839   $  35,906  $   36,923     $    (4,024)   $  (2,395)    $ 111,249
Comprehensive income (loss):
    Net income                                                                    18,446                                     18,446
    Unrealized gain on securities, net
        of reclassification adjustment
        and tax effect                                                                         11,151                        11,151
    Change in unfunded pension
        liability, net of tax                                                                    (589)                         (589)
                                                                                                                          ----------
    Total comprehensive income                                                                                               29,008
Cash dividends                                                                    (6,654)                                    (6,654)
5% stock dividend                              440         2,241      10,177     (12,418)                                       ---
Purchases of treasury stock                   (224)                                                            (5,828)       (5,828)
Exercise of common stock options and
    issuances under stock purchase plan         86           (27)                   (953)                       2,032         1,052
Tax benefits from employee stock
    transactions                                                         335                                                    335
                                         -------------------------------------------------------------------------------------------
Balance, December 31, 2002                   9,151        47,053      46,418      35,344        6,538          (6,191)      129,162
Comprehensive income (loss):
    Net income                                                                    20,400                                     20,400
    Unrealized gain on securities, net
        of reclassification adjustment
        and tax effect                                                                            626                           626
    Change in unfunded pension
        liability, net of tax                                                                    (568)                         (568)
                                                                                                                          ----------
    Total comprehensive income                                                                                               20,458
Cash dividends                                                                    (7,619)                                    (7,619)
5% stock dividend                              458         2,346      10,612     (12,984)                                       (26)
Stock split  paid in the form of a 20%
    stock dividend                           1,944         9,878                  (9,878)                                      ----
Purchases of treasury stock                   (125)                                                            (3,627)       (3,627)
Stock issued in connection with
    acquisition                                 26                       106                                      644           750
Exercise of common stock options and
    issuances under stock purchase plan        194           (21)                   (966)                       4,868         3,881
Tax benefits from employee stock
    transactions                                                         427                                                    427
                                         -------------------------------------------------------------------------------------------
Balance, December 31, 2003                  11,648        59,256      57,563      24,297        6,596          (4,306)      143,406
Comprehensive income (loss):
    Net income                                                                    21,798                                     21,798
    Unrealized loss on securities,
      net of reclassification
      adjustment and tax effect                                                                (3,140)                       (3,140)
    Change in unfunded pension
        liability, net of tax                                                                    (245)                         (245)
                                                                                                                          ---------
    Total comprehensive income                                                                                               18,413
Cash dividends                                                                    (8,215)                                    (8,215)
5% stock dividend                              584         2,949      15,103     (18,110)                                       (58)
Purchases of treasury stock                   (144)                                                            (4,151)       (4,151)
Exercise of common stock options and
    issuances under stock purchase plan        148           (98)                 (1,636)                       4,042         2,308
Tax benefits from employee stock
    transactions                                                         638                                                    638
                                         -------------------------------------------------------------------------------------------
Balance, December 31, 2004                  12,236     $  62,107   $  73,304  $   18,134  $     3,211       $  (4,415)    $ 152,341
                                         ===========================================================================================
</TABLE>

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


                                       44
<PAGE>

<TABLE>
<CAPTION>

Community Banks, Inc. and Subsidiaries
CONSOLIDATED STATEMENTS OF CASH FLOWS
For the Years Ended December 31, 2004, 2003, and 2002
(dollars in thousands)
                                                                       --------------------------------------------------
                                                                            2004             2003             2002
                                                                       --------------------------------------------------

    Operating Activities:
<S>                                                                    <C>             <C>               <C>
       Net income                                                      $      21,798   $       20,400    $       18,446
       Adjustments to reconcile net income to net cash
         provided by operating activities:
         Provision for loan losses                                             3,100            2,500             3,350
         Deferred income tax benefit                                            (481)            (152)             (192)
         Depreciation and amortization                                         3,310            3,075             2,541
         Net amortization of securities                                        1,106            2,431               779
         Realized gains on sales of available-for-sale securities,            (2,470)          (1,927)           (1,034)
           net
         Loans originated for sale                                           (10,959)         (66,976)          (66,158)
         Proceeds from sales of loans held for sale                           15,923           73,957            66,375
         Gains on loan sales                                                  (1,125)          (1,565)           (1,221)
         Earnings on investment in life insurance                             (1,593)          (1,455)           (1,476)
         Pension curtailment gain                                                ---             (497)              ---
         Net change in other assets                                            3,646            1,799              (652)
         Net change in accrued interest payable and other liabilities         (2,982)           2,848              (862)
         Tax benefits from employee stock transactions                           638              427               335
                                                                       --------------------------------------------------
           Net cash provided by operating activities                          29,911           34,865            20,231
                                                                       --------------------------------------------------

    Investing Activities:
       Net change in interest-bearing deposits in other banks                  1,515           (2,350)              421
       Activity in available-for-sale securities:
          Sales                                                              119,390          165,513           147,610
          Maturities, prepayments and calls                                  125,440          145,221            83,605
          Purchases                                                         (220,501)        (289,398)         (337,706)
       Net increase in total loans                                          (144,509)        (180,725)          (54,094)
       Proceeds from sale of credit card portfolio                             4,556              ---               ---
       Investment in life insurance                                           (5,000)             ---            (5,000)
       Net additions to premises and equipment                                (4,206)          (2,677)           (4,037)
       Other                                                                    (325)          (2,717)             (880)
                                                                       --------------------------------------------------
           Net cash used by investing activities                            (123,640)        (167,133)         (170,081)
                                                                       --------------------------------------------------

    Financing Activities:
       Net increase in deposits                                               74,852           97,773           129,688
       Net change in short-term borrowings                                    (5,648)         (41,361)            9,123
       Proceeds from issuance of long-term debt                               35,000           98,751            34,767
       Proceeds from subordinated debt                                           ---           15,464            15,464
       Repayment of long-term debt                                           (16,760)          (7,862)          (36,389)
       Cash dividends and cash paid in lieu of fractional shares              (8,273)          (7,645)           (6,654)
       Payments to acquire treasury stock                                     (4,151)          (3,627)           (5,828)
       Proceeds from issuance of common stock                                  2,308            4,525             1,052
                                                                       --------------------------------------------------
           Net cash provided by financing activities                          77,328          156,018           141,223
                                                                       --------------------------------------------------

           Net change in cash and cash equivalents                           (16,401)          23,750            (8,627)

    Cash and cash equivalents at beginning of period                          59,887           36,137            44,764
                                                                       --------------------------------------------------
    Cash and cash equivalents at end of period                         $      43,486   $       59,887    $       36,137
                                                                       ==================================================

    Cash paid during the year for:
        Interest                                                       $      42,426   $       42,311    $       46,617
        Income taxes                                                   $       3,738   $        4,170    $        4,304
</TABLE>

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


                                       45
<PAGE>

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

1.     SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES:

                     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),  and Community Banks Life Insurance  Company (CBLIC).
All significant intercompany transactions have been eliminated in consolidation.
Community operates through its executive office in Harrisburg, Pennsylvania, and
through  48  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.  Community 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.

                                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  estimates that are particularly  susceptible to significant
change in the near term relate to the  determination  of the  allowance for loan
losses and the  evaluation  of other than  temporary  impairment  of  investment
securities.

                             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.  During 2004,  $25 million of maturing  long-term FHLB
advances were repaid through short term borrowings with the FHLB.

                SIGNIFICANT GROUP CONCENTRATIONS OF CREDIT RISK:
Most of Community's  activities are with  customers  located within  Northeast /
Central  Pennsylvania  and  Northern  Maryland.  Note 2  discusses  the types of
securities  in which  Community  invests.  Note 3 discusses the types of lending
engaged in by Community.  Community does not have any significant concentrations
to any one industry or customer.

                             INVESTMENT SECURITIES:
Community  classifies debt and equity  securities as either  "held-to-maturity,"
"available-for-sale,"  or "trading."  Investments  for which  management has the
intent,  and Community 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, 2004 and 2003, 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 (1) the length of
time and the  extent to which the fair  value has been less than  cost,  (2) the
financial  condition and near-term  prospects of the issuer,  and (3) the intent
and ability of Community to retain its  investment in the issuer for a period of
time sufficient to allow for any

                                       46
<PAGE>
anticipated  recovery  in fair value.  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.

Equity  securities  include  Federal Home Loan Bank (FHLB) stock at December 31,
2004 and 2003 of $22.3 million and $21.2 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 Community
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.

The allowance  consists of specific,  general and  unallocated  components.  The
specific component relates to loans that are classified as doubtful, substandard
or special  mention.  For such loans that are also  classified  as impaired,  an
allowance  is  established  when  the  realizable  value of the  collateral,  or
discounted  cash flows,  or obtainable  market price, is lower than the carrying
value of that loan. The general component covers  non-classified  loans that are
evaluated as part of various  pools.  The  allowance for these pools is based on
historical loss  experience  adjusted for  qualitative  factors.  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 Community  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
                                       47
<PAGE>
Community Banks, Inc. and Subsidiaries
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

1.     SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (Continued):

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 fair
value of the collateral if the loan is collateral  dependent,  the present value
of expected future cash flows discounted at the loan's effective  interest rate,
or the loan's obtainable market price.

Large groups of smaller balance homogeneous loans are collectively evaluated for
impairment.  Accordingly,  Community  does not  separately  identify  individual
consumer and residential loans for impairment disclosures, unless such loans are
part of a restructuring agreement.

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  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.  Goodwill 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.  Goodwill
and  identifiable  intangible  assets totaled $5.1 million at December 31, 2004,
and $4.8  million  at  December  31,  2003  and are  included  in other  assets.
Identifiable  intangible assets are amortized over their estimated useful lives.
Amortization  of other  intangibles  was $161  thousand,  $94 thousand,  and $73
thousand for 2004, 2003, and 2002.

                             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 2004,
2003,  and 2002  transfers  from loans to  foreclosed  real estate  totaled $1.5
million, $5.0 million, and $3.7 million.

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:
Community 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.


                                       48
<PAGE>

Community  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 Community.  The expense related to this savings plan
was $1.5 million in 2004,  $1.1 million in 2003,  and $1.3 million in 2002,  and
has  been  included  in  salaries  and  benefits  expense.

Community  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 $ 379 thousand
for 2004,  $181  thousand  for 2003,  and $277  thousand  for 2002.  The accrued
liability  was $1.9 million at December  31, 2004,  and $1.6 million at December
31, 2003.  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.

                            STOCK-BASED COMPENSATION:
At December 31, 2004,  Community has a stock-based  compensation  plan, which is
described  more  fully in Note 12.  Community  accounts  for this plan under the
recognition  and  measurement  principles 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  Community  had  applied  the  fair  value  recognition
provisions  of FAS  No.  123,  "Accounting  for  Stock-Based  Compensation,"  to
stock-based compensation.

<TABLE>
<CAPTION>

                                                                                    Years Ended December 31,
                                                                              (In Thousands, Except Per Share Data)
                                                                          --------------------------------------------
                                                                              2004            2003            2002
                                                                          ------------    ------------    ------------

<S>                                                                       <C>             <C>             <C>
                  Net income, as reported                                 $    21,798     $   20,400      $    18,446
                  Deduct:  Total stock-based compensation
                    expense determined under fair value based
                    method for all awards, net of related tax effect           (1,418)          (822)            (644)
                                                                          ------------    ------------    ------------

                  Pro forma net income                                    $    20,380     $   19,578      $    17,802
                                                                          ============    ============    ============

                  Earnings per share:
                    Basic - as reported                                   $      1.78     $     1.68      $      1.51
                    Basic - pro forma                                     $      1.67     $     1.61      $      1.46

                    Diluted - as reported                                 $      1.73     $     1.63      $      1.48
                    Diluted - pro forma                                   $      1.62     $     1.57      $      1.43
</TABLE>

In late 2004,  FAS No. 123 was replaced by the issuance of Statement No. 123(R),
"Share-Based  Payment," which will be effective for periods beginning after June
15, 2005 and is more fully addressed under "Recent Accounting Pronouncements" in
this section.

                               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  Community  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.

                                       49
<PAGE>

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

1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (Continued):

Earnings per share for the years ended  December  31,  2004,  2003 and 2002 have
been computed as follows (in thousands, except per share data):

<TABLE>
<CAPTION>

                                                             -------------------------------------------
                                                                2004            2003           2002
                                                             -------------------------------------------

<S>                                                          <C>             <C>            <C>
        Net income                                           $    21,798     $   20,400     $   18,446
                                                             ============    ===========    ============

        Weighted average shares outstanding  (basic)              12,231         12,139         12,205
        Effect of dilutive stock options                             344            358            286
                                                             ------------    -----------    ------------

        Weighted average shares outstanding  (diluted)            12,575         12,497         12,491
                                                             ============    ===========    ============

        Per share information:
            Basic earnings per share                         $      1.78     $     1.68     $     1.51
            Diluted earnings per share                              1.73           1.63           1.48
</TABLE>

Antidilutive  options  excluded from the above  earnings per share  calculations
totaled 168,000 for 2004, and 10,000 for both 2003 and 2002.


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

<TABLE>
<CAPTION>

                                                                --------------------------------------------------
                                                                     2004              2003              2002
                                                                --------------------------------------------------
<S>                                                             <C>               <C>                <C>
            Unrealized holding gains (losses)
                 on available-for-sale securities               $     (2,362)     $      2,891       $     18,189
            Reclassification adjustments for
                 (gains) included in net income                       (2,470)           (1,927)            (1,034)
                                                                --------------    --------------     -------------
            Net unrealized gains (losses)                             (4,832)              964             17,155
            Tax effect                                                 1,692              (338)            (6,004)
                                                                --------------    --------------     -------------

                Net-of-tax amount                                     (3,140)              626             11,151
                                                                --------------    --------------     -------------

            Increase in unfunded pension liability                      (377)             (874)              (906)
            Tax effect                                                   132               306                317
                                                                --------------    --------------     -------------

                Net-of-tax amount                                       (245)             (568)              (589)
                                                                --------------    --------------     -------------

                                                                $     (3,385)     $         58       $     10,562
                                                                ==============    ==============     =============
</TABLE>


                                       50
<PAGE>

The  components  of  accumulated  other   comprehensive   income,   included  in
stockholders' equity, are as follows at December 31 (in thousands):

<TABLE>
<CAPTION>

                                                                        ------------------------------------------
                                                                                2004                    2003
                                                                        ------------------------------------------
<S>                                                                     <C>                    <C>
            Net unrealized gain on
                 available-for-sale securities                          $         8,515        $        13,347
            Tax effect                                                           (2,980)                (4,672)
                                                                        -------------------    -------------------
                 Net-of-tax amount                                                5,535                  8,675
                                                                        -------------------    -------------------

            Unfunded pension liability                                           (3,576)                (3,199)
            Tax effect                                                            1,252                  1,120
                                                                        -------------------    -------------------
                 Net-of-tax amount                                               (2,324)                (2,079)
                                                                        -------------------    -------------------

            Accumulated other comprehensive income                      $         3,211        $         6,596
                                                                        ===================    ===================
</TABLE>


                               SEGMENT REPORTING:
Community  has  determined  its only  reportable  segment is community  banking.
Community'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  Community,  (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)
Community  does not  maintain  effective  control  over the  transferred  assets
through an agreement to repurchase them before their maturity.

                         RECENT ACCOUNTING PROUNCEMENTS:
FAS 123(R) - In December 2004, the Financial  Accounting  Standards Board (FASB)
issued  Statement  No.  123(R),  "Share-Based  Payment."  Statement  No.  123(R)
replaces  Statement No. 123,  "Accounting  for  Stock-Based  Compensation,"  and
supersedes  APB  Opinion No. 25,  "Accounting  for Stock  Issued to  Employees."
Statement No. 123(R) requires  compensation costs related to share-based payment
transactions  to be recognized in the financial  statements over the period that
an employee  provides  service in exchange for the award.  Public  companies are
required to adopt the new standard using a modified  prospective  method and may
elect to restate prior periods using the modified  retrospective  method.  Under
the modified  prospective method,  companies are required to record compensation
cost for new and modified  awards over the related vesting period of such awards
prospectively  and  record  compensation  cost  prospectively  for the  unvested
portion,  at the date of adoption,  of previously issued and outstanding  awards
over the  remaining  vesting  period of such awards.  No change to prior periods
presented is permitted under the modified prospective method. Under the modified
retrospective  method,  companies  record  compensation  costs for prior periods
retroactively  through  restatement  of such  periods  using the exact pro forma
amounts disclosed in the companies'  footnotes.  Also, in the period of adoption
and after,  companies record compensation cost based on the modified prospective
method.  Statement No. 123(R) is effective for periods  beginning after June 15,
2005. Early application of Statement No. 123(R) is encouraged, but not required.

Community is currently  evaluating the various provisions of SFAS 123(R) and the
optional  transition  methods  that  may  be  applied  when  adopting  this  new
accounting  standard.  It is expected  that  Community  will adopt the  modified
prospective method on July 1, 2005. Total stock-based  compensation expense, net
of related tax  effects,  for  existing  option  grants will not have a material
impact on the  financial  statements in the last half of 2005 or in years beyond
2005. The impact of future option or stock grants is dependent upon the quantity
and nature of stock-based  compensation Community decides to grant.

                                       51
<PAGE>

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

1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (Continued):

SAB 105 - In March 2004,  the SEC released Staff  Accounting  Bulletin (SAB) No.
105,  "Application  of  Accounting  Principles  to  Loan  Commitments."  SAB 105
provides guidance about the measurements of loan commitments  recognized at fair
value under FASB Statement No. 133,  "Accounting for Derivative  Instruments and
Hedging   Activities."  SAB  105  also  requires  companies  to  disclose  their
accounting  policy for those loan commitments  including methods and assumptions
used to  estimate  fair  value and  associated  hedging  strategies.  SAB 105 is
effective for all loan commitments accounted for as derivatives that are entered
into  after  March 31,  2004.  The  adoption  of SAB 105 did not have a material
effect on Community's consolidated financial statements.

SOP 03-3 - In December 2003, the Accounting Standards Executive Committee issued
Statement of Position  03-3 (SOP 03-3),  "Accounting  for Certain  Loans or Debt
Securities   Acquired  in  a  Transfer."  SOP  03-3  addresses   accounting  for
differences  between  contractual  cash  flows  and cash  flows  expected  to be
collected  from an investor's  initial  investment  in loans or debt  securities
acquired in a transfer,  including business  combinations,  if those differences
are attributable, at least in part, to credit quality. SOP 03-3 is effective for
loans and debt securities  acquired in fiscal years beginning after December 15,
2004.  Community  adopted the provisions of SOP 03-3 effective  January 1, 2005,
and the initial  implementation  did not have a material  effect on  Community's
consolidated financial statements.  Such guidance,  however, will have an effect
on the accounting for future business combinations after the effective date.


                               RECLASSIFICATIONS:
Certain amounts  reported in prior years have been  reclassified to conform with
the  2004  presentation.  These  reclassifications  did  not  materially  impact
Community's financial condition or results of operations.



                                       52
<PAGE>
2.    INVESTMENT SECURITIES:

The amortized cost and fair value of investment securities at December 31, 2004
and 2003 are as follows (in thousands):
<TABLE>
<CAPTION>
                                  --------------------------------------------------------------------------------------------------
                                                       2004                                              2003
                                  --------------------------------------------------------------------------------------------------
                                                  Gross       Gross                                Gross        Gross
                                   Amortized   Unrealized   Unrealized    Fair      Amortized   Unrealized   Unrealized      Fair
                                     Cost         Gains       Losses      Value       Cost         Gains       Losses       Value
                                  --------------------------------------------------------------------------------------------------
Securities Available-For-Sale
---------------------------------
<S>                               <C>          <C>          <C>         <C>        <C>          <C>          <C>          <C>
Debt securities:
    U.S. Government and federal
     agency                       $  126,056   $      807   $   (1,322) $ 125,541  $  173,651   $     1,923  $  (2,282)   $  173,292
    Mortgage-backed, primarily
     federal agency                  178,437        1,517         (640)   179,314     121,853         1,817       (275)      123,395
    State and municipal              180,110        6,616         (360)   186,366     177,546         7,217       (282)      184,481
    Corporate                         58,928        1,388         (273)    60,043      95,461         3,283       (757)       97,987
                                  --------------------------------------------------------------------------------------------------
     Total debt securities           543,531       10,328       (2,595)   551,264     568,511        14,240     (3,596)      579,155
Equity securities                     67,085        1,390         (629)    67,846      65,070         2,961       (225)       67,806
                                  --------------------------------------------------------------------------------------------------
   Total securities
      available-for-sale          $  610,616   $   11,718   $   (3,224) $ 619,110  $  633,581   $    17,201  $  (3,821)   $  646,961
                                  ==================================================================================================
</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, 2004 (in thousands):
<TABLE>
<CAPTION>
                                                              ----------------------------------------------------------
                                                                  Less Than 12 Months            12 Months or More
                                                              ----------------------------------------------------------
                                                                              Unrealized                   Unrealized
                                                               Fair Value       Losses       Fair Value      Losses
                                                              ----------------------------------------------------------
              Securities Available-For-Sale
              -----------------------------------------------
<S>                                                           <C>            <C>            <C>           <C>
              Debt securities:
                  U.S. Government and federal agency          $     31,125   $     (315)    $     29,866  $    (1,007)
                  Mortgage-backed, primarily federal agency         84,099         (552)          11,170          (88)
                  State and municipal                               20,171         (185)           5,451         (175)
                  Corporate                                          6,688          (60)           6,189         (213)
                                                              ----------------------------------------------------------
                   Total debt securities                           142,083       (1,112)          52,676       (1,483)
              Equity securities                                     16,085         (209)           1,080         (420)
                                                              ----------------------------------------------------------
                 Total temporarily impaired securities        $    158,168   $   (1,321)    $     53,756  $    (1,903)
                                                              ==========================================================
</TABLE>

The above table represents 99 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 investment  grade debt securities with a maturity date and are expected
to be paid in full at maturity or are equity securities with  characteristics of
debt  securities,  including a specific  repricing  date. As management  has the
ability to hold securities for the foreseeable future, no declines are deemed to
be other than temporary.

The amortized cost and fair value of debt securities by contractual maturity, at
December 31, 2004,  follows.  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>
                        Within 1 year                                 $        8,076  $        8,115
                        Over 1 year and through 5 years                       31,107          31,479
                        Over 5 years through 10 years                        125,474         125,369
                        Over 10 years                                        200,437         206,987
                                                                      -------------------------------
                                                                             365,094         371,950
                        Mortgage-backed securities                           178,437         179,314
                                                                      -------------------------------
                                                                      $      543,531  $      551,264
                                                                      ===============================
</TABLE>
                                       53
<PAGE>
Community Banks, Inc. and Subsidiaries
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

2. INVESTMENT SECURITIES (Continued):

Gross  investment  security  gains and losses of $4.1 million and $ 1.6 million,
respectively were recognized in 2004. Gross gains and losses of $2.8 million and
$907 thousand,  respectively, were recognized in 2003. Gross gains and losses of
$1.9 million and $865 thousand,  respectively  were  recognized in 2002. The tax
provision  applicable to these net realized  gains  amounted to $865 thousand in
2004, $674 thousand in 2003 and $362 thousand in 2002.

At December 31, 2004 and 2003,  investment  securities with carrying  amounts of
$197.9 million and $227.5 million,  respectively,  were pledged to collateralize
public deposits and for other purposes required or permitted by law. At December
31,  2004 and  2003,  the  carrying  amount  of  securities  pledged  to  secure
repurchase agreements was $42.8 million and $68.8 million.

3.   LOANS:

The composition of loans outstanding by lending classification as of December 31
is as follows (in thousands):
<TABLE>
<CAPTION>
                                                             --------------------------------
                                                                  2004            2003
                                                             --------------------------------
<S>                                                          <C>             <C>
                  Commercial                                 $      409,105  $      367,444
                  Real estate-construction                            8,703           7,338
                  Real estate-mortgage
                      Residential                                    83,979          91,485
                      Commercial                                    356,871         283,661
                  Consumer                                          357,293         328,683
                                                             --------------------------------
                                                             $    1,215,951  $    1,078,611
                                                             ================================
</TABLE>

Changes in the  allowance  for loan  losses for years  ended  December 31 are as
follows (in thousands):
<TABLE>
<CAPTION>
                                                            ------------------------------------------------
                                                                 2004            2003             2002
                                                            ------------------------------------------------
<S>                                                         <C>             <C>              <C>
                  Balance, January 1                        $       13,178  $       12,343   $       12,132
                  Provision for loan losses                          3,100           2,500            3,350
                  Loan charge-offs                                  (2,910)         (2,839)          (4,180)
                  Recoveries                                         1,053           1,174            1,041
                                                            ------------------------------------------------
                  Balance, December 31                      $       14,421  $       13,178   $       12,343
                                                            ================================================
</TABLE>

The following table summarizes risk elements as of December 31 (in thousands):
<TABLE>
<CAPTION>
                                                             -------------------------------
                                                                  2004            2003
                                                             -------------------------------
<S>                                                          <C>             <C>
                  Loans on which accrual of interest has
                      been discontinued                      $        5,428  $        8,151
                  Foreclosed real estate                              2,094           4,865
                                                             -------------------------------

                  Total non-performing assets                         7,522          13,016

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

                      Total risk elements                    $        7,522  $       13,106
                                                             ===============================
</TABLE>

The following is a summary of  information  pertaining  to impaired  loans as of
December 31 (in thousands):
<TABLE>
<CAPTION>
                                                                      ----------------------------
                                                                          2004          2003
                                                                      ----------------------------
<S>                                                                   <C>           <C>
                  Impaired loans without a valuation allowance        $      1,927  $      3,644
                  Impaired loans with a valuation allowance                  2,018         2,112
                                                                      ----------------------------
                  Total impaired loans                                $      3,945  $      5,756
                                                                      ============================

                  Valuation allowance related to impaired loans       $        593  $        546
                                                                      ============================
</TABLE>
                                       54
<PAGE>

Impaired  loans are included in nonaccrual  loans.  For the years ended December
31, 2004,  2003 and 2002,  the average  recorded  investment  in impaired  loans
approximated $4.2 million,  $7.8 million, and $6.6 million.  Interest recognized
on impaired loans for the years ending  December 31, 2004, 2003 and 2002 was not
significant.


4.   PREMISES AND EQUIPMENT:

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

                                                              ------------------------------
                                                                   2004           2003
                                                              ------------------------------

<S>                                                           <C>             <C>
                  Banking premises                            $      27,017   $     25,279
                  Furniture, fixture, and equipment                  21,755         20,310
                  Leasehold improvements                              1,924          1,793
                  Construction-in-progress                              951            279
                                                              ------------------------------
                                                                     51,647         47,661
                  Less accumulated depreciation and
                      amortization                                  (26,130)       (23,508)
                                                              ------------------------------

                                                              $      25,517   $     24,153
                                                              ==============================
</TABLE>

Depreciation and amortization  expense related to premises and equipment charged
to  operations  totaled $2.8 million,  $3.0  million,  and $2.5 million in 2004,
2003, and 2002.

Certain branch offices,  land, and equipment are leased under  agreements  which
expire at varying dates through 2024. Most leases contain renewal  provisions at
Community's option. Total rental expense was approximately $1.2 million in 2004,
$1.1 million in 2003 and $853 thousand in 2002.  Future  minimum  payments as of
December  31,  2004 under  noncancelable  operating  leases  are as follows  (in
thousands):

<TABLE>
<CAPTION>

<S>                                                             <C>
                  2005                                          $      1,223
                  2006                                                 1,009
                  2007                                                   824
                  2008                                                   628
                  2009                                                   633
                  Thereafter                                           7,033
                                                                --------------

                                                                    $ 11,350
                                                                ==============
</TABLE>

5.  DEPOSITS:

Deposits consisted of the following as of December 31 (in thousands):
<TABLE>
<CAPTION>

                                                             ----------------------------
                                                                 2004           2003
                                                             ----------------------------

<S>                                                          <C>            <C>
               Non-interest bearing deposits                 $     184,359  $    165,174
               Savings deposits                                    160,505       162,908
               Money market deposits                                52,718        72,778
               NOW accounts                                        284,152       221,002
               Time deposits                                       623,803       608,823
                                                             ----------------------------

               Total                                         $   1,305,537  $  1,230,685
                                                             ============================
</TABLE>


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

5. DEPOSITS (Continued):

The aggregate amount of time deposits with minimum  denominations of $100,000 or
more totaled $106 million and $114 million at December 31, 2004 and 2003.

At December 31, 2004  scheduled  maturities of time deposits were as follows (in
thousands):
<TABLE>
<CAPTION>

<S>                                                             <C>
               2005                                             $    275,992
               2006                                                  135,047
               2007                                                  122,096
               2008                                                   41,045
               2009                                                   48,671
               Thereafter                                                952
                                                                -------------

                                                                $    623,803
                                                                =============
</TABLE>


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

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

                                                            ---------------------------------------------------
                                                               2004         Rate         2003         Rate
                                                            ---------------------------------------------------

<S>                                                         <C>              <C>      <C>              <C>
      Securities sold under agreements to repurchase        $    25,472      1.81%    $    23,732      0.75%
      Treasury tax and loan note                                  1,926      1.94%          2,032      0.76%
      Other                                                         ---       ---           2,000      2.42%
      FHLB borrowings                                            19,718      2.21%            ---       ---
                                                            ------------              ------------
                                                            $    47,116               $    27,764
                                                            ============              ============
</TABLE>


Securities sold under agreements to repurchase,  which are classified as secured
borrowings,  generally mature within one to four days from the transaction date.
Securities  sold under  agreements to repurchase  are reflected at the amount of
cash received in connection with the  transaction.  Community may be required to
provide  additional  collateral  based  on the  fair  value  of  the  underlying
securities.

The maximum short-term FHLB borrowings  outstanding at any month-end during 2004
and 2003 was $48.1 million and $139.3 million;  the average amounts  outstanding
during the year were $8.2 million and $73.1  million;  and the weighted  average
interest rate during the year approximated 1.50% and 1.35%.

At December 31, 2004,  additional amounts available for borrowing under non-FHLB
line of  credit  arrangements  totaled  approximately  $50  million.  Additional
amounts  available for borrowing at the FHLB totaled  $158.3 million at December
31, 2004.

                                       56
<PAGE>

Long-term debt consists of the following as of December 31 (in thousands):
<TABLE>
<CAPTION>

                                                                                       -----------------------------
                                                                                           2004           2003
                                                                                       -----------------------------

<S>                                                                                    <C>            <C>
          Outstanding  advances from the FHLB of Pittsburgh are currently  fixed
     rate and mature from 2005 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 1.84% to 6.36%,  with a weighted
     average  interest  rate of 4.56%.  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.                                $    404,364   $   411,117

          Other long-term debt has an interest rate of 4% and matures in 2017.                  298           305
                                                                                       -----------------------------
                                                                                       $    404,662   $   411,422
                                                                                       =============================
</TABLE>



           Maturities on long-term debt at December 31, 2004 are as follows (in
thousands):
<TABLE>
<CAPTION>

<S>                                                         <C>
                    2005                                    $        42,243
                    2006                                             37,243
                    2007                                             31,986
                    2008                                             32,797
                    2009                                                 81
                    Thereafter                                      260,312
                                                            ----------------
                                                                  $ 404,662
                                                            ================
</TABLE>

7. SUBORDINATED DEBT:

Community  has issued  floating  rate junior  subordinated  deferrable  interest
debentures  to two  non-consolidated  subsidiary  trusts,  CMTY Capital  Trust I
(Trust I) for $15.5 million and CMTY  Statutory  Capital Trust II (Trust II) for
$15.4  million.  Community  owns all of the  common  equity of each  trust.  The
debentures held by each trust are the sole assets of that trust.

The trusts issued  mandatorily  redeemable  preferred  securities to third-party
investors.  Community's  obligations under the debentures and related documents,
taken together,  constitute a full and  unconditional  guarantee by Community of
the Trusts' obligations under the preferred securities.  The junior subordinated
debt securities pay interest quarterly;  Trust I at 3-month LIBOR plus 3.35% and
Trust II at 3-month LIBOR plus 2.84%. The preferred securities are redeemable by
Community  at 100% of  principal  plus  accrued  interest;  Trust I on or  after
January  7, 2008 and  Trust II on or after  December  16,  2008.  The  preferred
securities must be redeemed upon maturity of the debentures;  Trust I on January
7, 2033, and Trust II on December 16, 2033.

In 2004, as a result of applying the provisions of FASB  Interpretation  No. 46,
"Consolidation of Variable Interest Entities,  an Interpretation of ARB No. 51",
which  represented  new accounting  guidance  governing when an equity  interest
should be consolidated, Community was required to deconsolidate these subsidiary
trusts from its  financial  statements.  Prior periods have been  restated.  The
deconsolidation  of the net assets and results of  operations  of the trusts had
virtually no impact on Community's  financial  statements or liquidity  position
since  Community  continues to be obligated to repay the debentures  held by the
trusts  and  guarantees  repayment  of the  preferred  securities  issued by the
trusts.  Community's  total debt obligation  related to the trusts did increase,
however,  from $30  million  to $30.9  million  upon  deconsolidation,  with the
difference  representing  Community's  common ownership  interest in the trusts,
which is now reported in "Other assets."


                                       57
<PAGE>

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

8.   INCOME TAXES:

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

                                                                            ---------------------------------------------
                                                                                 2004            2003           2002
                                                                            ---------------------------------------------
<S>                                                                         <C>             <C>             <C>
           Current                                                          $      5,360    $      4,511    $     3,559
           Deferred                                                                 (481)           (152)          (192)
                                                                            ---------------------------------------------
                                                                            $      4,879    $      4,359    $     3,367
                                                                            =============================================
</TABLE>

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

                                                                            ---------------------------------------------
                                                                                 2004            2003           2002
                                                                            ---------------------------------------------
<S>                                                                         <C>             <C>             <C>
           Provision on pre-tax income at statutory rate                    $      9,337    $      8,666    $     7,635
           Tax-exempt interest income                                             (3,409)         (3,284)        (2,939)
           Earnings on investment in insurance                                      (514)           (473)          (481)
           Other, net                                                               (535)           (550)          (848)
                                                                            ---------------------------------------------

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

The  components  of the net deferred  tax asset,  included in other assets as of
December 31, were as follows (in thousands):
<TABLE>
<CAPTION>

                                                                            -------------------------------
                                                                                 2004            2003
                                                                            -------------------------------
           Deferred tax assets:
<S>                                                                         <C>             <C>
                Allowance for loan losses                                   $        5,047  $        4,542
                Non-accrual loan interest income                                       136             230
                Unfunded pension adjustment                                          1,252           1,120
                Deferred loan fees                                                     233             211
                Deferred compensation                                                  752             586
                Alternative minimum tax                                                225             250
                Other                                                                   42              35
                                                                            -------------------------------
                    Total                                                            7,687           6,974
                                                                            -------------------------------

           Deferred tax liabilities
                Depreciation                                                           898           1,053
                Unrealized gain on available for sale securities                     2,980           4,672
                Prepaid pension cost                                                   738             647
                Life insurance company reserves                                        163             404
                Prepaid expenses                                                       290             ---
                Other                                                                  144              28
                                                                            -------------------------------
                    Total deferred tax liabilities                                   5,213           6,804
                                                                            -------------------------------

                    Net deferred tax asset                                  $        2,474  $          170
                                                                            ===============================
</TABLE>

As of December 31, 2004 and 2003,  Community 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.




                                       58
<PAGE>



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

9.  COMMITMENTS AND CONTINGENCIES:

In the normal course of business,  Community 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
                                                                 -----------------------------------
                                                                       2004              2003
                                                                 -----------------------------------
<S>                                                              <C>               <C>
           Commitments to fund loans                             $     55,672      $     76,499
           Unused lines of credit                                $    338,313      $    292,813
           Standby letters of credit                             $     36,256      $     34,974
           Unadvanced portions of construction loans             $     53,962      $     28,443
</TABLE>

Substantially  all of  Community'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.   Community   evaluates  each  customer's   credit  worthiness  on  a
case-by-case  basis. The amount of collateral  obtained,  if deemed necessary by
Community 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.

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 amount of the  liability  as of December  31,  2004 and 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,  Community  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  Community  would not be
affected materially by the outcome of such legal proceedings.



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

10.  REGULATORY MATTERS:

The  dividends  that may be paid by Community  Banks,  the  subsidiary  bank, to
Community are subject to certain legal and  regulatory  limitations.  Under such
limitations,  the total amount  available  for payment of dividends by Community
Banks was  approximately  $157  million  at  December  31,  2004.  Dividends  by
Community  Banks to Community  would also be  prohibited if payment would reduce
Community Bank's capital below applicable minimum capital requirements presented
below.

Under current  Federal  Reserve  regulations,  Community Banks is limited in the
amount  it may  loan to  affiliates,  including  Community.  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, 2004,  the maximum
amount  available for transfer from Community  Banks to Community in the form of
loans was approximately $159 million.

Community  Banks  and  Community  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 Community's  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 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 (as  defined in the  regulations).  Management  believes,  as of
December 31, 2004, that Community Banks and Community meet the capital  adequacy
requirements to which they are subject.

As of December 31, 2004, the most recent  notification  from the Federal Deposit
Insurance  Corporation  categorized  Community Banks as "well capitalized" under
the  regulatory  framework for prompt  corrective  action.  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,  2004 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 Community and Community Banks as of December 31, 2004
and 2003 (dollars in thousands):
<TABLE>
<CAPTION>

                                                    -----------------------------------------------------------------------------
                                                                              As of December 31, 2004
                                                    -----------------------------------------------------------------------------
                                                            Actual              Regulatory Minimum        "Well Capitalized"
                                                            ------              ------------------        ------------------
                                                      Amount       Ratio        Amount        Ratio       Amount        Ratio
                                                      ------       -----        ------        -----       ------        -----
<S>                                                 <C>             <C>      <C>                <C>     <C>             <C>
           Leverage ratio
               Community Banks, Inc.                $   171,755     8.8%     $     78,088       4%             n/a      n/a
               Bank only                            $   159,677     8.2%     $     77,712       4%     $    97,140       5%

           Tier 1 capital ratio
               Community Banks, Inc.                $   171,755    11.6%     $     59,135       4%             n/a      n/a
               Bank only                            $   159,677    10.8%     $     58,881       4%     $    88,322       6%

           Total risk-based capital ratio
               Community Banks, Inc.                $   186,513    12.6%     $    118,269       8%             n/a      n/a
               Bank only                            $   174,098    11.8%     $    117,762       8%     $   147,203      10%
</TABLE>


                                       60
<PAGE>


<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>

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  $5.6  million at December  31, 2004 and $6.2
million at December 31, 2003.



11.  PENSION PLAN:

Community   maintains  a  defined  benefit  pension  plan  for  employees  of  a
predecessor  bank which covers less than 25% of the current  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  thousand  related to the  recognition  of a
previously  unrecognized  prior  service  benefit,  which was  recorded as other
income.

The  determination  of pension  expense  for each of the last three  years is as
follows:
<TABLE>
<CAPTION>

         -----------------------------------------------------------------------------------------------------------
         (dollars in thousands)                                            2004           2003            2002
         -----------------------------------------------------------------------------------------------------------
<S>                                                                    <C>            <C>            <C>
         Components of net periodic benefit cost:

              Service cost benefit earned during the year                      ---    $        115   $        107
              Interest cost on projected benefit obligation                    416             428            401
              Actual return on plan assets                                    (249)           (549)          (453)
              Net amortization and deferral:
                 Net transition asset                                          ---             ---             (4)
                 Prior service benefit                                         ---            (103)          (103)
                 Net loss                                                      252             239            156
                 Gain (loss) deferred                                         (161)            150            ---
                                                                       ---------------------------------------------
         Pension cost                                                  $       258    $        280   $        104
                                                                       =============================================

         Increase in minimum liability included in other
         comprehensive income                                          $       377    $        874   $        906
                                                                       =============================================
</TABLE>




                                       61
<PAGE>

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

11.  PENSION PLAN (Continued):

The following table sets forth the pension plan's funded status:
<TABLE>
<CAPTION>
         -------------------------------------------------------------------------------------------
         (dollars in thousands)                                              2004              2003
         -------------------------------------------------------------------------------------------

<S>                                                                    <C>               <C>
         Change in benefit obligation:
             Benefit obligation at beginning of year                   $     6,807       $     6,238
             Service cost                                                      ---               115
             Interest cost                                                     416               428
             Benefits paid                                                    (291)             (314)
             Change in assumptions                                             452               662
             Experience loss                                                    16               156
             Curtailment                                                       ---              (478)
                                                                       -----------------------------
             Benefit obligation at end of year                               7,400             6,807
                                                                       -----------------------------
         Change in plan assets:
             Fair value of plan assets at beginning of year                  4,904             4,511
             Actual return on plan assets                                      249               549
             Employer contributions                                            930               158
             Benefits paid                                                    (291)             (314)
                                                                       -----------------------------
             Fair value of plan assets at end of year                        5,794             4,904
                                                                       -----------------------------

          Funded status, end of year                                        (1,606)           (1,903)

          Unrecognized net cost                                              3,576             3,199
          Recognition of additional minimum liability                       (3,576)           (3,199)
                                                                       -----------------------------
         Accrued pension liability                                     $    (1,606)      $    (1,903)
                                                                       =============================

         Amounts recognized in the consolidated balance sheet consist of:
             Prepaid benefit cost                                      $     1,970   $         1,296
             Accumulated other comprehensive income adjustment              (3,576)           (3,199)
                                                                       -----------------------------
         Net accrued pension liability                                 $    (1,606)      $    (1,903)
                                                                       =============================

         Accumulated benefit obligation                                $     7,400       $     6,807
                                                                       =============================
</TABLE>

Assumptions  used in the  determination  of the  funded  status  of the  plan at
December 31, 2004 and 2003 and pension  expense for each of the last three years
were as follows:
<TABLE>
<CAPTION>

                                                                ------------------------------------------
                                                                     2004           2003           2002
                                                                ------------------------------------------
<S>                                                                   <C>             <C>            <C>
         Discount rate                                                5.75%           6.25%          7.0%
         Expected long-term return on plan assets                     8.5%            9.0%           9.0%
         Annual salary increase                                       n/a             4.0%           4.0%
</TABLE>

<TABLE>
<CAPTION>
Estimated future benefit payments are as follows (in thousands):

<S>                                                                           <C>
                          2005                                                $     375
                          2006                                                      372
                          2007                                                      386
                          2008                                                      389
                          2009                                                      428
                          Years 2010 - 2014                                       2,331
</TABLE>


                                       62
<PAGE>

Community  maintains a pension investment policy which addresses the assumptions
required for the various  aspects of plan management and plan  accounting.  Plan
assumptions  are determined by management  pursuant to the guidance  provided by
the investment policy and through consultation with plan actuaries.

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 the plan has
been  curtailed  and a substantial  portion of the  benefited  employees are not
receiving  pension  benefits at the current time.  Pursuant to that policy,  the
following  targeted  allocations 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        2004       2003
                                                      ----------        -----      --------------------
<S>                                                       <C>           <C>            <C>        <C>
                 Equity                                   60%           50-70%         63%        64%
                 Fixed income                             35%           25-45%         25%        28%
                 Cash and/or equivalents                   5%            2-10%         12%         8%
                                                    ---------------

                                                         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.  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                                  10 yrs (12/31/04)   15 yrs (12/31/04)
                                         Asset                                        Annualized          Annualized
                                       Allocation             Benchmarks               Returns             Returns
                                       ----------             ----------               -------             -------
<S>                                       <C>             <C>                           <C>                 <C>
        Equities                          60%         S&P 500                           12.07%              10.93%
        Fixed income                      35%         Lehman Bros Aggregate             7.74%               7.72%
        Cash equivalents                   5%         3 mo T-Bill                       4.15%               4.50%
                                    -----------------

        Total pension                    100%                                           10.16%              9.49%
                                    =================
</TABLE>

The plan  currently  maintains no  investment  in the common stock of Community.
Community  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.



                                       63
<PAGE>
Community Banks, Inc. and Subsidiaries
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

12. STOCK-BASED PLANS:

Community has a Long-term  Incentive Plan (the "Plan") that allows  Community 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. Community 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,  Community  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 2004,  2003, and 2002 were $9.45,
$7.90,  and $5.66, and were estimated using the  Black-Scholes  option valuation
model with the following weighted average  assumptions for 2004, 2003, and 2002:
dividend yield of 2.4%,  2.0%,  and 2.6%;  volatility of 33%, 22%, and 26%; risk
free interest rates of 4.0%,  3.9%, and 3.8%; and expected life in years of 7.8,
7.9, and 8.4.

As of December 31, 2004,  828,000  shares were  authorized but not awarded under
the Plan.  The stock options  generally  vest from six months 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
                                                                     Shares Under        Average
                                                                        Option       Exercise Price
                                                                    (in thousands)      Per Share
               --------------------------------------------------------------------------------------
<S>                                                                      <C>           <C>
               Balance December 31, 2001                                   990           $   13.50
               Issued                                                      165               21.06
               Exercised                                                  (110)              11.22
               Forfeited                                                    (5)              16.37
               --------------------------------------------------------------------------------------
               Balance December 31, 2002                                 1,040           $   14.95
               Issued                                                      170               30.40
               Exercised                                                  (173)              12.30
               Forfeited                                                   (10)              17.87
               --------------------------------------------------------------------------------------
               Balance December 31, 2003                                 1,027           $   17.90
               Issued                                                      193               28.89
               Exercised                                                  (142)              13.34
               Forfeited                                                    (5)              23.06
               --------------------------------------------------------------------------------------
               Balance December 31, 2004                                 1,073           $   20.44
               --------------------------------------------------------------------------------------
</TABLE>

The following table provides certain information about stock options outstanding
and exercisable at December 31, 2004:

<TABLE>
<CAPTION>
                                                    Options Outstanding                       Options Exercisable
                                     -----------------------------------------------------------------------------------
                                                         Weighted          Weighted                         Weighted
                                                          Average          Average                          Average
                                         Number          Exercise         Remaining          Number         Exercise
                                       Outstanding         Price         Contractual      Exercisable        Price
Range of exercise prices per share   (in thousands)      Per Share      Life in Years    (in thousands)    Per Share
------------------------------------------------------------------------------------------------------------------------
<S>                                      <C>             <C>                  <C>               <C>         <C>
Under $12.16                                95           $     7.76           1.5                95         $    7.76
$12.17 - $15.20                            264           $    14.06           4.9               245         $   14.12
$15.21 - $18.24                             65           $    15.64           2.9                65         $   15.64
$18.25 - $21.28                            288           $    20.10           7.4               171         $   19.99
$27.36 - $30.40                            361           $    29.59           9.5               168         $   30.40
------------------------------------------------------------------------------------------------------------------------
$6.08 - $30.40                           1,073           $    20.44           6.7               744         $   18.46
------------------------------------------------------------------------------------------------------------------------
</TABLE>
                                       64
<PAGE>

Community  has  a  dividend  reinvestment  plan  for  shareholders  under  which
additional  shares of  Community  common stock may be purchased at a 5% discount
off market  prices  with  reinvested  dividends  and  voluntary  cash  payments.
Approximately  1.4 million  shares of common  stock have been  reserved for this
plan  and  approximately  1.3  million  shares  remain  unissued.  Purchases  of
Community  common  stock  pursuant to this plan totaled  45,000  shares in 2004,
64,000 shares in 2003, and 6,000 shares in 2002.

Community  has an Employee  Stock  Purchase Plan under which shares of Community
common stock may be purchased at a 10% discount off market prices with voluntary
cash payments.  Approximately  116,000 shares of common stock have been reserved
for this plan and  approximately  88,000  shares remain  unissued.  Purchases of
Community common stock pursuant to this plan totaled 9,000 shares in 2004, 6,000
shares in 2003, and 5,000 shares in 2002.

13.  RELATED PARTY TRANSACTIONS:

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 $13.0  million and $14.3 million at
December 31, 2004 and 2003.  During 2004, $3.2 million of new advances were made
and repayments totaled $4.5 million.

Certain  directors are owners or employees of entities that provide  services to
Community in the ordinary  course of business.  Fees for those services  totaled
$334 thousand in 2004, $310 thousand in 2003, and $268 thousand in 2002.

In January  2004,  Community  entered into new  employment  agreements  with its
executive officers that, among other provisions, provide for certain payments to
the executives if they terminate their employment for certain reasons, primarily
a change in the nature of their duties, a reduction in compensation, or a change
in control of Community.


14.  FAIR VALUES OF FINANCIAL INSTRUMENTS:


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

   CASH AND DUE FROM BANKS, INTEREST-BEARING DEPOSITS, AND FEDERAL FUNDS SOLD:
The fair  values for cash and due from  banks,  interest-bearing  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 and loans held for sale 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.

                                       65
<PAGE>
Community Banks, Inc. and Subsidiaries
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

14. FAIR VALUES OF FINANCIAL INSTRUMENTS (Continued):

                              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  Community's  long-term  borrowings  are  estimated  using
discounted  cash flows  analyses,  based on rates  available  to  Community  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, 2004 and 2003:

<TABLE>
<CAPTION>

                                                            ------------------------------------------------------------------
                                                                          2004                             2003
                                                            ------------------------------------------------------------------
                                                                                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
                deposits, and federal funds sold            $       45,273   $       45,273    $     63,188    $     63,188
               Investment securities                               619,110          619,110         646,961         646,961
               Loans held for sale                                   1,505            1,505           6,067           6,067
               Net loans                                         1,201,530        1,198,973       1,065,433       1,070,977
               Accrued interest receivable                           9,077            9,077           8,819           8,819

           Financial liabilities:
               Deposits                                     $    1,305,537   $    1,305,486    $  1,230,685    $  1,237,438
               Short-term borrowings                                47,116           47,116          27,764          27,764
               Long-term debt                                      404,662          408,168         411,422         420,306
               Trust preferred securities                           30,928           30,928          30,928          30,928
               Accrued interest payable                              4,105            4,105           3,289           3,289
               Off-balance sheet instruments                           ---              ---             ---             ---
</TABLE>



                                       66
<PAGE>

15.  CONDENSED FINANCIAL INFORMATION OF COMMUNITY BANKS, INC.  (PARENT ONLY)
<TABLE>
<CAPTION>

                                                                            ----------------------------
                                                                                2004          2003
                                                                            ----------------------------
                                                                                  (in thousands)
<S>                                                                         <C>           <C>
Condensed Balance Sheets:
     Cash                                                                   $      4,256  $      1,241
     Interest bearing deposits in other banks                                         72            64
     Investment securities, available for sale                                     1,324        17,130
     Investment in banking subsidiary                                            169,773       150,688
     Investment in nonbank subsidiaries                                            6,147         5,518
     Other assets                                                                  1,906         1,914
                                                                            ----------------------------
        Total assets                                                        $    183,478  $    176,555
                                                                            ============================

     Short-term borrowings                                                  $        ---  $      2,000
     Long-term debt                                                               30,928        30,928
     Other liabilities                                                               209           221
     Stockholders' equity                                                        152,341       143,406
                                                                            ----------------------------
        Total liabilities and stockholders' equity                          $    183,478  $    176,555
                                                                            ============================
</TABLE>
<TABLE>
<CAPTION>

                                                                           -------------------------------------------
                                                                               2004           2003           2002
                                                                           -------------------------------------------
                                                                                         (in thousands)
<S>                                                                        <C>            <C>            <C>
Condensed Statements of Income:
     Dividends from:
           Banking subsidiary                                              $       ---    $        ---   $     5,000
     Other income (expense)                                                     (1,215)           (830)         (354)
                                                                           -------------------------------------------
Income(loss) before equity in undistributed earnings of subsidiaries            (1,215)           (830)        4,646
                                                                           -------------------------------------------
Equity in undistributed earnings of:
     Banking subsidiary                                                         21,861          20,118        13,416
     Nonbank subsidiaries                                                        1,152           1,112           384
                                                                           -------------------------------------------
                                                                                23,013          21,230        13,800
                                                                           -------------------------------------------
Net income                                                                 $    21,798    $     20,400    $   18,446
                                                                           ===========================================

Condensed Statements of Cash Flows:
  Operating activities:
     Net income                                                            $    21,798    $     20,400   $    18,446
     Adjustments to reconcile net cash provided by operating activities:
         Undistributed earnings of:
              Banking subsidiary                                               (21,861)        (20,118)      (13,416)
              Nonbank subsidiaries                                              (1,152)         (1,112)         (384)
         Other, net                                                                391            (398)       (1,433)
                                                                           -------------------------------------------
              Net cash provided (used) by operating activities                    (824)         (1,228)        3,213
                                                                           -------------------------------------------
  Investing activities:
     Purchases of investment securities                                         (2,706)        (17,304)       (8,494)
     Proceeds from maturities and sales of investment securities                18,661           8,862           ---
     Investment in unconsolidated trust subsidiaries                               ---            (464)         (464)
                                                                           -------------------------------------------
              Net cash provided (used) by investing activities                  15,955          (8,906)       (8,958)
                                                                           -------------------------------------------
  Financing activities:
     Net change in short-term borrowings                                        (2,000)          2,000           ---
     Proceeds from issuance of long term debt                                      ---          15,464        15,464
     Proceeds from issuance of common stock                                      2,308           4,525         1,052
     Purchases of treasury stock                                                (4,151)         (3,627)       (5,828)
     Cash dividends                                                             (8,273)         (7,645)       (6,654)
                                                                           -------------------------------------------
              Net cash provided by (used) by financing activities              (12,116)         10,717         4,034
                                                                           -------------------------------------------

              Net change in cash and cash equivalents                            3,015             583        (1,711)
Cash and cash equivalents at beginning of period                                 1,241             658         2,369
                                                                           -------------------------------------------
Cash and cash equivalents at end of period                                 $     4,256    $      1,241    $      658
                                                                           ===========================================
</TABLE>



                                       67
<PAGE>

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

16.  QUARTERLY RESULTS OF OPERATIONS (UNAUDITED):

The following is a summary of the quarterly results of operations for the years
ended December 31, 2004 and 2003:
<TABLE>
<CAPTION>

                                                                         Three Months Ended
                                   -----------------------------------------------------------------------------------------------
                                                         2004                                            2003
                                   -----------------------------------------------------------------------------------------------
                                     Dec. 31     Sept. 30     June 30     Mar. 31     Dec. 31    Sept. 30    June 30     Mar. 31
                                   -----------------------------------------------------------------------------------------------
                                                           (dollars in thousands, except per share data)
<S>                                <C>          <C>         <C>          <C>         <C>        <C>         <C>         <C>
Interest income                    $  25,710    $  25,227   $  24,882    $  23,980   $  23,602  $  23,769   $  23,723   $  23,771
Interest expense                      11,089       10,934      10,678       10,541      10,428     10,520      10,699      10,703
                                   -----------------------------------------------------------------------------------------------
Net interest income                   14,621       14,293      14,204       13,439      13,174     13,249      13,024      13,068
Provision for loan losses                750          750         750          850         600        900         600         400
                                   -----------------------------------------------------------------------------------------------
Net interest income after
   provision for loan losses          13,871       13,543      13,454       12,589      12,574     12,349      12,424      12,668
Investment security gains, net           186          108         844        1,332          78        302         500       1,047
Mortgage banking activities              652          558         828          627         725        936         445         426
Other income                           4,584        5,346       4,484        3,664       4,748      4,268       4,066       2,921
Other expenses                        12,618       12,530      12,962       11,883      11,962     11,578      11,389      10,789
                                   -----------------------------------------------------------------------------------------------
Income before income taxes             6,675        7,025       6,648        6,329       6,163      6,277       6,046       6,273
Income taxes                           1,135        1,379       1,211        1,154         987      1,130       1,070       1,172
                                   -----------------------------------------------------------------------------------------------
Net income                         $   5,540    $   5,646   $   5,437    $   5,175   $   5,176  $   5,147   $   4,976   $   5,101
                                   ===============================================================================================

Basic earnings per share           $    0.45    $    0.46   $    0.45    $    0.42   $    0.43  $    0.42   $    0.41   $    0.42
Diluted earnings per share         $    0.44    $    0.45   $    0.43    $    0.41   $    0.41  $    0.41   $    0.40   $    0.41
Cash dividends declared            $    0.17    $    0.17   $    0.17    $    0.16   $    0.16  $    0.16   $    0.16   $    0.15
</TABLE>


17.  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 of  Community's  common stock 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   statements   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 is subject to periodic impairment testing and other intangibles are
amortized over their estimated useful lives.

In November 2004,  Community and PennRock  Financial Services Corp announced the
signing of a definitive  agreement pursuant to which Community and PennRock will
combine under  Community's  charter.  PennRock,  the parent company of Blue Ball
National Bank, is a financial holding company with approximately $1.2 billion in
assets at December 31, 2004. Under the terms of the definitive  agreement,  each
shareholder  of PennRock  will  receive 1.4 shares of  Community in exchange for
each share of PennRock  common stock.  Based upon  Community's  ten-day  average
share price of $29.89 prior to the  announcement,  the value of the  transaction
will  approximate  $326  million.  The merger is subject to required  regulatory
approvals  and  separate  voting  by the  shareholders  of  both  Community  and
PennRock.

                                       68
<PAGE>

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








             Report of Independent Registered Public Accounting Firm



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

We have audited the accompanying consolidated balance sheets of Community Banks,
Inc. and subsidiaries as of December 31, 2004 and 2003, and the related
consolidated statements of income, changes in stockholders' equity, and cash
flows for the years 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 audits. The
consolidated financial statements of Community Banks, Inc. for the year ended
December 31, 2002 was audited by other auditors, whose report dated January 24,
2003, expressed an unqualified opinion on those statements.

We conducted our audit in accordance with the standards of the Public Company
Accounting Oversight Board (United States). Those standards require that we plan
and perform the audit to obtain reasonable assurance about whether the financial
statements are free of material misstatement. 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 audits provide a
reasonable basis for our opinion.

In our opinion, the 2004 and 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, 2004 and 2003 and the
results of their operations and their cash flows for the years then ended in
conformity with accounting principles generally accepted in the United States of
America.

We have also  audited,  in accordance  with the standards of the Public  Company
Accounting  Oversight  Board (United  States),  the  effectiveness  of Community
Banks,  Inc.'s internal control over the financial  reporting as of December 31,
2004,  based on criteria  established in Internal  Control-Integrated  Framework
issued by the Committee of Sponsoring  Organizations of the Treadway  Commission
("COSO") and our report dated March 7, 2005 expressed an unqualified  opinion on
management's  assessment  of internal  control over  financial  reporting and an
unqualified  opinion on the  effectiveness  of internal  control over  financial
reporting.

                                   /s/ Beard Miller Company LLP

Harrisburg, Pennsylvania
March 7, 2005




                                       69
<PAGE>
                [GRAPHIC OMITTED]Community Banks[GRAPHIC OMITTED]


                    Management's Report on Internal Controls
                    ----------------------------------------

The management of Community Banks, Inc. is responsible for designing,
implementing, documenting, and maintaining an adequate system of internal
control over financial reporting. An adequate system of internal control over
financial reporting encompasses the processes and procedures that have been
established by management to:

     o    maintain records that accurately reflect the company's transactions;
     o    prepare  financial  statement and footnote  disclosures  in accordance
          with GAAP that can be relied upon by external users;
     o    prevent and detect  unauthorized  acquisition,  use, or disposition of
          the  company's  assets  that  could  have  a  material  effect  on the
          financial statements.

Management is also responsible to perform an annual  evaluation of the system of
internal  control  over  financial  reporting,  including an  assessment  of the
effectiveness of that system.  Management's assessment is based upon the control
framework  established  by the  Committee  of  Sponsoring  Organizations  of the
Treadway  Commission  (COSO).  The  COSO  framework   identifies  five  defining
characteristics  of a system of  internal  control as  follows:  an  appropriate
control  environment;  an adequate risk assessment  process;  sufficient control
activities;  satisfactory  communication  of pertinent  information;  and proper
monitoring controls.

Management  performed an assessment of the effectiveness of its internal control
over financial reporting in accordance with the COSO framework.  As part of this
process,  consideration was given to the potential  existence of deficiencies in
either  the  design  or  operating  effectiveness  of  controls.  Based  on this
assessment,  management  believes that Community  maintained  effective internal
controls over financial reporting, including disclosure controls and procedures,
as of December  31,  2004.  Furthermore,  during the conduct of its  assessment,
management  identified no material  weakness in its financial  reporting control
system.

The Board of  Directors  of  Community,  through its Audit  Committee,  provides
oversight to management's  conduct of the financial reporting process. The Audit
Committee,  which  is  composed  entirely  of  independent  directors,  is  also
responsible to recommend the appointment of independent public accountants.  The
Audit Committee also meets with  management,  the internal audit staff,  and the
independent  public  accountants  throughout the year to provide assurance as to
the adequacy of the financial reporting process and to monitor the overall scope
of the work  performed by the internal  audit staff and the  independent  public
accountants.

The  consolidated  financial  statements of Community have been audited by Beard
Miller Company LLP, an independent  registered  public  accounting firm, who was
engaged  to  express  an opinion  as to the  fairness  of  presentation  of such
financial  statements.  In  connection  therewith,  Beard Miller  Company LLP is
required to issue an attestation  report on management's  assessment of internal
control over financial  reporting and, in addition,  is required to form its own
opinion as to the effectiveness of those controls. Their opinion on the fairness
of the financial  statement  presentation,  and their attestation and opinion on
internal controls over financial reporting are included herein.


/s/ Eddie L. Dunklebarger                          /s/ Donald F. Holt
Chairman of the Board and                          Executive Vice President and
Chief Executive Officer                            Chief Financial Officer



Community Banks, Inc. o 750 East Park Drive, 2nd Floor o Harrisburg,  PA 17111 o
Phone 717-920-1698

                                       70
<PAGE>
[GRAPHIC OMITTED]
Beard Miller Company LLP
Certified Public Accountants and Consultants
[GRAPHIC OMITTED]


             Report of Independent Registered Public Accounting Firm

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

We  have  audited   management's   assessment,   included  in  the  accompanying
Management's Report on Internal Controls,  that Community Banks, Inc. maintained
effective  internal  control over  financial  reporting as of December 31, 2004,
based on criteria established in Internal  Control--Integrated  Framework issued
by  the  Committee  of  Sponsoring  Organizations  of  the  Treadway  Commission
("COSO").  Community Bank's management is responsible for maintaining  effective
internal  control  over  financial  reporting  and  for  its  assessment  of the
effectiveness of internal control over financial  reporting.  Our responsibility
is to  express  an  opinion  on  management's  assessment  and an opinion on the
effectiveness of the company's  internal control over financial  reporting based
on our audit.

We conducted  our audit in accordance  with the standards of the Public  Company
Accounting Oversight Board (United States). Those standards require that we plan
and perform the audit to obtain  reasonable  assurance  about whether  effective
internal  control  over  financial  reporting  was  maintained  in all  material
respects. Our audit included obtaining an understanding of internal control over
financial reporting,  evaluating management's assessment, testing and evaluating
the design and operating  effectiveness of internal control, and performing such
other  procedures as we considered  necessary in the  circumstances.  We believe
that our audit provides a reasonable basis for our opinion.

A company's  internal control over financial  reporting is a process designed to
provide reasonable  assurance  regarding the reliability of financial  reporting
and the preparation of financial  statements for external purposes in accordance
with generally accepted accounting principles. A company's internal control over
financial  reporting  includes those policies and procedures that (1) pertain to
the  maintenance  of records that, in reasonable  detail,  accurately and fairly
reflect the  transactions  and  dispositions  of the assets of the company;  (2)
provide  reasonable  assurance  that  transactions  are recorded as necessary to
permit preparation of financial statements in accordance with generally accepted
accounting  principles,  and that receipts and  expenditures  of the company are
being made only in accordance with authorizations of management and directors of
the company; and (3) provide reasonable assurance regarding prevention or timely
detection of  unauthorized  acquisition,  use, or  disposition  of the company's
assets that could have a material effect on the financial statements.

Because of its inherent  limitations,  internal control over financial reporting
may not prevent or detect misstatements.  Also, projections of any evaluation of
effectiveness to future periods are subject to the risk that controls may become
inadequate  because of changes in  conditions,  or that the degree of compliance
with the policies or procedures may deteriorate.

In our opinion,  management's  assessment that Community Banks, Inc.  maintained
effective internal control over financial  reporting as of December 31, 2004, is
fairly  stated,  in all  material  respects,  based on criteria  established  in
Internal  Control--Integrated  Framework  issued by the  Committee of Sponsoring
Organizations of the Treadway Commission.  Also in our opinion, Community Banks,
Inc.  maintained,  in all material  respects,  effective  internal  control over
financial  reporting as of December 31, 2004,  based on criteria  established in
Internal  Control--Integrated  Framework  issued by the  Committee of Sponsoring
Organizations of the Treadway Commission.

We have also  audited,  in accordance  with the standards of the Public  Company
Accounting  Oversight Board (United States),  the consolidated balance sheets of
Community Banks, Inc. and subsidiaries as of December 31, 2004 and 2003, and the
related consolidated  statements of income, changes in stockholders' equity, and
cash  flows for the  years  then  ended  and our  report  dated  March 7,  2005,
expressed an unqualified opinion thereon.

                                                    /s/ Beard Miller Company LLP
Harrisburg, Pennsylvania
March 7, 2005

                                       71
<PAGE>

Item  9.  Changes  in and  Disagreements  With  Accountants  on  Accounting  and
--------------------------------------------------------------------------------
Financial Disclosure:
---------------------

Disclosure  relating to a change in accountants is set forth in a Current Report
on Form 8-K dated June 9, 2003 previously filed by the Registrant.


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

Under the  supervision  and with the  participation  of Community's  management,
including its Chief Executive Officer and Chief Financial Officer, Community has
evaluated the  effectiveness  of its  disclosure  controls and  procedures as of
December 31, 2004. Based upon this evaluation,  the Chief Executive  Officer and
Chief Financial Officer have concluded that Community's  disclosure controls and
procedures  are  adequate  and  effective  to ensure that  material  information
relating to Community 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  Community'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,
Community's internal control over financial reporting.

Because of inherent limitations,  our disclosure controls and procedures may not
prevent or detect misstatements.  A control system, no matter how well conceived
and operated,  can provide only  reasonable,  not absolute,  assurance  that the
objectives of the control system are met. Because of the inherent limitations in
all control systems,  no evaluation of controls can provide  absolute  assurance
that all control issues and instances of fraud, if any, have been detected.

Management's report on internal controls can be found at page 70.



Item 9B.  Other Information:
----------------------------

None.


                                       72
<PAGE>

PART III

     Item 10.  Directors and Executive Officers of the Registrant:
     -------------------------------------------------------------
<TABLE>
<CAPTION>

                            Name                       Age                      Position
                            ----                       ---                      --------
<S>                                                    <C>     <C>
        Eddie L. Dunklebarger                          51      Director, Chairman of the Board,
                                                               President and Chief Executive Officer
        Ronald E. Boyer                                67      Director
        Samuel E. Cooper                               70      Director
        Peter DeSoto                                   65      Director
        Thomas W. Long                                 75      Director
        Donald L. Miller                               75      Director
        Thomas L. Miller                               72      Director
        Earl L. Mummert                                59      Director
        Wayne H. Mummert                               70      Director
        Scott J. Newkam                                54      Director
        Robert W. Rissinger                            78      Director
        Allen Shaffer                                  79      Director
        John W. Taylor, Jr.                            74      Director
        James A. Ulsh                                  58      Director
        Donald F. Holt                                 48      Executive Vice President, Chief Financial
                                                               Officer
        Robert W. Lawley                               50      Executive Vice President, Operations
        Anthony N. Leo                                 44      Executive Vice President, Financial
                                                               Services and Administration
        Jeffrey M. Seibert                             45      Executive Vice President, Banking Services
</TABLE>

Directors to Continue in Office until the 2005 Annual Meeting
-------------------------------------------------------------

Samuel E. Cooper has been a director of Community since 1992. From 1972 to 1996,
Mr.  Cooper  was the  superintendent  of the  Warrior  Run  School  District  in
Turbotville,  Pennsylvania.  He has been  retired  since  1996.  Mr.  Cooper has
indicated that he does not intend to stand for reelection.

Thomas W. Long has been a director of the Bank since 1981 and of Community since
its formation in 1983.  From 1958 until his  retirement in 1997,  Mr. Long was a
principal and owner of Millersburg  Hardware  Company,  Inc., a retail  hardware
business  based in  Millersburg,  Pennsylvania.  Mr.  Long  will not  stand  for
reelection,  due to the requirement in Community's bylaws that directors may not
stand for reelection after they have reached age 75.

Donald L.  Miller  has been a director  of the Bank since 1981 and of  Community
since its  formation in 1983.  From 1953 to 2003,  Mr. Miller was engaged in the
ownership and operation of Miller  Brothers Dairy,  inc.,  based in Millersburg,
Pennsylvania,  a business  engaged  in milk  production  and sales.  He has been
retired  since  2003.  Mr.  Miller  will not  stand for  reelection,  due to the
requirement  in  Community's  bylaws that directors may not stand for reelection
after they have reached age 75.

Eddie L.  Dunklebarger has been a member of Community's Board of Directors since
1998.  He has served as  President  and CEO of  Community  since 1998 and became
Chairman  in  2002.  Mr.  Dunklebarger  has  also  been  President  and  CEO  of
Community's  banking subsidiary since 1999. If Mr.  Dunklebarger is reelected at
the 2005 annual meeting of  shareholders,  as proposed by the Community board of
directors, his term will extend until the 2009 annual meeting.

Directors to Continue in Office until the 2006 Annual Meeting of Shareholders
-----------------------------------------------------------------------------

Earl L. Mummert has been a director of  Community  since 1998.  Since 1976,  Mr.
Mummert has been  employed as a  consulting  actuary by Conrad  Siegel,  Inc., a
company  which  provides a broad  array of services to  companies  and  employee
benefit plans in Harrisburg, Pennsylvania.

                                       73
<PAGE>

Allen Shaffer has been a director of Community and its  predecessor  since 1960.
Mr. Shaffer is a partner in Shaffer & Engle Law Offices and has practiced law in
Millersburg and Harrisburg, Pennsylvania, since 1952.

John W. Taylor, Jr. has been a director of Community since 1998. Since 1980, Mr.
Taylor  has been  president  of Air Brake & Power  Equipment  Company,  based in
Pottsville, Pennsylvania, a company which distributes truck and industrial parts
and equipment.  Pursuant to Community's bylaws, Mr. Taylor's term of office will
expire on the day before the 2006 annual meeting.

Directors to Continue in Office until the 2007 Annual Meeting of  Shareholders
------------------------------------------------------------------------------

Wayne H. Mummert has been a director  since 1998.  Mr. Mummert has been a farmer
since 1952 and from 1960 to 1991 was employed by the U. S. Postal  Service.  Mr.
Mummert has  indicated  that if the merger  between  Community  and  PennRock is
completed,  he will resign as a director in order to create a vacancy  that will
enable the Community board to achieve the board  composition  agreed upon in the
merger agreement.

Scott J. Newkam has been a director since 2003. Since September 1999, Mr. Newkam
has been the president and CEO of Hershey  Entertainment  & Resorts  Company,  a
company which owns and operates resort and entertainment  facilities in Hershey,
Pennsylvania.  From 1997 to  September  1999,  Mr.  Newkam  was  executive  vice
president and chief operating officer of the company.  Mr. Newkam has supervised
and been actively involved in the preparation of financial statements.

Robert W. Rissinger has been a director of Community and its  predecessor  since
1961. Since 1977, Mr. Rissinger has been the Secretary/Treasurer of Alvord-Polk,
Inc., based in Millersburg,  Pennsylvania,  a company which manufactures cutting
tools.  Since 1978, he has also been a principal in and owner of Engle-Rissinger
Auto Group,  Inc., a retail  vehicle sales  business also based in  Millersburg,
Pennsylvania.

Directors to Continue in Office until the 2008 Annual Meeting of Shareholders
-----------------------------------------------------------------------------

Ronald E. Boyer has been a director of Community and its predecessor since 1981.
Since 1977,  Mr. Boyer has been the  president of  Alvord-Polk,  Inc.,  based in
Millersburg, Pennsylvania, a company which manufactures cutting tools.

Peter DeSoto has been a director of Community  and its  predecessor  since 1981.
Since 1997, Mr. DeSoto has been the CEO of J. T. Walker Industries, Inc., parent
of M.I. Home Products  based in  Elizabethville,  Pennsylvania,  a company which
manufactures vinyl, aluminum and cellular composite windows and doors.

Thomas L.  Miller has been a director of  Community  and its  predecessor  since
1966.  From 1967 to 1998,  Mr. Miller was the president and CEO of the Bank and,
from 1983 to 1998,  president  and CEO of  Community.  Mr.  Miller  retired  his
positions as president and CEO in 1998.  Mr.  Miller has  indicated  that if the
merger between Community and PennRock is completed, he will resign as a director
in order to create a vacancy that will enable the Community board to achieve the
board composition agreed upon in the merger agreement.

James A. Ulsh has been a director of Community and its  predecessor  since 1977.
Since 1973,  Mr. Ulsh has been  employed  as an  attorney  with the  Harrisburg,
Pennsylvania law firm of Mette, Evans & Woodside.

Executive Officers of Community
-------------------------------

The following  executive  officers are expected to continue in their  respective
offices  pursuant to the terms and  conditions of their  employment  agreements,
which are discussed below beginning on page 80.

Donald F.  Holt is  Community's  chief  financial  officer  and  executive  vice
president of finance,  a position he has held since  December  31, 2001.  He was
employed by Keystone Financial, Inc. as its senior vice president and controller
from 1987 - 1998 and as executive  vice  president and chief  financial  officer
from  1999-2000.  During 2001,  Mr. Holt served as vice president of finance and
administration of the Pennsylvania Chamber of Business and Industry.

Robert W. Lawley is Community's  executive vice president of operations.  He has
been an executive vice president of Community since 1984.

                                       74
<PAGE>

Anthony N. Leo is Community's executive vice president of financial services and
administration. He has been an executive vice president of Community since 1998.

Jeffrey M. Seibert is Community's  executive vice president of banking services.
He has been an executive vice president of Community since 1998.

                                 Audit Committee

The members of the audit  committee  are Scott J. Newkam  (Chairman),  Ronald E.
Boyer, Samuel E. Cooper, Earl L. Mummert and Wayne H. Mummert. The Committee met
six times in 2004. The Board has adopted a charter for the Committee,  which can
be  found  on  the  investor   relations  section  of  Community's   website  at
www.communitybanks.com.  Each member of the committee is independent, as defined
by the NASDAQ  Marketplace  Rules and  applicable  rules of the  Securities  and
Exchange  Commission.  The  Board  has  determined  that Mr.  Newkam is an audit
committee   financial   expert,  as  defined  by  the  Securities  and  Exchange
Commission.

                  Nominating and Corporate Governance Committee

The Board has established a nominating and corporate governance committee, whose
members are Robert W.  Rissinger  (Chair),  Earl L. Mummert and Scott J. Newkam.
Each  member  of  the  Committee  is  independent,  as  defined  by  the  NASDAQ
Marketplace  Rules. The functions of the committee are to provide  assistance to
the  Community  board of  directors  in  fulfilling  its  responsibility  to the
shareholders,  potential  shareholders  and investment  community by identifying
individuals  qualified to become  directors and  recommending  that the Board of
Directors select the candidates for all  directorships to be filled by the board
of directors or by the shareholders;  developing and recommending to the Board a
set of corporate  governance  principles  applicable  to Community and otherwise
taking a leadership  role in shaping the corporate  governance  of Community.  A
copy of the  charter  that the  committee  has  adopted  can be found  under the
investor relations section on Community's  website,  at  www.communitybanks.com.
Before  recommending  candidates  for election to the board,  the committee will
consider the candidate's character, judgment, business experience, expertise and
acumen,  as well as any other  criteria  contained in the  Community  bylaws for
membership on the Board. The committee met four times in 2004.

                                 Code of Ethics

Community has adopted a Code of Ethics that is applicable to  Community's  chief
executive officer,  chief financial officer,  principal  accounting officer, and
other designated senior officers and a code of conduct that is applicable to all
employees and  directors of Community.  Copies of the code of ethics and code of
conduct  can be found  under the  corporate  governance  section of  Community's
website at www.communitybanks.com.

                    Shareholder Communications with the Board

Stockholders who wish to communicate  directly with Community's Board may direct
such communications in writing,  via facsimile and/or letter to: Audit Committee
Chair, c/o Community Banks, Inc., 750 East Park Drive, Harrisburg, PA 17111 (Fax
#  717-920-1683).  The  Audit  Committee  Chair  will  convey  any and all  such
communications to the full Board for consideration and review.

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

The following tables and reports apply to the compensation Community paid to the
President/CEO and Community's four other most highly compensated officers. These
five individuals are referred to in Item 11 as the "Named Executive Officers."

The  following  Summary  Compensation  Table  shows the annual  salary and other
compensation for the Named Executive Officers for the last three years.


                                       75
<PAGE>

<TABLE>
<CAPTION>

                           Summary Compensation Table


                                         ------------------------------------------------------
                                                                                 Long Term
                                                                               Compensation
                                               Annual Compensation(1)            Awards(2)
--------------------------------------------------------------------------------------------------------------------

                                                                                Securities
                                                                                Underlying           All Other
    Name and Principal                                                         Options/SARs        Compensation
         Position                Year       Salary ($)         Bonus($)           (#)(3)              ($)(4)
--------------------------------------------------------------------------------------------------------------------

<S>                              <C>          <C>               <C>                 <C>                 <C>
Eddie L. Dunklebarger            2004         350,000           175,000             30,000              127,506
President & CEO of               2003         325,000           161,500             25,200               58,383
Community and Community          2002         300,000           218,900             26,460               57,162
Banks
--------------------------------------------------------------------------------------------------------------------

Donald F. Holt                   2004         160,000            66,000             10,000               37,716
Executive Vice-                  2003         150,000            53,800              7,560               12,000
President/Finance                2002         135,000            67,000              7,938               11,916
--------------------------------------------------------------------------------------------------------------------

Robert W. Lawley                 2004         160,000            66,000             10,000               58,379
Executive                        2003         150,000            53,800              7,560               27,266
Vice-President/Operations        2002         137,080            73,000              7,938               28,824
--------------------------------------------------------------------------------------------------------------------

Anthony N. Leo                   2004         160,000            66,000             10,000               36,058
Executive                        2003         150,000            53,800              7,560               21,759
Vice-President/Financial         2002         135,000            73,000              7,938               23,469
Services and Administration
--------------------------------------------------------------------------------------------------------------------

Jeffrey M. Seibert               2004         160,000            66,000             10,000               38,221
Executive                        2003         150,000            53,800              7,560               22,655
Vice-President/Banking           2002         135,000            84,000              7,938               24,288
Services
--------------------------------------------------------------------------------------------------------------------
</TABLE>

(1) The total personal  benefits  provided by Community and its subsidiaries for
any Named Executive Officer,  individually, or all Named Executive Officers as a
group did not exceed the lesser of $50,000 or 10% of the salary and bonus of the
officer  for any of the years  shown.  This does not include  benefits  that are
available   to  all   salaried   officers,   directors   and   employees   on  a
non-discriminatory basis.
(2)  Community  has not  issued any  restricted  stock  awards to any  executive
officer. Additionally,  Community does not maintain any Long-Term Incentive Plan
other than a stock option plan, and grants to Named Executive  Officers pursuant
to that plan are reported in the Stock Option Grant Table.
(3)  When  appropriate,  stock  options  shown  above  have  been  adjusted  for
subsequent stock dividends and stock splits.
(4) "All other compensation" includes the following:
Mr.  Dunklebarger  - Director  fees of $10,000  for 2004,  $10,000  for 2003 and
$5,400 for 2002; employer contributions to Community's 401(k) Plan of $14,350 in
2004,  $12,000 in 2003 and $18,000 in 2002;  SERP  accruals of $103,156 in 2004,
$36,383 in 2003 and $33,762 in 2002.
Mr. Holt - Employer contributions to Community's 401(k) Plan of $14,350 in 2004,
$12,000 in 2003 and $11,916 in 2002; SERP accruals of $23,366 in 2004.
Mr. Lawley - Employer  contributions  to  Community's  401(k) Plan of $14,350 in
2004,  $12,000 in 2003 and  $14,587 in 2002;  SERP  accruals of $44,029 in 2004,
$15,266 in 2003, and $14,237 in 2002.
Mr. Leo - Employer  contributions to Community's 401(k) Plan of $14,350 in 2004,
$12,000 in 2003 and $14,413 in 2002; SERP accruals of $21,708 in 2004, $9,759 in
2003 and $9,056 in 2002.
Mr. Seibert - Employer  contributions  to Community's  401(k) Plan of $14,350 in
2004,  $12,000 in 2003 and  $14,400 in 2002;  SERP  accruals of $23,871 in 2004,
$10,655 in 2003, and $9,888 in 2002.


                                       76
<PAGE>

Stock Options
-------------

In 1998,  the  shareholders  of  Community  adopted the  Community  Banks,  Inc.
Long-Term  Incentive  Plan.  This plan allows  Community  to issue awards to key
officers of Community. Awards may be made in the form of incentive stock options
(ISOs),  non-qualified  stock  options  (NQSOs)  and stock  appreciation  rights
(SARs).

                             Incentive Stock Options

The Internal  Revenue  Code  requires all ISOs to be granted at a price not less
than 100% of the fair market value of Community common stock on the date the ISO
is granted. ISOs are not transferable,  except upon death by will or descent and
distribution,  and may not have a term of  exercise  longer  than ten years.  In
addition,  no ISO may be exercised for a period of at least six months after the
ISO is granted.

The plan requires  adjustment of the options to reflect changes in the number of
outstanding  shares  caused by events such as the  declaration  and payment of a
stock dividend.  Consequently,  the option price of and number of shares subject
to all ISOs  granted  has been  adjusted  each  time a stock  dividend  has been
declared and paid.

                       Non-Qualified Stock Options (NQSO)

NQSOs  may or may not have a  vesting  schedule,  depending  on the terms of the
grant as  determined  by the  Committee  administering  the plan.  Although  tax
treatment  of ISOs and NQSOs  may  differ,  the plan  imposes  the same  general
conditions and  restrictions on NQSOs as it does on ISOs.  These  conditions are
described  above.  To date,  all NQSOs granted have an option price equal to the
fair market value of Community common stock on the date the NQSO was granted.

                               Stock Option Grants

The following table shows:

     o    the number of stock  options  granted to Named  Executive  Officers in
          2004;
     o    the percentage which the executive's  options bears in relation to the
          total options granted to all employees during the year;
     o    the option price;
     o    the expiration of the option; and
     o    the potential  realizable  value of the options assuming certain rates
          of stock appreciation:

<TABLE>
<CAPTION>

                                            Stock Option Grants in Last Fiscal Year
    ------------------------------------------------------------------------------------------------------------------------
                                                                                                    Potential Realizable
                                                                                                  Value At Assumed Annual
                                         Individual Grants                                          Rates Of Stock Price
                                                                                                  Appreciation For Option
                                                                                                            Term
    ------------------------------------------------------------------------------------------------------------------------
              (a)                    (b)              (c)            (d)             (e)            (f)             (g)
                                                  % Of Total
                                  Number Of         Options
                                 Securities       Granted To      Exercise
                                 Underlying        Employees      Or Base
                                   Options         In Fiscal      Price          Expiration
              Name               Granted (#)         Year         ($/Sh)(1)         Date          5% ($)(2)      10% ($)(2)
   ------------------------------------------------------------------------------------------------------------------------

<S>                                <C>               <C>            <C>           <C>               <C>           <C>
    Eddie L. Dunklebarger (CEO)    30,000            16.5           28.89         12/6/2014         545,063       1,381,297
    Donald F. Holt                 10,000            5.55           28.89         12/6/2014         181,687         460,432
    Robert W. Lawley               10,000            5.55           28.89         12/6/2014         181,687         460,432
    Anthony N. Leo                 10,000            5.55           28.89         12/6/2014         181,687         460,432
    Jeffrey M. Seibert             10,000            5.55           28.89         12/6/2014         181,687         460,432
    ------------------------------------------------------------------------------------------------------------------------
</TABLE>


                                       77
<PAGE>

     (1) Options were granted in December,  2004, each with an exercise price of
     $28.89 per share.  The option  prices in all events  equal the fair  market
     value of  Community  common  stock on the date of the  grant.  The  options
     granted in December, 2004 were for the year 2004.
     (2) Applicable Securities and Exchange Commission regulations require us to
     disclose  the  potential  appreciation  in  options  granted  to  executive
     officers,  assuming  annualized rates of stock price appreciation of 5% and
     10% over the  term of the  option.  Appreciation  is  determined  as of the
     expiration  date of the option.  The figures  shown above assume 5% and 10%
     rates of  appreciation on an annual basis,  with annual  compounding of the
     appreciation rate, beginning with the original option price of $28.89.

                             Stock Option Exercises

The following table shows:

     o    all options exercised by the Named Executive Officers during 2004;
     o    the number of shares acquired on exercise;
     o    the value realized by the Named Executive Officer upon exercise; and
     o    the number of exercisable and un-exercisable  options  outstanding for
          each Named Executive  Officer,  and the value of those options,  as of
          December 31, 2004:

<TABLE>
<CAPTION>

                      Aggregated Option Exercises In Last Fiscal Year And Fiscal Year-End Option Values
   -------------------------------------------------------------------------------------------------------------------------
             (a)                   (b)                (c)                     (d)                           (e)

                                                                       Number Of Securities        Value Of Unexercised
                                                                      Underlying Unexercised      In-The-Money Options At
                                 Shares                               Options At FY-End (#)             FY-End ($)
                               Acquired On                          Exercisable/Unexercisable    Exercisable/Unexercisable
             Name             Exercise (#)     Value Realized($)               (1)                        (1)(2)
   -------------------------------------------------------------------------------------------------------------------------

<S>                               <C>                <C>                 <C>                         <C>
   Eddie L. Dunklebarger
   (CEO)                          2,500              52,700             200,495 / 46,581          2,461,308 / 271,621
   Donald F. Holt                   0                  0                 10,498 / 14,763              22,543 / 33,817
   Robert W. Lawley               3,800              70,604              40,889 / 19,556             405,942 / 86,007
   Anthony N. Leo                   0                  0                 40,562 / 19,556             398,442 / 86,007
   Jeffrey M. Seibert               0                  0                 70,128 / 19,556             976,673 / 86,007
   -------------------------------------------------------------------------------------------------------------------------
</TABLE>


     (1) All options granted through December 31, 2004 are reported. Exercisable
     options  are  fully  vested.  Options  which  will vest in the  future  are
     reported as unexercisable.
     (2) The dollar  values  shown  above were  calculated  by  determining  the
     difference  between the closing trading price of Community  common stock at
     December 31, 2004, which was $28.16 per share, and the option price of each
     option as of December 31, 2004.

Pension Plan
------------

The Bank maintains a pension plan for certain  individuals  who were employed by
Community Banks, N.A., a predecessor of Community's  subsidiary bank.  Employees
hired by Community Banks, N.A. prior to December 31, 1998 became participants in
the pension plan on January 1 or July 1 after completing one year of service (12
continuous  months and 1,000 hours  worked) and reaching age 21. The cost of the
pension is  actuarially  determined  and paid by the bank. The amount of monthly
pension is equal to 1.15% of average  monthly pay, plus .60% of average  monthly
pay in excess of $650, multiplied by the number of years of service completed by
an employee.  The years of service for the  additional  portion are limited to a
maximum of 37. Average monthly pay is based upon the five consecutive plan years
of highest pay in the last ten years. The maximum amount of annual  compensation
used in determining  retirement benefits is $205,000.  A participant is eligible
for early retirement after reaching age 60 and completing five years of service.
The early retirement benefit is the actuarial  equivalent of the pension accrued
to the date of  early  retirement.  As of  December  31,  2004,  the only  Named
Executive  Officer who  participates  in the plan and who has been credited with
years of service is Robert W. Lawley (twenty-nine years of service).

                                       78
<PAGE>

In 1999, the Board of directors  amended the plan so that pension  benefits will
be offset by employer  contributions to Community's 401(k) Plan. Employees hired
after  December 31, 1998 are not eligible to participate in the pension plan. In
2003, the board of directors amended the plan so that all benefit accruals under
the Plan shall cease as of December 31, 2003 and all  participants  will be 100%
vested in their accrued  benefit  effective as of December 31, 2003.  The amount
shown on the  following  table  assumes  an  annual  retirement  benefit  for an
employee who chose a straight  life annuity and who will retire at age 65. These
amounts are not yet offset for the employer contribution in the 401(k) Plan.

<TABLE>
<CAPTION>

                               Pension Plan Table

     ----------------------------------------------------------------------------------------------------------------------
             Remuneration ($)                                            Years Of Service
     ----------------------------------------------------------------------------------------------------------------------
                                                  15               20               25              30               35
<S>                      <C>                   <C>              <C>             <C>              <C>              <C>
                         35,000                $  8,486         $ 11,314        $ 14,143         $ 16,971         $ 19,800
                         55,000                $ 13,736         $ 18,314        $ 22,893         $ 27,471         $ 32,050
                         75,000                $ 18,986         $ 25,314        $ 31,643         $ 37,971         $ 44,300
                         95,000                $ 24,236         $ 32,314        $ 40,393         $ 48,471         $ 56,550
                        115,000                $ 29,486         $ 39,314        $ 49,143         $ 58,971         $ 68,800
                        135,000                $ 34,736         $ 46,314        $ 57,893         $ 69,471         $ 81,050
                        150,000                $ 38,673         $ 51,564        $ 64,455         $ 77,346         $ 90,237
                        175,000                $ 45,236         $ 60,314        $ 75,393         $ 90,471         $105,550
              200,000 and above                $ 51,798         $ 69,064        $ 86,330         $103,596         $120,862
     ----------------------------------------------------------------------------------------------------------------------
</TABLE>

     (a) The compensation  covered by the pension plan includes salary and bonus
     compensation,  as reported under the heading "Annual  Compensation"  in the
     Summary  Compensation  Table,  appearing  elsewhere in Item 11 of this Form
     10-K.
     (b) Of the Named Executive  Officers,  only Mr. Lawley  participates in the
     Pension Plan. As of December 31, 2004, Mr. Lawley had twenty-nine  years of
     credited service under the Plan.
     (c) The estimated  benefits shown in the table above were computed assuming
     that  participants  would elect to receive straight line annuity  payments.
     The  amounts  shown  on the  above  table  do not  take  into  account  any
     deductions for Social Security or other offset amounts.


          Board Compensation Committee Report On Executive Compensation

The members of the committee are Earl L. Mummert (Chair),  Peter DeSoto,  Donald
L. Miller,  Robert W. Rissinger and John W. Taylor,  Jr. The committee met twice
in 2004. The functions of the committee are to evaluate Community's compensation
policies and plans, review and evaluate the individual  performance of executive
officers,   establish   the   compensation   of  the   President/CEO   and  make
recommendations  on the compensation of the remaining named executive  officers.
Each of the members of the  committee is  independent,  as defined in the NASDAQ
Marketplace Rules.

Through our executive compensation policy, we seek to achieve the following
goals in determining compensation of our executive officers:

     o    integrate   compensation   with   Community's   annual  and  long-term
          performance goals;
     o    reward exceptional performance;
     o    recognize individual initiative and achievements;
     o    attract and retain qualified executives;
     o    provide compensation  packages competitive with those offered by other
          similar bank holding companies and banks; and
     o    encourage stock ownership by executive officers.

                                       79
<PAGE>

The compensation  committee believes that compensation for Community's executive
officers  can  best  be  accomplished   through  a  combination  of  techniques,
including:

     o    salary;
     o    Community's bonus program;
     o    the Long-Term Incentive Plan; and
     o    appropriate fringe benefits.


Community's Bonus Program
-------------------------

Community  maintains a bonus program for the executive officers of Community and
its subsidiaries.  Pursuant to this program,  a certain percentage of net income
is placed in a bonus pool. Bonuses paid to the executive officers are determined
by  the  compensation  committee  pursuant  to  guidelines  established  by  the
Committee.  The  guidelines  are based  upon the level of net  income  Community
achieves  during the year.  The  remainder of the bonus pool is  distributed  to
other  officers of Community or its  subsidiaries.  The  compensation  committee
delegates to the Chief  Executive  Officer the  distribution of the remainder of
the bonus pool. In 2004,  Eddie L.  Dunklebarger,  President  and CEO,  earned a
bonus of  $175,000.  The total amount of bonuses  earned by all Named  Executive
Officers, including the amount paid to Mr. Dunklebarger, was $439,000.

Long-Term Incentive Plan
------------------------

In 1998, Community adopted a Long-Term Incentive Plan. Under the plan, Community
can issue incentive stock options,  stock appreciation rights, and non-qualified
stock  options.  The  compensation  committee  believes that stock  ownership by
management  helps  align  management's  interests  with  the  interests  of  the
shareholders in enhancing and increasing the value of Community's  common stock.
The compensation committee considers the same criteria in awarding stock options
that it considers in making other compensation decisions.

Employment Agreements
---------------------

On January 1, 2004, Community entered into employment  agreements with our Named
Executive  Officers that replaced prior  employment  agreements.  The agreements
provide that the executives  are employed for a period of three years  beginning
January  1,  2004.  Upon  each  anniversary  of the  agreement,  the  employment
automatically extends for an additional year (resulting in successive three-year
terms) unless,  no later than ninety days prior to the expiration  date,  either
Community or the executive gives written  notification to the other of an intent
not to renew the  employment  agreement.  In the event of a change of control in
Community, the agreement automatically extends to a three-year term.

Community may  terminate  the  agreement  for cause or if the executive  becomes
permanently  disabled.  After a termination for one of those reasons,  or if the
executive  terminates his  employment  without good reason,  Community  would be
obligated to pay the executive the  compensation  that he had earned through the
date of termination.  The agreement also requires Community to pay the executive
120% of his salary for the remainder of the term of the agreement,  in the event
that the executive  terminates  his employment  for certain  reasons,  such as a
reassignment of duties, a reduction in compensation,  Community's  breach of the
agreement  or the removal of the  executive  from his current  position.  If the
executive  terminates his employment as the result of a change of control, he is
entitled to a lump-sum  payment of an amount equal to three times the average of
his  salaries  and bonuses in the three years  preceding  the  termination.  The
executive  and his family  would also be  entitled in that  situation  either to
participate  in the employee  benefit  plans of the  successor  company until he
reaches the age of 65 or to be paid an amount that would enable the executive to
purchase comparable benefits.

Pursuant to the agreements,  each executive  officer  receives an annual salary,
which is subject to  increase  as the  compensation  committee  and the board of
directors deem  appropriate.  Under the terms and conditions of the  agreements,
the  executives  are entitled to  participate  in  Community's  executive  bonus
program,  receive benefits under all of Community's employment benefit plans and
participate in  Community's  existing stock option plan. The executives are also
entitled to other benefits and  perquisites  as  Community's  board of directors
deems appropriate.

                                       80
<PAGE>

Executive Compensation
----------------------

The  compensation  committee  seeks to attract  and retain  qualified  executive
officers by offering compensation  competitive with that offered by similar bank
holding companies. The compensation committee considers objective and subjective
criteria.  Among  other  things,  the  Committee  considers  data  from  the SNL
Executive  Compensation  Review and data  compiled by Human  Resource  Partners,
which  used a  peer  analysis  of  similarly  sized  Pennsylvania  bank  holding
companies. The SNL Executive Compensation Review compares:



     o    asset size;
     o    return on assets;
     o    the  salaries  of the chief  executive  officer  and  other  executive
          officers;
     o    return on average assets; and
     o    return on average equity.

The compensation  committee also considers the performance of Community's common
stock on the NASDAQ Stock Market,  particularly compared with the performance of
the stock of other comparable bank holding companies.

The  compensation  committee does not make its  recommendations  based solely on
corporate performance. The Committee also considers subjective factors. However,
the Committee  considers peer group information and corporate  performance to be
significant factors in determining executive compensation.

Mr. Dunklebarger

For 2004, Mr. Dunklebarger  received an annual salary of $350,000. He was also a
participant  in  the  Community  Banks,   Inc.  Long  Term  Incentive  Plan  and
Community's Bonus Program. Mr. Dunklebarger earned a bonus of $175,000. Pursuant
to Community's Long Term Incentive Plan, Mr. Dunklebarger was awarded options to
purchase  30,000  shares of  Community's  common  stock at an exercise  price of
$28.89 per share. These options, granted in December of 2004, were based on 2004
performance.

Other Executive Officers

With respect to the compensation of Community's  other executive  officers,  the
compensation  committee  considers  information  provided by the Chief Executive
Officer about each executive officer including:

     1)   level of individual performance;
     2)   contribution to the consolidated organization; and
     3)   salary history.

The Compensation committee also considers:

     4)   the earnings of Community on a consolidated basis;
     5)   the peer group compensation information discussed above;
     6)   individual performance factors; and
     7)   its subjective  evaluation of the services  provided by each executive
          officer.

You can see the compensation paid to Community's other executive officers in the
Summary Compensation Table appearing elsewhere in Item 11 of this Form 10-K.

This  report  is  given by the  Compensation  committee,  consisting  of Earl L.
Mummert (Chair),  Peter DeSoto, Donald L. Miller, Robert W. Rissinger,  and John
W. Taylor, Jr.

                                       81
<PAGE>
          Other Compensation Arrangements for Named Executive Officers

Community Banks, Inc. 401(k) Profit Sharing Plan
------------------------------------------------

Employees are eligible to participate in Community's 401(k) plan after they have
completed three months of service and have reached their twenty-first  birthday.
The plan offers both immediate and future  benefits to employees in the program.
The  plan  was  submitted  to  the  Internal   Revenue   Service  for  favorable
determination as a tax deferred retirement program.

Community  allocates  for  participating  accounts  an  annual  amount  based on
Community's  earnings at the end of each calendar year. The amount  allocated to
an employee's  account is based on the  relationship  of the  employee's  annual
compensation to the total annual compensation paid by Community to all employees
participating  in the plan.  Subject to limitations of the plan and the trustees
under the plan,  an employee can receive a percentage  (to be  determined in the
discretion  of the board of directors)  of his or her annual  compensation  as a
contribution  to the plan  account  each  year.  The  monies  allocated  to each
employee's account are held and invested by the trustee for the plan.  Employees
become  fully vested in the plan after five years of service.  Upon  retirement,
employees  will be  eligible  to  withdraw  their  vested  interest  in the plan
according to the plan provisions. Should the participant become disabled or upon
his or her death, the plan allows for other payment options. As a participant in
the plan,  the employee has the right to direct the  investment of all of his or
her funds. An employee may split his or her investment between two or more types
of investments or instruct the  administrator  to place the entire amount in one
investment account.

In order to allow  participants  the  opportunity to increase  their  retirement
income,  each participant may, at the discretion of the administrator,  elect to
voluntarily  contribute no less than 1% and no more than 70% (subject to certain
limitations) of his or her total  compensation  earned while a participant under
the plan. The amounts in each participant's  voluntary  contribution account are
fully vested at all times and are not subject to forfeiture for any reason.  The
normal retirement age under the plan is age 65.

Survivor Income Agreements
--------------------------

On June 1, 1994,  Community Banks, N.A. entered into a Survivor Income Agreement
with Robert W. Lawley. On February 5, 1999, The Peoples State Bank and Community
entered into similar agreements with Eddie L.  Dunklebarger,  Anthony N. Leo and
Jeffrey M. Seibert. On December 31, 2001,  Community Banks, N.A. and The Peoples
State Bank merged to form one bank named Community Banks, Community's subsidiary
bank. On August 29, 2002,  Community Banks entered into a similar agreement with
Donald  F.  Holt.  For  the  purpose  of  describing  the  provisions  of  these
agreements, Community Banks and its predecessors will each be referred to as the
"Bank."  In  these  agreements,  the  Bank  promised  to pay to  each  executive
employee's  designated  beneficiary a survivor  income  benefit.  The survivor's
income benefit is payable only if the executive employee dies before terminating
employment  with  the  Bank and only to the  extent  that  the  Bank  owns  life
insurance  policies on the executive  employee's  life at the time of his or her
death.

The base death benefit is equal to the lesser of:

     o    three times the executive employee's base salary for the calendar year
          in which the executive's death occurs; or
     o    the amount of life insurance  proceeds received by the Bank due to the
          executive's death.

The base death  benefit,  however,  will be  increased by an amount equal to the
death benefit  multiplied by  Community's  projected  highest  marginal  federal
income  tax rate  for the  year in  which  the  executive's  death  occurs.  The
survivor's  income  benefit  will be paid in a lump sum within 60 days after the
executive  employee's  death.  These  agreements  are  funded by life  insurance
policies on each executive employee's life.

The life  insurance  policies  are owned by the  Bank,  and are in place of each
executive  employee's  participation  in the Bank's group life insurance plan. A
split dollar insurance  agreement goes into effect after the executive  employee
reaches  the age of 65,  as long he has  completed  ten (10)  years of  service.
Pursuant to the terms of the split dollar agreement,  the executive employee has
the right to designate the  beneficiary  of the death  proceeds of the policy to
the extent the  proceeds  exceed the cash  surrender  value of the policy on the
date before the executive employee's death.

                                       82
<PAGE>

Supplemental Executive Retirement Plans
---------------------------------------

Community maintains  Supplemental  Executive  Retirement Plans providing key man
life  insurance  on the lives of certain  executive  employees.  Pursuant to the
plans,  Community  has  purchased  key man life  insurance  policies  with death
benefits  payable  to  Community  if an  executive  dies  in the  course  of his
employment with Community, in initial net amounts of:

     o    $2,911,000 covering the life of Eddie L. Dunklebarger;
     o    $1,076,000 covering the life of Donald F. Holt;
     o    $3,124,000 covering the life of Robert W. Lawley;
     o    $2,373,000 covering the life of Anthony N. Leo; and
     o    $2,530,000 covering the life of Jeffrey M. Seibert.

The plans also provide salary continuation  benefits for the executives pursuant
to  Salary  Continuation  Agreements  entered  into  between  Community  and the
executives.  If the executive remains employed by Community until he reaches age
62, then the executive will be entitled to salary  continuation for twenty years
after  retirement.  Pursuant  to  their  respective  agreements,  the  following
individuals are entitled to the following amounts:

     o    Eddie L. Dunklebarger - $180,000 per year;
     o    Donald F. Holt - $48,000 per year;
     o    Robert W. Lawley - $80,000 per year.
     o    Anthony N. Leo - $75,000 per year;
     o    Jeffrey M. Seibert - $75,000 per year.

If the executive's  employment  with Community is terminated  before age 62, the
executive will receive reduced  benefits at age 62 in accordance with accrual of
benefits schedules set forth in the respective agreements.  Benefits will not be
paid if an  executive's  employment is  terminated  for cause (as defined in the
respective agreements). In the event of termination due to disability, Community
may elect to pay the accrued  benefit  immediately in a lump sum,  discounted to
present  value.  In the event that an executive is terminated  after a change in
control but prior to age 62, the  executive  will  receive at age 62 his accrued
benefit,  plus an additional  benefit equal to three years additional accrual in
the case of Mr.  Dunklebarger,  and two years additional accrual in the cases of
Messrs.  Holt, Leo, Seibert and Lawley. If the executive dies prior to or during
the benefit payment period,  normal  retirement  benefits will be payable to the
executive's  beneficiaries  beginning  within  one month  after the  executive's
death.

           Directors and Senior Management Deferred Compensation Plan

On January 1, 2004,  Community adopted the Community Banks,  Inc.  Directors and
Senior  Management  Deferred  Compensation  Plan,  effective January 1, 2004, to
assist   directors  and   executives  in   establishing  a  program  to  provide
supplemental  retirement  benefits.  This plan is a voluntary  variable deferred
compensation plan. The amount deferred from salary or bonus by Community's chief
executive officer and the four most highly compensated executives is included in
the Summary Compensation Table under the Salary column, as having been earned in
2004.


                                       83
<PAGE>


                                    DIRECTORS

Attendance Fees
---------------

In 2004, each Company director received a quarterly fee of $1,250. Each director
who was not an executive officer also received $500 for each board and committee
meeting attended.  Members of the executive  committee of Community's board were
also paid an annual retainer of $2,500. Directors of Community's bank subsidiary
(which  include  some of the  directors  of  Community)  receive  the  following
additional fees:

     o    $5,000 annual retainer; and
     o    $400 fee for each board and committee meeting attended.

Directors' Stock Option Plan
----------------------------

In 2000, the  shareholders  of Community  approved the  Directors'  Stock Option
Plan. The purpose of the  Directors'  Stock Option Plan is to attract and retain
non-employee  directors  who have  outstanding  abilities.  The plan enables the
directors to purchase shares on terms which will give the directors a direct and
continuing  interest in the success of Community.  The price of the options must
equal at least the fair market value of Community shares on the date the options
are granted. Directors may not exercise the options before the first anniversary
of the option grant or a change of control in Community, whichever first occurs.
The options will expire in ten years, unless they are exercised.

On December 6, 2004,  Community  granted options to all non-employee  directors,
except  emeritus  directors,  to  purchase  600  shares at a price of $28.89 per
share.  Each  non-employee  member of the  executive  committee of the board was
awarded  options to purchase an  additional  300 shares,  and each chairman of a
board committee received options to purchase an additional 100 shares.

                             STOCK PERFORMANCE GRAPH

The following graph shows the yearly percentage change in Community's cumulative
total shareholder  return on its common stock from December 31, 1999 to December
31, 2004  compared with the  cumulative  total return of the NASDAQ Stock Market
(U.S.  Companies),  and a  self-determined  peer group consisting of twelve bank
holding  companies.  The bank holding  companies in the peer group are Bryn Mawr
Bank Corp., Columbia Bancorp,  Comm Bancorp,  Inc., Community Bank System, Inc.,
Harleysville  National Corp.,  KNBT Bancorp,  Inc.,  Leesport  Financial  Corp.,
National Penn  Bancshares,  Inc.,  Omega Financial  Corp., S & T Bancorp,  Inc.,
Sandy Spring  Bancorp,  Inc., and Sterling  Financial Corp.  Community  selected
these  companies  because they conduct a community  banking  business in similar
markets   and  they  are  similar  to   Community   in  asset  size  and  market
capitalization.  Two of the  companies  that were in the peer  group used in the
stock  performance  graph in Community's 2004 proxy statement have been deleted.
PennRock was deleted  because of the merger that is discussed in this  document.
Sun Bancorp,  Inc. was deleted,  because it has merged into another bank holding
company,  and the necessary stock price  information is no longer  available for
it. In place of these two entities,  Community has added  Community Bank System,
Inc., a $4.4 billion financial  institution based in New York, and KNBT Bancorp,
Inc., a $2.4 billion financial institution based in Bethlehem, Pennsylvania.



                                       84
<PAGE>



<TABLE>
<CAPTION>

                Comparison of Five-Year Cumulative Total Returns
                   Performance Graph for Community Banks, Inc.



                                        12/1999  12/2000  12/2001   12/2002   12/2003  12/2004
                                        -------  -------  -------   -------   -------  -------


<S>                                      <C>       <C>     <C>        <C>      <C>       <C>
Community Banks, Inc.                    100.0     97.2    138.2      153.0    233.8     216.0
NASDAQ Stock Market                      100.0     60.3     47.8       33.1     49.4      53.8
(US Companies)
Self-Determined Peer Group               100.0     90.7    121.6      144.1    190.3     210.9

</TABLE>



                                       85
<PAGE>


           Compensation Committee Interlocks and Insider Participation
           -----------------------------------------------------------

None of the  committee  members has been an officer or employee of  Community or
any of its  subsidiaries  at any time.  Earl L. Mummert is a consulting  actuary
with Conrad M. Siegel, Inc. which provides actuarial services for Community.  As
is the case with other board  members,  any  indebtedness  of the members of the
compensation  committee to  Community's  bank  subsidiary  is on the same terms,
including interest rate and collateral on loans, as those prevailing at the time
of corporate  transactions with others and does not involve more than the normal
risk of collectibility or present other unfavorable features.


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

The following table provides information regarding the common stock of Community
that is available for issuance under equity compensation plans.

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

------------------------------------------------------------------------------------------------------------------------------------
          Plan Category                          (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
                                             and rights                   warrants and rights                 column (a))
------------------------------------------------------------------------------------------------------------------------------------
<S>                                           <C>                               <C>                           <C>
Equity compensation plans
approved by security holders                  1,073,000                         $20.44                        916,000 (1)
------------------------------------------------------------------------------------------------------------------------------------
Equity compensation plans not
approved by security holders (2)                None                              n/a                             n/a
------------------------------------------------------------------------------------------------------------------------------------
              Total                           1,073,000                         $20.44                          916,000
------------------------------------------------------------------------------------------------------------------------------------
</TABLE>

     (1)  Includes 88,000 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.


                                       86
<PAGE>

The following  table shows the number of shares of common stock owned by each of
Community's  directors  and Named  Executive  Officers and by the  directors and
Named Executive  Officers as a group,  as of February 28, 2005.  Common stock is
the only class of equity  securities that is outstanding.  No one owns more than
5% of Community's common stock.

<TABLE>
<CAPTION>

         ----------------------------------------------------------------------------------------------------------------
                                                                                                          Percentage of
                                                                                Number of Shares           Outstanding
         Name of Beneficial Owner and Position                               Beneficially Owned (1)        Common Stock
         -------------------------------------                               ----------------------        ------------

         Directors

<S>                                                                                    <C>                       <C>
         Ronald E. Boyer                                                               47,903  (2)                 *
         Samuel E. Cooper                                                               8,124  (3)                 *
         Peter DeSoto                                                                  79,967  (4)                 *
         Eddie L. Dunklebarger, Chairman, President and CEO                           334,426  (5)              2.677%
         Thomas W. Long                                                                21,567  (6)                 *
         Donald L. Miller                                                             141,262  (7)              1.148%
         Thomas L. Miller                                                              63,307  (8)                 *
         Earl L. Mummert                                                               40,246  (9)                 *
         Wayne H. Mummert                                                              89,154  (10)                *
         Scott J. Newkam                                                                1,207  (11)                *
         Robert W. Rissinger                                                          393,166  (12)             3.196%
         Allen Shaffer                                                                163,966  (13)             1.332%
         John W. Taylor, Jr.                                                           42,372  (14)                *
         James A. Ulsh                                                                 31,417  (15)                *

         Named Executive Officers (other than Mr. Dunklebarger)

         Donald F. Holt, Executive Vice President and CFO                              10,738  (16)                *
         Robert W. Lawley, Executive Vice President                                    41,094  (17)                *
         Anthony N. Leo, Executive Vice President                                      51,678  (18)                *
         Jeffrey M. Seibert, Executive Vice President                                 105,422  (19)                *

         Directors and Named Executive Officers as a group                          1,654,974  (20)            13.018%
         -------------------------------------------------

         *Indicates less than one percent (1%)
         ---------------------------------------------------------------- ------------------------------ ------------------
</TABLE>


        Notes to Security Ownership Table
        ---------------------------------

(1)  The  securities  "beneficially  owned" by an individual  are  determined in
     accordance  with the definition of "beneficial  ownership" set forth in the
     regulations of the Securities and Exchange  Commission.  Accordingly,  they
     may include securities owned by or for, among others, the wife and/or minor
     children of the  individual and any other relative who has the same home as
     such individual, as well as other securities as to which the individual has
     or shares  voting or  investment  power or has the right to  acquire  under
     outstanding   stock  options  within  60  days  after  February  28,  2005.
     Beneficial ownership may be disclaimed as to certain of the securities.
(2)  Includes  shares  12,041  shares owned by Alvord Polk,  Inc. , the stock of
     which is held 50% by Ronald Boyer and 50% by Robert Rissinger; 1,797 shares
     owned by Mr. Boyer's wife; and stock options to acquire 4.855 shares.
(3)  Includes stock options to acquire 4,176 shares.
(4)  Includes 3,780 shares held in Mr. DeSoto's IRA and stock options to acquire
     5,170 shares.
(5)  Includes 13,926 shares held in Mr. Dunklebarger's IRA; 4,828 shares held in
     an ESPP;  20,804  shares  held in his 401K;  516  shares  held by his wife;
     17,977  shares  held  by  his   children;   and  stock  options  (ISOs  and
     Non-Qualified Stock Options) to acquire 193,292 shares.
(6)  Includes  20,681  shares  held in  Revocable  Trusts  and stock  options to
     acquire 630 shares.
(7)  Includes stock options to acquire 5,170 shares.
(8)  Includes  58,134  shares  held in  Revocable  Trusts  and stock  options to
     acquire 5,170 shares.

                                       87
<PAGE>

(9)  Includes  28,116  shares  held by Mr.  Mummert's  IRA and stock  options to
     acquire 6,163 shares.
(10) Includes  21,005  shares held by Mr.  Mummert's  wife and stock  options to
     acquire 5,170 shares.
(11) Includes stock options to acquire 945 shares.
(12) Includes  12,041 shares owned by Alvord Polk,  Inc.,  the stock of which is
     held 50% by Robert Rissinger and 50% by Ronald Boyer.  Also includes 26,833
     shares held by Engle Ford,  Inc.;  114,972  shares held in Mr.  Rissinger's
     IRA;  69,674  shares  held by Mr.  Rissinger's  wife and stock  options  to
     acquire 6,163 shares.
(13) Includes 88,434 shares owned by the Polk  Foundation,  of which Mr. Shaffer
     is chairman,  and for which Mr. Shaffer holds voting and investment  power;
     and stock options to acquire 5,170 shares.
(14) Includes  1,388 shares held in Mr.  Taylor's IRA;  1,941 shares held by his
     wife; 213 shares held by his wife as custodian in Uniform Gift to Minor Act
     accounts  for minor  grandchildren;  and stock  options  to  acquire  5,170
     shares.
(15) Includes 2,772 shares held in Mr. Ulsh's 401K, and stock options to acquire
     5,170 shares.
(16) Includes  3 shares  held in Mr.  Holt's  IRA and stock  options  to acquire
     10,735 shares.
(17) Includes 131 shares held in Mr.  Lawley's  ESPP; 4 shares held in his 401K;
     69 shares held by his children; and stock options to acquire 40,889 shares.
(18) Includes 335 shares held by Mr. Leo's ESPP;  9,872 shares held in his 401K;
     and stock options to acquire 40,562 shares.
(19) Includes 12,036 shares held in Mr.  Seibert's IRA; 3,538 shares held in his
     ESPP;  9,197  shares held in his 40K; and stock  options to acquire  67,184
     shares.
(20) Includes 282,938 shares that are indirectly held. The 12,041 shares held by
     Alvord Polk, Inc. are counted only once in this total, as Alvord Polk, Inc.
     is 50% owned by Robert W. Rissinger and 50% owned by Ronald E. Boyer. Thus,
     these shares are indicated  above as being  beneficially  owned by both Mr.
     Rissinger and Mr. Boyer.


Section 16(a) Beneficial Ownership Reporting Compliance

Our directors and executive  officers must file reports with the  Securities and
Exchange  Commission  indicating the number of shares of Community  common stock
they beneficially own and changes in their beneficial ownership.  To the best of
our  knowledge,  all such reports were filed on a timely  basis,  except for one
late filing by Thomas L. Miller relating to an acquisition of two hundred shares
by his spouse.


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

Transactions  with Officers and Directors
During  2004,  the  Bank  had,  and  expects  to  have  in the  future,  banking
transactions  in the ordinary  course of business with directors and officers of
Community  and their  associates  on  substantially  the same  terms,  including
interest  rates and  collateral  on loans,  as those  prevailing at the time for
comparable transactions with other persons. Management believes that these loans
present  no more than the normal  risk of  collectibility  or other  unfavorable
features.

Allen  Shaffer,  a director  of  Community,  is a partner in Shaffer & Engle Law
Offices with offices in Harrisburg and Millersburg,  Pennsylvania,  who has been
retained in the last  fiscal year by  Community  and who  Community  proposes to
retain in the current fiscal year. James A. Ulsh, a director of Community,  is a
shareholder/employee  of the law firm of Mette,  Evans &  Woodside,  Harrisburg,
Pennsylvania,  which Community has retained in the last fiscal year and proposes
to retain in the current fiscal year. Earl L. Mummert,  a director of Community,
is  an  actuarial   consultant   with  Conrad  M.  Siegel,   Inc.,   Harrisburg,
Pennsylvania, which provides actuarial services to Community.


                                       88
<PAGE>

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

Community's Audit Committee engaged Beard Miller Company LLP ("Beard Miller") to
act as Community's auditor for 2003 and 2004. The Sarbanes Oxley Act of 2002 and
the auditor  independence  rules of the United  States  Securities  and Exchange
Commission  require all public  accounting  firms who audit public  companies to
obtain  pre-approval  from their respective Audit Committees in order to provide
professional  services  without  impairing  independence.  Before  Beard  Miller
performs any services for Community,  the Audit  Committee is informed that such
services are necessary and is advised of the estimated  costs of such  services.
The Audit Committee then decides  whether to approve Beard Miller's  performance
of the services.  In 2004, all services  performed by Beard Miller were approved
in advance pursuant to these procedures. The Audit Committee has determined that
the performance by Beard Miller of tax services is compatible  with  maintaining
that firm's independence.

Beard Miller has  previously  issued  engagement  letters to or obtained  formal
approval from Community's Audit Committee for certain  services.  These services
are summarized below.

             Fees Billed By Independent Certified Public Accountants

Community's  principal  accountants  billed the  following  fees in the last two
fiscal years:
<TABLE>
<CAPTION>

                                                                   Audit-
               Year                                Audit (1)     Related (2)      Tax (3)        All Other Fees
               ----                                ---------    -------------     -------        --------------
                                                    PricewaterhouseCoopers LLP
               ------------------------------------------------------------------------------------------------------
<S>            <C>                                 <C>              <C>             <C>                  <C>
               2003                                $    9,452       $  21,985       $  28,199            ---

                                                    Beard Miller Company LLP
               ------------------------------------------------------------------------------------------------------
               2003                                $  115,967       $   8,195       $     425            ---
               2004                                   139,990          19,062          10,713            ---
</TABLE>

     (1)  Includes  professional  services rendered for the audit of Community's
          annual  financial   statements  and  review  of  financial  statements
          included in Forms 10-Q, FDICIA attestation, Sarbanes Oxley attestation
          and out-of-pocket expenses.
     (2)  Includes  separate  audit  reports on  subsidiaries  of Community  and
          assistance  on  matters of  accounting  and due  diligence  related to
          proposed acquisitions.
     (3)  Includes  the review of state and federal  tax returns and  assistance
          with various tax matters.


                                       89
<PAGE>
                                     PART IV

Item 15.  Exhibits, Financial Statements Schedules:
---------------------------------------------------

(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, 2004 and 2003
     (ii) Consolidated  Statements  of Income for the Years Ended  December  31,
          2004, 2003 and 2002
     (iii)Consolidated  Statements  of Changes in  Stockholders'  Equity for the
          Years  Ended  December  2004,   2003,  and  2002.
     (iv) Consolidated Statements of Cash Flows for the Years Ended December 31,
          2004, 2003 and 2002.
     (v)  Notes to Consolidated Financial Statements
     (vi) Report of Beard Miller  Company  LLP,  Independent  Registered  Public
          Accounting Firm

     2.   Financial Statements 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

     2.1  Agreement and Plan of  Reorganization,  dated November 7, 2000,  among
          Community Banks, Inc.; The Peoples State Bank; and The Glen Rock State
          Bank,  not  including  schedules.  Community  will furnish the omitted
          schedules to the  Securities  and Exchange  Commission  upon  request.
          (Incorporated  by reference to Exhibit 2 to  Community's  registration
          statement on Form S-4, filed on January 17, 2001)
     2.2  Merger  agreement  between  PennRock   Financial  Services  Corp.  and
          Community  Banks,   Inc.,  dated  November  16,  2004,  not  including
          schedules.  Community  will  furnish  the  omitted  schedules  to  the
          Securities  and Exchange  Commission  upon request.  (Incorporated  by
          reference to Exhibit 10.1 to  Community's  Current Report on Form 8-K,
          filed with the Commission on November 22, 2004)
     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, 2003,  filed with
          the Commission on March 28, 2003)
     10.3 Form  of  Stock  Option   Agreement  -  Directors  Stock  Option  Plan
          (Incorporated  by reference to 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  for  Eddie  L.  Dunklebarger  (Incorporated  by
          reference to Exhibit 10.1 to Community's Quarterly Report on Form 10-Q
          for the quarter ended September 30, 2004, filed with the Commission on
          November 9, 2004)*
     10.6 Employment  Agreement for Donald F. Holt (Incorporated by reference to
          Exhibit  10.2 to  Community's  Quarterly  Report  on Form 10-Q for the
          quarter  ended  September  30,  2004,  filed  with the  Commission  on
          November 9, 2004)*
     10.7 Employment  Agreement for Robert W. Lawley  (Incorporated by reference
          to Exhibit 10.3 to Community's  Quarterly  Report on Form 10-Q for the
          quarter  ended  September  30,  2004,  filed  with the  Commission  on
          November 9, 2004)*
     10.8 Employment  Agreement for Anthony N. Leo (Incorporated by reference to
          Exhibit  10.4 to  Community's  Quarterly  Report  on Form 10-Q for the
          quarter  ended  September  30,  2004,  filed  with the  Commission  on
          November 9, 2004)*
     10.9 Employment Agreement for Jeffrey M. Seibert (Incorporated by reference
          to Exhibit 10.5 to Community's  Quarterly  Report on Form 10-Q for the
          quarter  ended  September  30,  2004,  filed  with the  Commission  on
          November 9, 2004)*
                                       90
<PAGE>

     10.10Amended  and  Restated  Salary  Continuation  Agreement  of  Eddie  L.
          Dunklebarger (Incorporated by reference to Exhibit 10.1 to Community's
          Quarterly  Report on Form 10-Q for the quarter  ended March 31,  2004,
          filed with the Commission on May 10, 2004)*
     10.11Salary  Continuation  Agreement  of Donald F.  Holt  (Incorporated  by
          reference to Exhibit 10.2 to Community's Quarterly Report on Form 10-Q
          for the quarter ended March 31, 2004, filed with the Commission on May
          10, 2004)*
     10.12Amended  and  Restated  Salary  Continuation  Agreement  of  Robert W.
          Lawley  (Incorporated  by  reference  to Exhibit  10.3 to  Community's
          Quarterly  Report on Form 10-Q for the quarter  ended March 31,  2004,
          filed with the Commission on May 10, 2004)*
     10.13Amended and Restated Salary  Continuation  Agreement of Anthony N. Leo
          (Incorporated  by reference to Exhibit 10.4 to  Community's  Quarterly
          Report on Form 10-Q for the quarter  ended March 31, 2004,  filed with
          the Commission on May 10, 2004)*
     10.14Amended  and  Restated  Salary  Continuation  Agreement  of Jeffrey M.
          Seibert  (Incorporated  by reference  to Exhibit  10.5 to  Community's
          Quarterly  Report on Form 10-Q for the quarter  ended March 31,  2004,
          filed with the Commission on May 10, 2004)*
     10.15Rights 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)
     10.16Community  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)
     10.17Survivor  Income  Agreement,  with Split Dollar Addendum  thereto,  of
          Eddie L.  Dunklebarger  (Incorporated  by reference to Exhibit to 3.2,
          attached to Community's  Quarterly Report on Form 10-Q for the quarter
          ended September 30, 2003)*
     10.18Survivor  Income  Agreement,  with Split Dollar Addendum  thereto,  of
          Donald F. Holt (Incorporated by reference to Exhibit to 10.6, attached
          to  Community's  Quarterly  Report on Form 10-Q for the quarter  ended
          March 31, 2004)*
     10.19Survivor  Income  Agreement,  with Split Dollar Addendum  thereto,  of
          Robert  W.  Lawley  (Incorporated  by  reference  to  Exhibit  to 3.2,
          attached to Community's  Quarterly Report on Form 10-Q for the quarter
          ended September 30, 2003)*
     10.20Survivor  Income  Agreement,  with Split Dollar Addendum  thereto,  of
          Anthony N. Leo  (Incorporated by reference to Exhibit to 3.2, attached
          to  Community's  Quarterly  Report on Form 10-Q for the quarter  ended
          September 30, 2003)*
     10.21Survivor  Income  Agreement,  with Split Dollar Addendum  thereto,  of
          Jeffrey  M.  Seibert  (Incorporated  by  reference  to Exhibit to 3.2,
          attached to Community's  Quarterly Report on Form 10-Q for the quarter
          ended September 30, 2003)*
     21   Subsidiaries of the Registrant (See Item 1, page #3)
     23.1 Consent  of  Independent  Registered  Public  Accounting  Firm - Beard
          Miller Company LLP
     23.2 Consent  of   Independent   Registered   Public   Accounting   Firm  -
          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   Registered   Public   Accounting   Firm  -
          PricewaterhouseCoopers LLP

          * identifies a management contract or compensatory plan or arrangement

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

     (c)Financial Statements Schedules - None required.




                                       91
<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 9, 2005
<TABLE>

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.

<S>                              <C>                                                     <C>
/S/     (Donald F. Holt)         Ex. Vice President and                                  3/9/05
-------------------------------- Chief Financial Officer
        (Donald F. Holt)        (Principal Accounting Officer)

/S/     (Ronald E. Boyer)        Director                                                3/9/05
--------------------------------
        (Ronald E. Boyer)

/S/     (Samuel E. Cooper)       Director                                                3/9/05
--------------------------------
        (Samuel E. Cooper)

/S/     (Peter DeSoto)           Director                                                3/9/05
--------------------------------
        (Peter DeSoto)

/S/     (Thomas W. Long)         Director                                                3/9/05
--------------------------------
        (Thomas W. Long)

/S/     (Donald L. Miller)       Director                                                3/9/05
--------------------------------
        (Donald L. Miller)

/S/     (Thomas L. Miller)       Director                                                3/9/05
--------------------------------
        (Thomas L. Miller)

/S/     (Earl L. Mummert)        Director                                                3/9/05
--------------------------------
        (Earl L. Mummert)

/S/     (Wayne H. Mummert)       Director                                                3/9/05
--------------------------------
        (Wayne H. Mummert)

/S/     (Scott J. Newkam)        Director                                                3/9/05
--------------------------------
        (Scott J. Newkam)

/S/     (Robert W. Rissinger)    Director                                                3/9/05
--------------------------------
        (Robert W. Rissinger)

/S/     (Allen Shaffer)          Director                                                3/9/05
--------------------------------
        (Allen Shaffer)

/S/     (John W. Taylor, Jr.)    Director                                                3/9/05
--------------------------------
        (John W. Taylor, Jr.)

/S/     (James A. Ulsh)          Director                                                3/9/05
--------------------------------
        (James A. Ulsh)
</TABLE>



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