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**UNITED STATES**

**SECURITIES AND EXCHANGE COMMISSION**

**WASHINGTON, DC. 20549**

 

**FORM 10-K**

 

**x****     ****ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIESEXCHANGE ACT OF 1934**

 

**For the fiscal year ended  December 31,2009**

 

**OR**

 

**o****        ****TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THESECURITIES EXCHANGE ACT OF 1934 (NO FEE REQUIRED)**

 

**Commission file number  0-17077**

 

**PENNS WOODS BANCORP, INC.**

 

| **Pennsylvania**                                                      | ** ** | **23-2226454**                         |
|-----------------------------------------------------------------------|------------|----------------------------------------|
| (State or other  jurisdiction of incorporation or  organization)      | ** ** | (I.R.S.  Employer Identification  No.) |
| ** **                                                            | ** ** | ** **                             |
| **300 Market  Street, P.O. Box 967  Williamsport, Pennsylvania** | ** ** | **17703-0967**                         |

 

Registrant’s telephone number, including areacode    (**570) 322-1111**

 

Securitiesregistered pursuant to Section 12(b) of the Act:

 

| **Title of  each class**                    | ** ** | **Name of  each exchange which registered** |
|---------------------------------------------|------------|---------------------------------------------|
| **Common Stock, par value $8.33 per share** | ** ** | **The NASDAQ Stock Market LLC**             |

 

Securitiesto be registered pursuant to Section 12(g) of the Act:

 

**None**

(Title of Class)

 

Indicateby check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405of the Securities Act.  o  Yes  x  No

 

Indicateby check mark if the registrant is not required to file reports pursuant to Section 13or Section 15(d) of the Act. o  Yes  x  No

 

Indicate by check markwhether the registrant (1) has filed all reports required to be filed by Section 13or 15(d) of the Securities Exchange Act of 1934 during the preceding 12months (or for such shorter period that the registrant was required to filesuch reports), and (2) has been subject to such filing requirements forthe past 90 days.   Yes x  No  o

 

Indicate by check markwhether the registrant has submitted electronically and posted on its corporatewebsite, if any, every Interactive Data File required to be submitted andposted pursuant to Rule 405 of Regulation S-T during the preceding 12months (or for such shorter period that the registrant was required to submitand post such files).  Yes o No o

 

Indicate by check mark ifdisclosure of delinquent filers pursuant to Item 405 of Regulation S-K is notcontained herein, and will not be contained, to the best of registrant’sknowledge, in definitive proxy or information statements incorporated byreference in Part III of this Form 10-K or any amendment to this Form 10-K. x

 

Indicate by check markwhether the registrant is a large accelerated filer, an accelerated filer, anonaccelerated filer, or a smaller reporting company. See definition of “largeaccelerated filer”, “accelerated filer”, and “smaller reporting company” in Rule 12b-2of the Exchange Act.  (Check one): 

 

Large accelerated filer o        Accelerated filer x       Non-accelerated filer o       Smaller reporting company o

(Do not check if a smallerreporting company)

 

Indicate by check markwhether the registrant is a shell company (as defined in Rule 12b-2 of theExchange Act). o Yes  x No

 

State the aggregatemarket value of the voting stock held by non-affiliates of the registrant **$111,692,367 at June 30, 2009.**

 

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

 

| **Class**                         | ** ** | **Outstanding at March 2, 2010** |
|-----------------------------------|------------|------------------------------------------------------|
| **Common Stock, $8.33 Par Value** | ** ** | **3,834,475 Shares**                                 |

 

 

 

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**DOCUMENTS INCORPORATED BY REFERENCE**

 

Portions of theregistrant’s definitive proxy statement prepared in connection with its annualmeeting of shareholders to be held on April 28, 2010 are incorporated byreference in Part III hereof.

 

**INDEX**

 
| ** **                                                                                                                                       | **PAGE** |
|--------------------------------------------------------------------------------------------------------------------------------------------------|----------|
| **PART I**                                                                                                                                  |     |
|                                                                                                                                             |     |
| ITEM                                                                                                                                             |     |
| Item  1.    Business                                                                                                              | 3        |
| Item 1A. Risk Factors                                                                                                                            | 8        |
| Item 1B.  Unresolved Staff Comments                                                                                                              | 10       |
| Item 2.     Properties                                                                                                            | 10       |
| Item  3.    Legal Proceedings                                                                                                     | 11       |
| Item  4.    (Removed and Reserved)                                                                                                | 11       |
|                                                                                                                                             |     |
| **PART II**                                                                                                                                 |     |
|                                                                                                                                             |     |
| Item 5.     Market for the Registrant’s Common Stock, Related  Stockholder Matters, and Issuer Purchase of Equity Securities | 11       |
| Item 6.     Selected Financial Data                                                                                               | 13       |
| Item  7.    Management’s Discussion and Analysis of Consolidated  Financial Condition and Results of Operations              | 15       |
| Item 7A. Quantitative and Qualitative Disclosures  About Market Risk                                                                             | 32       |
| Item 8.    Financial Statements and  Supplementary Data                                                                           | 33       |
| Item 9.    Changes in and Disagreements  with Accountants on Accounting and Financial Disclosure                                  | 68       |
| Item 9A. Controls and Procedures                                                                                                            | 68       |
| Item  9B. Other Information                                                                                                                      | 70       |
|                                                                                                                                             |     |
| **PART III**                                                                                                                                |     |
|                                                                                                                                             |     |
| Item 10.  Directors and Executive Officers of the  Registrant                                                                               | 70       |
| Item 11.  Executive Compensation                                                                                                            | 70       |
| Item 12.  Security Ownership and Certain  Beneficial Owners and Management and Related Stockholder Matters                                  | 70       |
| Item 13.  Certain Relationships and Related  Transactions                                                                                   | 70       |
| Item 14.  Principal Accountant Fees and Services                                                                                            | 70       |
|                                                                                                                                             |     |
| **PART IV**                                                                                                                                 |     |
|                                                                                                                                             |     |
| Item 15.  Exhibits and Financial Statement  Schedules                                                                                       | 71       |
| Index  to Exhibits                                                                                                                               | 71       |
| Signatures                                                                                                                                       | 72       |
| Exhibits                                                                                                                                         |     |

 

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**PART I**

 

**ITEM 1           BUSINESS**

 

**A. General Development of Business and History**

 

OnJanuary 7, 1983, Penns Woods Bancorp, Inc. (the “Company”) wasincorporated under the laws of the Commonwealth of Pennsylvania as a bankholding company. The Jersey Shore State Bank, a Pennsylvania state-chartedbank, (the “Bank”) became a wholly owned subsidiary of the Company, and eachoutstanding share of Bank common stock was converted into one share of Companycommon stock.  This transaction wasapproved by the shareholders of the Bank on April 11, 1983 and waseffective on July 12, 1983.  TheCompany’s two other wholly-owned subsidiaries are Woods Real Estate DevelopmentCompany, Inc. and Woods Investment Company, Inc.  The Company’s business has consistedprimarily of managing and supervising the Bank, and its principal source ofincome has been dividends paid by the Bank and Woods Investment Company, Inc.

 

TheBank is engaged in commercial and retail banking which includes the acceptanceof time, savings, and demand deposits, the funding of commercial, consumer, andmortgage loans, and safe deposit services. Utilizing a thirteen branch office network, ATMs, internet, andtelephone banking delivery channels, the Bank delivers its products and servicesto the communities it resides in.

 

InOctober 2000, the Bank acquired The M Group, Inc. D/B/A TheComprehensive Financial Group (“The M Group”). The M Group, which operates as asubsidiary of the Bank, offers insurance and securities brokerage services.Securities are offered by The M Group through ING Financial Partners, Inc.,a registered broker-dealer.

 

Neitherthe Company nor the Bank anticipates that compliance with environmental lawsand regulations will have any material effect on capital expenditures,earnings, or on its competitive position. The Bank is not dependent on a single customer or a few customers, theloss of whom would have a material effect on the business of the Bank.

 

TheBank employed 192 persons as of December 31, 2009 in either a full-time orpart-time capacity.  The Company does nothave any employees.  The principalofficers of the Bank also serve as officers of the Company.

 

WoodsInvestment Company, Inc., a Delaware holding company, maintains aninvestment portfolio that is managed for total return and to fund dividendpayments to the Company.

 

WoodsReal Estate Development Company, Inc. serves the Company through itsacquisition and ownership of certain properties utilized by the Bank.

 

**B. Regulation and Supervision**

 

TheCompany is also subject to the provisions of the Bank Holding Company Act of1956, as amended (the “BHCA”) and to supervision and examination by the Boardof Governors of the Federal Reserve System (the “FRB”).  The Bank is subject to the supervision andexamination by the Federal Deposit Insurance Corporation (the “FDIC”), as itsprimary federal regulator and as the insurer of the Bank’s deposits.  The Bank is also regulated and examined bythe Pennsylvania Department of Banking (the “Department”).

 

Theinsurance activities of The M Group are subject to regulation by the insurancedepartments of the various states in which The M Group, conducts businessincluding principally the Pennsylvania Department of Insurance. The securitiesbrokerage activities of The M Group are subject to regulation by federal andstate securities commissions.

 

TheFRB has issued regulations under the BHCA that require a bank holding companyto serve as a source of financial and managerial strength to its subsidiarybanks.  As a result, the FRB, pursuant tosuch regulations, may require the Company to stand ready to use its resourcesto provide adequate capital funds to the Bank during periods of financialstress or adversity.  The BHCA requiresthe Company to secure the prior approval of the FRB before it can acquire allor substantially all of the assets of any bank, or acquire ownership or controlof 5% or more of any voting shares of any bank. Such a transaction would also require approval of the Department.

 

Abank holding company is prohibited under the BHCA from engaging in, oracquiring direct or indirect control of, more than 5% of the voting shares ofany company engaged in non-banking activities unless the FRB, by order orregulation, has found such activities to be so closely related to banking ormanaging or controlling banks as to be a proper incident thereto.  Under the BHCA, the FRB has the authority torequire a bank holding company to terminate any activity or relinquish 

 

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controlof a non-bank subsidiary (other than a non-bank subsidiary of a bank) upon theFRB’s determination that such activity or control constitutes a serious risk tothe financial soundness and stability of any bank subsidiary of the bankholding company.

 

Bankholding companies are required to comply with the FRB’s risk-based capitalguidelines.  The risk-based capital rules aredesigned to make regulatory capital requirements more sensitive to differencesin risk profiles among banks and bank holding companies and to minimizedisincentives for holding liquid assets. Currently, the required minimum ratio of total capital to risk-weightedassets (including certain off-balance sheet activities, such as standby lettersof credit) is 8%.  At least half of thetotal capital is required to be Tier 1 capital, consisting principally ofcommon shareholders’ equity, less certain intangible assets. The remainder (“Tier2 capital”) may consist of certain preferred stock, a limited amount ofsubordinated debt, certain hybrid capital instruments and other debtsecurities, 45% of net unrealized gains on marketable equity securities, and alimited amount of the general loan loss allowance.  The risk-based capital guidelines arerequired to take adequate account of interest rate risk, concentration ofcredit risk, and risks of nontraditional activities.

 

Inaddition to the risk-based capital guidelines, the FRB requires each bankholding company to comply with the leverage ratio, under which the bank holdingcompany must maintain a minimum level of Tier 1 capital to average totalconsolidated assets of 3% for those bank holding companies which have thehighest regulatory examination ratings and are not contemplating or experiencingsignificant growth or expansion.  Allother bank holding companies are expected to maintain a leverage ratio of atleast 4% to 5%. The Bank is subject to similar capital requirements adopted bythe FDIC.

 

**Dividends**

 

Federaland state laws impose limitations on the payment of dividends by the Bank.  The Pennsylvania Banking Code restricts theavailability of capital funds for payment of dividends by the Bank to itsadditional paid-in capital.

 

Inaddition to the dividend restrictions described above, the banking regulatorshave the authority to prohibit or to limit the payment of dividends by the Bankif, in the banking regulator’s opinion, payment of a dividend would constitutean unsafe or unsound practice in light of the financial condition of the Bank.

 

UnderPennsylvania law, the Company may not pay a dividend, if, after giving effectthereto, it would be unable to pay its debts as they become due in the usualcourse of business and, after giving effect to the dividend, the total assetsof the Company would be less than the sum of its total liabilities plus theamount that would be needed, if the Company were to be dissolved at the time ofdistribution, to satisfy the preferential rights upon dissolution ofshareholders whose rights are superior to those receiving the dividend.

 

Itis also the policy of the FRB that a bank holding company generally only paydividends on common stock out of net income available to common shareholdersover the past year and only if the prospective rate of earnings retentionappears consistent with a bank holding company’s capital needs, asset quality,and overall financial condition.  In thecurrent financial and economic environment, the FRB has indicated that bankholding companies should carefully review their dividend policy and hasdiscouraged dividend pay-out ratios at the 100% level unless both asset qualityand capital are very strong.  A bankholding company also should not maintain a dividend level that places undue pressureon the capital of such institution’s subsidiaries, or that may undermine thebank holding company’s ability to serve as a source of strength for suchsubsidiaries.

 

**C. Regulation of the Bank**

 

Fromtime to time, various types of federal and state legislation have been proposedthat could result in additional regulation of, and restrictions of, thebusiness of the Bank. It cannot be predicted whether any such legislation willbe adopted or how such legislation would affect business of the Bank.  As a consequence of the extensive regulationof commercial banking activities in the United States, the Bank’s business isparticularly susceptible to being affected by federal legislation andregulations that may increase the costs of doing business.

 

**Prompt Corrective Action**

 

TheFDIC has specified the levels at which an insured institution will beconsidered “well-capitalized,” “adequately capitalized,” “undercapitalized,”and “critically undercapitalized.” In the event an institution’s capitaldeteriorates to the “undercapitalized” category or below, the Federal DepositInsurance Act (the “FDIA”) and FDIC regulations prescribe an increasing amountof regulatory intervention, including: (1) the institution of a capitalrestoration plan by a bank and a guarantee of the plan by a parent institutionand liability for civil money damages for failure to fulfill its commitment on 

 

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thatguarantee; and (2) the placement of a hold on increases in assets, numberof branches, or lines of business.  Ifcapital has reached the significantly or critically undercapitalized levels,further material restrictions can be imposed, including restrictions oninterest payable on accounts, dismissal of management and (in criticallyundercapitalized situations) appointment of a receiver.  For well-capitalized institutions, the FDIAprovides authority for regulatory intervention where the institution is deemedto be engaging in unsafe or unsound practices or receives a less thansatisfactory examination report rating for asset quality, management, earningsor liquidity.

 

**Deposit Insurance**

 

The FDIC maintains theDeposit Insurance Fund (“DIF”) by assessing depository institutions an insurancepremium. The amount each institution is assessed is based upon a variety offactors that include the balance of insured deposits as well as the degree ofrisk the institution poses to the insurance fund.  As a result of the enactment of the EmergencyEconomic Stabilization Act of 2008, the FDIC increased the amount of depositsit insures from $100,000 to $250,000. This increase is temporary and willcontinue through December 31, 2013. The Bank pays an insurance premiuminto the DIF based on the quarterly average daily deposit liabilities net ofcertain exclusions. The FDIC uses a risk-based premium system that assesseshigher rates on those institutions that pose greater risks to the DIF. The FDICplaces each institution in one of four risk categories using a two-step processbased first on capital ratios (the capital group assignment) and then on otherrelevant information (the supervisory group assignment). Subsequently, the ratefor each institution within a risk category may be adjusted depending upondifferent factors that either enhance or reduce the risk the institution posesto the DIF, including the unsecured debt, secured liabilities and brokereddeposits related to each institution. Finally, certain risk multipliers may beapplied to the adjusted assessment. In 2009, the FDIC increased the amountassessed from financial institutions by increasing its risk-based depositinsurance assessment scale.  Thequarterly annualized assessment scale for 2009 ranged from twelve basis pointsof assessable deposits for the strongest institutions to over fifty basispoints for the weakest.  In 2009, theFDIC also adopted a uniform special assessment rate for all institutions not toexceed 10 basis points on the individual bank’s assessment base.

 

On November 12,2009, the FDIC approved a rule to require insured institutions to prepaytheir estimated quarterly risk-based assessments for the fourth quarter of2009, and for all of 2010, 2011, and 2012. An insured institution’s risk-baseddeposit insurance assessments will continue to be calculated on a quarterlybasis, but will be paid from the amount the institution prepaid until the laterof the date that amount is exhausted or June 30, 2013, at which point anyremaining funds would be returned to the insured institution. Consequently, theCompany’s prepayment of DIF premiums made in December 2009 resulted in aprepaid asset of $2,366,000.

 

**Federal Home Loan Bank System**

 

TheBank is a member of the Federal Home Loan Bank of Pittsburgh (the “FHLB”),which is one of 12 regional Federal Home Loan Banks. Each Federal Home LoanBank serves as a reserve or central bank for its members within its assignedregion.  It is funded primarily fromfunds deposited by member institutions and proceeds from the sale ofconsolidated obligations of the Federal Home Loan Bank System. It makes loansto members (i.e., advances) in accordance with policies and proceduresestablished by the board of directors of the Federal Home Loan Bank.  At December 31, 2009, the Bank had$91,933,000 in FHLB advances.

 

Asa member, the Bank is required to purchase and maintain stock in the FHLB in anamount equal to the greater of 1% of its aggregate unpaid residential mortgageloans, home purchase contracts or similar obligations at the beginning of eachyear or 5% of its outstanding advances from the FHLB.  At December 31, 2009, the Bank had$7,271,000 million in stock of the FHLB which was in compliance with thisrequirement.

 

**Other Legislation**

 

TheFair and Accurate Credit Transactions Act (“FACT”) was signed into law on December 4,2003.  This law extends the previouslyexisting Fair Credit Reporting Act.  Newprovisions added by FACT address the growing problem of identity theft.Consumers will be able to initiate a fraud alert when they are victims ofidentity theft, and credit reporting agencies will have additional duties.Consumers will also be entitled to obtain free credit reports through thecredit beaures, and will be granted certain additional privacy rights.

 

TheSarbanes-Oxley Act of 2002 was enacted to enhance penalties for accounting andauditing improprieties at publicly traded companies and to protect investors byimproving the accuracy and reliability of corporate disclosures under thefederal securities laws.  TheSarbanes-Oxley Act generally applies to all companies, including the Company,that file or are required to file periodic reports with the Securities andExchange Commission under the Securities Exchange Act of 1934, or the ExchangeAct.  The legislation includesprovisions, among other things, governing the services that can be provided bya public company’s independent auditors and the procedures for approving suchservices, requiring the chief executive 

 

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officerand principal accounting officer to certify certain matters relating to thecompany’s periodic filings under the Exchange Act, requiring expedited filingsof reports by insiders of their securities transactions and containing otherprovisions relating to insider conflicts of interest, increasing disclosurerequirements relating to critical financial accounting policies and theirapplication, increasing penalties for securities law violations, and creating anew public accounting oversight board, a regulatory body subject to SECjurisdiction with broad powers to set auditing, quality control, and ethicsstandards for accounting firms.  In responseto the legislation, the national securities exchanges and NASDAQ have adoptednew rules relating to certain matters, including the independence ofmembers of a company’s audit committee as a condition to listing or continuedlisting.

 

Congressis currently debating major legislation that may fundamentally change theregulatory oversight of banking institutions in the United States.  Whether any legislation will be enacted oradditional regulations will be adopted, and how they might impact the Companycannot be determined at this time.

 

Inaddition to federal banking law, the Bank is subject to the PennsylvaniaBanking Code. The Banking Code was amended in late 2000 to provide morecomplete “parity” in the powers of state-chartered institutions compared tonational banks and federal savings banks doing business in Pennsylvania.Pennsylvania banks have the same ability to form financial subsidiariesauthorized by the Gramm-Leach-Bliley Act, as do national banks.

 

**Environmental Laws**

 

Environmentallyrelated hazards have become a source of high risk and potential liability forfinancial institutions relating to their loans. Environmentally contaminatedproperties owned by an institution’s borrowers may result in a drasticreduction in the valueof the collateral securing the institution’s loans to such borrowers,high environmental clean up costs to the borrower affecting its ability torepay the loans, the subordination of any lien in favor of the institution to astate or federal lien securing clean up costs, and liability to the institutionfor clean up costs if it forecloses on the contaminated property or becomesinvolved in the management of the borrower. The Company is not aware of anyborrower who is currently subject to any environmental investigation or cleanup proceeding which is likely to have a material adverse effect on thefinancial condition or results of operations of the Company.

 

**Effect of Government Monetary Policies**

 

Theearnings of the Company are and will be affected by domestic economicconditions and the monetary and fiscal policies of the United States Governmentand its agencies.   The monetary policiesof the FRB have had, and will likely continue to have, an important impact onthe operating results of commercial banks through its power to implementnational monetary policy in order, among other things, to curb inflation orcombat a recession. The FRB has a major effect upon the levels of bank loans,investments, and deposits through its open market operations in the UnitedStates Government securities and through its regulation of, among other things,the discount rate on borrowing of member banks and the reserve requirementsagainst member bank deposits.  It is notpossible to predict the nature and impact of future changes in monetary andfiscal policies.

 

**DESCRIPTION OF BANK**

 

**History and Business**

 

JerseyShore State Bank (“Bank”) was incorporated under the laws of the Commonwealthof Pennsylvania as a state bank in 1934 and became a wholly owned subsidiary ofthe Company on July 12, 1983.

 

Asof December 31, 2009, the Bank had total assets of $667,933,000; totalshareholders’ equity of $55,117,000 and total deposits of $500,100,000. TheBank’s deposits are insured by the Federal Deposit Insurance Corporation forthe maximum amount provided under current law.

 

TheBank engages in business as a commercial bank, doing business at severallocations in Lycoming, Clinton, and Centre Counties, Pennsylvania.  The Bank offers insurance, securitiesbrokerage services, annuity and mutual fund investment products, and financialplanning through its wholly owned subsidiary, The M Group, Inc. D/B/A TheComprehensive Financial Group.

 

Servicesoffered by the Bank include accepting time, demand and savings depositsincluding Super NOW accounts, statement savings accounts, money market accounts,fixed rate certificates of deposit, and club accounts.  Its services also include making secured andunsecured business and consumer loans that include financing commercialtransactions as well as construction and residential mortgage loans and revolvingcredit loans with overdraft protection.

 

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TheBank’s loan portfolio mix can be classified into four principalcategories.  These are real estate,agricultural, commercial, and consumer. Real estate loans can be further segmented into construction and landdevelopment, farmland, one-to-four family residential, multi-family, andcommercial or industrial.  Qualifiedborrowers are defined by policy and our underwriting standards. Owner providedequity requirements range from 20% to 30% with a first lien statusrequired.  Terms are generally restrictedto between 10 and 20 years with the exception of construction and landdevelopment, which are limited to one to five years.  Real estate appraisals, property constructionverifications, and site visitations comply with policy and industry regulatorystandards.

 

Prospectiveresidential mortgage customer’s repayment ability is determined frominformation contained in the application and recent income tax returns.  Emphasis is on credit, employment, income,and residency verification.  Broad hazardinsurance is always required and flood insurance where applicable.  In the case of construction mortgages,builders risk insurance is requested.

 

Agriculturalloans for the purchase or improvement of real estate must meet the Bank’s realestate underwriting criteria.  The onlypermissible exception is when a Farmers Home Loan Administration guaranty isobtained.  Agricultural loans made forthe purchase of equipment are usually payable in five years, but never morethan seven, depending upon the useful life of the purchased asset. Minimumborrower equity ranges from 20% to 30%. Livestock financing criteria depends upon the nature of the operation.Agricultural loans are also made for crop production purposes.  Such loans are structured to repay within theproduction cycle and not carried over into a subsequent year.

 

Commercialloans are made for the acquisition and improvement of real estate, purchase ofequipment, and for working capital purposes on a seasonal or revolvingbasis.  General purpose working capitalloans are also available with repayment expected within one year.  Equipment loans are generally amortized overthree to seven years, with an owner equity contribution required of at least20% of the purchase price. Insurance coverage with the Bank as loss payee isrequired, especially in the case where the equipment is rolling stock. It isalso a general policy to collateralize non-real estate loans with the assetpurchased and, dependant upon loan terms, junior liens are filed on otheravailable assets.  Financial informationrequired on all commercial mortgages includes the most current three yearsbalance sheets and income statements and projections on income to be developedthrough the project. In the case of corporations and partnerships, theprincipals are often asked to personally guaranty the entity’s debt.

 

Seasonaland revolving lines of credit are offered for working capital purposes.  Collateral for such a loan includes thepledge of inventory and/or receivables. Drawing availability is usually 50% of inventory and 75% of eligiblereceivables.  Eligible receivables aredefined as invoices less than 90 days delinquent.  Exclusive reliance is very seldom placed onsuch collateral; therefore, other lienable assets are also taken into thecollateral pool.  Where reliance isplaced on inventory and accounts receivable, the applicant must providefinancial information including agings on a monthly basis.  In addition, the guaranty of the principalsis usually obtained.

 

Letterof Credit availability is limited to standbys where the customer is well knownto the Bank.  Credit criteria is the sameas that utilized in making a direct loan. Collateral is obtained in most cases,and whenever the expiration date is beyond one year.

 

Consumerloan products include second mortgages, automobile financing, small loanrequests, overdraft check lines, and PHEAA referral loans.  Our policy includes standards used in theindustry on debt service ratios and terms are consistent with prudentunderwriting standards and the use of proceeds. Verifications are made ofemployment and residency, along with credit history.

 

Secondmortgages are confined to equity borrowing and home improvements.  Terms are generally ten years or less andrates are fixed.  Loan to collateralvalue criteria is 80% or less and verifications are made to determinevalues.   Automobile financing isgenerally restricted to five years and done on a direct basis.  The Bank, as a practice, does not floor planand therefore does not discount dealer paper. Small loan requests are to accommodate personal needs such as thepurchase of small appliances or for the payment of taxes.  Overdraft check lines are limited to $5,000or less.

 

TheBank’s investment portfolio is analyzed and priced on a monthly basis.Investments are made in U.S. Treasuries, U.S. Agency issues, bank qualifiedmunicipal bonds, corporate bonds, and corporate stocks which consist ofPennsylvania bank stocks.  Bonds with BAAor better ratings are used, unless a local issue is purchased that has a lesseror no rating.  Factors 

 

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takeninto consideration when investments are purchased include liquidity, theCompany’s tax position, tax equivalent yield, third party investment ratings,and the policies of the Asset/Liability Committee.

 

Thebanking environment in Lycoming, Clinton, and Centre Counties, Pennsylvania ishighly competitive.  The Bank operatesthirteen full service offices in these markets and competes for loans anddeposits with numerous commercial banks, savings and loan associations, andother financial institutions. The economic base of the region is developedaround small business, health care, educational facilities (college and publicschools), light manufacturing industries, and agriculture.

 

TheBank has a relatively stable deposit base and no material amount of deposits isobtained from a single depositor or group of depositors, excluding publicentities that account for approximately 10% of total deposits.  Although the Bank has regular opportunitiesto bid on pools of funds of $100,000 or more in the hands of municipalities,hospitals, and others, it does not rely on these monies to fund loans orintermediate or longer-term investments.

 

TheBank has not experienced any significant seasonal fluctuations in the amount ofits deposits.

 

**Supervision and Regulation**

 

Theearnings of the Bank are affected by the policies of regulatory authoritiesincluding the FDIC and the FRB. An important function of the FRB is to regulatethe money supply and interest rates. Among the instruments used to implement these objectives are open marketoperations in U.S. Government Securities, changes in reserve requirementsagainst member bank deposits, and limitations on interest rates that memberbanks may pay on time and savings deposits. These instruments are used in varying combinations to influence overallgrowth and distribution of bank loans, investments on deposits, and their usemay also affect interest rates charged on loans or paid for deposits.

 

Thepolicies and regulations of the FRB have had and will probably continue to havea significant effect on the Bank’s deposits, loans and investment growth, aswell as the rate of interest earned and paid, and are expected to affect theBank’s operation in the future. The effect of such policies and regulationsupon the future business and earnings of the Bank cannot accurately bepredicted.

 

**ITEM 1A        RISK FACTORS**

 

Thefollowing sets forth several risk factors that are unique to the Company.

 

**Changes in interest rates could reduce our income, cash flows and assetvalues.**

 

Ourincome and cash flows and the value of our assets depend to a great extent onthe difference between the interest rates we earn on interest-earning assets,such as loans and investment securities, and the interest rates we pay oninterest-bearing liabilities such as deposits and borrowings.  These rates are highly sensitive to manyfactors which are beyond our control, including general economic conditions andpolicies of various governmental and regulatory agencies and, in particular,the Board of Governors of the Federal Reserve System. Changes in monetarypolicy, including changes in interest rates, will influence not only theinterest we receive on our loans and investment securities and the amount ofinterest we pay on deposits and borrowings but will also affect our ability tooriginate loans and obtain deposits and the value of our investmentportfolio.  If the rate of interest wepay on our deposits and other borrowings increases more than the rate ofinterest we earn on our loans and other investments, our net interest income,and therefore our earnings, could be adversely affected.  Our earnings also could be adversely affectedif the rates on our loans and other investments fall more quickly than those onour deposits and other borrowings.

 

**Economic conditions either nationally or locally in areas in which ouroperations are concentrated may adversely affect our business.**

 

Deteriorationin local, regional, national or global economic conditions could cause us toexperience a reduction in deposits and new loans, an increase in the number ofborrowers who default on their loans and a reduction in the value of thecollateral securing their loans, all of which could adversely affect ourperformance and financial condition. Unlike larger banks that are moregeographically diversified, we provide banking and financial services locally.Therefore, we are particularly vulnerable to adverse local economic conditions.

 

**Our financial condition and results of operations would be adverselyaffected if our allowance for loan losses is not sufficient to absorb actuallosses or if we are required to increase our allowance.**

 

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Despiteour underwriting criteria, we may experience loan delinquencies andlosses.  In order to absorb lossesassociated with nonperforming loans, we maintain an allowance for loan lossesbased on, among other things, historical experience, an evaluation of economicconditions, and regular reviews of delinquencies and loan portfolioquality.  Determination of the allowanceinherently involves a high degree of subjectivity and requires us to makesignificant estimates of current credit risks and future trends, all of whichmay undergo material changes.  At anytime there are likely to be loans in our portfolio that will result in lossesbut that have not been identified as nonperforming or potential problemcredits. We cannot be sure that we will be able to identify deterioratingcredits before they become nonperforming assets or that we will be able tolimit losses on those loans that are identified. We may be required to increaseour allowance for loan losses for any of several reasons.  Federal regulators, in reviewing our loanportfolio as part of a regulatory examination, may request that we increase ourallowance for loan losses.  Changes ineconomic conditions affecting borrowers, new information regarding existingloans, identification of additional problem loans and other factors, bothwithin and outside of our control, may require an increase in ourallowance.  In addition, if charge-offsin future periods exceed our allowance for loan losses, we will need additionalincreases in our allowance for loan losses. Any increases in our allowance for loan losses will result in a decreasein our net income and, possibly, our capital, and may materially affect ourresults of operations in the period in which the allowance is increased.

 

**Many of our loans are secured, in whole or in part, with real estatecollateral which is subject to declines in value.**

 

Inaddition to considering the financial strength and cash flow characteristics ofa borrower, we often secure our loans with real estate collateral. Real estatevalues and the real estate market are generally affected by, among otherthings, changes in local, regional or national economic conditions, fluctuationsin interest rates and the availability of loans to potential purchasers,changes in tax laws and other governmental statutes, regulations and policies,and acts of nature.  The real estatecollateral provides an alternate source of repayment in the event of default bythe borrower.  If real estate prices inour markets decline, the value of the real estate collateral securing our loanscould be reduced. If we are required to liquidate real estate collateral securingloans during a period of reduced real estate values to satisfy the debt, ourearnings and capital could be adversely affected.

 

**Competition may decrease our growth or profits.**

 

Weface substantial competition in all phases of our operations from a variety ofdifferent competitors, including commercial banks, savings and loanassociations, mutual savings banks, credit unions, consumer finance companies,factoring companies, leasing companies, insurance companies, and money marketmutual funds.  There is very strongcompetition among financial services providers in our principal servicearea.  Our competitors may have greaterresources, higher lending limits, or larger branch systems than we do.  Accordingly, they may be able to offer abroader range of products and services as well as better pricing for thoseproducts and services than we can.

 

Inaddition, some of the financial services organizations with which we competeare not subject to the same degree of regulation as is imposed on federallyinsured financial institutions.  As aresult, those nonbank competitors may be able to access funding and providevarious services more easily or at less cost than we can, adversely affectingour ability to compete effectively.

 

**The value of certain investment securities is volatile and futuredeclines or other-than-temporary impairments could materially adversely affectour future earnings and regulatory capital.**

 

Continuedvolatility in the market value for certain of our investment securities,whether caused by changes in market perceptions of credit risk, as reflected inthe expected market yield of the security, or actual defaults in the portfoliocould result in significant fluctuations in the value of the securities. Thiscould have a material adverse impact on our accumulated other comprehensive lossand shareholders’ equity depending on the direction of the fluctuations.Furthermore, future downgrades or defaults in these securities could result infuture classifications of investment securities as other than temporarilyimpaired. This could have a material impact on our future earnings, althoughthe impact on shareholders’ equity will be offset by any amount alreadyincluded in other comprehensive income for securities where we have recordedtemporary impairment.

 

**We may be adversely affected by government regulation.**

 

Thebanking industry is heavily regulated. Banking regulations are primarilyintended to protect the federal deposit insurance funds and depositors, notshareholders. Changes in the laws, regulations, and regulatory practicesaffecting the banking industry may increase our costs of doing business orotherwise adversely affect us and create competitive advantages for others.Regulations affecting banks and financial services companies undergo continuouschange, and we

 

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cannotpredict the ultimate effect of these changes, which could have a materialadverse effect on our profitability or financial condition.

 

**We rely on our management and other key personnel, and the loss of anyof them may adversely affect our operations.**

 

Weare and will continue to be dependent upon the services of our executivemanagement team. In addition, we will continue to depend on our ability toretain and recruit key commercial loan officers. The unexpected loss ofservices of any key management personnel or commercial loan officers could havean adverse effect on our business and financial condition because of theirskills, knowledge of our market, years of industry experience, and thedifficulty of promptly finding qualified replacement personnel.

 

**Environmental liability associated with lending activities could resultin losses.**

 

Inthe course of our business, we may foreclose on and take title to propertiessecuring our loans.  If hazardoussubstances were discovered on any of these properties, we could be liable togovernmental entities or third parties for the costs of remediation of thehazard, as well as for personal injury and property damage.  Many environmental laws can impose liabilityregardless of whether we knew of, or were responsible for, thecontamination.  In addition, if wearrange for the disposal of hazardous or toxic substances at another site, wemay be liable for the costs of cleaning up and removing those substances fromthe site even if we neither own nor operate the disposal site.  Environmental laws may require us to incursubstantial expenses and may materially limit use of properties we acquirethrough foreclosure, reduce their value or limit our ability to sell them inthe event of a default on the loans they secure.  In addition, future laws or more stringentinterpretations or enforcement policies with respect to existing laws may increaseour exposure to environmental liability.

 

**Failure to implement new technologies in our operations may adverselyaffect our growth or profits.**

 

Themarket for financial services, including banking services and consumer financeservices is increasingly affected by advances in technology, includingdevelopments in telecommunications, data processing, computers, automation,Internet-based banking, and telebanking. Our ability to compete successfully inour markets may depend on the extent to which we are able to exploit suchtechnological changes. However, we can provide no assurance that we will beable to properly or timely anticipate or implement such technologies orproperly train our staff to use such technologies.  Any failure to adapt to new technologiescould adversely affect our business, financial condition or operating results.

 

**An investment in our common stock is not an insured deposit.**

 

Ourcommon stock is not a bank deposit and, therefore, is not insured against lossby the Federal Deposit Insurance Corporation, commonly referred to as the FDIC,any other deposit insurance fund or by any other public or private entity.  Investment in our common stock is subject tothe same market forces that affect the price of common stock in any company.

 

**ITEM 1B        UNRESOLVED STAFF COMMENTS**

 

None.

 

**ITEM 2****          ****PROPERTIES**

 

TheCompany owns and leases its properties. Listed herewith are the locations of properties owned or leased as of December 31,2009, in which the banking offices are located; all properties are in goodcondition and adequate for the Bank’s purposes:

 
| **Office**    | ** ** | **Address**                       | ** ** | **Ownership** |
|---------------|------------|-----------------------------------|------------|---------------|
| Main          |       | 115 South Main  Street            |       | Owned         |
|          |       | P.O. Box  5098               |       |          |
|          |       | Jersey Shore,  Pennsylvania 17740 |       |          |
|          |       |                              |       |          |
| Bridge Street |       | 112 Bridge  Street                |       | Owned         |
|          |       | Jersey Shore,  Pennsylvania 17740 |       |          |
|          |       |                              |       |          |
| DuBoistown    |       | 2675 Euclid  Avenue               |       | Owned         |
|          |       | Williamsport,  Pennsylvania 17702 |       |          |
|          |       |                              |       |          |
| Williamsport  |       | 300 Market  Street                |       | Owned         |

 

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|                                     |   | P.O. Box  967                        |   |             |
|------------------------------------------|--------|-------------------------------------------|--------|------------------|
|                                     |   | Williamsport,  Pennsylvania 17703-0967    |   |             |
|                                     |   |                                      |   |             |
| Montgomery                               |   | 9094 Rt. 405  Highway                     |   | Owned            |
|                                     |   | Montgomery,  Pennsylvania 17752           |   |             |
|                                     |   |                                      |   |             |
| Lock Haven                               |   | 4 West Main  Street                       |   | Owned            |
|                                     |   | Lock Haven,  Pennsylvania 17745           |   |             |
|                                     |   |                                      |   |             |
| Mill Hall                                |   | (Inside  Wal-Mart), 173 Hogan Boulevard   |   | Under Lease      |
|                                     |   | Mill Hall,  Pennsylvania 17751            |   |             |
|                                     |   |                                      |   |             |
| Spring Mills                             |   | 3635 Penns  Valley Road, P.O. Box 66 |   | Owned            |
|                                     |   | Spring Mills,  Pennsylvania 16875         |   |             |
|                                     |   |                                      |   |             |
| Centre Hall                              |   | 2842 Earlystown  Road                     |   | Land Under Lease |
|                                     |   | Centre Hall,  Pennsylvania 16828          |   |             |
|                                     |   |                                      |   |             |
| Zion                                     |   | 100 Cobblestone  Road                     |   | Under Lease      |
|                                     |   | Bellefonte,  Pennsylvania 16823           |   |             |
|                                     |   |                                      |   |             |
| State College                            |   | 2050 North  Atherton Street               |   | Land Under Lease |
|                                     |   | State College,  Pennsylvania 16803        |   |             |
|                                     |   |                                      |   |             |
| Montoursville                            |   | 820 Broad Street                          |   | Under Lease      |
|                                     |   | Montoursville,  Pennsylvania 17754        |   |             |
|                                     |   |                                      |   |             |
| The M  Group, Inc.                  |   | 705 Washington  Boulevard                 |   | Under Lease      |
| D/B/A The Comprehensive  Financial Group |   | Williamsport,  Pennsylvania 17701         |   |             |

 

**ITEM 3           LEGAL PROCEEDINGS**

 

TheCompany is subject to lawsuits and claims arising out of its business.  In the opinion of management, after reviewand consultation with counsel, any proceedings that may be assessed will nothave a material adverse effect on the consolidated financial position of theCompany.

 

**ITEM 4           (REMOVEDAND RESERVED)**

 

##### **PART II**

 

**ITEM  5**          **MARKET FOR THE REGISTRANT’S COMMON STOCK, RELATED STOCKHOLDER MATTERS,AND ISSUER PURCHASES OF EQUITY SECURITIES**

 

The Common Stock islisted on the NASDAQ Global Select Market under the symbol “PWOD”.  The following table sets forth (1) thequarterly high and low close prices for a share of the Company’s Common Stockduring the periods indicated, and (2) quarterly dividends on a share ofthe Common Stock with respect to each quarter since January 1, 2006.  The following quotations represent pricesbetween buyers and sellers and do not include retail markup, markdown orcommission.  They may not necessarilyrepresent actual transactions.

 

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| ** **     | ** ** | ** ** | ** ** | ** ** | ** ** | **Dividends** | ** ** |
|----------------|------------|------------|------------|------------|------------|---------------|------------|
| ** **     | ** ** | **High**   | ** ** | **Low**    | ** ** | **Declared**  | ** ** |
| **2007**       |       |       |       |       |       |          |       |
| First quarter  |       | $          | 37.75      |       | $          | 35.00         |       | $ | 0.44 |   |
| Second quarter |       | 35.00      |       | 33.86      |       | 0.44          |       |
| Third quarter  |       | 35.00      |       | 30.80      |       | 0.45          |       |
| Fourth quarter |       | 32.50      |       | 30.33      |       | 0.46          |       |
| **2008**       |       |       |       |       |       |          |       |
| First quarter  |       | $          | 33.47      |       | $          | 29.66         |       | $ | 0.46 |   |
| Second quarter |       | 33.15      |       | 33.01      |       | 0.46          |       |
| Third quarter  |       | 35.00      |       | 29.00      |       | 0.46          |       |
| Fourth quarter |       | 30.40      |       | 23.00      |       | 0.46          |       |
| **2009**       |       |       |       |       |       |          |       |
| First quarter  |       | $          | 25.61      |       | $          | 23.00         |       | $ | 0.46 |   |
| Second quarter |       | 31.81      |       | 24.89      |       | 0.46          |       |
| Third quarter  |       | 34.25      |       | 29.89      |       | 0.46          |       |
| Fourth quarter |       | 33.24      |       | 30.37      |       | 0.46          |       |

 

The Bank has paid cashdividends since 1941.  The Company haspaid dividends since the effective date of its formation as a bank holdingcompany.  It is the present intention of theRegistrant’s Board of Directors to continue the dividend payment policy;however, further dividends must necessarily depend upon earnings, financialcondition, appropriate legal restrictions, and other factors relevant at thetime the Board of Directors of the Company considers dividend policy.  Cash available for dividend distributions toshareholders of the Company primarily comes from dividends paid by the Bank tothe Company. Therefore, the restrictions on the Bank’s dividend payments aredirectly applicable to the Company.  Seealso the information appearing in Note 19 to Notes to Consolidated FinancialStatements included in the Annual Report on Form 10-K for additionalinformation related to dividend restrictions.

 

Under the PennsylvaniaBusiness Corporation Law of 1988 a corporation may not pay a dividend, if aftergiving effect thereto, the corporation would be unable to pay its debts as theybecome due in the usual course of business and after giving effect thereto thetotal assets of the corporation would be less than the sum of its totalliabilities plus the amount that would be needed, if the corporation were to bedissolved at the time of the distribution, to satisfy the preferential rightsupon dissolution of the shareholders whose preferential rights are superior tothose receiving the dividend.

 

As of March 2, 2010,the Company had approximately 1,270 shareholders of record.

 

Following is a scheduleof the shares of the Company’s common stock purchased by the Company during thefourth quarter of 2009.

 
| ** **                  | ** ** | **Total**      | ** ** | **Average**    | ** ** | **Total Number of**           | ** ** | **Maximum Number (or**          | ** ** |
|-----------------------------|------------|----------------|------------|----------------|------------|-------------------------------|------------|---------------------------------|------------|
| ** **                  | ** ** | **Number of**  | ** ** | **Price Paid** | ** ** | **Shares (or Units)**         | ** ** | **Approximate Dollar Value)**   | ** ** |
| ** **                  | ** ** | **Shares (or** | ** ** | **per Share**  | ** ** | **Purchased as Part of** | ** ** | **of Shares (or Units) that**   | ** ** |
| ** **                  | ** ** | **Units)**     | ** ** | **(or Units)** | ** ** | **Publicly Announced**        | ** ** | **May Yet Be Purchased**   | ** ** |
| **Period**                  | ** ** | **Purchased**  | ** ** | **Purchased**  | ** ** | **Plans or Programs**         | ** ** | **Under the Plans or Programs** | ** ** |
|                        |       |           |       |           |       |                          |       |                            |       |
| Month #1 (October 1 -  |       |           |       |           |       |                          |       |                            |       |
| October 31, 2009)      |       | —         |       | —         |       | —                        |       | 78,344                          |       |
|                        |       |           |       |           |       |                          |       |                            |       |
| Month #2 (November 1 - |       |           |       |           |       |                          |       |                            |       |
| November 30, 2009)          |       | —         |       | —         |       | —                        |       | 78,344                          |       |
|                        |       |           |       |           |       |                          |       |                            |       |
| Month #3 (December 1 - |       |           |       |           |       |                          |       |                            |       |
| December 31, 2009)     |       | —         |       | —         |       | —                        |       | 78,344                          |       |

 

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Setforth below is a line graph comparing the yearly dollar changes in thecumulative shareholder return on the Company’s common stock against thecumulative total return of the S&P 500 Stock Index, NASDAQ Bank Index, andNASDAQ Composite for the period of five fiscal years assuming the investment of$100.00 on December 31, 2004 and assuming the reinvestment of dividends.The shareholder return shown on the graph below is not necessarily indicativeof future performance.

 

 
| ** **                     | ** ** | **Period Ending** | ** ** |
|--------------------------------|------------|-------------------|------------|
| **Index**                      | ** ** | **12/31/04**      | ** ** | **12/31/05** | ** ** | **12/31/06** | ** ** | **12/31/07** | ** ** | **12/31/08** | ** ** | **12/31/09** | ** ** |
| Penns Woods Bancorp, Inc. |       | 100.00            |       | 100.79 |   | 102.55 |   | 93.06 |   | 70.13 |   | 105.20 |   |
| S&P 500                    |       | 100.00            |       | 104.91 |   | 121.48 |   | 128.16 |   | 80.74 |   | 102.11 |   |
| NASDAQ Composite               |       | 100.00            |       | 101.37 |   | 111.03 |   | 121.92 |   | 72.49 |   | 104.31 |   |
| NASDAQ Bank Index              |       | 100.00            |       | 95.67 |   | 106.20 |   | 82.76 |   | 62.96 |   | 51.31 |   |

 

##### **ITEM  6   SELECTED FINANCIAL DATA**

 

The following table setsforth certain financial data as of and for each of the years in the five-yearperiod ended December 31, 2009.

 

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| **(In Thousands, Except Per Share Amounts)**              | ** ** | **2009**  | ** ** | **2008**  | ** ** | **2007**  | ** ** | **2006**  | ** ** | **2005**  | ** ** |
|-----------------------------------------------------------|------------|-----------|------------|-----------|------------|-----------|------------|-----------|------------|-----------|------------|
|                                                      |       |      |       |      |       |      |       |      |       |      |       |
| Consolidated Statement of Income Data:                    |       |      |       |      |       |      |       |      |       |      |       |
| Interest income                                           |       | $         | 36,191     |      | $          | 36,108    |       | $         | 35,949     |      | $          | 33,753 |   | $ | 30,903 |   |
| Interest expense                                          |       | 12,398    |       | 14,832    |       | 16,447    |       | 14,210    |       | 10,381    |       |
| Net interest income                                       |       | 23,793    |       | 21,276    |       | 19,502    |       | 19,543    |       | 20,522    |       |
| Provision for loan losses                                 |       | 917       |       | 375       |       | 150       |       | 635       |       | 720       |       |
| Net interest income after provision for loan losses       |       | 22,876    |       | 20,901    |       | 19,352    |       | 18,908    |       | 19,802    |       |
| Noninterest income                                        |       | 2,287     |       | 5,456     |       | 7,478     |       | 9,029     |       | 9,431     |       |
| Noninterest expense                                       |       | 19,812    |       | 17,949    |       | 17,316    |       | 16,329    |       | 15,108    |       |
| Income before income taxes                                |       | 5,351     |       | 8,408     |       | 9,514     |       | 11,608    |       | 14,125    |       |
| Applicable income taxes                                   |       | (742      | )          | 405       |       | 637       |       | 1,961     |       | 3,224     |       |
| Net Income                                                |       | $         | 6,093      |      | $          | 8,003     |       | $         | 8,877      |      | $          | 9,647 |   | $ | 10,901 |   |
|                                                      |       |      |       |      |       |      |       |      |       |      |       |
| Consolidated Balance Sheet at End of Period:              |       |      |       |      |       |      |       |      |       |      |       |
| Total assets                                              |       | $         | 676,204    |      | $          | 652,803   |       | $         | 628,138    |      | $          | 592,285 |   | $ | 568,668 |   |
| Loans                                                     |       | 405,529   |       | 381,478   |       | 360,478   |       | 360,384   |       | 338,438   |       |
| Allowance for loan losses                                 |       | (4,657    | )          | (4,356    | )          | (4,130    | )          | (4,185    | )          | (3,679    | )          |
| Deposits                                                  |       | 497,287   |       | 421,368   |       | 389,022   |       | 395,191   |       | 352,529   |       |
| Long-term debt                                            |       | 86,778    |       | 86,778    |       | 106,378   |       | 82,878    |       | 84,478    |       |
| Shareholders’ equity                                 |       | 66,916    |       | 61,027    |       | 70,559    |       | 74,594    |       | 73,919    |       |
|                                                      |       |      |       |      |       |      |       |      |       |      |       |
| Per Share Data:                                           |       |      |       |      |       |      |       |      |       |      |       |
| Earnings per share - Basic                                |       | $         | 1.59       |      | $          | 2.07      |       | $         | 2.28       |      | $          | 2.45 |   | $ | 2.75 |   |
| Earnings per share - Diluted                              |       | 1.59      |       | 2.07      |       | 2.28      |       | 2.45      |       | 2.74      |       |
| Cash dividends declared                                   |       | 1.84      |       | 1.84      |       | 1.79      |       | 1.73      |       | 1.56      |       |
| Book value                                                |       | 17.45     |       | 15.93     |       | 18.21     |       | 19.12     |       | 18.59     |       |
| Number of shares outstanding, at end of period            |       | 3,834,114 |       | 3,831,500 |       | 3,875,632 |       | 3,900,742 |       | 3,975,787 |       |
| Average number of shares outstanding-basic                |       | 3,832,789 |       | 3,859,724 |       | 3,886,277 |       | 3,934,138 |       | 3,971,926 |       |
|                                                      |       |      |       |      |       |      |       |      |       |      |       |
| Selected financial ratios:                                |       |      |       |      |       |      |       |      |       |      |       |
| Return on average shareholders’ equity               |       | 9.66      | %          | 12.02     | %          | 12.14     | %          | 12.93     | %          | 14.54     | %          |
| Return on average total assets                            |       | 0.92      | %          | 1.27      | %          | 1.49      | %          | 1.67      | %          | 1.97      | %          |
| Net interest income to average interest earning  assets   |       | 4.40      | %          | 4.14      | %          | 3.95      | %          | 4.06      | %          | 4.29      | %          |
| Dividend payout ratio                                     |       | 115.74    | %          | 88.67     | %          | 78.33     | %          | 70.51     | %          | 57.10     | %          |
| Average shareholders’ equity to average total assets |       | 9.50      | %          | 10.53     | %          | 12.23     | %          | 12.92     | %          | 13.56     | %          |
| Loans to deposits, at end of period                       |       | 81.55     | %          | 90.53     | %          | 92.66     | %          | 91.19     | %          | 96.00     | %          |

 

Per share data and number of shares outstanding have been adjusted togive retroactive effect to a six for five stock split issued November 18,2005.

 

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**ITEM 7  MANAGEMENT’SDISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATION**

 

# **RESULTS OF OPERATIONS**

# ** **

**NETINTEREST INCOME**

 

Net interest income isdetermined by calculating the difference between the yields earned oninterest-earning assets and the rates paid on interest-bearing liabilities. Tocompare the tax-exempt asset yields to taxable yields, amounts are adjusted totaxable equivalents based on the marginal corporate federal tax rate of 34%.  The tax equivalent adjustments to netinterest income for 2009, 2008, and 2007 were $2,952,000, $2,714,000, and$2,410,000, respectively.

 

**2009 vs 2008**

 

Reported net interestincome increased $2,517,000 or 11.83% to $23,793,000 for the year ended December 31,2009 compared to the year ended December 31, 2008, although the yield onearning assets decreased to 6.43% from 6.68%, respectively.  On a tax equivalent basis, the change in netinterest income was an increase of $2,755,000 or 11.48% to $26,745,000 for theyear ended December 31, 2009 compared to the year ended December 31,2008.  Total interest income increased$83,000 due to growth in the average balance of the loan portfolio offset by adecrease in investment portfolio income resulting from decreaseddividends.  The increase in earning assetvolume compensated for the negative impact on earning asset yields caused bythe prolonged low interest rate cycle enacted by the Federal Open MarketsCommittee (“FOMC”). Interest income recognized on the loan portfolio increased$340,000 as a portion of the portfolio repriced downward due to the FOMCactions that have maintained the prime rate at 3.25% for the past year coupledwith the market dictating that new loan generation occurred at lower rates thanduring 2008.  Interest and dividendincome generated from the investment portfolio and interest bearing cashdeposits decreased $257,000.  Thedecrease was the result of a minimal decrease in the yield on the investmentportfolio of 3 basis points (“bp”) in conjunction with the average balance ofthe investment portfolio decreasing by $2,137,000.  Dividend and other interest income decreased$574,000 to $194,000 for the year ended December 31, 2009.  The decrease is the result of the FHLBceasing to pay dividends on its stock, a reduction in equity holdings of$5,470,000, and a general reduction in the dividends paid by the various equityholdings.

 

Interest expensedecreased $2,434,000 to $12,398,000 for the year ended December 31, 2009compared to 2008.  Leading the decreasein interest expense was a decline of 14.33% or $1,386,000 related todeposits.  The FOMC actions notedpreviously together with a strategic shortening of the duration of theportfolio led to a 108 bp decline in the rate paid on time deposits from 3.92%for the year ended December 31, 2008 to 2.84% for the year ended December 31,2009 resulting in a $1,633,000 decline in expense, while the average balance oftime deposits increased $18,692,000. Growth in the average balance of money market deposits of $31,985,000resulted in an increase in interest expense of $528,000 despite a decline of 31bp in rate.  The overall growth inaverage deposit balances of $58,642,000 allowed for a reduction in average short-termborrowings of $22,904,000 which coupled with a reduction in rate paid on suchborrowings of 89 bp resulted in interest expense on short-term borrowingsdecreasing $785,000.

 

**2008 vs 2007**

 

Reported net interestincome increased $1,774,000 or 9.10% to $21,276,000 for the year ended December 31,2008 compared to the year ended December 31, 2007, although the yield onearning assets decreased to 6.68% from 6.91%, respectively.  On a tax equivalent basis the change in netinterest income was an increase of $2,078,000 or 9.48% to $23,990,000 for theyear ended December 31, 2008 compared to the year ended December 31,2007.  Total interest income increased$159,000 primarily due to growth in the average balance of the loan andsecurities portfolios.  The increase inearning asset volume compensated for the negative impact on earning assetyields caused by the rate reductions enacted by the FOMC. Interest incomerecognized on the loan portfolio decreased $871,000 as a portion of theportfolio repriced downward due to the FOMC actions that lowered the prime ratefrom 7.25% at December 31, 2007 to 3.25% at December 31, 2008 coupledwith the market dictating that new loan generation occurred at lower rates thanduring 2007.  Interest and dividendincome generated from the investment portfolio and interest bearing cashdeposits increased $1,030,000.  Theincrease was the result of the yield on the investment portfolio increasing 12basis points (“bp”) while the average balance of the investment portfolioincreased by $17,067,000. The majority of the increase in the securitiesportfolio was from a leverage strategy undertaken during the second half of2007.

 

Interest expensedecreased $1,615,000 to $14,832,000 for the year ended December 31, 2008compared to 2007.  Leading the decreasein interest expense was a decline of 11.70% or $1,281,000 related todeposits.  The FOMC actions notedpreviously together with a strategic shortening of the duration of theportfolio led to an 81 bp decline in the rate paid on time deposits from 4.73%for the year ended December 31, 2007 to 3.92% for the year ended December 31,2008 resulting in a $1,502,000 decline in expense.  The economic turmoil experienced over thepast year has led to a significant decline in short-term interest rates whichhas allowed for a 214 bp decline in the rate paid on short-termborrowings.  Several long-term debtmaturities paved the way for a decline in the rate paid on long-term borrowingsof 23 bp to 4.39% for the year ended December 31, 2008 versus 4.62% forthe year ended December 31, 2007.

 

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**AVERAGE BALANCES ANDINTEREST RATES**

 

Thefollowing tables set forth certain information relating to the Company’saverage balance sheet and reflect the average yield on assets and average costof liabilities for the periods indicated and the average yields earned andrates paid.  Such yields and costs arederived by dividing income or expense by the average balance of assets orliabilities, respectively, for the periods presented.

 
| ** **                                       | ** ** | **AVERAGE  BALANCES AND INTEREST RATES** | ** ** |
|--------------------------------------------------|------------|------------------------------------------|------------|
| ** **                                       | ** ** | **2009**                                 | ** ** | **2008** | ** ** | **2007** | ** ** |
| ** **                                       | ** ** | **Average**                              | ** ** | ** ** | ** ** | **Average** | ** ** | **Average** | ** ** | ** ** | ** ** | **Average** | ** ** | **Average** | ** ** | ** ** | ** ** | **Average** | ** ** |
| **(In Thousands)**                               | ** ** | **Balance**                              | ** ** | **Interest** | ** ** | **Rate** | ** ** | **Balance** | ** ** | **Interest** | ** ** | **Rate** | ** ** | **Balance** | ** ** | **Interest** | ** ** | **Rate** | ** ** |
| Assets:                                          |       |                                     |       |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| Tax-exempt  loans                                |       | $                                        | 16,688     |   | $ | 1,100 |   | 6.59 | % | $ | 9,230 |   | $ | 603 |   | 6.53 | % | $ |  7,857 |   | $ | 485 |   | 6.17 | % |
| All  other loans                                 |       | 382,433                                  |       | 24,842 |   | 6.50 | % | 361,945 |   | 24,830 |   | 6.86 | % | 353,528 |   | 25,779 |   | 7.29 | % |
| Total  loans                                     |       | 399,121                                  |       | 25,942 |   | 6.50 | % | 371,175 |   | 25,433 |   | 6.85 | % | 361,385 |   | 26,264 |   | 7.27 | % |
|                                             |       |                                     |       |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| Taxable  investment securities                   |       | 103,338                                  |       | 5,617 |   | 5.44 | % | 104,245 |   | 6,008 |   | 5.76 | % | 93,480 |   | 5,474 |   | 5.86 | % |
| Tax-exempt  investment securities                |       | 104,800                                  |       | 7,583 |   | 7.24 | % | 106,030 |   | 7,380 |   | 6.96 | % | 99,728 |   | 6,602 |   | 6.62 | % |
| Total  securities                                |       | 208,138                                  |       | 13,200 |   | 6.34 | % | 210,275 |   | 13,388 |   | 6.37 | % | 193,208 |   | 12,076 |   | 6.25 | % |
|                                             |       |                                     |       |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| Interest-bearing  deposits                       |       | 1,938                                    |       | 1 |   | 0.05 | % | 10 |   | 1 |   | 10.00 | % | 345 |   | 19 |   | 5.51 | % |
|                                             |       |                                     |       |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| Total  interest-earning assets                   |       | 609,197                                  |       | 39,143 |   | 6.43 | % | 581,460 |   | 38,822 |   | 6.68 | % | 554,938 |   | 38,359 |   | 6.91 | % |
|                                             |       |                                     |       |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| Other  assets                                    |       | 54,642                                   |       |   |   |   |   | 50,779 |   |   |   |   |   | 42,602 |   |   |   |   |   |
|                                             |       |                                     |       |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| Total  assets                                    |       | $                                        | 663,839    |   |   |   |   |   | $ | 632,239 |   |   |   |   |   | $ | 597,540 |   |   |   |   |   |
|                                             |       |                                     |       |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| Liabilities  and shareholders’ equity:      |       |                                     |       |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| Savings                                          |       | $                                        | 60,815     |   | 313 |   | 0.51 | % | $ | 60,324 |   | 443 |   | 0.73 | % | $ | 58,710 |   | 428 |   | 0.73 | % |
| Super  Now deposits                              |       | 58,591                                   |       | 507 |   | 0.87 | % | 52,117 |   | 658 |   | 1.26 | % | 46,596 |   | 611 |   | 1.31 | % |
| Money  market deposits                           |       | 62,906                                   |       | 1,227 |   | 1.95 | % | 30,921 |   | 699 |   | 2.26 | % | 23,920 |   | 540 |   | 2.26 | % |
| Time  deposits                                   |       | 219,264                                  |       | 6,237 |   | 2.84 | % | 200,572 |   | 7,870 |   | 3.92 | % | 198,029 |   | 9,372 |   | 4.73 | % |
| Total  interest-bearing deposits                 |       | 401,576                                  |       | 8,284 |   | 2.06 | % | 343,934 |   | 9,670 |   | 2.81 | % | 327,255 |   | 10,951 |   | 3.35 | % |
|                                             |       |                                     |       |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| Short-term  borrowings                           |       | 27,641                                   |       | 396 |   | 1.42 | % | 50,545 |   | 1,181 |   | 2.31 | % | 36,816 |   | 1,639 |   | 4.45 | % |
| Long-term  borrowings, FHLB                      |       | 86,778                                   |       | 3,718 |   | 4.23 | % | 89,256 |   | 3,981 |   | 4.39 | % | 83,490 |   | 3,857 |   | 4.62 | % |
| Total  borrowings                                |       | 114,419                                  |       | 4,114 |   | 3.55 | % | 139,801 |   | 5,162 |   | 3.64 | % | 120,306 |   | 5,496 |   | 4.57 | % |
|                                             |       |                                     |       |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| Total  interest-bearing liabilities              |       | 515,995                                  |       | 12,398 |   | 2.39 | % | 483,735 |   | 14,832 |   | 3.05 | % | 447,561 |   | 16,447 |   | 3.67 | % |
|                                             |       |                                     |       |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| Demand  deposits                                 |       | 74,618                                   |       |   |   |   |   | 73,618 |   |   |   |   |   | 69,953 |   |   |   |   |   |
| Other  liabilities                               |       | 10,169                                   |       |   |   |   |   | 8,282 |   |   |   |   |   | 6,924 |   |   |   |   |   |
| Shareholders’  equity                       |       | 63,057                                   |       |   |   |   |   | 66,604 |   |   |   |   |   | 73,102 |   |   |   |   |   |
| Total  liabilities and shareholders’ equity |       | $                                        | 663,839    |   |   |   |   |   | $ | 632,239 |   |   |   |   |   |   |   |   |   |   |   |
|                                             |       |                                     |       |   |   |   |   |   |   |   |   |   |   | $ | 597,540 |   |   |   |   |   |
| Interest  rate spread                            |       |                                     |       |   |   | 4.03 | % |   |   |   |   | 3.63 | % |   |   |   |   | 3.24 | % |
| Net  interest income/margin                      |       |                                     |       | $ | 26,745 |   | 4.40 | % |   |   | $ | 23,990 |   | 4.14 | % |   |   | $ | 21,912 |   | 3.95 | % |

 

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·                  Fees on loans are included withinterest on loans. Loan fees are included in interest income as follows:2009-$349,000, 2008-$472,000, 2007-$453,000.

·                  Information on this table hasbeen calculated using average daily balance sheets to obtain average balances.

·                  Nonaccrual loans have beenincluded with loans for the purpose of analyzing net interest earnings.

·                  Income and rates on a fullytaxable equivalent basis include an adjustment for the difference betweenannual income from tax-exempt obligations and the taxable equivalent of suchincome at the standard 34% tax rate.

 

**Reconcilementof Taxable Equivalent Net Interest Income**

 
| **(In Thousands)**                              | ** ** | **2009** | ** ** | **2008** | ** ** | **2007** | ** ** |
|-------------------------------------------------|------------|----------|------------|----------|------------|----------|------------|
|                                            |       |     |       |     |       |     |       |
| Total interest  income                          |       | $        | 36,191     |     | $          | 36,108   |       | $ | 35,949 |   |
| Total interest  expense                         |       | 12,398   |       | 14,832   |       | 16,447   |       |
|                                            |       |     |       |     |       |     |       |
| Net interest  income                            |       | 23,793   |       | 21,276   |       | 19,502   |       |
| Tax equivalent  adjustment                      |       | 2,952    |       | 2,714    |       | 2,410    |       |
|                                            |       |     |       |     |       |     |       |
| Net interest  income (fully taxable equivalent) |       | $        | 26,745     |     | $          | 23,990   |       | $ | 21,912 |   |

 

**Rate/Volume Analysis**

 

The table below setsforth certain information regarding changes in our interest income and interestexpense for the periods indicated. For interest-earning assets andinterest-bearing liabilities, information is provided on changes attributableto (i) changes in volume (changes in average volume multiplied by oldrate) and (ii) changes in rates (changes in rate multiplied by old averagevolume). Increases and decreases due to both interest rate and volume, whichcannot be separated, have been allocated proportionally to the change due tovolume and the change due to interest rate. Income and interest rates are on a taxable equivalent basis.

 

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| ** **                          | ** ** | **Year Ended December 31,** | ** ** |
|-------------------------------------|------------|----------------------------------|------------|
| ** **                          | ** ** | **2009 vs 2008**                 | ** ** | **2008 vs 2007** | ** ** |
| ** **                          | ** ** | **Increase (Decrease)**          | ** ** | **Increase (Decrease)** | ** ** |
| ** **                          | ** ** | **Due to**                       | ** ** | **Due to** | ** ** |
| **(In Thousands)**                  | ** ** | **Volume**                       | ** ** | **Rate** | ** ** | **Net** | ** ** | **Volume** | ** ** | **Rate** | ** ** | **Net** | ** ** |
| Interest income:                    |       |                             |       |   |   |   |   |   |   |   |   |   |   |
| Loans,  tax-exempt                  |       | $                                | 491        |   | $ | 6 |   | $ | 497 |   | $ | 92 |   | $ | 26 |   | $ | 118 |   |
| Loans                               |       | 1,358                            |       | (1,346 | ) | 12 |   | 638 |   | (1,587 | ) | (949 | ) |
| Taxable  investment securities      |       | (51                              | )          | (340 | ) | (391 | ) | 621 |   | (87 | ) | 534 |   |
| Tax-exempt  investment securities   |       | (87                              | )          | 290 |   | 203 |   | 532 |   | 246 |   | 778 |   |
| Interest bearing  deposits          |       | 3                                |       | (3 | ) | — |   | (27 | ) | 9 |   | (18 | ) |
| Total  interest-earning assets      |       | 1,714                            |       | (1,393 | ) | 321 |   | 1,856 |   | (1,393 | ) | 463 |   |
|                                |       |                             |       |   |   |   |   |   |   |   |   |   |   |
| Interest  expense:                  |       |                             |       |   |   |   |   |   |   |   |   |   |   |
| Savings deposits                    |       | 4                                |       | (134 | ) | (130 | ) | 12 |   | 3 |   | 15 |   |
| Super Now  deposits                 |       | 75                               |       | (226 | ) | (151 | ) | 71 |   | (24 | ) | 47 |   |
| Money market  deposits              |       | 636                              |       | (108 | ) | 528 |   | 158 |   | 1 |   | 159 |   |
| Time deposits                       |       | 682                              |       | (2,315 | ) | (1,633 | ) | 119 |   | (1,621 | ) | (1,502 | ) |
| Short-term  borrowings              |       | (425                             | )          | (360 | ) | (785 | ) | 484 |   | (942 | ) | (458 | ) |
| Long-term borrowings,  FHLB         |       | (113                             | )          | (150 | ) | (263 | ) | 260 |   | (136 | ) | 124 |   |
| Total  interest-bearing liabilities |       | 859                              |       | (3,293 | ) | (2,434 | ) | 1,104 |   | (2,719 | ) | (1,615 | ) |
| Change in net  interest income      |       | $                                | 855        |   | $ | 1,900 |   | $ | 2,755 |   | $ | 752 |   | $ | 1,326 |   | $ | 2,078 |   |

 

### **PROVISION FOR LOAN LOSSES**

###  

**2009 vs 2008**

 

The provision for loanlosses is based upon management’s quarterly review of the loan portfolio.  The purpose of the review is to assess loanquality, identify impaired loans, analyze delinquencies, ascertain loan growth,evaluate potential charge-offs and recoveries, and assess general economicconditions in the markets served.  Anexternal independent loan review is also performed annually for the Bank.  Management remains committed to an aggressiveprogram of problem loan identification and resolution.

 

The allowance iscalculated by applying loss factors to outstanding loans by type, excludingloans for which a specific allowance has been determined.  Loss factors are based on management’sconsideration of the nature of the portfolio segments, changes in mix andvolume of the loan portfolio, and historical loan loss experience.  In addition, management considers industrystandards and trends with respect to nonperforming loans and its knowledge andexperience with specific lending segments.

 

Although management believes that it uses thebest information available to make such determinations and that the allowancefor loan losses is adequate at December 31, 2009, future adjustments couldbe necessary if circumstances or economic conditions differ substantially fromthe assumptions used in making the initial determinations.  A downturn in the local economy or employmentand delays in receiving financial information from borrowers could result inincreased levels of nonperforming assets and charge-offs, increased loan lossprovisions and reductions in interest income. Additionally, as an integral part of the examination process, bankregulatory agencies periodically review the Bank’s loan loss allowanceadequacy. The banking regulators could require the recognition of additions tothe loan loss allowance based on their judgment of information available tothem at the time of their examination.

 

While determining theappropriate allowance level, management has attributed the allowance for loanlosses to various portfolio segments; however, the allowance is available forthe entire portfolio as needed.

 

The allowance for loanlosses increased from $4,356,000 at December 31, 2008 to $4,657,000 at December 31,2009.  At December 31, 2009,allowance for loan losses was 1.15% of total loans compared to 1.14% of totalloans at December 31, 2008.

 

The provision for loanlosses totaled $917,000 for the year ended December 31, 2009 compared to$375,000 for the year ended December 31, 2008. The increase of the provisionwas appropriate when considering the gross loan growth experienced during 2009of $24,051,000 coupled with net charge-offs of $616,000 to average loans forthe year ended December 31, 2008 of 0.16% compared to $149,000 and 0.04%for the year ended December 31, 2008. In addition, nonperforming loans increased to $4,456,000 from $1,735,000at December 31, 2008 primarily due to a commercial real estate loan.  The loan is collateralized with no lossanticipated at this time.  Continueduncertainty surrounding the economy and internal loan review and analysis,coupled with the ratios noted previously, dictated an increase in the provisionfor loan losses.  The increase did notequate to the increase in charge-offs and nonperforming loans due to thecollateral status of the nonperforming loans and overall loan portfolio ingeneral, which limits the loan specific allocation of the allowance for loanlosses.  Utilizing both internal andexternal resources, as noted, senior management has concluded that the allowancefor loan losses remains at a level adequate to provide for probable lossesinherent in the loan portfolio.

 

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**2008 vs 2007**

 

The allowance for loanlosses increased from $4,130,000 at December 31, 2007 to $4,356,000 at December 31,2008.  At December 31, 2008,allowance for loan losses was 1.14% of total loans compared to 1.15% of totalloans at December 31, 2007.

 

The provision for loanlosses totaled $375,000 for the year ended December 31, 2008 compared to$150,000 for the year ended December 31, 2007. Management concluded thatthe increase of the provision was appropriate when considering the gross loangrowth experienced during 2008 of $21,000,000 coupled with net charge-offs toaverage loans for the year ended December 31, 2008 of 0.04%. Utilizingboth internal and external resources, as noted, senior management has concludedthat the allowance for loan losses remains at a level adequate to provide forprobable losses inherent in the loan portfolio.

 

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Following is a tableshowing the changes in the allowance for loan losses for the years ended December 31,2009, 2008, 2007, 2006, and 2005:

 
| **(In Thousands)**                                                                         | ** ** | **2009** | ** ** | **2008** | ** ** | **2007** | ** ** | **2006** | ** ** | **2005** | ** ** |
|--------------------------------------------------------------------------------------------|------------|----------|------------|----------|------------|----------|------------|----------|------------|----------|------------|
| Balance at  beginning of period                                                            |       | $        | 4,356      |     | $          | 4,130    |       | $        | 4,185      |     | $          | 3,679 |   | $ | 3,338 |   |
| Charge-offs:                                                                               |       |     |       |     |       |     |       |     |       |     |       |
| Real estate                                                                                |       | 374      |       | 48       |       | —   |       | 50       |       | 132      |       |
| Commercial and  industrial                                                                 |       | 133      |       | 51       |       | 103      |       | 28       |       | 206      |       |
| Installment  loans to individuals                                                          |       | 225      |       | 214      |       | 201      |       | 249      |       | 108      |       |
| Total  charge-offs                                                                         |       | 732      |       | 313      |       | 304      |       | 327      |       | 446      |       |
| Recoveries:                                                                                |       |     |       |     |       |     |       |     |       |     |       |
| Real estate                                                                                |       | 14       |       | 17       |       | 13       |       | 68       |       | 45       |       |
| Commercial and  industrial                                                                 |       | 10       |       | 60       |       | 1        |       | 40       |       | 8        |       |
| Installment  loans to individuals                                                          |       | 92       |       | 87       |       | 85       |       | 90       |       | 14       |       |
| Total recoveries                                                                           |       | 116      |       | 164      |       | 99       |       | 198      |       | 67       |       |
| Net charge-offs                                                                            |       | 616      |       | 149      |       | 205      |       | 129      |       | 379      |       |
| Additions  charged to operations                                                           |       | 917      |       | 375      |       | 150      |       | 635      |       | 720      |       |
| Balance at end  of period                                                                  |       | $        | 4,657      |     | $          | 4,356    |       | $        | 4,130      |     | $          | 4,185 |   | $ | 3,679 |   |
| Ratio of net  charge-offs during the period to average loans outstanding during the period |       | 0.16     | %          | 0.04     | %          | 0.06     | %          | 0.04     | %          | 0.11     | %          |

 

### **NON-INTEREST INCOME**

###  

**2009 vs 2008**

 

Total non-interest incomedecreased $3,169,000 from the year ended December 31, 2008 to 2009.  Excluding security losses, non-interestincome decreased $354,000 year over year. Service charges decreased asoverdraft protection fees decreased $44,000 and customers continued to migrateto checking accounts having reduced or no service charges.  Earnings on bank-owned life insuranceincreased due to the full year impact of policies purchased during 2008 and again on death benefit. Insurance commissions decreased due to the generaleconomic downturn, which has led to a decrease in volume of sales.  Management of The M Group continues to pursuenew and build upon current relationships. However, the sales cycle for insurance and investment products can taketypically from six months to one year or more to complete. The increase inother income was primarily due to increases in revenues from debit/credit cardtransactions and merchant card commissions.

** **
| ** **                 | ** ** | **2009**   | ** ** | **2008**    | ** ** | **Change** | ** ** |
|----------------------------|------------|------------|------------|-------------|------------|------------|------------|
| **(In Thousands)**         | ** ** | **Amount** | ** ** | **% Total** | ** ** | **Amount** | ** ** | **% Total** | ** ** | **Amount** | ** ** | **%** | ** ** |
| Deposit service  charges   |       | $          | 2,200      |        | 96.20      | %          | $          | 2,289 |   | 41.95 | % | $ | (89 | ) | (3.89 | )% |
| Securities  losses, net    |       | (4,846     | )          | (211.89     | )          | (2,031     | )          | (37.23 | ) | (2,815 | ) | (138.60 | ) |
| Bank owned life  insurance |       | 713        |       | 31.18       |       | 472        |       | 8.65 |   | 241 |   | 51.06 |   |
| Gain on sale of  loans     |       | 826        |       | 36.12       |       | 882        |       | 16.17 |   | (56 | ) | (6.35 | ) |
| Insurance  commissions     |       | 1,189      |       | 51.99       |       | 1,928      |       | 35.34 |   | (739 | ) | (38.33 | ) |
| Other                      |       | 2,205      |       | 96.40       |       | 1,916      |       | 35.12 |   | 289 |   | 15.08 |   |
| Total  non-interest income |       | $          | 2,287      |        | 100.00     | %          | $          | 5,456 |   | 100.00 | % | $ | (3,169 | ) | (58.08 | )% |

 

**2008 vs 2007**

 

Total non-interestincome decreased $2,022,000 from the year ended December 31, 2007 to2008.  Excluding security losses,non-interest income decreased $45,000. Service charges increased as overdraftprotection fees increased $100,000 and offset customer migrations to checkingaccounts having reduced or no service charges. Earnings on bank-owned life insurance increased as additional policieswere purchased. Insurance commissions decreased due to the general economicdownturn, which has led to a decrease in volume of sales.  Management of The M Group continues to pursuenew and build upon current relationships. However, the sales cycle for insurance and investment products can taketypically from six months to one year or more to complete. The increase inother income was primarily due to increases in revenues from debit cardtransactions, merchant card commissions, and title insurance.

 

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| ** **                 | ** ** | **2008**   | ** ** | **2007**    | ** ** | **Change** | ** ** |
|----------------------------|------------|------------|------------|-------------|------------|------------|------------|
| **(In Thousands)**         | ** ** | **Amount** | ** ** | **% Total** | ** ** | **Amount** | ** ** | **% Total** | ** ** | **Amount** | ** ** | **%** | ** ** |
| Deposit service  charges   |       | $          | 2,289      |        | 41.95      | %          | $          | 2,246 |   | 30.03 | % | $ | 43 |   | 1.91 | % |
| Securities  losses, net    |       | (2,031     | )          | (37.23      | )          | (54        | )          | (0.72 | ) | (1,977 | ) | (3,661.11 | ) |
| Bank owned life  insurance |       | 472        |       | 8.65        |       | 410        |       | 5.48 |   | 62 |   | 15.12 |   |
| Gain on sale of  loans     |       | 882        |       | 16.17       |       | 921        |       | 12.32 |   | (39 | ) | (4.23 | ) |
| Insurance  commissions     |       | 1,928      |       | 35.34       |       | 2,222      |       | 29.72 |   | (294 | ) | (13.23 | ) |
| Other                      |       | 1,916      |       | 35.12       |       | 1,733      |       | 23.17 |   | 183 |   | 10.56 |   |
| Total  non-interest income |       | $          | 5,456      |        | 100.00     | %          | $          | 7,478 |   | 100.00 | % | $ | (2,022 | ) | (27.04 | )% |

 

### **NON-INTEREST EXPENSE**

###  

**2009 vs 2008**

 

Total non-interestexpenses increased $1,863,000 from the year ended December 31, 2008 to December 31,2009. Salaries and employee benefits increased due to several factors includingstandard cost of living wage adjustments for employees and increased benefitcosts.  Pennsylvania shares tax increaseddue to tax credits associated with an investment in low income housing withinthe Lycoming County market that were utilized during 2008. Other expensesincreased primarily due to an increase in FDIC insurance expense of $1,010,000.

** **
| ** **                                          | ** ** | **2009**   | ** ** | **2008**    | ** ** | **Change** | ** ** |
|-----------------------------------------------------|------------|------------|------------|-------------|------------|------------|------------|
| **(In Thousands)**                                  | ** ** | **Amount** | ** ** | **% Total** | ** ** | **Amount** | ** ** | **% Total** | ** ** | **Amount** | ** ** | **%** | ** ** |
| Salaries and  employee benefits                     |       | $          | 10,189     |        | 51.43      | %          | $          | 9,634 |   | 53.67 | % | $ | 555 |   | 5.76 | % |
| Occupancy, net                                      |       | 1,266      |       | 6.39        |       | 1,288      |       | 7.18 |   | (22 | ) | (1.71 | ) |
| Furniture and  equipment                            |       | 1,212      |       | 6.12        |       | 1,182      |       | 6.59 |   | 30 |   | 2.54 |   |
| Pennsylvania  shares tax                            |       | 685        |       | 3.46        |       | 421        |       | 2.35 |   | 264 |   | 62.71 |   |
| Amortization of  investment in limited partnerships |       | 567        |       | 2.86        |       | 712        |       | 3.97 |   | (145 | ) | (20.37 | ) |
| Other                                               |       | 5,893      |       | 29.74       |       | 4,712      |       | 26.24 |   | 1,181 |   | 25.06 |   |
| Total  non-interest expense                         |       | $          | 19,812     |        | 100.00     | %          | $          | 17,949 |   | 100.00 | % | $ | 1,863 |   | 10.40 | % |

###  

**2008 vs 2007**

 

Total non-interestexpenses increased $633,000 from the year ended December 31, 2007 to December 31,2008. Salaries and employee benefits increased due to several factors includingstandard cost of living wage adjustments for employees, increased benefitcosts, and expenses associated with the post-retirement segment of split-dollarbank owned life insurance.  Pennsylvaniashares tax decreased due to tax credits associated with an investment in lowincome housing within the Lycoming County market. Other expenses increased primarilydue to increases in legal and insurance costs coupled with our continuedemphasis on giving back to the communities that we serve resulting in adoubling of donations during 2008 compared to 2007.

** **
| ** **                                          | ** ** | **2008**   | ** ** | **2007**    | ** ** | **Change** | ** ** |
|-----------------------------------------------------|------------|------------|------------|-------------|------------|------------|------------|
| **(In Thousands)**                                  | ** ** | **Amount** | ** ** | **% Total** | ** ** | **Amount** | ** ** | **% Total** | ** ** | **Amount** | ** ** | **%** | ** ** |
| Salaries and  employee benefits                     |       | $          | 9,634      |        | 53.67      | %          | $          | 9,078 |   | 52.43 | % | $ | 556 |   | 6.12 | % |
| Occupancy, net                                      |       | 1,288      |       | 7.18        |       | 1,306      |       | 7.54 |   | (18 | ) | (1.38 | ) |
| Furniture and  equipment                            |       | 1,182      |       | 6.59        |       | 1,126      |       | 6.50 |   | 56 |   | 4.97 |   |
| Pennsylvania  shares tax                            |       | 421        |       | 2.35        |       | 643        |       | 3.71 |   | (222 | ) | (34.53 | ) |
| Amortization of  investment in limited partnerships |       | 712        |       | 3.97        |       | 761        |       | 4.39 |   | (49 | ) | (6.44 | ) |
| Other                                               |       | 4,712      |       | 26.24       |       | 4,402      |       | 25.43 |   | 310 |   | 7.04 |   |
| Total  non-interest expense                         |       | $          | 17,949     |        | 100.00     | %          | $          | 17,316 |   | 100.00 | % | $ | 633 |   | 3.66 | % |

 

### **INCOME TAXES**

###  

**2009 vs 2008**

 

The provision forincome taxes for the year ended December 31, 2009 resulted in an effectiveincome tax rate of (13.9)% compared to 4.8% for 2008. This decrease isprimarily the result of an increase in net securities losses of $2,815,000which accounted for a reduction

 

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in tax expense ofapproximately $957,000.  In addition,tax-exempt investment income and bank-owned life insurance income increased$134,000 and $241,000, respectively resulting in approximately and additionalreduction in tax expense of $128,000.

 

An analysis has been performed to determine if there is a need for avaluation allowance related to the deferred tax asset that has been booked dueto the investment losses.  As of December 31,2009, management determined that a valuation analysis was not necessary.

 

**2008 vs 2007**

 

The provision forincome taxes for the year ended December 31, 2008 resulted in an effectiveincome tax rate of 4.8% compared to 6.7% for 2007. This decrease is the resultof the continued shift in the investment portfolio from taxable mortgage-backedbonds to tax-exempt municipal bonds coupled with the recognition of tax creditsrelated to low income housing partnerships investments.

 

### **FINANCIAL CONDITION**

###  

### **INVESTMENTS**

###  

**2009**

 

The carrying value of the investment portfolioincreased $489,000 from December 31, 2008 to 2009, while the amortizedcost decreased $6,955,000 over the same period. The decrease in amortized value was due to a reduction of U.S.Government and agency securities due to routine principal payments and areduction in equity securities due to both other than temporary impairmentwrite downs and that certain positions were liquidated to maximize the abilityto carry back capital losses for tax purposes. Offsetting these decreases in part was an increase in state andpolitical securities.  This segment ofthe aggregate portfolio was increased due to its ability to complement theshorter duration assets within the earning asset composition.  The increase in carrying or fair value wasthe result of the previously noted reduction in amortized cost offset by areduction in aggregate net unrealized losses of $7,451,000 primarily related tothe equity segment of the portfolio.

 

**2008**

 

The carrying value of the investment portfoliodecreased $6,346,000 or 2.96% from December 31, 2007 to 2008, while theamortized cost increased $3,241,000 over the same period.  The majority of the changes in value occurredwithin the state and municipal segment of the portfolio.  The amortized cost position in state andpolitical securities increased $22,607,000 as the Bank continued to build callprotection, maintain taxable equivalent yields, reduce the effective federalincome tax rate, and invest in communities across the Commonwealth ofPennsylvania and the country. The amortized cost position of U.S. Governmentand agency securities decreased $15,934,000 due to the focus on building themunicipal bond segment of the portfolio. The increased level of unrealized losses, which offset the increase inamortized cost, was the result of changes in the yield curve and illiquidmarkets, not credit quality, as the credit quality of the portfolio remainedsound.

 

The carrying amounts of investment securitiesare summarized as follows for the years ended December 31, 2009, 2008, and2007:

 
| ** **                                      | ** ** | **2009**    | ** ** | **2008**        | ** ** | **2007**    | ** ** |
|-------------------------------------------------|------------|-------------|------------|-----------------|------------|-------------|------------|
| **(In Thousands)**                              | ** ** | **Balance** | ** ** | **% Portfolio** | ** ** | **Balance** | ** ** | **% Portfolio** | ** ** | **Balance** | ** ** | **% Portfolio** | ** ** |
| U.S. Government  agencies:                      |       |        |       |            |       |        |       |   |   |   |   |   |   |
| Held to maturity                                |       | $           | 6          |            | 0.00       | %           | $          | 10 |   | 0.00 | % | $ | 14 |   | 0.01 | % |
| Available for  sale                             |       | 39,136      |       | 18.74           | %          | 47,586      |       | 22.84 | % | 62,904 |   | 29.29 | % |
| State and  political subdivisions (tax-exempt): |       |        |       |            |       |        |       |   |   |   |   |   |   |
| Held to maturity                                |       | —      |       | —          |       | —      |       | — |   | — |   | — |   |
| Available for  sale                             |       | 106,928     |       | 51.19           | %          | 103,173     |       | 49.51 | % | 107,314 |   | 49.98 | % |
| State and  political subdivisions (taxable):    |       |        |       |            |       |        |       |   |   |   |   |   |   |
| Held to maturity                                |       | —      |       | —          |       | —      |       | — |   | — |   | — |   |
| Available for  sale                             |       | 37,949      |       | 18.17           | %          | 28,668      |       | 13.76 | % | 10,501 |   | 4.89 | % |
| Other bonds,  notes and debentures:             |       |        |       |            |       |        |       |   |   |   |   |   |   |
| Held to maturity                                |       | 101         |       | 0.05            | %          | 125         |       | 0.06 | % | 263 |   | 0.12 | % |
| Available for  sale                             |       | 12,976      |       | 6.21            | %          | 15,554      |       | 7.46 | % | 15,767 |   | 7.34 | % |
| Total bonds,  notes and debentures              |       | 197,096     |       | 94.36           | %          | 195,116     |       | 93.63 | % | 196,763 |   | 91.63 | % |
| Corporate stock  - Available for Sale           |       | 11,779      |       | 5.64            | %          | 13,270      |       | 6.37 | % | 17,969 |   | 8.37 | % |
| Total                                           |       | $           | 208,875    |            | 100.00     | %           | $          | 208,386 |   | 100.00 | % | $ | 214,732 |   | 100.00 | % |

 

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The following tableshows the maturities and repricing of investment securities, at amortized costand the weighted average yields (for tax-exempt obligations on a fully taxablebasis assuming a 34% tax rate) at December 31, 2009:

 
| ** **                                      | ** ** | **Within** | ** ** | **After One**  | ** ** | **After Five** | ** ** | **After** | ** ** | **Amortized** | ** ** |
|-------------------------------------------------|------------|------------|------------|----------------|------------|----------------|------------|-----------|------------|---------------|------------|
| ** **                                      | ** ** | **One**    | ** ** | **But Within** | ** ** | **But Within** | ** ** | **Ten**   | ** ** | **Cost**      | ** ** |
| **(In Thousands)**                              | ** ** | **Year**   | ** ** | **Five Years** | ** ** | **Ten Years**  | ** ** | **Years** | ** ** | **Total**     | ** ** |
| U.S. Government  agencies:                      |       |       |       |           |       |           |       |      |       |          |       |
| HTM Amount                                      |       | $          | —     |           | $          | —         |       | $         | —     |          | $          | 6 |   | $ | 6 |   |
| Yield                                           |       | —     |       | —         |       | —         |       | 8.62      | %          | 8.62          | %          |
| AFS Amount                                      |       | —     |       | —         |       | —         |       | 37,038    |       | 37,038        |       |
| Yield                                           |       | —     |       | —         |       | —         |       | 5.82      | %          | 5.82          | %          |
| State and  political subdivisions (tax-exempt): |       |       |       |           |       |           |       |      |       |          |       |
| HTM Amount                                      |       | —     |       | —         |       | —         |       | —    |       | —        |       |
| Yield                                           |       | —     |       | —         |       | —         |       | —    |       | —        |       |
| AFS Amount                                      |       | —     |       | —         |       | 1,454          |       | 111,159   |       | 112,613       |       |
| Yield                                           |       | —     |       | —         |       | 7.98           | %          | 6.60      | %          | 6.61          | %          |
| State and  political subdivisions (taxable):    |       |       |       |           |       |           |       |      |       |          |       |
| HTM Amount                                      |       | —     |       | —         |       | —         |       | —    |       | —        |       |
| Yield                                           |       | —     |       | —         |       | —         |       | —    |       | —        |       |
| AFS Amount                                      |       | —     |       | 1,007          |       | —         |       | 40,294    |       | 41,301        |       |
| Yield                                           |       | —     |       | 6.01           | %          | —         |       | 5.98      | %          | 5.98          | %          |
| Other bonds,  notes and debentures:             |       |       |       |           |       |           |       |      |       |          |       |
| HTM Amount                                      |       | 25         |       | 76             |       | —         |       | —    |       | 101           |       |
| Yield                                           |       | 7.31       | %          | 6.30           | %          | —         |       | —    |       | 6.55          | %          |
| AFS Amount                                      |       | 25         |       | 10,349         |       | 1              |       | 1,896     |       | 12,271        |       |
| Yield                                           |       | 0.66       | %          | 5.11           | %          | 0.90           | %          | 6.82      | %          | 5.37          | %          |
| Total Amount                                    |       | $          | 50         |           | $          | 11,432         |       | $         | 1,455      |          | $          | 190,393 |   | $ | 203,330 |   |
| Total Yield                                     |       | 3.99       | %          | 5.20           | %          | 7.97           | %          | 6.32      | %          | 6.27          | %          |
|                                            |       |       |       |           |       |           |       |      |       |          |       |
| Equity  Securities                              |       |       |       |           |       |           |       |      |       | $             | 10,959     |   |
| Total Investment  Portfolio Value               |       |       |       |           |       |           |       |      |       | $             | 214,289    |   |
| Total Investment  Portfolio Yield               |       |       |       |           |       |           |       |      |       | 5.94          | %          |

 

All yields representweighted average yields expressed on a tax equivalent basis.  They are calculated on the basis of the cost,adjusted for amortization of premium and accretion of discount, and effectiveyields weighted for the scheduled maturity of each security.  The taxable equivalent adjustment representsthe difference between annual income from tax-exempt obligations and thetaxable equivalent of such income at the standard 34% tax rate (derived bydividing tax-exempt interest by 66%).

 

The distribution of credit ratings by amortized cost and estimated fairvalue for the debt security portfolio at December 31, 2009 is as follows:

 
| ** **                             | ** ** | **A- to  AAA** | ** ** | **B- to  BBB+** | ** ** | **C to  CCC+** | ** ** | **Not  Rated** | ** ** | **Total**     | ** ** |
|----------------------------------------|------------|----------------|------------|-----------------|------------|----------------|------------|----------------|------------|---------------|------------|
| ** **                             | ** ** | **Amortized**  | ** ** | **Fair**        | ** ** | **Amortized**  | ** ** | **Fair**       | ** ** | **Amortized** | ** ** | **Fair** | ** ** | **Amortized** | ** ** | **Fair** | ** ** | **Amortized** | ** ** | **Fair** | ** ** |
| **(In Thousands)**                     | ** ** | **Cost**       | ** ** | **Value**       | ** ** | **Cost**       | ** ** | **Value**      | ** ** | **Cost**      | ** ** | **Value** | ** ** | **Cost** | ** ** | **Value** | ** ** | **Cost** | ** ** | **Value** | ** ** |
| Available for  sale (AFS)              |       |           |       |            |       |           |       |           |       |          |       |   |   |   |   |   |   |   |   |   |   |
| U.S. Government  and agency securities |       | $              | 37,038     |            | $          | 39,136         |       | $              | —     |          | $          | — |   | $ | — |   | $ | — |   | $ | — |   | $ | — |   | $ | 37,038 |   | $ | 39,136 |   |
| State and  political securities        |       | 136,585        |       | 129,219         |       | 8,340          |       | 7,370          |       | —        |       | — |   | 8,989 |   | 8,288 |   | 153,914 |   | 144,877 |   |
| Other debt  securities                 |       | 10,915         |       | 11,624          |       | 400            |       | 355            |       | —        |       | — |   | 956 |   | 997 |   | 12,271 |   | 12,976 |   |
| Total debt  securities AFS             |       | $              | 184,538    |            | $          | 179,979        |       | $              | 8,740      |          | $          | 7,725 |   | $ | — |   | $ | — |   | $ | 9,945 |   | $ | 9,285 |   | $ | 203,223 |   | $ | 196,989 |   |
|                                   |       |           |       |            |       |           |       |           |       |          |       |   |   |   |   |   |   |   |   |   |   |
| Held to maturity  (HTM)                |       |           |       |            |       |           |       |           |       |          |       |   |   |   |   |   |   |   |   |   |   |
| U.S. Government  and agency securities |       | $              | 6          |            | $          | 6              |       | $              | —     |          | $          | — |   | $ | — |   | $ | — |   | $ | — |   | $ | — |   | $ | 6 |   | $ | 6 |   |
| Other debt  securities                 |       | 101            |       | 102             |       | —         |       | —         |       | —        |       | — |   | — |   | — |   | 101 |   | 102 |   |
| Total debt  securities HTM             |       | $              | 107        |            | $          | 108            |       | $              | —     |          | $          | — |   | $ | — |   | $ | — |   | $ | — |   | $ | — |   | $ | 107 |   | $ | 108 |   |

 

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### **LOAN PORTFOLIO**

###  

**2009**

 

Gross loans of $405,529,000at December 31, 2009 represented an increase of $24,051,000 from December 31,2008. The continued emphasis on well collateralized real estate loans resultedin commercial real estate secured loans increasing $16,051,000 from December 31,2008 to 2009. The success in carrying out this long term strategy has played asignificant role in limiting net charge-offs for 2009 to 0.16% of averageloans.  The composition of the portfoliohas shifted toward commercial from residential since December 31, 2008.  This shift is the by-product of the majorityof residential mortgages being sold into the secondary market versus beingadded to the loan portfolio.

 

**2008**

 

Gross loans of$381,478,000 at December 31, 2008 represented an increase of $21,000,000from December 31, 2007. The continued emphasis on well collateralized realestate loans resulted in real estate secured loans increasing $17,039,000 from December 31,2007 to 2008. The success in carrying out this long term strategy has played asignificant role in limiting net chargeoffs for 2008 to 0.04% of averageloans.  Despite the softening economy,the Bank has increased outstanding loans while maintaining its lendingpractices and is capitalizing on opportunities because larger regional bankshave withdrawn, in part, from select market segments.

 

The amounts of loans outstanding at theindicted dates are shown in the following table according to type of loan at December 31,2009, 2008, 2007, 2006, and 2005:

 
| ** **                              | ** ** | **2009**   | ** ** | **2008**    | ** ** | **2007**   | ** ** | **2006**    | ** ** | **2005**   | ** ** |
|-----------------------------------------|------------|------------|------------|-------------|------------|------------|------------|-------------|------------|------------|------------|
| **(In Thousands)**                      | ** ** | **Amount** | ** ** | **% Total** | ** ** | **Amount** | ** ** | **% Total** | ** ** | **Amount** | ** ** | **% Total** | ** ** | **Amount** | ** ** | **% Total** | ** ** | **Amount** | ** ** | **% Total** | ** ** |
| Commercial,  financial and agricultural |       | $          | 46,647     |        | 11.5       | %          | $          | 40,602      |       | 10.6       | %          | $ | 35,739 |   | 9.9 | % | $ | 36,995 |   | 10.3 | % | $ | 37,553 |   | 11.1 | % |
| Real estate  mortgage:                  |       |       |       |        |       |       |       |        |       |       |       |   |   |   |   |   |   |   |   |   |   |
| Residential                             |       | 174,346    |       | 43.1        |       | 177,406    |       | 46.5        |       | 163,268    |       | 45.3 |   | 158,219 |   | 43.9 |   | 150,000 |   | 44.3 |   |
| Commercial                              |       | 152,209    |       | 37.5        |       | 136,158    |       | 35.7        |       | 132,943    |       | 36.9 |   | 135,404 |   | 37.6 |   | 127,131 |   | 37.5 |   |
| Construction                            |       | 21,795     |       | 5.4         |       | 15,838     |       | 4.2         |       | 16,152     |       | 4.5 |   | 16,749 |   | 4.6 |   | 10,681 |   | 3.2 |   |
| Installment loans  to individuals       |       | 11,549     |       | 2.8         |       | 12,487     |       | 3.3         |       | 13,317     |       | 3.7 |   | 14,035 |   | 3.9 |   | 14,135 |   | 4.2 |   |
| Less: Net  deferred loan fees           |       | 1,017      |       | (0.3        | )          | 1,013      |       | (0.3        | )          | 941        |       | (0.3 | ) | 1,018 |   | (0.3 | ) | 1,062 |   | (0.3 | ) |
| Gross loans                             |       | $          | 405,529    |        | 100.0      | %          | $          | 381,478     |       | 100.0      | %          | $ | 360,478 |   | 100.0 | % | $ | 360,384 |   | 100.0 | % | $ | 338,438 |   | 100.0 | % |

 

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The amounts of domesticloans at December 31, 2009 are presented below by category and maturity:

 
| ** **                                | ** ** | ** **      | ** ** | **Commercial** | ** ** | **Installment** | ** ** | ** ** | ** ** |
|-------------------------------------------|------------|-----------------|------------|----------------|------------|-----------------|------------|------------|------------|
| ** **                                | ** ** | ** **      | ** ** | **and**        | ** ** | **Loans to**    | ** ** | ** ** | ** ** |
| **(In Thousands)**                        | ** ** | **Real Estate** | ** ** | **Other**      | ** ** | **Individuals** | ** ** | **Total**  | ** ** |
| Loans with  floating interest rates:      |       |            |       |           |       |            |       |       |       |
| 1 year or less                            |       | $               | 23,811     |           | $          | 11,100          |       | $          | 2,070      |   | $ | 36,981 |   |
| 1 through 5  years                        |       | 16,313          |       | 2,083          |       | 10              |       | 18,406     |       |
| 5 through 10  years                       |       | 27,916          |       | 2,917          |       | 1               |       | 30,834     |       |
| After 10 years                            |       | 225,824         |       | 10,620         |       | 873             |       | 237,317    |       |
| Total floating  interest rate loans       |       | 293,864         |       | 26,720         |       | 2,954           |       | 323,538    |       |
| Loans with  predetermined interest rates: |       |            |       |           |       |            |       |       |       |
| 1 year or less                            |       | 3,295           |       | 1,557          |       | 1,025           |       | 5,877      |       |
| 1 through 5  years                        |       | 15,788          |       | 12,426         |       | 6,865           |       | 35,079     |       |
| 5 through 10  years                       |       | 20,379          |       | 2,586          |       | 767             |       | 23,732     |       |
| After 10 years                            |       | 13,736          |       | 3,539          |       | 28              |       | 17,303     |       |
| Total  predetermined interest rate loans  |       | 53,198          |       | 20,108         |       | 8,685           |       | 81,991     |       |
| Total                                     |       | $               | 347,062    |           | $          | 46,828          |       | $          | 11,639     |   | $ | 405,529 |   |

 

·                  The loan maturity informationis based upon original loan terms and is not adjusted for “rollovers.”  In the ordinary course of business, loansmaturing within one year may be renewed, in whole or in part, at interest ratesprevailing at the date of renewal.

·                  Scheduled repayments arereported in maturity categories in which the payment is due.

 

The Bank does not makeloans that provide for negative amortization nor do any loans containconversion features. The Bank does not have any foreign loans outstanding at December 31,2009.

 

### **ALLOWANCE FOR LOAN LOSSES**

###  

**2009**

 

The allowance for loan losses represents theamount which management estimates is adequate to provide for probable lossesinherent in its loan portfolio, as of the consolidated balance sheet date.  All loan losses are charged to the allowanceand all recoveries are credited to it per the allowance method of providing forloan losses.  The allowance for loanlosses is established through a provision for loan losses charged tooperations.  The provision for loanlosses is based upon management’s quarterly review of the loan portfolio.  The purpose of the review is to assess loanquality, identify impaired loans, analyze delinquencies, ascertain loan growth,evaluate potential charge-offs and recoveries, and assess general economicconditions in the markets served. An external independent loan review is alsoperformed annually for the Bank. Management remains committed to an aggressive program of problem loanidentification and resolution.

 

The allowance iscalculated by applying loss factors to outstanding loans by type, excludingloans for which a specific allowance has been determined.  Loss factors are based on management’sconsideration of the nature of the portfolio segments, changes in mix andvolume of the loan portfolio, and historical loan loss experience.  In addition, management considers industrystandards and trends with respect to nonperforming loans and its knowledge andexperience with specific lending segments.

 

The allowance for loanlosses increased from $4,356,000 at December 31, 2008 to $4,657,000 at December 31,2009.  At December 31, 2009, theallowance for loan losses was 1.15% of total loans compared to 1.14% of totalloans at December 31, 2008. This percentage is consistent with the Bank’shistorical experience and peer banks. Management’s conclusion is that the allowance for loan losses isadequate to provide for probable losses inherent in its loan portfolio as ofthe balance sheet date.

 

Based on management’sloan-by-loan review, the past performance of the borrowers, and currenteconomic conditions, including recent business closures and bankruptcy levels,management does not anticipate any current losses related to nonaccrual,nonperforming, or classified loans above those that have already beenconsidered in its overall judgment of the adequacy of the reserve.

 

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**2008**

 

At December 31,2008, the allowance for loan losses as a percent of total loans decreased to1.14% from 1.15% at December 31, 2007. An increase in gross loans of$21,000,000 from $360,478,000 at December 31, 2007 to $381,478,000 at December 31,2008 coupled with net charge-offs of $149,000 led to the slight decline in theallowance for loan losses as a percent of total loans.

 

**Allocation In The Allowance For Loan Losses**

 
| ** **                              | ** ** | ** ** | ** ** | **Percent  Of**  | ** ** |
|-----------------------------------------|------------|------------|------------|------------------|------------|
| ** **                              | ** ** | ** ** | ** ** | **Loan In**      | ** ** |
| ** **                              | ** ** | ** ** | ** ** | **Each**         | ** ** |
| ** **                              | ** ** | ** ** | ** ** | **Category  To** | ** ** |
| **(In Thousands)**                      | ** ** | **Amount** | ** ** | **Total  Loans** | ** ** |
| **December 31, 2009:**             | ** ** | ** ** |       |             |       |
| Balance at end of period applicable to: |       |       |       |             |       |
| Commercial and agricultural             |       | $          | 566        |             | 11.5       | % |
| Real estate mortgage:                   |       |       |       |             |       |
| Residential                             |       | 968        |       | 42.9             | %          |
| Commercial                              |       | 1,484      |       | 37.4             | %          |
| Construction                            |       | 1,396      |       | 5.4              | %          |
| Installment loans to individuals        |       | 221        |       | 2.8              | %          |
| Unallocated                             |       | 22         |       | —           |       |
| Total                                   |       | $          | 4,657      |             | 100.0      | % |
| **December 31, 2008:**             | ** ** | ** ** |       |             |       |
| Balance at end of period applicable to: |       |       |       |             |       |
| Commercial and agricultural             |       | $          | 580        |             | 10.6       | % |
| Real estate mortgage:                   |       |       |       |             |       |
| Residential                             |       | 659        |       | 46.4             | %          |
| Commercial                              |       | 1,326      |       | 35.6             | %          |
| Construction                            |       | 1,471      |       | 4.1              | %          |
| Installment loans to individuals        |       | 250        |       | 3.3              | %          |
| Unallocated                             |       | 70         |       | —           |       |
| Total                                   |       | $          | 4,356      |             | 100.0      | % |
| **December 31, 2007:**             | ** ** | ** ** |       |             |       |
| Balance at end of period applicable to: |       |       |       |             |       |
| Commercial and agricultural             |       | $          | 823        |             | 9.9        | % |
| Real estate mortgage:                   |       |       |       |             |       |
| Residential                             |       | 1,031      |       | 45.1             | %          |
| Commercial                              |       | 1,634      |       | 36.8             | %          |
| Construction                            |       | 112        |       | 4.5              | %          |
| Installment loans to individuals        |       | 228        |       | 3.7              | %          |
| Unallocated                             |       | 302        |       | —           |       |
| Total                                   |       | $          | 4,130      |             | 100.0      | % |
| **December 31, 2006:**             | ** ** | ** ** |       |             |       |
| Balance at end of period applicable to: |       |       |       |             |       |
| Commercial and agricultural             |       | $          | 679        |             | 10.2       | % |
| Real estate mortgage:                   |       |       |       |             |       |
| Residential                             |       | 951        |       | 43.8             | %          |
| Commercial                              |       | 1,972      |       | 37.5             | %          |
| Construction                            |       | 108        |       | 4.6              | %          |
| Installment loans to individuals        |       | 295        |       | 3.9              | %          |
| Unallocated                             |       | 180        |       | —           |       |
| Total                                   |       | $          | 4,185      |             | 100.0      | % |
| **December 31, 2005:**             | ** ** | ** ** |       |             |       |
| Balance at end of period applicable to: |       |       |       |             |       |
| Commercial and agricultural             |       | $          | 582        |             | 10.1       | % |
| Real estate mortgage:                   |       |       |       |             |       |
| Residential                             |       | 1,107      |       | 44.2             | %          |
| Commercial                              |       | 1,482      |       | 37.5             | %          |
| Construction                            |       | 79         |       | 3.1              | %          |
| Installment loans to individuals        |       | 192        |       | 5.1              | %          |
| Unallocated                             |       | 237        |       | —           |       |
| Total                                   |       | $          | 3,679      |             | 100.0      | % |

 

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**NONPERFORMING LOANS**

 

Nonaccrual loansincreased $415,000 to $1,891,000 at December 31, 2009 as severalcommercial real estate relationships deteriorated in quality. Overallnonperforming loans increased $2,721,000 to $4,456,000 from fiscal year end2008 due to one commercial loan that is well secured with no loss expected atthis time.

 

The following tablepresents information concerning nonperforming loans.  The accrual of interest will be discontinuedwhen the principal or interest of a loan is in default for 90 days or more, oras soon as payment is questionable, unless the loan is well secured and in theprocess of collection. Consumer loans and residential real estate loans securedby 1 to 4 family dwellings are not ordinarily subject to those guidelines.  The reversal of previously accrued butuncollected interest applicable to any loan placed in a nonaccrual status andthe treatment of subsequent payments of either principal or interest will behandled in accordance with GAAP.  Theseprinciples do not require a write-off of previously accrued interest ifprincipal and interest are ultimately protected by sound collateralvalues.  A nonperforming loan may berestored to accruing status when:

 

1.               Principal and interest isno longer due and unpaid;

2.               It becomes well securedand in the process of collection;

3.               Prospects for futurecontractual payments are no longer in doubt;

 
| ** **         | ** ** | **Total Nonperforming Loans** | ** ** |
|--------------------|------------|-------------------------------|------------|
| ** **         | ** ** | ** **                    | ** ** | **90 Days** | ** ** | ** ** | ** ** |
| **(In Thousands)** | ** ** | **Nonaccrual**                | ** ** | **Past Due** | ** ** | **Total** | ** ** |
| 2009               |       | $                             | 1,891      |   | $ | 2,565 |   | $ | 4,456 |   |
| 2008               |       | 1,476                         |       | 259 |   | 1,735 |   |
| 2007               |       | 955                           |       | 365 |   | 1,320 |   |
| 2006               |       | 370                           |       | 119 |   | 489 |   |
| 2005               |       | 540                           |       | 63 |   | 603 |   |
| 2004               |       | 1,381                         |       | 345 |   | 1,726 |   |
| 2003               |       | 827                           |       | 429 |   | 1,256 |   |
|                    |            |                               |            |  |  |  |  |  |  |  |

 

The level ofnonaccruing loans continues to fluctuate annually and is attributed to thevarious economic factors experienced both regionally and nationally.  Overall; the portfolio is well secured with amajority of the balance making regular payments or scheduled to be satisfied inthe near future.  Presently, there are nosignificant amounts of loans where serious doubts exist as to the ability ofthe borrower to comply with the current loan payment terms which are notincluded in the nonperforming categories as indicated above.

 

Management’s judgmentin determining the amount of the additions to the allowance charged tooperating expense considers the following factors with no single factor beingdeterminative:

 

1.               Economic conditions andthe impact on the loan portfolio.

2.               Analysis of past loancharge-offs experienced by category and comparison to outstanding loans.

3.               Effect of problem loanson overall portfolio quality.

4.               Reports of examination ofthe loan portfolio by the Pennsylvania State Department of Banking and theFDIC.

 

**DEPOSITS**

 

**2009 vs 2008**

 

Total average depositswere $476,194,000 for 2009, an increase of $58,642,000 or 14.04% from2008.  Core deposits, which exclude timedeposits, increased due to growth in average money market accounts of$31,985,000 or 103.44%.  This growth isthe result of the impact of natural gas exploration throughout our marketfootprint and municipal account gathering efforts.  Time deposits also increased due to thereasons noted previously.  In addition,the Bank has continued to capitalize on its reputation of safety and soundnessduring this prolonged economic downturn.

 

**2008 vs 2007**

 

Total average depositswere $417,552,000 for 2008, an increase of $20,344,000 or 5.12% from 2007.  Core deposits, which exclude time deposits,increased due to renewed focus on deposit gathering efforts and the impact of naturalgas exploration through out our market 

 

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footprint.  Time deposits remained stable as the Bankfocused on service rather than attracting deposits purely on rate.  In addition, the Bank has been able tocapitalize on its reputation of safety and soundness during the events of 2008that unsettled consumer confidence. Additionally, the FDIC temporarily raised thelimit on federal deposit insurance from $100,000 to $250,000. 

 

Theaverage amount and the average rate paid on deposits are summarized below forthe years ended December 31, 2009, 2008, and 2007:

 
| ** **              | ** ** | **2009**            | ** ** | **2008** | ** ** | **2007**            | ** ** |
|-------------------------|------------|---------------------|------------|----------|------------|---------------------|------------|
| **(In Thousands)**      | ** ** | **Average  Amount** | ** ** | **Rate** | ** ** | **Average  Amount** | ** ** | **Rate** | ** ** | **Average  Amount** | ** ** | **Rate** | ** ** |
| Noninterest-bearing     |       | $                   | 74,618     |     | 0.00       | %                   | $          | 73,618 |   | 0.00 | % | $ | 69,953 |   | 0.00 | % |
| Savings                 |       | 60,815              |       | 0.51     | %          | 60,324              |       | 0.73 | % | 58,710 |   | 0.73 | % |
| Super Now               |       | 58,591              |       | 0.87     | %          | 52,117              |       | 1.26 | % | 46,596 |   | 1.31 | % |
| Money Market            |       | 62,906              |       | 1.95     | %          | 30,921              |       | 2.26 | % | 23,920 |   | 2.26 | % |
| Time                    |       | 219,264             |       | 2.84     | %          | 200,572             |       | 3.92 | % | 198,029 |   | 4.73 | % |
| Total average  deposits |       | $                   | 476,194    |     | 1.74       | %                   | $          | 417,552 |   | 2.31 | % | $ | 397,208 |   | 2.76 | % |

##### ** **

##### **SHAREHOLDERS’EQUITY**

##### ** **

**2009**

 

Shareholders’ equity increased $5,889,000 to$66,916,000 at December 31, 2009 compared to December 31, 2008 asaccumulated other comprehensive loss was reduced by $6,777,000.  The reduction in accumulated othercomprehensive loss is primarily a result of a change in unrealized losses onavailable for sale securities from an unrealized loss of $8,486,000 at December 31,2008 to an unrealized loss of $3,569,000 at December 31, 2009.  The other component in the reduction ofaccumulated other comprehensive loss is a decrease of $1,860,000 in the netexcess of the projected benefit obligation over the market value of the planassets of the defined benefit pension plan, due to an increase in the marketvalue of the plan assets caused by relative improved performance in the stockand bond markets over the past year.  Thecurrent level of shareholders’ equity equates to a book value per share of$17.45 at December 31, 2009 compared to $15.93 at December 31, 2008and an equity to asset ratio of 9.90% at December 31, 2009.  Book value per share, excluding accumulatedother comprehensive loss, was $18.88 at December 31, 2009 compared to$19.13 at December 31, 2008. Dividends paid to shareholders were $1.84 for each of the twelve monthsended December 31, 2009 and 2008.

 

**2008**

 

Shareholders’ equitydecreased $9,532,000 to $61,027,000 at December 31, 2008 as accumulatedcomprehensive loss increased $6,327,000, and $1,371,000 in common stock wasstrategically repurchased as part of the previously announced stock buybackplan, while net income outpaced dividends paid. The decrease in accumulated other comprehensive income is a result of adecline in the market value of certain securities held in the investmentportfolio at December 31, 2008 compared to December 31, 2007,resulting in a net unrealized loss of $8,486,000 at December 31, 2008compared to a net unrealized loss of $2,159,000 at December 31, 2007. Inaddition, the net excess of the projected benefit obligation over the marketvalue of the plan assets of the defined benefit pension plan increased$2,405,000 due to a decline in the market value of the plan assets caused bythe significant downturn in the stock and bond markets over the past year.  The current level of shareholders’ equityequates to a book value per share of $15.93 at December 31, 2008 comparedto $18.21 at December 31, 2007 and an equity to asset ratio of 9.35% at December 31,2008. Book value per share, excluding accumulated other comprehensive loss, was$19.13 at December 31, 2008 compared to $19.12 at December 31, 2007.During the twelve months ended December 31, 2008 cash dividends of $1.84 pershare were paid to shareholders compared to $1.79 for the comparable period of2007.

 

Bank regulators haverisk based capital guidelines.  Underthese guidelines the Company and Bank are required to maintain minimum ratiosof core capital and total qualifying capital as a percentage of risk weightedassets and certain off-balance sheet items. At December 31, 2009, both theCompany’s and Bank’s required ratios were well above the minimum ratios asfollows:

 
| ** **            | ** ** | ** **  | ** ** | ** ** | ** ** | **Minimum**   | ** ** |
|-----------------------|------------|-------------|------------|------------|------------|---------------|------------|
| ** **            | ** ** | **Company** | ** ** | **Bank**   | ** ** | **Standards** | ** ** |
| Tier 1 capital  ratio |       | 9.3         | %          | 8.0        | %          | 4.0           | %          |
| Total capital  ratio  |       | 15.4        | %          | 13.4       | %          | 8.0           | %          |

 

For a more comprehensive discussion of theserequirements, see “Regulations and Supervision” in Item 1 of the Annual Reporton Form 10-K.  Management believesthat the Company will continue to exceed regulatory capital requirements.

 

**RETURNON EQUITY AND ASSETS**

 

The ratio of net incometo average total assets and average shareholders’ equity, and other certainequity ratios are presented as follows:

 

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| ** **                                                               | ** ** | **2009** | ** ** | **2008** | ** ** | **2007** | ** ** |
|--------------------------------------------------------------------------|------------|----------|------------|----------|------------|----------|------------|
| Percentage of  net income to:                                            |       |     |       |     |       |     |       |
| Average total  assets                                                    |       | 0.92     | %          | 1.27     | %          | 1.49     | %          |
| Average  shareholders’ equity                                       |       | 9.66     | %          | 12.02    | %          | 12.14    | %          |
| Percentage of  dividends declared to net income                          |       | 115.74   | %          | 88.67    | %          | 78.33    | %          |
| Percentage of  average shareholders’ equity to average total assets |       | 9.50     | %          | 10.53    | %          | 12.23    | %          |

 

##### **LIQUIDITY,INTEREST RATE SENSITIVITY, AND MARKET RISK**

##### ** **

## ***The asset/liabilitycommittee addresses the liquidity needs of the Company to ensure thatsufficient funds are available to meet credit demands and deposit withdrawalsas well as to the placement of available funds in the investment portfolio.  In assessing liquidity requirements, equalconsideration is given to the current position as well as the future outlook.***

## *** ***

The following liquidity measures are monitoredfor compliance and were within the limits cited at December 31, 2009:

 

1.  NetLoans to Total Assets, 85% maximum

2.  NetLoans to Total Deposits, 100% maximum

3. Cumulative 90 day Maturity GAP %, +/- 20% maximum

4. Cumulative 1 Year Maturity GAP %, +/- 25% maximum

 

Fundamental objectivesof the Company’s asset/liability management process are to maintain adequate liquiditywhile minimizing interest rate risk. The maintenance of adequate liquidityprovides the Company with the ability to meet its financial obligations todepositors, loan customers, and shareholders. Additionally, it provides fundsfor normal operating expenditures and business opportunities as theyarise.  The objective of interest ratesensitivity management is to increase net interest income by managing interestsensitive assets and liabilities in such a way that they can be repriced inresponse to changes in market interest rates.

 

The Company, like otherfinancial institutions, must have sufficient funds available to meet itsliquidity needs for deposit withdrawals, loan commitments, and expenses.  In order to control cash flow, the Bank estimatesfuture flows of cash from deposits and loan payments.  The primary sources of funds are deposits,principal and interest payments on loans and mortgage-backed securities, aswell as FHLB borrowings.  Funds generatedare used principally to fund loans and purchase investment securities.Management believes the Company has adequate resources to meet its normalfunding requirements.

 

Management monitors theCompany’s liquidity on both a long and short-term basis, thereby, providingmanagement necessary information to react to current balance sheet trends.  Cash flow needs are assessed and sources offunds are determined.  Funding strategiesconsider both customer needs and economical cost.  Both short and long term funding needs areaddressed by maturities and sales of available for sale investment securities,loan repayments and maturities, and liquidating money market investments suchas federal funds sold. The use of these resources, in conjunction with accessto credit, provides core ingredients to satisfy depositor, borrower, andcreditor needs.

 

Management monitors anddetermines the desirable level of liquidity. Consideration is given to loan demand, investment opportunities, depositpricing and growth potential, as well as the current cost of borrowing funds.  The Company has a current borrowing capacityat the FHLB of $216,229,000 with $91,933,000 utilized, leaving $124,296,000available.  In addition to this creditarrangement, the Company has additional lines of credit with correspondentbanks of $13,845,000. The Company’s management believes that it has sufficientliquidity to satisfy estimated short-term and long-term funding needs.

 

Interest rate sensitivity, which is closelyrelated to liquidity management, is a function of the repricing characteristicsof the Company’s portfolio of assets and liabilities.  Asset/liability management strives to matchmaturities and rates between loan and investment security assets with thedeposit liabilities and borrowings that fund them.  Successful asset/liability management resultsin a balance sheet structure which can cope effectively with market ratefluctuations. The matching process is affected by segmenting both assets andliabilities into future time periods (usually 12 months, or less) based uponwhen repricing can be effected. Repriceable assets are subtracted from repriceable liabilities, for aspecific time period to determine the “gap”, or difference.  Once known, the gap is managed based onpredictions about future market interest rates. Intentional mismatching, or gapping, can enhance net interest income ifmarket rates move as predicted.  However,if market rates behave in a manner contrary to predictions, net interest incomewill suffer.  Gaps, therefore, contain anelement of risk and must be prudently managed. In addition to gap management, the Company has an asset liabilitymanagement policy which incorporates a market value at risk calculation whichis used to determine the effects of interest rate movements on shareholders’equity and a simulation analysis to monitor the effects of interest ratechanges on the Company’s balance sheet.

 

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The Company currently maintains a gap positionof being liability sensitive.  TheCompany has strategically taken this position as it has decreased the durationof the time deposit portfolio, while continuing to maintain a primarily fixedrate earning asset portfolio with a duration greater than the liabilitiesutilized to fund earning assets. Lengthening of the liability portfolio coupled with the addition oflimited short-term assets is being undertaken. These actions are expected to reduce, but not eliminate, the liabilitysensitive structure of the balance sheet.

 

A market value at risk calculation is utilizedto monitor the effects of interest rate changes on the Company’s balance sheetand more specifically shareholders’ equity. The Company does not manage the balance sheet structure in order tomaintain compliance with this calculation. The calculation serves as a guideline with greater emphases placed oninterest rate sensitivity.  Changes tocalculation results from period to period are reviewed as changes in resultscould be a signal of future events.  Asof the most recent analysis, the results of the market value at riskcalculation were outside of established guidelines due to the strategicdirection being taken.

 

**INTEREST RATE SENSITIVITY**

 

In this analysis the Company examines theresult of a 100 and 200 basis point change in market interest rates and theeffect on net interest income. It is assumed that the change is instantaneousand that all rates move in a parallel manner. Assumptions are also made concerning prepayment speeds on mortgage loansand mortgage securities.

 

The following is a rateshock forecast for the twelve month period ended December 31, 2009assuming a static balance sheet as of December 31, 2008.

 
| ** **                  | ** ** | **Parallel Rate Shock in Basis Points** | ** ** |
|-----------------------------|------------|-----------------------------------------|------------|
| **(In Thousands)**          | ** ** | **-200**                                | ** ** | **-100** | ** ** | **Static** | ** ** | **+100** | ** ** | **+200** | ** ** |
| Net interest  income        |       | $                                       | 21,612     |   | $ | 22,308 |   | $ | 22,651 |   | $ | 22,569 |   | $ | 22,301 |   |
| Change from  static         |       | (1,039                                  | )          | (343 | ) | — |   | (82 | ) | (350 | ) |
| Percent change  from static |       | -4.59                                   | %          | -1.51 | % | — |   | -0.36 | % | -1.55 | % |
|                             |            |                                         |            |  |  |  |  |  |  |  |  |  |  |  |  |  |

 

The model utilized to create the reportpresented above makes various estimates at each level of interest rate changeregarding cash flow from principal repayment on loans and mortgage-backedsecurities and or call activity on investment securities.  Actual results could differ significantlyfrom these estimates which would result in significant differences in thecalculated projected change.  Inaddition, the limits stated above do not necessarily represent the level ofchange under which management would undertake specific measures to realign itsportfolio in order to reduce the projected level of change.  Generally, management believes the Company iswell positioned to respond expeditiously when the market interest rate outlookchanges.

 

##### **INFLATION**

 

The asset and liabilitystructure of a financial institution is primarily monetary in nature;therefore, interest rates rather than inflation have a more significant impacton the Company’s performance.  Interestrates are not always affected in the same direction or magnitude as prices ofother goods and services, but are reflective of fiscal policy initiatives oreconomic factors that are not measured by a price index.

 

**CRITICAL ACCOUNTING POLICIES**

 

The Company’saccounting policies are integral to understanding the results reported.  The accounting policies are described indetail in Note 1 of the consolidated financial statements.  Our most complex accounting policies requiremanagement’s judgment to ascertain the valuation of assets, liabilities,commitments, and contingencies.  We haveestablished detailed policies and control procedures that are intended toensure valuation methods are well controlled and applied consistently fromperiod to period.  In addition, thepolicies and procedures are intended to ensure that the process for changingmethodologies occurs in an appropriate manner. The following is a brief description of our current accounting policiesinvolving significant management valuation judgments.

 

**Other Than Temporary Impairment of Debt and Equity Securities**

 

Debt and equitysecurities are evaluated periodically to determine whether a decline in theirvalue is other than temporary. Management utilizes criteria such as themagnitude and duration of the decline, in addition to the reason underlying thedecline, to determine whether the loss in value is other than temporary. Theterm “other than temporary” is not intended to indicate that the decline ispermanent.  It indicates that theprospects for a near term recovery of value are not necessarily favorable, orthat there is a lack of evidence to support fair values equal to, or greaterthan, the carrying value of the investment. Once a decline in value is determined to be other than temporary, thevalue of the security is reduced and a corresponding charge to earnings isrecognized. For a full discussion of the Company’s methodology of assessingimpairment, refer to Note 3 of the “Notes to Consolidated Financial Statements”of the Annual Report on Form 10-K.

 

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**Allowance for Loan Losses**

 

Arrivingat an appropriate level of allowance for loan losses involves a high degree ofjudgment.  The Company’s allowance forloan losses provides for probable losses based upon evaluations of known andinherent risks in the loan portfolio.

 

Managementuses historical information to assess the adequacy of the allowance for loanlosses as well as the prevailing business environment; as it is affected bychanging economic conditions and various external factors, which may impact theportfolio in ways currently unforeseen. The allowance is increased by provisions for loan losses and byrecoveries of loans previously charged-off and reduced by loanscharged-off.  For a full discussion ofthe Company’s methodology of assessing the adequacy of the reserve forallowance for loan losses, refer to Note 1 of the “Notes to ConsolidatedFinancial Statements” of the Annual Report of Form 10-K.

 

**Goodwill and Other IntangibleAssets**

 

Asdiscussed in Note 7 of the “Notes to Consolidated Financial Statements” of theAnnual Report on Form 10-K, the Company must assess goodwill and otherintangible assets each year for impairment. This assessment involves estimating cash flows for future periods. Ifthe future cash flows were less than the recorded goodwill and other intangibleassets balances, we would be required to take a charge against earnings towrite down the assets to the lower value.

 

**Deferred Tax Assets**

 

Weuse an estimate of future earnings to support our position that the benefit ofour deferred tax assets will be realized. If future income should prove non-existent or less than the amount ofthe deferred tax assets within the tax years to which they may be applied, theasset may not be realized and our net income will be reduced.  Our deferred tax assets are described furtherin Note 11 of the “Notes to Consolidated Financial Statements” of the AnnualReport on Form 10-K.

 

**Pension Benefits**

 

Pensioncosts and liabilities are dependent on assumptions used in calculating suchamounts.  These assumptions includediscount rates, benefits earned, interest costs, expected return on planassets, mortality rates, and other factors. In accordance with GAAP, actual results that differ from the assumptionsare accumulated and amortized over future periods and, therefore, generallyaffect recognized expense and the recorded obligation of future periods.  While management believes that theassumptions used are appropriate, differences in actual experience or changesin assumptions may affect the Company’s pension obligations and futureexpense.  Our pension benefits aredescribed further in Note 12 of the “Notes to Consolidated Financial Statements”of the Annual Report on Form 10-K.

 

**CONTRACTUALOBLIGATIONS**

 

The Company has various financial obligations,including contractual obligations which may require future cash payments. Thefollowing table presents, as of December 31, 2009, significant fixed anddeterminable contractual obligations to third parties by payment date.  Further discussion of the nature of eachobligation is included in the “Notes to Consolidated Financial Statements” ofthe Annual Report on Form 10-K.

 
| ** **                         | ** ** | **Payments  Due In** | ** ** |
|------------------------------------|------------|----------------------|------------|
| ** **                         | ** ** | ** **           | ** ** | **One  to** | ** ** | **Three  to** | ** ** | **Over** | ** ** | ** ** | ** ** |
| ** **                         | ** ** | **One  Year**        | ** ** | **Three** | ** ** | **Five** | ** ** | **Five** | ** ** | ** ** | ** ** |
| **(In  Thousands)**                | ** ** | **or  Less**         | ** ** | **Years** | ** ** | **Years** | ** ** | **Years** | ** ** | **Total** | ** ** |
| Deposits without a stated maturity |       | $                    | 279,721    |   | $ | — |   | $ | — |   | $ | — |   | $ | 279,721 |   |
| Time Deposits                      |       | 154,702              |       | 49,015 |   | 12,802 |   | 1,047 |   | 217,566 |   |
| Repurchase agreements              |       | 13,199               |       | — |   | — |   | — |   | 13,199 |   |
| Short-term borrowings, FHLB        |       | 5,155                |       | — |   | — |   | — |   | 5,155 |   |
| Long-term borrowings, FHLB         |       | —               |       | 35,000 |   | 15,500 |   | 36,278 |   | 86,778 |   |
| Operating leases                   |       | 383                  |       | 613 |   | 408 |   | 1,522 |   | 2,926 |   |
|                                    |            |                      |            |  |  |  |  |  |  |  |  |  |  |  |  |  |

 

The Corporation’s operating lease obligationsrepresent short and long-term lease and rental payments for branchfacilities.  The Bank leases certainfacilities under operating leases which expire on various dates through2024.  Renewal options are available onthe majority of these leases.

 

**CAUTIONARY STATEMENT FOR PURPOSES OF THE PRIVATE SECURITIESLITIGATION REFORM ACT OF 1995**

 

ThisReport contains certain “forward-looking statements” including statementsconcerning plans, objectives, future events or performance and assumptions andother statements which are other than statements of historical fact.  The Company wishes to caution readers thatthe following important factors, among others, may have affected and could inthe future affect the Company’s actual results 

 

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andcould cause the Company’s actual results for subsequent periods to differmaterially from those expressed in any forward-looking statement made by or onbehalf of the Company herein:  (i) theeffect of changes in laws and regulations, including federal and state bankinglaws and regulations, with which the Company must comply, and the associatedcosts of compliance with such laws and regulations either currently or in thefuture as applicable; (ii) the effect of changes in accounting policiesand practices, as may be adopted by the regulatory agencies as well as by theFinancial Accounting Standards Board, or of changes in the Company’sorganization, compensation and benefit plans; (iii) the effect on theCompany’s competitive position within its market area of the increasingconsolidation within the banking and financial services industries, includingthe increased competition from larger regional and out-of-state bankingorganizations as well as non-bank providers of various financial services; (iv) theeffect of changes in interest rates; and (v) the effect of changes in thebusiness cycle and downturns in the local, regional or national economies.

 

**ITEM 7A QUANTITATIVE AND QUALITATIVE DISCLOSURESABOUT MARKET RISK**

 

Market risk forthe Company is comprised primarily from interest rate risk exposure andliquidity risk.  Interest rate risk andliquidity risk management is performed at the Bank level as well as the Companylevel.  The Company’s interest ratesensitivity is monitored by management through selected interest rate riskmeasures produced internally. Additional information and details are providedin the Interest Sensitivity section of Item 7 Management’s Discussion andAnalysis of Financial Condition and Results of Operations.

 

Generally,management believes the Company is well positioned to respond expeditiouslywhen the market interest rate outlook changes.

 

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**ITEM 8****                                                       ****FINANCIALSTATEMENTS AND SUPPLEMENTARY DATA**

 

 

Board of Directors and Shareholders

Penns Woods Bancorp, Inc.

 

We have audited theaccompanying consolidated balance sheets of PennsWoods Bancorp, Inc. (the “Company”) and subsidiaries as of December 31,2009 and 2008, and the related consolidated statements of income, comprehensiveincome, stockholders’ equity, and cash flows for each of the three years in theperiod ended December 31, 2009. These financial statements are theresponsibility of the Company’s management. Our responsibility is to express an opinion on these financialstatements based on our audits.

 

We conducted our audits inaccordance with the standards of the Public Company Accounting Oversight Board(United States).  Those standards requirethat we plan and perform the audit to obtain reasonable assurance about whetherthe financial statements are free of material misstatement.  An audit includes examining, on a test basis,evidence supporting the amounts and disclosures in the financialstatements.  An audit also includesassessing 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 areasonable basis for our opinion.

 

In our opinion, theconsolidated financial statements referred to above present fairly, in allmaterial respects, the financial position of the Company and subsidiaries as ofDecember 31, 2009 and 2008, and the results of their operations and theircash flows for each of the three years in the period ended December 31,2009, in conformity with U.S. generally accepted accounting principles.

 

As discussed in Note 1 to the consolidated financialstatements, effective January 1, 2008, the Company adopted Emerging IssuesTask Force No. 06-4, *Accounting for DeferredCompensation and Postretirement Benefit Aspects of Endorsement Split-DollarLife Insurance Arrangements*.  This guidance was subsequently codified into Financial AccountingStandards Board ASC Topic 715-60, *Compensation — RetirementBenefits*.

 

Wehave also audited, in accordance with the standards of the Public CompanyAccounting Oversight Board (United States), the Company’s and subsidiaries’internal control over financial reporting as of December 31, 2009, basedon criteria established in *Internal Control— Integrated Framework* issued by the Committee of SponsoringOrganizations of the Treadway Commission, and our report dated March 9,2010 expressed an unqualified opinion on the effectiveness of the Company’sinternal control over financial reporting.

 

 

Wexford, PA

March 9, 2010

 

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**PENNSWOODS BANCORP, INC.**

**CONSOLIDATEDBALANCE SHEET**

 
| ** **                                                                                          | ** ** | **December 31,** | ** ** |
|-----------------------------------------------------------------------------------------------------|------------|-----------------------|------------|
| **(In  Thousands, Except Share Data)**                                                              | ** ** | **2009**              | ** ** | **2008** | ** ** |
|                                                                                                |       |                  |       |   |   |
| **ASSETS:**                                                                                         |       |                  |       |   |   |
| Noninterest-bearing balances                                                                        |       | $                     | 13,760     |   | $ | 16,563 |   |
| Interest-bearing deposits in other financial  institutions                                          |       | 28                    |       | 18 |   |
| Total cash and cash equivalents                                                                     |       | 13,788                |       | 16,581 |   |
|                                                                                                |       |                  |       |   |   |
| Investment securities, available for sale, at fair  value                                           |       | 208,768               |       | 208,251 |   |
| Investment securities held to maturity (fair value  of $108 and $136)                               |       | 107                   |       | 135 |   |
| Loans held for sale                                                                                 |       | 4,063                 |       | 3,622 |   |
| Loans                                                                                               |       | 405,529               |       | 381,478 |   |
| Less: Allowance for loan losses                                                                     |       | 4,657                 |       | 4,356 |   |
| Loans, net                                                                                          |       | 400,872               |       | 377,122 |   |
| Premises and equipment, net                                                                         |       | 7,988                 |       | 7,865 |   |
| Accrued interest receivable                                                                         |       | 3,523                 |       | 3,614 |   |
| Bank-owned life insurance                                                                           |       | 14,942                |       | 14,546 |   |
| Investment in limited partnerships                                                                  |       | 4,898                 |       | 4,727 |   |
| Goodwill                                                                                            |       | 3,032                 |       | 3,032 |   |
| Deferred tax asset                                                                                  |       | 9,491                 |       | 10,879 |   |
| Other assets                                                                                        |       | 4,732                 |       | 2,429 |   |
| **TOTAL ASSETS**                                                                                    |       | $                     | 676,204    |   | $ | 652,803 |   |
|                                                                                                |       |                  |       |   |   |
| **LIABILITIES:**                                                                                    |       |                  |       |   |   |
| Interest-bearing deposits                                                                           |       | $                     | 417,388    |   | $ | 345,333 |   |
| Noninterest-bearing deposits                                                                        |       | 79,899                |       | 76,035 |   |
| Total deposits                                                                                      |       | 497,287               |       | 421,368 |   |
|                                                                                                |       |                  |       |   |   |
| Short-term borrowings                                                                               |       | 18,354                |       | 73,946 |   |
| Long-term borrowings, Federal Home Loan Bank (FHLB)                                                 |       | 86,778                |       | 86,778 |   |
| Accrued interest payable                                                                            |       | 1,073                 |       | 1,317 |   |
| Other liabilities                                                                                   |       | 5,796                 |       | 8,367 |   |
| TOTAL LIABILITIES                                                                                   |       | 609,288               |       | 591,776 |   |
|                                                                                                |       |                  |       |   |   |
| SHAREHOLDERS’ EQUITY                                                                           |       |                  |       |   |   |
| Common stock, par value $8.33, 10,000,000 shares  authorized; 4,013,142 and 4,010,528 shares issued |       | 33,443                |       | 33,421 |   |
| Additional paid-in capital                                                                          |       | 18,008                |       | 17,959 |   |
| Retained earnings                                                                                   |       | 27,218                |       | 28,177 |   |
| Accumulated other comprehensive loss:                                                               |       |                  |       |   |   |
| Net unrealized loss on available for sale  securities                                               |       | (3,569                | )          | (8,486 | ) |
| Defined benefit plan                                                                                |       | (1,920                | )          | (3,780 | ) |
| Less: Treasury stock at cost, 179,028 shares                                                        |       | (6,264                | )          | (6,264 | ) |
| TOTAL SHAREHOLDERS’ EQUITY                                                                     |       | 66,916                |       | 61,027 |   |
| **TOTAL LIABILITIES AND  SHAREHOLDERS’ EQUITY**                                                |       | $                     | 676,204    |   | $ | 652,803 |   |

 

See accompanyingnotes to the consolidated financial statements.

 

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PENNS WOODSBANCORP, INC.

CONSOLIDATEDSTATEMENT OF INCOME

 
| ** **                                              | ** ** | **Year Ended December 31,** | ** ** |
|---------------------------------------------------------|------------|----------------------------------|------------|
| **(In  Thousands, Except Per Share Data)**              | ** ** | **2009**                         | ** ** | **2008** | ** ** | **2007** | ** ** |
|                                                    | ** ** | ** **                       | ** ** | ** ** | ** ** | ** ** | ** ** |
| **INTEREST AND DIVIDEND INCOME:**                       |       |                             |       |   |   |   |   |
| Loans  including fees                                   |       | $                                | 25,568     |   | $ | 25,228 |   | $ | 26,099 |   |
| Investment  securities:                                 |       |                             |       |   |   |   |   |
| Taxable                                                 |       | 5,424                            |       | 5,241 |   | 4,098 |   |
| Tax-exempt                                              |       | 5,005                            |       | 4,871 |   | 4,357 |   |
| Dividend  and other interest income                     |       | 194                              |       | 768 |   | 1,395 |   |
| TOTAL  INTEREST AND DIVIDEND INCOME                     |       | 36,191                           |       | 36,108 |   | 35,949 |   |
|                                                    |       |                             |       |   |   |   |   |
| **INTEREST EXPENSE:**                                   |       |                             |       |   |   |   |   |
| Deposits                                                |       | 8,284                            |       | 9,670 |   | 10,951 |   |
| Short-term  borrowings                                  |       | 396                              |       | 1,181 |   | 1,639 |   |
| Long-term  borrowings, FHLB                             |       | 3,718                            |       | 3,981 |   | 3,857 |   |
| TOTAL  INTEREST EXPENSE                                 |       | 12,398                           |       | 14,832 |   | 16,447 |   |
|                                                    |       |                             |       |   |   |   |   |
| **NET INTEREST INCOME**                                 |       | 23,793                           |       | 21,276 |   | 19,502 |   |
|                                                    |       |                             |       |   |   |   |   |
| PROVISION  FOR LOAN LOSSES                              |       | 917                              |       | 375 |   | 150 |   |
|                                                    |       |                             |       |   |   |   |   |
| **NET INTEREST INCOME AFTER PROVISION FOR LOAN LOSSES** |       | 22,876                           |       | 20,901 |   | 19,352 |   |
|                                                    |       |                             |       |   |   |   |   |
| **NON-INTEREST INCOME:**                                |       |                             |       |   |   |   |   |
| Service  charges                                        |       | 2,200                            |       | 2,289 |   | 2,246 |   |
| Securities  losses, net                                 |       | (4,846                           | )          | (2,031 | ) | (54 | ) |
| Earnings  on bank-owned life insurance                  |       | 713                              |       | 472 |   | 410 |   |
| Gain  on sale of loans                                  |       | 826                              |       | 882 |   | 921 |   |
| Insurance  commissions                                  |       | 1,189                            |       | 1,928 |   | 2,222 |   |
| Other                                                   |       | 2,205                            |       | 1,916 |   | 1,733 |   |
| TOTAL  NON-INTEREST INCOME                              |       | 2,287                            |       | 5,456 |   | 7,478 |   |
|                                                    |       |                             |       |   |   |   |   |
| **NON-INTEREST EXPENSE:**                               |       |                             |       |   |   |   |   |
| Salaries  and employee benefits                         |       | 10,189                           |       | 9,634 |   | 9,078 |   |
| Occupancy,  net                                         |       | 1,266                            |       | 1,288 |   | 1,306 |   |
| Furniture  and equipment                                |       | 1,212                            |       | 1,182 |   | 1,126 |   |
| Pennsylvania  shares tax                                |       | 685                              |       | 421 |   | 643 |   |
| Amortization  of investment in limited partnerships     |       | 567                              |       | 712 |   | 761 |   |
| Other                                                   |       | 5,893                            |       | 4,712 |   | 4,402 |   |
| TOTAL  NON-INTEREST EXPENSE                             |       | 19,812                           |       | 17,949 |   | 17,316 |   |
|                                                    |       |                             |       |   |   |   |   |
| **INCOME BEFORE INCOME TAX (BENEFIT) PROVISION**        |       | 5,351                            |       | 8,408 |   | 9,514 |   |
| INCOME  TAX (BENEFIT) PROVISION                         |       | (742                             | )          | 405 |   | 637 |   |
| **NET INCOME**                                          |       | $                                | 6,093      |   | $ | 8,003 |   | $ | 8,877 |   |
| ** **                                              |       |                             |       |   |   |   |   |
| **NET INCOME PER SHARE - BASIC**                        |       | $                                | 1.59       |   | $ | 2.07 |   | $ | 2.28 |   |
| ** **                                              |       |                             |       |   |   |   |   |
| **NET INCOME PER SHARE - DILUTED**                      |       | $                                | 1.59       |   | $ | 2.07 |   | $ | 2.28 |   |
| ** **                                              |       |                             |       |   |   |   |   |
| **WEIGHTED AVERAGE SHARES OUTSTANDING - BASIC**         |       | 3,832,789                        |       | 3,859,724 |   | 3,886,277 |   |
| ** **                                              |       |                             |       |   |   |   |   |
| **WEIGHTED AVERAGE SHARES OUTSTANDING - DILUTED**       |       | 3,832,886                        |       | 3,859,833 |   | 3,886,514 |   |
| ** **                                              |       |                             |       |   |   |   |   |
| **DIVIDENDS PER SHARE**                                 |       | 1.84                             |       | 1.84 |   | 1.79 |   |

 

See accompanyingnotes to the consolidated financial statements.

 

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PENNS WOODSBANCORP, INC.

CONSOLIDATEDSTATEMENT OF CHANGES IN SHAREHOLDERS’ EQUITY

 
| ** **                                                                                      | ** ** | ** ** | ** ** | ** **     | ** ** | ** **   | ** ** | ** **        | ** ** | **ACCUMULATED**    | ** ** | ** **             | ** ** | ** ** | ** ** |
|-------------------------------------------------------------------------------------------------|------------|------------|------------|----------------|------------|--------------|------------|-------------------|------------|--------------------|------------|------------------------|------------|------------|------------|
| ** **                                                                                      | ** ** | **COMMON** | ** ** | **ADDITIONAL** | ** ** | ** **   | ** ** | **OTHER**         | ** ** | ** **         | ** ** | **TOTAL**              | ** ** |
| ** **                                                                                      | ** ** | **STOCK**  | ** ** | **PAID-IN**    | ** ** | **RETAINED** | ** ** | **COMPREHENSIVE** | ** ** | **TREASURY**       | ** ** | **SHAREHOLDERS’** | ** ** |
| **(In Thousands, Except Per Share  Data)**                                                      | ** ** | **SHARES** | ** ** | **AMOUNT**     | ** ** | **CAPITAL**  | ** ** | **EARNINGS**      | ** ** | **INCOME  (LOSS)** | ** ** | **STOCK**              | ** ** | **EQUITY** | ** ** |
| Balance,  December 31, 2006                                                                |       | 4,003,514  |       | $              | 33,362     |         | $          | 17,810            |       | $                  | 25,783     |                   | $          | 1,560      |       | $ | (3,921 | ) | $ | 74,594 |   |
|                                                                                            |       |       |       |           |       |         |       |              |       |               |       |                   |       |       |       |
| Comprehensive  income:                                                                          |       |       |       |           |       |         |       |              |       |               |       |                   |       |       |       |
| Net  income                                                                                     |       |       |       |           |       |         |       | 8,877             |       |               |       |                   |       | 8,877      |       |
| Other  comprehensive loss                                                                       |       |       |       |           |       |         |       |              |       | (5,094             | )          |                   |       | (5,094     | )          |
| Dividends  declared ($1.79 per share)                                                           |       |       |       |           |       |         |       | (6,953            | )          |               |       |                   |       | (6,953     | )          |
| Stock  options exercised                                                                        |       | 330        |       | 3              |       | 5            |       |              |       |               |       |                   |       | 8          |       |
| Common  shares issued for employee stock purchase plan                                          |       | 3,090      |       | 26             |       | 73           |       |              |       |               |       |                   |       | 99         |       |
| Purchase  of treasury stock (28,530 shares)                                                     |       |       |       |           |       |         |       |              |       |               |       | (972                   | )          | (972       | )          |
| Balance,  December 31, 2007                                                                |       | 4,006,934  |       | 33,391         |       | 17,888       |       | 27,707            |       | (3,534             | )          | (4,893                 | )          | 70,559     |       |
|                                                                                            |       |       |       |           |       |         |       |              |       |               |       |                   |       |       |       |
| Cumulative  effect of change in accounting for endorsment split-dollar life insurance contracts |       |       |       |           |       |         |       | (437              | )          |               |       |                   |       | (437       | )          |
| Comprehensive  loss:                                                                            |       |       |       |           |       |         |       |              |       |               |       |                   |       |       |       |
| Net  income                                                                                     |       |       |       |           |       |         |       | 8,003             |       |               |       |                   |       | 8,003      |       |
| Other  comprehensive loss                                                                       |       |       |       |           |       |         |       |              |       | (8,732             | )          |                   |       | (8,732     | )          |
| Dividends  declared, ($1.84 per share)                                                          |       |       |       |           |       |         |       | (7,096            | )          |               |       |                   |       | (7,096     | )          |
| Stock  options exercised                                                                        |       | 330        |       | 3              |       | 8            |       |              |       |               |       |                   |       | 11         |       |
| Common  shares issued for employee stock purchase plan                                          |       | 3,264      |       | 27             |       | 63           |       |              |       |               |       |                   |       | 90         |       |
| Purchase  of treasury stock (47,726 shares)                                                     |       |       |       |           |       |         |       |              |       |               |       | (1,371                 | )          | (1,371     | )          |
| Balance,  December 31, 2008                                                                |       | 4,010,528  |       | 33,421         |       | 17,959       |       | 28,177            |       | (12,266            | )          | (6,264                 | )          | 61,027     |       |
|                                                                                            |       |       |       |           |       |         |       |              |       |               |       |                   |       |       |       |
| Comprehensive  income:                                                                          |       |       |       |           |       |         |       |              |       |               |       |                   |       |       |       |
| Net  income                                                                                     |       |       |       |           |       |         |       | 6,093             |       |               |       |                   |       | 6,093      |       |
| Other  comprehensive income                                                                     |       |       |       |           |       |         |       |              |       | 6,777              |       |                   |       | 6,777      |       |
| Dividends  declared, ($1.84 per share)                                                          |       |       |       |           |       |         |       | (7,052            | )          |               |       |                   |       | (7,052     | )          |
| Common  shares issued for employee stock purchase plan                                          |       | 2,614      |       | 22             |       | 49           |       |              |       |               |       |                   |       | 71         |       |
| Balance,  December 31, 2009                                                                |       | 4,013,142  |       | $              | 33,443     |         | $          | 18,008            |       | $                  | 27,218     |                   | $          | (5,489     | )          | $ | (6,264 | ) | $ | 66,916 |   |

 

**PENNSWOODS BANCORP, INC.**

**CONSOLIDATEDSTATEMENT OF COMPREHENSIVE INCOME (LOSS)**

 
| ** **                                                                             | ** ** | **For the years ended December 31,** | ** ** |
|----------------------------------------------------------------------------------------|------------|-------------------------------------------|------------|
| ** **                                                                             | ** ** | **2009**                                  | ** ** | **2008** | ** ** | **2007** | ** ** |
|                                                                                   |       |                                      |       |   |   |   |   |   |   |   |   |   |   |
| Net Income                                                                             |       |                                      |       | $ | 6,093 |   |   |   | $ | 8,003 |   |   |   | $ | 8,877 |   |
| Other Comprehensive income (loss), net of tax:                                         |       |                                      |       |   |   |   |   |   |   |   |   |   |   |
| Change in unrealized gain (loss) on available for  sale securities                     |       | 1,719                                     |       |   |   | (7,667 | ) |   |   | (4,334 | ) |   |   |
| Net realized loss included in net income, net of  tax benefit of $1,648, $691, and $18 |       | 3,198                                     |       |   |   | 1,340 |   |   |   | 36 |   |   |   |
|                                                                                   |       | 4,917                                     |       |   |   | (6,327 | ) |   |   | (4,298 | ) |   |   |
| Defined benefit pension plan, net of tax:                                              |       |                                      |       |   |   |   |   |   |   |   |   |   |   |
| Net transition asset                                                                   |       | 1                                         |       |   |   | (2 | ) |   |   | (2 | ) |   |   |
| Prior service cost                                                                     |       | 16                                        |       |   |   | 17 |   |   |   | 17 |   |   |   |
| Net gain (loss)                                                                        |       | 1,843                                     |       |   |   | (2,420 | ) |   |   | (811 | ) |   |   |
| Other comprehensive income (loss), net of tax                                          |       |                                      |       | 6,777 |   |   |   | (8,732 | ) |   |   | (5,094 | ) |
| Comprehensive income (loss)                                                            |       |                                      |       | $ | 12,870 |   |   |   | $ | (729 | ) |   |   | $ | 3,783 |   |

 

See AccompanyingNotes to the Consolidated Financial Statements

 

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PENNS WOODSBANCORP, INC.

CONSOLIDATEDSTATEMENT OF CASH FLOWS

(UNAUDITED)

 
| ** **                                                                         | ** ** | **Year Ended December 31,** | ** ** |
|------------------------------------------------------------------------------------|------------|----------------------------------|------------|
| **(In  Thousands)**                                                                | ** ** | **2009**                         | ** ** | **2008** | ** ** | **2007** | ** ** |
|                                                                               |       |                             |       |   |   |   |   |
| **OPERATING ACTIVITIES:**                                                          |       |                             |       |   |   |   |   |
| Net  Income                                                                        |       | $                                | 6,093      |   | $ | 8,003 |   | $ | 8,877 |   |
| Adjustments  to reconcile net income to net cash provided by operating activities: |       |                             |       |   |   |   |   |
| Depreciation  and amortization                                                     |       | 724                              |       | 663 |   | 680 |   |
| Provision  for loan losses                                                         |       | 917                              |       | 375 |   | 150 |   |
| Accretion  and amortization of investment security discounts and premiums          |       | (1,590                           | )          | (1,361 | ) | (1,011 | ) |
| Securities  losses, net                                                            |       | 4,846                            |       | 2,031 |   | 54 |   |
| Originations  of loans held for sale                                               |       | (34,723                          | )          | (39,456 | ) | (43,783 | ) |
| Proceeds  of loans held for sale                                                   |       | 35,108                           |       | 40,930 |   | 44,206 |   |
| Gain  on sale of loans                                                             |       | (826                             | )          | (882 | ) | (921 | ) |
| Earnings  on bank-owned life insurance                                             |       | (713                             | )          | (472 | ) | (410 | ) |
| Increase  in prepaid federal deposit insurance                                     |       | (2,315                           | )          | — |   | — |   |
| Other,  net                                                                        |       | (1,202                           | )          | (2,830 | ) | (214 | ) |
| Net  cash provided by operating activities                                         |       | 6,319                            |       | 7,001 |   | 7,628 |   |
| **INVESTING ACTIVITIES**                                                           |       |                             |       |   |   |   |   |
| Investment  securities available for sale:                                         |       |                             |       |   |   |   |   |
| Proceeds  from sales                                                               |       | 14,757                           |       | 40,169 |   | 60,485 |   |
| Proceeds  from calls and maturities                                                |       | 9,084                            |       | 6,759 |   | 5,233 |   |
| Purchases                                                                          |       | (20,006                          | )          | (50,995 | ) | (98,799 | ) |
| Investment  securities held to maturity:                                           |       |                             |       |   |   |   |   |
| Proceeds  from calls and maturities                                                |       | 29                               |       | 4 |   | 12 |   |
| Purchases                                                                          |       | —                           |       | 176 |   | — |   |
| Net  increase in loans                                                             |       | (25,375                          | )          | (21,613 | ) | (374 | ) |
| Acquisition  of bank premises and equipment                                        |       | (847                             | )          | (1,754 | ) | (717 | ) |
| Proceeds  from the sale of foreclosed assets                                       |       | 491                              |       | 112 |   | 65 |   |
| Purchase  of bank-owned life insurance                                             |       | (59                              | )          | (1,699 | ) | (619 | ) |
| Proceeds  from bank-owned life insurance death benefit                             |       | 376                              |       | — |   | — |   |
| Investment  in limited partnership                                                 |       | (738                             | )          | — |   | (1,250 | ) |
| Proceeds  from redemption of regulatory stock                                      |       | —                           |       | 4,606 |   | 5,081 |   |
| Purchases  of regulatory stock                                                     |       | (170                             | )          | (4,629 | ) | (6,816 | ) |
| Net  cash used for investing activities                                            |       | (22,458                          | )          | (28,864 | ) | (37,699 | ) |
| **FINANCING ACTIVITIES**                                                           |       |                             |       |   |   |   |   |
| Net  increase (decrease) in interest-bearing deposits                              |       | 72,055                           |       | 30,982 |   | (7,680 | ) |
| Net  increase in noninterest-bearing deposits                                      |       | 3,864                            |       | 1,364 |   | 1,511 |   |
| Proceeds  of long-term borrowings, FHLB                                            |       | —                           |       | 10,000 |   | 40,000 |   |
| Repayment  of long-term borrowings, FHLB                                           |       | —                           |       | (29,600 | ) | (16,500 | ) |
| Net  (decrease) increase in short-term borrowings                                  |       | (55,592                          | )          | 18,631 |   | 20,618 |   |
| Dividends  paid                                                                    |       | (7,052                           | )          | (7,096 | ) | (6,953 | ) |
| Issuance  of common stock                                                          |       | 71                               |       | 90 |   | 99 |   |
| Stock  options exercised                                                           |       | —                           |       | 11 |   | 8 |   |
| Purchase  of treasury stock                                                        |       | —                           |       | (1,371 | ) | (972 | ) |
| Net  cash provided by financing activities                                         |       | 13,346                           |       | 23,011 |   | 30,131 |   |
| NET  (DECREASE) INCREASE IN CASH AND CASH EQUIVALENTS                              |       | (2,793                           | )          | 1,148 |   | 60 |   |
| CASH  AND CASH EQUIVALENTS, BEGINNING                                              |       | 16,581                           |       | 15,433 |   | 15,373 |   |
| CASH  AND CASH EQUIVALENTS, ENDING                                                 |       | $                                | 13,788     |   | $ | 16,581 |   | $ | 15,433 |   |
|                                                                               |       |                             |       |   |   |   |   |
| **SUPPLEMENTAL DISCLOSURES OF CASH FLOW INFORMATION**                              |       |                             |       |   |   |   |   |
|                                                                               |       |                             |       |   |   |   |   |
| Interest  paid                                                                     |       | $                                | 12,642     |   | $ | 15,259 |   | $ | 16,235 |   |
| Income  taxes paid                                                                 |       | 1,325                            |       | 2,085 |   | 1,610 |   |
| Transfer  of loans to foreclosed real estate                                       |       | 708                              |       | 464 |   | 75 |   |

 

See accompanyingnotes to the unaudited consolidated financial statements.

 

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**PENNS WOODS BANCORP, INC.**

**NOTES TO CONSOLIDATED FINANCIAL STATEMENTS**

 

**NOTE 1 —OPERATIONS AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES**

 

**Principles ofConsolidation**

 

Theaccompanying consolidated financial statements include the accounts of PennsWoods Bancorp, Inc. and its wholly owned subsidiaries, Jersey Shore StateBank (the “Bank”), Woods Real Estate Development Co., Inc., WoodsInvestment Company, Inc., and The M Group Inc. D/B/A The ComprehensiveFinancial Group (“The M Group”), a wholly owned subsidiary of the Bank(collectively, the “Company”).  Allsignificant intercompany balances and transactions have been eliminated.

 

**Nature of Business**

 

TheBank engages in a full-service commercial banking business, making available tothe community a wide range of financial services including, but not limited to,installment loans, credit cards, mortgage and home equity loans, lines ofcredit, construction financing, farm loans, community development loans, loansto non-profit entities and local government, and various types of time anddemand deposits including, but not limited to, checking accounts, savingsaccounts, clubs, money market deposit accounts, certificates of deposit, andIRAs.  Deposits are insured by theFederal Deposit Insurance Corporation (“FDIC”) to the extent provided by law.

 

Thefinancial services are provided by the Bank to individuals, partnerships,non-profit organizations, and corporations through its twelve offices locatedin Clinton, Lycoming, and Centre Counties, Pennsylvania.

 

WoodsReal Estate Development Co., Inc. engages in real estate transactions onbehalf of Penns Woods Bancorp, Inc. and the Bank.

 

WoodsInvestment Company, Inc., a Delaware holding company, is engaged ininvesting activities.

 

TheM Group engages in securities brokerage and financial planning services, whichinclude the sale of life insurance products, annuities, and estate planningservices.

 

Operationsare managed and financial performance is evaluated on a corporate-widebasis.  Accordingly, all financialservice operations are considered by management to be aggregated in onereportable operating segment.

 

**Use of Estimates**

 

Thepreparation of financial statements in conformity with U.S. generally acceptedaccounting principles (“GAAP”) requires management to make estimates andassumptions that affect the reported amounts of assets and liabilities anddisclosure of contingent assets and liabilities at the date of the consolidatedfinancial statements and the reported amounts of revenues and expenses duringthe reporting period.  Actual results maydiffer from those estimates.

 

Material estimates that are particularly susceptible to significantchange relate to the determination of the allowance for loan losses, deferredtax assets and liabilities, and the valuation of real estate acquired through,or in lieu of, foreclosure on settlement of debt.

 

**Cash and Cash Equivalents**

 

Cashequivalents include cash on hand and in banks. Interest-earning deposits mature within 90 days and are carried atcost.  Net cash flows are reported forloan, deposit, and short-term borrowing transactions.

 

**Restrictions on Cash and CashEquivalents**

 

Basedon deposit levels, the Company must maintain cash and other reserves with theFederal Reserve Bank of Philadelphia (FRB).

 

**Investment Securities**

 

Investmentsecurities are classified at the time of purchase, based on management’sintention and ability, as securities held to maturity or securities availablefor sale.  Debt securities acquired withthe intent and ability to 

 

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holdto maturity are stated at cost, adjusted for amortization of premium andaccretion of discount, which are computed using the interest method andrecognized as adjustments of interest income. Certain other debt securitieshave been classified as available for sale to serve principally as a source ofliquidity.  Unrealized holding gains andlosses for available for sale securities are reported as a separate componentof stockholders’ equity, net of tax, until realized.  Realized security gains and losses arecomputed using the specific identification method for debt securities and theaverage cost method for marketable equity securities.  Interest and dividends on investmentsecurities are recognized as income when earned.

 

Securitiesare periodically reviewed for other-than-temporary impairment based upon anumber of factors, including, but not limited to, the length of time and extentto which the market value has been less than cost, the financial condition ofthe underlying issuer, the ability of the issuer to meet contractual obligations,the likelihood of the security’s ability to recover any decline in its marketvalue, whether it is more likely than not that the Company would be required tosell the security before its anticipated recovery in market value, and a reviewof the Company’s capital adequacy, interest rate risk position, and liquidity.The assessment of a security’s ability to recover any decline in market value,the ability of the issuer to meet contractual obligations, and management’sintent and ability requires considerable judgment. A decline in value that isconsidered to be other-than-temporary is recorded as a loss within noninterestincome in the consolidated statement of income.

 

Investmentsecurities fair values are based on observed market prices.  Certain investment securities do not haveobserved bid prices and their fair value is based on instruments with similarrisk elements. Since regulatory stock is redeemable at par, the Company carriesit at cost.

 

**Loans**

 

Loansare stated at the principal amount outstanding, net of deferred fees,unamortized loan fees and costs, and the allowance for loan losses. Interest onloans is recognized as income when earned on the accrual method.  The Company’s general policy has been to stopaccruing interest on loans when it is determined a reasonable doubt exists asto the collectability of additional interest. Income is subsequently recognizedonly to the extent that cash payments are received provided the loan is notdelinquent in payment and, in management’s judgment, the borrower has theability and intent to make future principal payments.

 

Loan origination and commitmentfees as well as certain direct loan origination costs are being deferred andamortized as an adjustment to the related loan’s yield over the contractuallives of the related loans.

 

**Allowance forLoan Losses**

 

The allowance for loan lossesrepresents the amount which management estimates is adequate to provide forprobable losses inherent in its loan portfolio, as of the balance sheetdate.  The allowance method is used inproviding for loan losses.  Accordingly,all loan losses are charged to the allowance and all recoveries are credited toit.  The allowance for loan losses isestablished through a provision for loan losses charged to operations.  The provision for loan losses is based uponmanagement’s quarterly review of the loan portfolio.  The purpose of the review is to assess loanquality, identify impaired loans, analyze delinquencies, ascertain loan growth,evaluate potential charge-offs and recoveries, and assess general economicconditions in the markets served.  Anexternal independent loan review is also performed annually for the Bank.  Management remains committed to an aggressiveprogram of problem loan identification and resolution.

 

Theallowance is calculated by applying loss factors to outstanding loans by type,excluding loans for which a specific allowance has been determined.  Loss factors are based on management’sconsideration of the nature of the portfolio segments, changes in mix andvolume of the loan portfolio, historical loan loss experience, and generaleconomic conditions.  In addition,management considers industry standards and trends with respect tononperforming loans and its knowledge and experience with specific lendingsegments.

 

Althoughmanagement believes that it uses the best information available to make suchdeterminations and that the allowance for loan losses is adequate at December 31,2009, future adjustments could be necessary if circumstances or economic conditionsdiffer substantially from the assumptions used in making the initialdeterminations.  A downturn in the localeconomy, rising unemployment, or negative performance trends in financialinformation from borrowers could be indicators of subsequent increased levelsof nonperforming assets and possible charge-offs, which would normally requireincreased loan loss provisions. An integral part of the periodic regulatoryexamination process is the review of the adequacy of the Bank’s loan lossallowance. The regulatory agencies could require the Bank, based on theirevaluation of information available at the time of their examination, toprovide additional loan loss provisions to further supplement the allowance.

 

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Impairedloans are commercial and commercial real estate loans for which it is probablethe Bank will not be able to collect all amounts due according to thecontractual terms of the loan agreement. The Bank individually evaluates such loans for impairment and does notaggregate loans by major risk classifications. The definition of “impaired loans” is not the same as the definition of “nonaccrualloans,” although the two categories overlap. The Bank may choose to place a loan on nonaccrual status due to paymentdelinquency or uncertain collectability, while not classifying the loan asimpaired if the loan is not a commercial or commercial real estate loan.Factors considered by management in determining impairment include paymentstatus and collateral value.  The amountof impairment for these types of loans is determined by the difference betweenthe present value of the expected cash flows related to the loan, using theoriginal interest rate, and its recorded value, or as a practical expedient inthe case of collateralized loans, the difference between the fair value of thecollateral and the recorded amount of the loans.  When foreclosure is probable, impairment ismeasured based on the fair value of the collateral.

 

Mortgageloans on one-to-four family properties and all consumer loans are large groupsof smaller-balance homogeneous loans and are measured for impairmentcollectively. Loans that experience insignificant payment delays, which aredefined as 90 days or less, generally are not classified as impaired.  Management determines the significance ofpayment delays on a case-by-case basis taking into consideration allcircumstances surrounding the loan and the borrower including the length of thedelay, the borrower’s prior payment record, and the amount of shortfall inrelation to the principal and interest owed.

 

**Loans Held for Sale**

 

Ingeneral, fixed rate residential mortgage loans originated by the Bank are heldfor sale and are carried at cost due to their short holding period, which canrange from less than two weeks to a maximum of thirty days.  Sold loans are not serviced by the Bank.Proceeds from the sale of loans in excess of the carrying value are accountedfor as a gain.  Total gains on the saleof loans are shown as a component of non-interest income within theconsolidated statement of income.

 

**Foreclosed Assets Held for Sale**

 

Foreclosedassets held for sale are carried at the lower of cost or fair value lessestimated selling costs.  Prior toforeclosure, the value of the underlying loan is written down to the fair valueof the real estate to be acquired by a charge to the allowance for loan losses,if necessary. Any subsequent write-downs are charged against operatingexpenses.  Net operating expenses andgains and losses realized from disposition are included in non-interest expenseand income, respectively.

 

**Premises and Equipment**

 

Premisesand equipment are stated at cost less accumulated depreciation. Depreciation iscomputed using straight-line and accelerated methods over the estimated usefullives of the related assets, which range from five to ten years for furniture,fixtures, and equipment and fifteen to forty years for buildings andimprovements.  Costs incurred for routinemaintenance and repairs are charged to operations as incurred.  Costs of major additions and improvements arecapitalized.

 

**Bank-Owned Life Insurance**

 

TheCompany has purchased life insurance policies on certain officers anddirectors.  Bank-owned life insurance isrecorded at its cash surrender value, or the amount that can be realized.  Increases in the cash surrender value are recognizedas a component of non-interest income within the consolidated statement ofincome.

 

**Endorsement Split-Dollar Life Insurance Arrangements**

 

OnJanuary 1, 2008, the Company changed its accounting policy and recognizeda cumulative-effect adjustment to retained earnings totaling $437,000 relatedto account for certain endorsement split-dollar life insurance arrangements inconnection with the adoption of Emerging Issues Task Force Issue No. 06-4,*Accounting for Deferred Compensation andPostretirement Benefit Aspects of Endorsement Split Dollar Life InsuranceArrangements*.   This statementwas subsequently codified into Financial Accounting Standard Board (“FASB”) ASCTopic 715-60 *Compensation — Retirement Benefits*.

 

**Goodwill**

 

TheCompany performs an annual impairment analysis of goodwill for its purchasedsubsidiary, The M Group.  Based on thefair value of this reporting unit, estimated using the expected present valueof future cash flows, no 

 

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impairmentof goodwill was recognized in 2009 and 2008.

 

**Investments in LimitedPartnerships**

 

TheCompany is a limited partner in four partnerships at December 31, 2009that provide low income elderly housing in the Company’s geographic market area.The carrying value of the Company’s investments in limited partnerships was$4,898,000 at December 31, 2009 and $4,727,000 at December 31, 2008.The Company is fully amortizing the investment in the partnership entered intoprior to 2005 over the fifteen-year holding period.  The partnerships entered into after 2004 arebeing fully amortized over the ten-year tax credit receipt period utilizing thestraight-line method.  The partnershipsare amortized once the projects reach the level of occupancy needed to beginthe ten year tax credit recognition period. Amortization of limited partnership investments amounted to $567,000 in2009, $712,000 in 2008, and $761,000 in 2007.

 

**Off-Balance Sheet FinancialInstruments**

 

Inthe ordinary course of business, the Company enters into off-balance sheetfinancial instruments. Those instruments consist of commitments to extendcredit and standby letters of credit. When those instruments are funded orbecome payable, the Company reports the amounts in its financial statements.

 

**Advertising Cost**

 

Advertisingcosts are generally expensed as incurred.

 

**Income Taxes**

 

The Company prescribes arecognition threshold and a measurement attribute for the financial statementrecognition and measurement of a tax position taken or expected to be taken ina tax return. Benefits from tax positions should be recognized in the financialstatements only when it is more likely than not that the tax position will besustained upon examination by the appropriate taxing authority that would havefull knowledge of all relevant information. A tax position that meets themore-likely-than-not recognition threshold is measured at the largest amount ofbenefit that is greater than fifty percent likely of being realized uponultimate settlement. Tax positions that previously failed to meet themore-likely-than-not recognition threshold should be recognized in the firstsubsequent financial reporting period in which that threshold is met.Previously recognized tax positions that no longer meet the more-likely-than-notrecognition threshold should be derecognized in the first subsequent financialreporting period in which that threshold is no longer met.

 

Deferredtax assets and liabilities result from temporary differences in financial andincome tax methods of accounting, and are reflected at currently enacted incometax rates applicable to the period in which the deferred tax assets orliabilities are expected to be realized or settled. As changes in tax laws orrates are enacted, deferred tax assets and liabilities are adjusted through theprovision for income taxes.  The Companyanalyzed its deferred tax asset position and determined that there was not aneed for a valuation allowance due to the Company’s ability to generate futureordinary and capital taxable income.

 

**Earnings Per Share**

 

TheCompany provides dual presentation of basic and diluted earnings pershare.  Basic earnings per share iscalculated utilizing net income as reported in the numerator and weightedaverage shares outstanding in the denominator. The computation of diluted earnings per share differs in that thedilutive effects of any stock options are adjusted in the denominator.

 

**Employee Benefits**

 

Pensionand employee benefits include contributions, determined actuarially, to a definedbenefit retirement plan covering the eligible employees of the Bank.  The plan is funded on a current basis to theextent that it is deductible under existing federal tax regulations.  Pension and other employee benefits alsoinclude contributions to a defined contribution Section 401(k) plancovering eligible employees. Contributions matching those made by eligible employees are fundedthroughout the year. In addition, an elective contribution is made annually atthe discretion of the Board of Directors.

 

**The M Group Products and IncomeRecognition**

 

TheM Group product line is comprised primarily of annuities, life insurance, andmutual funds.  The revenues generatedfrom life insurance sales are commission only, as The M Group does notunderwrite the policies.  Life insurancesales include permanent and term policies with the majority of the policieswritten being permanent.  Term lifeinsurance policies are written for 10, 15, 20, and 30 year terms with themajority of the policies being written for 20 years.  None of these products are offered as anintegral part of lending activities.

 

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Commissionsfrom the sale of annuities are recognized at the time notice is received fromthe third party broker/dealer or an insurance company that the transaction hasbeen accepted and approved, which is also the time when commission income isreceived.

 

Lifeinsurance commissions are recognized at varying points based on the paymentoption chosen by the customer. Commissions from monthly and annual payment plans are recognized at thestart of each annual period for the life insurance, while quarterly andsemi-annual premium payments are recognized quarterly and semi-annually whenthe earnings process is complete.  Forexample, semi-annual payments on the first of January and July wouldresult in commission income recognition on the first of January and July,while payments on the first of January, April, July, and October wouldresult in commission income recognition on those dates. The potential forchargebacks only exists for those policies on a monthly payment plan sinceincome is recognized at the beginning of the annual coverage period versus atthe time of each monthly payment.  Noliability is maintained for chargebacks as these are removed from income at thetime of the occurrence.

 

**Stock Options**

 

TheCompany maintains a stock option plan for directors and certain officers andemployees with the last option grant being in 2000. All options were grantedwhen the exercise price of the Company’s stock options was greater than orequal to the market price of the underlying stock on the date of the grant,therefore, no compensation expense was recognized in the Company’s financialstatements.

 

**Accumulated Other ComprehensiveIncome**

 

TheCompany is required to present accumulated other comprehensive income in a fullset of general-purpose financial statements for all periods presented.Accumulated other comprehensive income is comprised of unrealized holding gains(losses) on the available for sale securities portfolio and the unrecognizedcomponents of net periodic benefit costs of the defined benefit pension plan.

 

**Segment Reporting**

 

ASC 280, *SegmentReporting,* requires that public business enterprises reportfinancial and descriptive information about their reportable operatingsegments. Based on the guidance provided by the standard, the Company hasdetermined that its only reportable segment is Community Banking.

 

**Reclassification of ComparativeAmounts**

 

Certainitems previously reported have been reclassified to conform to the current year’sreporting format.  Such reclassificationsdid not affect net income or shareholders’ equity.

 

**Recent AccountingPronouncements**

 

On December 30,2008, the FASB issued new authoritative accounting guidance under ASCTopic 715, *Compensation—Retirement Benefits*,which provides guidance related to an employer’s disclosures about plan assetsof defined benefit pension or other post-retirement benefit plans. Under ASCTopic 715, disclosures should provide users of financial statements withan understanding of how investment allocation decisions are made, the factorsthat are pertinent to an understanding of investment policies and strategies,the major categories of plan assets, the inputs and valuation techniques usedto measure the fair value of plan assets, the effect of fair value measurementsusing significant unobservable inputs on changes in plan assets for the periodand significant concentrations of risk within plan assets. This guidance iseffective fiscal year ending after December 15, 2009.  The new authoritative accounting guidanceunder ASC Topic 715 became effective for the Company’s financialstatements for the year ended December 31, 2009 and the requireddisclosures are reported in Note 12.

 

In April 2009, theFASB issued new authoritative accounting guidance under ASC Topic 805, *Business Combinations*, which became effective for periodsbeginning after December 15, 2008. ASC Topic 805 applies to all transactions and other events in whichone entity obtains control over one or more other businesses. ASCTopic 805 requires an acquirer, upon initially obtaining control ofanother entity, to recognize the assets, liabilities and any non-controllinginterest in the acquiree at fair value as of the acquisition date. Contingentconsideration is required to be recognized and measured at fair value on thedate of acquisition rather than at a later date when the amount of thatconsideration may be determinable beyond a reasonable doubt. This fair valueapproach replaces the cost-allocation process required under previousaccounting guidance whereby the cost of an acquisition was allocated to theindividual assets 

 

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acquired and liabilitiesassumed based on their estimated fair value. ASC Topic 805 requiresacquirers to expense acquisition-related costs as incurred rather thanallocating such costs to the assets acquired and liabilities assumed, as waspreviously the case under prior accounting guidance. Assets acquired andliabilities assumed in a business combination that arise from contingencies areto be recognized at fair value if fair value can be reasonably estimated. Iffair value of such an asset or liability cannot be reasonably estimated, theasset or liability would generally be recognized in accordance with ASCTopic 450, *Contingencies*. Under ASCTopic 805, the requirements of ASC Topic 420, *Exit orDisposal Cost Obligations*, would have to be met in order to accruefor a restructuring plan in purchase accounting. Pre-acquisition contingenciesare to be recognized at fair value, unless it is a non-contractual contingencythat is not likely to materialize, in which case, nothing should be recognizedin purchase accounting and, instead, that contingency would be subject to theprobable and estimable recognition criteria of ASC Topic 450, *Contingencies*.  Theadoption of this new guidance did not have a material impact on the Company’sfinancial position or results of operations.

 

In April 2009, the FASB issued new guidanceimpacting ASC Topic 820, *Fair Value Measurementsand Disclosures*.  This ASCprovides additional guidance in determining fair values when there is no activemarket or where the price inputs being used represent distressed sales.  It reaffirms the need to use judgment toascertain if a formerly active market has become inactive and in determiningfair values when markets have become inactive. The adoption of this new guidance did not have a material effect on theCompany’s results of operations or financial position.

 

In April 2009, the FASB issued new guidanceimpacting ASC 825-10-50, *Financial Instruments*,which relates to fair value disclosures for any financial instruments that arenot currently reflected on the balance sheet of companies at fair value.  This guidance amended existing GAAP torequire disclosures about fair value of financial instruments for interimreporting periods of publicly traded companies as well as in annual financialstatements.  This guidance is effectivefor interim and annual periods ending after June 15, 2009.  The adoption of this new guidance did nothave a material impact on the Company’s financial position or results ofoperations.

 

In April 2009, theFASB issued new guidance impacting ASC 320-10, *Investments— Debt and Equity Securities*, which provides additional guidancedesigned to create greater clarity and consistency in accounting for andpresenting impairment losses on securities. This guidance is effective for interim and annual periods ending after June 15,2009.  The adoption of this new guidancedid not have a material impact on the Company’s financial position or resultsof operations.

 

In June 2009, theFASB issued Accounting Standards Update (“ASU”) No. 2009-01, *Topic 105 - Generally Accepted Accounting Principles - FASB AccountingStandards CodificationTM and the Hierarchy of Generally Accepted AccountingPrinciples*.* *TheCodification is the single source of authoritative nongovernmentalGAAP.  The Codification does not change current GAAP, but is intendedto simplify user access to all authoritative GAAP by providing all theauthoritative literature related to a particular topic in oneplace.  Rules and interpretive releases of the SEC under federalsecurities laws are also sources of authoritative GAAP for SEC registrants. TheCompany adopted this standard for the interim reporting period ending September 30,2009.

 

In June 2009, theFASB issued an accounting standard related to the accounting for transfers offinancial assets, which is effective for fiscal years beginning after November 15,2009, and interim periods within those fiscal years.  This standard enhances reporting abouttransfers of financial assets, including securitizations, and where companieshave continuing exposure to the risks related to transferred financial assets.This standard eliminates the concept of a “qualifying special-purpose entity”and changes the requirements for derecognizing financial assets. This standardalso requires additional disclosures about all continuing involvements withtransferred financial assets including information about gains and lossesresulting from transfers during the period. This accounting standard was subsequently codified into ASC Topic 860, *Transfers and Servicing*. The adoption of this standard is not expected to have a material effecton the Company’s results of operations or financial position.

 

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In August 2009, the FASB issued ASU No. 2009-05,*Fair Value Measurements and Disclosures (Topic 820)— Measuring Liabilities at Fair Value*.  This ASU providesamendments for fair value measurements of liabilities.  It providesclarification that in circumstances in which a quoted price in an active marketfor the identical liability is not available, a reporting entity is required tomeasure fair value using one or more techniques.  ASU 2009-05 alsoclarifies that when estimating a fair value of a liability, a reporting entityis not required to include a separate input or adjustment to other inputsrelating to the existence of a restriction that prevents the transfer of theliability.  ASU 2009-05 is effective for the first reporting period(including interim periods) beginning after issuance or fourth quarter2009.  The adoption of this new guidance did not have a materialimpact on the Company’s financial position or results of operations.

 

TheFASB issued new authoritative accounting guidance under ASC Topic 855, *Subsequent Events*, which establishes general standards ofaccounting for and disclosure of events that occur after the balance sheet datebut before financial statements are issued or available to be issued. ASCTopic 855 defines (i) the period after the balance sheet date duringwhich a reporting entity’s management should evaluate events or transactionsthat may occur for potential recognition or disclosure in the financialstatements, (ii) the circumstances under which an entity should recognizeevents or transactions occurring after the balance sheet date in its financialstatements, and (iii) the disclosures an entity should make about eventsor transactions that occurred after the balance sheet date. The newauthoritative accounting guidance under ASC Topic 855 is effective forperiods ending after June 15, 2009.  The required disclosures are provided in Note 24.

 

**NOTE 2 - PER SHARE DATA**

 

Thereare no convertible securities which would affect the denominator in calculatingbasic and dilutive earnings per share; therefore, net income as presented onthe consolidated statement of income will be used as the numerator.  The following table sets forth thecomposition of the weighted average common shares (denominator) used in thebasic and dilutive per share computation.

 
| ** **                                                                                                 | ** ** | **2009**  | ** ** | **2008**  | ** ** | **2007**  | ** ** |
|------------------------------------------------------------------------------------------------------------|------------|-----------|------------|-----------|------------|-----------|------------|
|                                                                                                       |       |      |       |      |       |      |       |
| Weighted  average common shares issued                                                                     |       | 4,011,817 |       | 4,008,553 |       | 4,005,181 |       |
|                                                                                                       |       |      |       |      |       |      |       |
| Average  treasury stock shares                                                                             |       | (179,028  | )          | (148,829  | )          | (118,904  | )          |
|                                                                                                       |       |      |       |      |       |      |       |
| Weighted  average common shares andcommon stock equivalents used to calculate basic  earnings per share    |       | 3,832,789 |       | 3,859,724 |       | 3,886,277 |       |
|                                                                                                       |       |      |       |      |       |      |       |
| Additional  common stock equivalents (stock options) used to calculate diluted earnings  per share         |       | 97        |       | 109       |       | 237       |       |
|                                                                                                       |       |      |       |      |       |      |       |
| Weighted  average common shares and common stock equivalents used to calculate diluted  earnings per share |       | 3,832,886 |       | 3,859,833 |       | 3,886,514 |       |

 

Options to purchase 990, 1,980, and 10,913shares of common stock at a range in price of $24.72 to $31.82 were outstandingat December 31, 2009, 2008, and 2007, respectively.  The options were included in the computationof diluted earnings per share on a weighted average basis determined by thelength of time during each period that the market value exceeded the strikeprice.

 

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**NOTE 3 - INVESTMENT SECURITIES**

 

The amortized costand fair values of investment securities at December 31, 2009 and 2008 areas follows:

 
| ** **                            | ** ** | **2009**      | ** ** |
|---------------------------------------|------------|---------------|------------|
| ** **                            | ** ** | ** **    | ** ** | **Gross** | ** ** | **Gross** | ** ** | ** ** | ** ** |
| ** **                            | ** ** | **Amortized** | ** ** | **Unrealized** | ** ** | **Unrealized** | ** ** | **Fair** | ** ** |
| **(In Thousands)**               | ** ** | **Cost**      | ** ** | **Gains** | ** ** | **Losses** | ** ** | **Value** | ** ** |
| Available  for sale (AFS)             |       |          |       |   |   |   |   |   |   |
| U.S.  Government and agencysecurities |       | $             | 37,038     |   | $ | 2,098 |   | $ | — |   | $ | 39,136 |   |
| State  and political securities       |       | 153,914       |       | 733 |   | (9,770 | ) | 144,877 |   |
| Other  debt securities                |       | 12,271        |       | 834 |   | (129 | ) | 12,976 |   |
| Total  debt securities                |       | 203,223       |       | 3,665 |   | (9,899 | ) | 196,989 |   |
| Equity  securities                    |       | 10,952        |       | 981 |   | (154 | ) | 11,779 |   |
| Total  investment securities AFS      |       | $             | 214,175    |   | $ | 4,646 |   | $ | (10,053 | ) | $ | 208,768 |   |
|                                  |       |          |       |   |   |   |   |   |   |
| Held  to maturity (HTM)               |       |          |       |   |   |   |   |   |   |
| U.S.  Government and agencysecurities |       | $             | 6          |   | $ | — |   | $ | — |   | $ | 6 |   |
| Other  debt securities                |       | 101           |       | 1 |   | — |   | 102 |   |
| Total  investment securities HTM      |       | $             | 107        |   | $ | 1 |   | $ | — |   | $ | 108 |   |

 
| ** **                            | ** ** | **2008**      | ** ** |
|---------------------------------------|------------|---------------|------------|
| ** **                            | ** ** | ** **    | ** ** | **Gross** | ** ** | **Gross** | ** ** | ** ** | ** ** |
| ** **                            | ** ** | **Amortized** | ** ** | **Unrealized** | ** ** | **Unrealized** | ** ** | **Fair** | ** ** |
| **(In  Thousands)**                   | ** ** | **Cost**      | ** ** | **Gains** | ** ** | **Losses** | ** ** | **Value** | ** ** |
| Available  for sale (AFS)             |       |          |       |   |   |   |   |   |   |
| U.S.  Government and agencysecurities |       | $             | 46,452     |   | $ | 1,134 |   | $ | — |   | $ | 47,586 |   |
| State  and political securities       |       | 142,258       |       | 348 |   | (10,764 | ) | 131,842 |   |
| Other  debt securities                |       | 15,970        |       | 649 |   | (1,065 | ) | 15,554 |   |
| Total  debt securities                |       | 204,680       |       | 2,131 |   | (11,829 | ) | 194,982 |   |
| Equity  securities                    |       | 16,429        |       | 225 |   | (3,385 | ) | 13,269 |   |
| Total  investment securities AFS      |       | $             | 221,109    |   | $ | 2,356 |   | $ | (15,214 | ) | $ | 208,251 |   |
|                                  |       |          |       |   |   |   |   |   |   |
| Held  to maturity (HTM)               |       |          |       |   |   |   |   |   |   |
| U.S.  Government and agencysecurities |       | $             | 10         |   | $ | 1 |   | $ | — |   | $ | 11 |   |
| Other  debt securities                |       | 125           |       | — |   | — |   | 125 |   |
| Total  investment securities HTM      |       | $             | 135        |   | $ | 1 |   | $ | — |   | $ | 136 |   |

 

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**The following tables show theCompany’s gross unrealized losses and fair value, aggregated by investmentcategory and length of time, that the individual securities have been in acontinuous unrealized loss position, at December 31, 2009 and 2008.**

** **
| ** **                            | ** ** | **2009**                    | ** ** |
|---------------------------------------|------------|-----------------------------|------------|
| ** **                            | ** ** | **Less than Twelve Months** | ** ** | **Twelve Months or Greater** | ** ** | **Total** | ** ** |
| ** **                            | ** ** | ** **                  | ** ** | **Gross** | ** ** | ** ** | ** ** | **Gross** | ** ** | ** ** | ** ** | **Gross** | ** ** |
| ** **                            | ** ** | **Fair**                    | ** ** | **Unrealized** | ** ** | **Fair** | ** ** | **Unrealized** | ** ** | **Fair** | ** ** | **Unrealized** | ** ** |
| **(In  Thousands)**                   | ** ** | **Value**                   | ** ** | **Losses** | ** ** | **Value** | ** ** | **Losses** | ** ** | **Value** | ** ** | **Losses** | ** ** |
|                                  |       |                        |       |   |   |   |   |   |   |   |   |   |   |
| U.S. Government and agency securities |       | $                           | —     |   | $ | — |   | $ | — |   | $ | — |   | $ | — |   | $ | — |   |
| State and political securities        |       | 60,005                      |       | 2,336 |   | 36,267 |   | 7,434 |   | 96,272 |   | 9,770 |   |
| Other debt securities                 |       | —                      |       | — |   | 1,191 |   | 129 |   | 1,191 |   | 129 |   |
| Total debt securities                 |       | 60,005                      |       | 2,336 |   | 37,458 |   | 7,563 |   | 97,463 |   | 9,899 |   |
| Equity securities                     |       | 159                         |       | 27 |   | 918 |   | 127 |   | 1,077 |   | 154 |   |
| Total                                 |       | $                           | 60,164     |   | $ | 2,363 |   | $ | 38,376 |   | $ | 7,690 |   | $ | 98,540 |   | $ | 10,053 |   |

 
| ** **                            | ** ** | **2008**                    | ** ** |
|---------------------------------------|------------|-----------------------------|------------|
| ** **                            | ** ** | **Less than Twelve Months** | ** ** | **Twelve Months or Greater** | ** ** | **Total** | ** ** |
| ** **                            | ** ** | ** **                  | ** ** | **Gross** | ** ** | ** ** | ** ** | **Gross** | ** ** | ** ** | ** ** | **Gross** | ** ** |
| ** **                            | ** ** | **Fair**                    | ** ** | **Unrealized** | ** ** | **Fair** | ** ** | **Unrealized** | ** ** | **Fair** | ** ** | **Unrealized** | ** ** |
| **(In  Thousands)**                   | ** ** | **Value**                   | ** ** | **Losses** | ** ** | **Value** | ** ** | **Losses** | ** ** | **Value** | ** ** | **Losses** | ** ** |
|                                  |       |                        |       |   |   |   |   |   |   |   |   |   |   |
| U.S. Government and agency securities |       | $                           | —     |   | $ | — |   | $ | — |   | $ | — |   | $ | — |   | $ | — |   |
| State and political securities        |       | 48,388                      |       | 4,378 |   | 67,412 |   | 6,386 |   | 115,800 |   | 10,764 |   |
| Other debt securities                 |       | 6,341                       |       | 451 |   | 2,012 |   | 614 |   | 8,353 |   | 1,065 |   |
| Total debt securities                 |       | 54,729                      |       | 4,829 |   | 69,424 |   | 7,000 |   | 124,153 |   | 11,829 |   |
| Equity securities                     |       | 164                         |       | 80 |   | 5,364 |   | 3,305 |   | 5,528 |   | 3,385 |   |
| Total                                 |       | $                           | 54,893     |   | $ | 4,909 |   | $ | 74,788 |   | $ | 10,305 |   | $ | 129,681 |   | $ | 15,214 |   |

** **

At December 31, 2009 and 2008 there were 86 and 95individual securities in a continuous unrealized loss position for less thantwelve months and 106 and 184 individual securities in a continuous unrealizedloss position for greater than twevle months, respectively.

 

There are 192 and 279 positions that are consideredtemporarily impaired as of December 31, 2009 and 2008 respectively.  The Company reviews its position quarterlyand has asserted that at December 31, 2009 and 2008 , the declinesoutlined in the above table represent temporary declines and the Company doesnot intend to sell and does not believe they will be required to sell thesesecurities before recovery of their cost basis, which may be at maturity.  The Company has concluded that any impairmentof its investment securities portfolio is not other than temporary but is theresult of interest rate changes that are not expected to result in thenoncollection of principal and interest during the period.

 

Theamortized cost and fair value of debt securities at December 31, 2009, bycontractual maturity, are shown below. Expected maturities may differ fromcontractual maturities since borrowers may have the right to call or prepayobligations with or without call or prepayment penalties.

** **
| ** **                        | ** ** | **Available for Sale** | ** ** | **Held to Maturity** | ** ** |
|-----------------------------------|------------|------------------------|------------|----------------------|------------|
| ** **                        | ** ** | **Amortized**          | ** ** | ** **           | ** ** | **Amortized** | ** ** | ** ** | ** ** |
| **(In  Thousands)**               | ** ** | **Cost**               | ** ** | **Fair Value**       | ** ** | **Cost** | ** ** | **Fair Value** | ** ** |
| Due in one year or less           |       | $                      | 25         |                 | $          | 25 |   | $ | 25 |   | $ | 25 |   |
| Due after one year to five years  |       | 11,355                 |       | 12,172               |       | 76 |   | 77 |   |
| Due after five years to ten years |       | 1,456                  |       | 1,472                |       | — |   | — |   |
| Due after ten years               |       | 190,387                |       | 183,320              |       | 6 |   | 6 |   |
| Total                             |       | $                      | 203,223    |                 | $          | 196,989 |   | $ | 107 |   | $ | 108 |   |

 

Totalgross proceeds from sales of securities available for sale were $14,757,000,$40,169,000, and $60,485,000 for 2009, 2008, and 2007, respectively.  The following table represents gross realizedgains and losses on those transactions in addition to impairment chargesrelated to the equity securities portfolio:

 

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| **(In  Thousands)**                   | ** ** | **2009** | ** ** | **2008** | ** ** | **2007** | ** ** |
|---------------------------------------|------------|----------|------------|----------|------------|----------|------------|
| Gross realized gains:                 |       |     |       |     |       |     |       |
| U.S. Government and agency securities |       | $        | —     |     | $          | 253      |       | $ | 68 |   |
| State and political securities        |       | —   |       | 236      |       | 840      |       |
| Other debt securities                 |       | 575      |       | 6        |       | 2        |       |
| Equity securities                     |       | 22       |       | 539      |       | 772      |       |
| Total gross realized gains            |       | $        | 597        |     | $          | 1,034    |       | $ | 1,682 |   |
|                                  |       |     |       |     |       |     |       |
| Gross realized losses:                |       |     |       |     |       |     |       |
| U.S. Government and agency securities |       | $        | —     |     | $          | 36       |       | $ | 902 |   |
| State and political securities        |       | —   |       | 204      |       | —   |       |
| Other debt securities                 |       | 1,062    |       | 510      |       | —   |       |
| Equity securities                     |       | 4,381    |       | 2,315    |       | 834      |       |
| Total gross realized losses           |       | $        | 5,443      |     | $          | 3,065    |       | $ | 1,736 |   |

 

Grossrealized losses for the equity securities portfolio include impairment chargesof $4,614,000, $2,797,000 and $834,000 for the years ended December 31,2009, 2008 and 2007, respectively.

 

Investmentsecurities with a carrying value of approximately $97,366,000 and $102,362,000at December 31, 2009 and 2008, respectively, were pledged to securecertain deposits, repurchase agreements, and for other purposes as required bylaw.

 

Thereis no concentration of investments that exceed ten percent of shareholders’equity for any individual issuer, excluding those guaranteed by the U.S.Government.

 

# **NOTE 4 - FEDERAL HOME LOAN BANK STOCK**

# ** **

TheBank is a member of the Federal Home Loan Bank of Pittsburgh (the “FHLB”),which is one of 12 regional Federal Home Loan Banks. Each Federal Home LoanBank serves as a reserve or central bank for its members within its assignedregion.  It is funded primarily from funds deposited by memberinstitutions and proceeds from the sale of consolidated obligations of theFederal Home Loan Bank System. It makes loans to members (i.e., advances) inaccordance with policies and procedures established by the board of directorsof the Federal Home Loan Bank.  As a member, the Bank is required topurchase and maintain stock in the FHLB in an amount equal to the greater of 1%of its aggregate unpaid residential mortgage loans, home purchase contracts orsimilar obligations at the beginning of each year or 5% of its outstandingadvances from the FHLB.  At December 31, 2009, the Bank held$7,271,000 in stock of the FHLB, which was in compliance with this requirement.

 

The Company evaluated its holding of FHLB stockfor impairment and deemed the stock to not be impaired due to the expectedrecoverability of the par value, which equals the value reflected within theCompany’s financial statements.  Thedecision was based on several items ranging from the estimated true economiclosses embedded within the FHLB’s mortgage portfolio to the FHLB’s liquidityposition and credit rating.  The Companyutilizes the impairment framework outlined in GAAP to evaluate FHLB stock forimpairment.

 

The following factors were evaluated todetermine the ultimate recoverability of the par value of the Company’s FHLBstock holding; (i) the significance of the decline in net assets of theFHLB as compared to the capital stock amount for the FHLB and the length oftime this situation has persisted; (ii) commitments by the FHLB to makepayments required by law or regulation and the level of such payments inrelation to the operating performance of the FHLB; (iii) the impact of legislativeand regulatory changes on the institutions and, accordingly, on the customerbase of the FHLB; (iv) the liquidity position of the FHLB; and (v) whethera decline is temporary or whether it affects the ultimate recoverability of theFHLB stock based on (a) the materiality of the carrying amount to themember institution and (b) whether an assessment of the institution’soperational needs for the foreseeable future allow management to dispose of thestock.

 

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Based on its analysis of these factors, theCompany determined that its holding of FHLB stock was not impaired on December 31,2009.

 

**NOTE 5 — LOANS**

 

Major loan classifications asof December 31, 2009 and 2008 are summarized as follows:

 
| ** **                        | ** ** | **2009**    | ** ** |
|-----------------------------------|------------|-------------|------------|
| ** **                        | ** ** | ** **  | ** ** | ** ** | ** ** | **Past Due** | ** ** | ** ** | ** ** | ** ** | ** ** |
| ** **                        | ** ** | ** **  | ** ** | ** ** | ** ** | **90 Days** | ** ** | ** ** | ** ** | ** ** | ** ** |
| ** **                        | ** ** | ** **  | ** ** | **Past Due** | ** ** | **Or More** | ** ** | ** ** | ** ** | ** ** | ** ** |
| ** **                        | ** ** | ** **  | ** ** | **30 To 90** | ** ** | **& Still** | ** ** | **Non-** | ** ** | ** ** | ** ** |
| **(In  Thousands)**               | ** ** | **Current** | ** ** | **Days** | ** ** | **Accruing** | ** ** | **Accrual** | ** ** | **Total** | ** ** |
| Commercial  and agricultural      |       | $           | 45,930     |   | $ | 457 |   | $ | 182 |   | $ | 78 |   | $ | 46,647 |   |
| Real  estate mortgage:            |       |        |       |   |   |   |   |   |   |   |   |
| Residential                       |       | 165,313     |       | 7,333 |   | 951 |   | 749 |   | 174,346 |   |
| Commercial                        |       | 147,455     |       | 2,860 |   | 1,429 |   | 465 |   | 152,209 |   |
| Construction                      |       | 18,247      |       | 2,992 |   | — |   | 556 |   | 21,795 |   |
| Installment  loans to individuals |       | 11,192      |       | 311 |   | 3 |   | 43 |   | 11,549 |   |
|                              |       | 388,137     |       | $ | 13,953 |   | $ | 2,565 |   | $ | 1,891 |   | 406,546 |   |
| Less:  Net deferred loan fees     |       | 1,017       |       |   |   |   |   |   |   | 1,017 |   |
| Allowance  for loan losses        |       | 4,657       |       |   |   |   |   |   |   | 4,657 |   |
| Loans, net                        |       | $           | 382,463    |   |   |   |   |   |   |   | $ | 400,872 |   |

 
| ** **                        | ** ** | **2008**    | ** ** |
|-----------------------------------|------------|-------------|------------|
| ** **                        | ** ** | ** **  | ** ** | ** ** | ** ** | **Past Due** | ** ** | ** ** | ** ** | ** ** | ** ** |
| ** **                        | ** ** | ** **  | ** ** | ** ** | ** ** | **90 Days** | ** ** | ** ** | ** ** | ** ** | ** ** |
| ** **                        | ** ** | ** **  | ** ** | **Past Due** | ** ** | **Or More** | ** ** | ** ** | ** ** | ** ** | ** ** |
| ** **                        | ** ** | ** **  | ** ** | **30 To 90** | ** ** | **& Still** | ** ** | **Non-** | ** ** | ** ** | ** ** |
| **(In  Thousands)**               | ** ** | **Current** | ** ** | **Days** | ** ** | **Accruing** | ** ** | **Accrual** | ** ** | **Total** | ** ** |
| Commercial  and agricultural      |       | $           | 40,006     |   | $ | 517 |   | $ | — |   | $ | 79 |   | $ | 40,602 |   |
| Real  estate mortgage:            |       |        |       |   |   |   |   |   |   |   |   |
| Residential                       |       | 170,011     |       | 6,582 |   | 223 |   | 590 |   | 177,406 |   |
| Commercial                        |       | 134,647     |       | 775 |   | — |   | 736 |   | 136,158 |   |
| Construction                      |       | 15,652      |       | 167 |   | — |   | 19 |   | 15,838 |   |
| Installment  loans to individuals |       | 12,053      |       | 346 |   | 36 |   | 52 |   | 12,487 |   |
|                              |       | 372,369     |       | $ | 8,387 |   | $ | 259 |   | $ | 1,476 |   | 382,491 |   |
| Less:  Net deferred loan fees     |       | 1,013       |       |   |   |   |   |   |   | 1,013 |   |
| Allowance  for loan losses        |       | 4,356       |       |   |   |   |   |   |   | 4,356 |   |
| Loans,  net                       |       | $           | 367,000    |   |   |   |   |   |   |   | $ | 377,122 |   |

 

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Impaired loans totaled$8,312,000 and $5,042,000 at December 31, 2009 and 2008, respectively with$5,343,000 and $4,066,000 not having a specific allocation within the allowancefor loan losses.  .  The portion of the allowance for loan lossesallocated for impaired loans was $802,000 and $166,000 at December 31,2009 and 2008, respectively. The average recorded investment in impaired loansduring the years ended December 31, 2009 and 2008 was approximately$6,699,000 and $3,410,000, respectively.

 

TheCompany recognized interest income on impaired loans in the amount of $278,000and $123,000 for the years ended December 31, 2009 and 2008, respectively.On a cash basis, interest income on impaired loans amounted to $36,000 and$7,000 for the years ended December 31, 2009 and 2008, respectively.

 

Noadditional funds are committed to be advanced in connection with impairedloans.

 

Loanson which the accrual of interest has been discontinued or reduced, exclusive ofimpaired loans,  amounted toapproximately $1,891,000 and $1,476,000 at December 31, 2009 and 2008,respectively.  If interest had beenrecorded based on the original loan agreement terms and rate of interest forthose loans, income would have approximated $134,000, $72,000, and $87,000 forthe years ended December 31, 2009, 2008, and 2007, respectively.  Interest income on such loans, is recorded asreceived and amounted to approximately $48,000, $9,000, and $17,000 for theyears ended December 31, 2009, 2008, and 2007, respectively.

 

Changesin the allowance for loan losses for the years ended December 31, 2009,2008, and 2007 are as follows:

** **
| **(In  Thousands)**             | ** ** | **2009** | ** ** | **2008** | ** ** | **2007** | ** ** |
|---------------------------------|------------|----------|------------|----------|------------|----------|------------|
|                            |       |     |       |     |       |     |       |
| Balance, beginning of year      |       | $        | 4,356      |     | $          | 4,130    |       | $ | 4,185 |   |
| Provision charged to operations |       | 917      |       | 375      |       | 150      |       |
| Loans charged off               |       | (732     | )          | (313     | )          | (304     | )          |
| Recoveries                      |       | 116      |       | 164      |       | 99       |       |
| Balance, end of year            |       | $        | 4,657      |     | $          | 4,356    |       | $ | 4,130 |   |

 

TheCompany has a concentration of loans to both owners of commercial andresidential rental properties at December 31, 2009 and 2008 of 15.26% and15.07% and 15.62% and 14.67% of total loans, respectively.

 

TheCompany grants commercial, industrial, residential, and installment loans tocustomers throughout north-central Pennsylvania. Although the Company has adiversified loan portfolio at December 31, 2009 and 2008, a substantialportion of its debtors’ ability to honor their contracts is dependent on theeconomic conditions within this region.

 

**NOTE 6 - PREMISES AND EQUIPMENT**

 

Majorclassifications of premises and equipment are summarized as follows at December 31,2009 and 2008:

 
| **(In  Thousands)**                             | ** ** | **2009** | ** ** | **2008** | ** ** |
|-------------------------------------------------|------------|----------|------------|----------|------------|
|                                            |       |     |       |     |       |
| Land                                            |       | $        | 1,480      |     | $          | 1,480 |   |
| Premises                                        |       | 7,206    |       | 6,929    |       |
| Furniture and equipment                         |       | 6,623    |       | 6,067    |       |
| Leasehold improvements                          |       | 885      |       | 871      |       |
| Total                                           |       | 16,194   |       | 15,347   |       |
| Less  accumulated depreciation and amortization |       | 8,206    |       | 7,482    |       |
| Net premises and equipment                      |       | $        | 7,988      |     | $          | 7,865 |   |

 

Depreciationand amortization charged to operations for the years ended 2009, 2008, and 2007was $724,000, $663,000, and $680,000, respectively.

 

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**NOTE 7 - GOODWILL**

 

Asof December 31, 2009, 2008, and 2007 goodwill had a gross carrying valueof $3,308,000 and accumulated amortization of $276,000 resulting in a netcarrying amount of $3,032,000.

 

Thegross carrying amount of goodwill is tested for impairment in the third quarterof each fiscal year.  Based on fair valueof the reporting unit, estimated using the expected present value of futurecash flows, there was no evidence of impairment of the carrying amount at December 31,2009, 2008, and 2007, respectively.

 

**NOTE 8 - TIME DEPOSITS**

 

Timedeposits of $100,000 or more totaled approximately $79,840,000 on December 31,2009 and $67,356,000 on December 31, 2008. Interest expense related tosuch deposits was approximately $2,336,000, $2,894,000, and $3,216,000, for theyears ended December 31, 2009, 2008, and 2007, respectively.

 

AtDecember 31, 2009, the scheduled maturities on time deposits of $100,000or more are as follows:

 
| **(In  Thousands)**         | ** ** | **2009** | ** ** |
|-----------------------------|------------|----------|------------|
|                        |       |     |       |
| Three months or less        |       | $        | 23,707     |   |
| Three months to six months  |       | 16,300   |       |
| Six months to twelve months |       | 23,321   |       |
| Over twelve months          |       | 16,512   |       |
| Total                       |       | $        | 79,840     |   |

 

Total time deposit maturities are as follows at December 31,2009:

 
| **(In  Thousands)** | ** ** | **2009** | ** ** |
|---------------------|------------|----------|------------|
|                |       |     |       |
| 2010                |       | $        | 154,702    |   |
| 2011                |       | 34,895   |       |
| 2012                |       | 14,120   |       |
| 2013                |       | 12,117   |       |
| 2014                |       | 685      |       |
| Thereafter          |       | 1,047    |       |
| Total               |       | $        | 217,566    |   |

 

**NOTE 9 - SHORT-TERM BORROWINGS**

 

Short-termborrowings consist of securities sold under agreements to repurchase andprimarily FHLB advances, which generally represent overnight or less than sixmonth borrowings.  In addition to theoutstanding balances noted below, the Bank also had additional lines of credittotaling $15,139,000 available from correspondent banks other than theFHLB.  The outstanding balances andrelated information for short-term borrowings are summarized as follows at December 31,2009, 2008, and 2007:

 

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| **(In  Thousands)**                         | ** ** | **2009** | ** ** | **2008** | ** ** | **2007** | ** ** |
|---------------------------------------------|------------|----------|------------|----------|------------|----------|------------|
| **Repurchase Agreements:**                  |       |     |       |     |       |     |       |
| Balance at year end                         |       | $        | 13,199     |     | $          | 12,933   |       | $ | 17,155 |   |
| Maximum amount outstanding at any month end |       | 16,008   |       | 18,839   |       | 19,058   |       |
| Average balance outstanding during the year |       | 13,664   |       | 15,840   |       | 16,746   |       |
| Weighted-average interest rate:             |       |     |       |     |       |     |       |
| At year end                                 |       | 2.01     | %          | 2.83     | %          | 3.37     | %          |
| Paid during the year                        |       | 2.21     | %          | 2.83     | %          | 3.69     | %          |
|                                        |       |     |       |     |       |     |       |
| **Open Repo Plus:**                         |       |     |       |     |       |     |       |
| Balance at year end                         |       | $        | 5,155      |     | $          | 61,013   |       | $ | 38,160 |   |
| Maximum amount outstanding at any month end |       | 40,330   |       | 61,013   |       | 38,895   |       |
| Average balance outstanding during the year |       | 11,772   |       | 31,495   |       | 19,299   |       |
| Weighted-average interest rate:             |       |     |       |     |       |     |       |
| At year end                                 |       | 0.62     | %          | 0.59     | %          | 4.32     | %          |
| Paid during the year                        |       | 0.71     | %          | 2.04     | %          | 5.09     | %          |
|                                        |       |     |       |     |       |     |       |
| **Short-Term FHLB:**                        |       |     |       |     |       |     |       |
| Balance at year end                         |       | $        | —     |     | $          | —   |       | $ | — |   |
| Maximum amount outstanding at any month end |       | 15,000   |       | 10,000   |       | 15,000   |       |
| Average balance outstanding during the year |       | 2,205    |       | 3,210    |       | 771      |       |
| Weighted-average interest rate:             |       |     |       |     |       |     |       |
| At year end                                 |       | —   |       | —   |       | —   |       |
| Paid during the year                        |       | 0.42     | %          | 2.58     | %          | 5.06     | %          |

 

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**NOTE 10 — LONG TERM BORROWINGS**

 

Thefollowing represents outstanding long-term borrowings with the FHLB bycontractual maturities at December 31, 2009 and 2008:

 

(In Thousands)

 
| ** **         | ** ** | ** **   | ** ** | **Weighted-**        | ** ** | **Weighted-**        | ** ** | **Stated Interest** | ** ** | ** ** | ** ** | ** ** | ** ** |
|--------------------|------------|--------------|------------|----------------------|------------|----------------------|------------|---------------------|------------|------------|------------|------------|------------|
| ** **         | ** ** | ** **   | ** ** | **Average Interest** | ** ** | **Average Interest** | ** ** | **Rate Range**      | ** ** | ** ** | ** ** | ** ** | ** ** |
| **Description**    | ** ** | **Maturity** | ** ** | **Rate 2009**        | ** ** | **Rate 2008**        | ** ** | **From**            | ** ** | **To**     | ** ** | **2009**   | ** ** | **2008** | ** ** |
| Variable           |       | 2010         |       | 4.87                 | %          | 4.87                 | %          | 3.98                | %          | 6.65       | %          | $          | 15,000     |   | $ | 15,000 |   |
| Variable           |       | 2011         |       | 4.49                 | %          | 4.49                 | %          | 4.25                | %          | 4.72       | %          | 10,000     |       | 10,000 |   |
| Variable           |       | 2012         |       | 4.18                 | %          | 4.18                 | %          | 3.68                | %          | 4.43       | %          | 15,000     |       | 15,000 |   |
| Variable           |       | 2013         |       | 3.74                 | %          | 3.74                 | %          | 3.74                | %          | 3.74       | %          | 5,000      |       | 5,000 |   |
| Variable           |       | 2015         |       | 3.97                 | %          | 3.97                 | %          | 3.97                | %          | 3.97       | %          | 10,000     |       | 10,000 |   |
| Variable           |       | 2017         |       | 4.22                 | %          | 4.22                 | %          | 4.15                | %          | 4.28       | %          | 20,000     |       | 20,000 |   |
| Variable           |       | 2018         |       | 3.18                 | %          | 3.18                 | %          | 3.18                | %          | 3.18       | %          | 10,000     |       | 10,000 |   |
| **Total Variable** | ** ** | ** **   | ** ** | **4.18**             | **%**      | **4.18**             | **%**      | ** **          | ** ** | ** ** | ** ** | **85,000** | ** ** | **85,000** | ** ** |
| Fixed              |       | 2011         |       | 6.92                 | %          | 6.92                 | %          | 6.92                | %          | 6.92       | %          | 500        |       | 500 |   |
| Fixed              |       | 2013         |       | 5.87                 | %          | 5.87                 | %          | 5.87                | %          | 5.87       | %          | 528        |       | 528 |   |
| Fixed              |       | 2015         |       | 6.92                 | %          | 6.92                 | %          | 6.92                | %          | 6.92       | %          | 750        |       | 750 |   |
| **Total Fixed**    | ** ** | ** **   | ** ** | **6.61**             | **%**      | **6.61**             | **%**      | ** **          | ** ** | ** ** | ** ** | **1,778**  | ** ** | **1,778** | ** ** |
| **Total**          | ** ** | ** **   | ** ** | **4.23**             | **%**      | **4.23**             | **%**      | ** **          | ** ** | ** ** | ** ** | **$**      | **86,778** | ** ** | **$** | **86,778** | ** ** |

 

(In Thousands)

 
| **Year Ending**       | ** ** | ** ** | ** ** | **Weighted-**    | ** ** |
|-----------------------|------------|------------|------------|------------------|------------|
| **December 31,** | ** ** | **Amount** | ** ** | **Average Rate** | ** ** |
| 2010                  |       | $          | 15,000     |             | 4.87       | % |
| 2011                  |       | 10,500     |       | 4.60             | %          |
| 2012                  |       | 15,000     |       | 4.18             | %          |
| 2013                  |       | 5,528      |       | 3.94             | %          |
| 2014 and after        |       | 40,750     |       | 3.95             | %          |
| ** **            | ** ** | **$**      | **86,778** | ** **       | **4.23**   | **%** |

 

Theterms of the convertible borrowings allow the FHLB to convert the interest rateto an adjustable rate based on the three month London Interbank Offered Rate (“LIBOR”)at a predetermined anniversary date of the borrowing’s origination, rangingfrom three months to five years.  If theFHLB converts the interest rate on one of the predetermined dates, the Bank hasthe ability to payoff the debt on the conversion date and quarterly thereafterwithout incurring the customary pre-payment penalty.

 

TheBank maintains a credit arrangement which includes a revolving line of creditwith the FHLB.  Under this creditarrangement, the Bank has a remaining borrowing capacity of $124,296,000 at December 31,2009, which is subject to annual renewal, and typically incurs no servicecharges.  Under terms of a blanketagreement, collateral for the FHLB borrowings must be secured by certainqualifying assets of the Bank which consist principally of first mortgage loansand mortgage-backed securities.

 

**NOTE 11 - INCOME TAXES**

 

Thefollowing temporary differences gave rise to the net deferred tax assetposition at December 31, 2009 and 2008:

 

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| **(In  Thousands)**                              | ** ** | **2009** | ** ** | **2008** | ** ** |
|--------------------------------------------------|------------|----------|------------|----------|------------|
| Deferred tax assets:                             |       |     |       |     |       |
| Allowance for loan losses                        |       | $        | 1,583      |     | $          | 1,481 |   |
| Deferred compensation                            |       | 403      |       | 402      |       |
| Pension                                          |       | 1,148    |       | 2,014    |       |
| Loan fees and costs                              |       | 346      |       | 344      |       |
| Investment securities allowance                  |       | 1,620    |       | 548      |       |
| Unrealized loss on available for sale securities |       | 1,839    |       | 4,372    |       |
| Low income housing credit carryforward           |       | 2,132    |       | 1,571    |       |
| Capital loss                                     |       | 1,195    |       | 503      |       |
| Other                                            |       | 296      |       | 373      |       |
| Total                                            |       | 10,562   |       | 11,608   |       |
|                                             |       |     |       |     |       |
| Deferred tax liabilities:                        |       |     |       |     |       |
| Bond accretion                                   |       | 207      |       | 61       |       |
| Depreciation                                     |       | 263      |       | 141      |       |
| Amortization                                     |       | 601      |       | 526      |       |
| Total                                            |       | 1,071    |       | 728      |       |
|                                             |       |     |       |     |       |
| Deferred tax asset, net                          |       | $        | 9,491      |     | $          | 10,880 |   |

 

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Novaluation allowance was established at December 31, 2009 and 2008, becauseof the Company’s ability to carry back capital losses to recover taxes paid inprevious years and certain tax strategies, together with the anticipated futuretaxable income as evidenced by the Company’s earning potential.

 

Thebenefit or provision for income taxes is comprised of the following for theyear ended December 31, 2009, 2008, and 2007:

 
| **(In  Thousands)**       | ** ** | **2009** | ** ** | **2008** | ** ** | **2007** | ** ** |
|---------------------------|------------|----------|------------|----------|------------|----------|------------|
|                      |       |     |       |     |       |     |       |
| Currently payable         |       | $        | 1,360      |     | $          | 1,967    |       | $ | 1,758 |   |
| Deferred benefit          |       | (2,102   | )          | (1,562   | )          | (1,121   | )          |
|                      |       |     |       |     |       |     |       |
| Total (benefit) provision |       | $        | (742       | )        | $          | 405      |       | $ | 637 |   |

 

Areconciliation between the expected income tax and the effective income taxrate on income before income tax provision follows for the year ended December 31,2009, 2008, and 2007:

 
| ** **                                         | ** ** | **2009**   | ** ** | **2008** | ** ** | **2007**   | ** ** |
|----------------------------------------------------|------------|------------|------------|----------|------------|------------|------------|
| **(In Thousands)**                                 | ** ** | **Amount** | ** ** | **%**    | ** ** | **Amount** | ** ** | **%** | ** ** | **Amount** | ** ** | **%** | ** ** |
|                                               |       |       |       |     |       |       |       |   |   |   |   |   |   |
| Provision at expected rate                         |       | $          | 1,819      |     | 34.0       | %          | $          | 2,859 |   | 34.0 | % | $ | 3,235 |   | 34.0 | % |
| Decrease in tax resulting  from:                   |       |       |       |     |       |       |       |   |   |   |   |   |   |
| Tax-exempt income                                  |       | (2,005     | )          | (37.5    | )          | (1,757     | )          | (20.9 | ) | (1,512 | ) | (15.9 | ) |
| Tax credits                                        |       | (560       | )          | (10.5    | )          | (601       | )          | (7.2 | ) | (1,048 | ) | (11.0 | ) |
| Other, net                                         |       | 4          |       | 0.1      |       | (96        | )          | (1.1 | ) | (38 | ) | (0.4 | ) |
|                                               |       |       |       |     |       |       |       |   |   |   |   |   |   |
| Effective income tax  (benefit) provision and rate |       | $          | (742       | )        | (13.9      | )%         | $          | 405 |   | 4.8 | % | $ | 637 |   | 6.7 | % |

 

**NOTE 12 - EMPLOYEE BENEFIT PLANS**

 

**Defined Benefit Pension Plan**

 

TheCompany has a noncontributory defined benefit pension plan (the “Plan”) for allemployees meeting certain age and length of service requirements that werehired prior to January 1, 2004, at which time entrance into the Plan wasfrozen.  Benefits are based primarily onyears of service and the average annual compensation during the highest fiveconsecutive years within the final ten years of employment.

 

Thefollowing table sets forth the obligation and funded status as of December 31,2009 and 2008:

 

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| **(In Thousands)**                                                               | ** ** | **2009** | ** ** | **2008** | ** ** |
|----------------------------------------------------------------------------------|------------|----------|------------|----------|------------|
| **Change in  benefit obligation:**                                               |       |     |       |     |       |
| Benefit obligation at  beginning of year                                         |       | $        | 11,987     |     | $          | 10,450 |   |
| Service cost                                                                     |       | 525      |       | 546      |       |
| Interest cost                                                                    |       | 679      |       | 609      |       |
| Actuarial (gain) loss                                                            |       | (6       | )          | (166     | )          |
| Benefits paid                                                                    |       | (293     | )          | (210     | )          |
| Other, change in actuarial  assumptions                                          |       | (1,563   | )          | 758      |       |
| Benefit obligation at end  of year                                               |       | 11,329   |       | 11,987   |       |
|                                                                             |       |     |       |     |       |
| **Change in  plan assets:**                                                      |       |     |       |     |       |
| Fair value of plan assets  at beginning of year                                  |       | 6,065    |       | 7,891    |       |
| Actual return on plan  assets                                                    |       | 1,396    |       | (2,504   | )          |
| Employer contribution                                                            |       | 805      |       | 875      |       |
| Benefits paid                                                                    |       | (312     | )          | (210     | )          |
| Adjustment to fair value  of plan assets                                         |       | —   |       | 13       |       |
| Fair value of plan assets  at end of year                                        |       | 7,954    |       | 6,065    |       |
| Funded status                                                                    |       | $        | (3,375     | )        | $          | (5,922 | ) |
|                                                                             |       |     |       |     |       |
| **Accounts  recognized on balance sheet as:**                                    |       |     |       |     |       |
| Total liabilities                                                                |       | $        | (3,375     | )        | $          | (5,922 | ) |
|                                                                             |       |     |       |     |       |
| **Amounts  not yet recognized as a component of net periodic pension cost:**     |       |     |       |     |       |
| Amounts recognized in  accumulated other comprehensive income (loss) consist of: |       |     |       |     |       |
| Net transition asset                                                             |       | $        | (7         | )        | $          | (9 | ) |
| Prior service cost                                                               |       | 102      |       | 127      |       |
| Net loss                                                                         |       | 2,814    |       | 5,609    |       |
| Total                                                                            |       | $        | 2,909      |     | $          | 5,727 |   |

 

The accumulated benefitobligation for the Plan was $9,871,000 and $9,410,000 at December 31, 2009and 2008, respectively.

 

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Components of Net Periodic Costand Other Amounts Recognized in other Comprehensive Income as of December 31,2009, 2008, and 2007 are as follows:

 
| **(In Thousands)**                     | ** ** | **2009**   | ** ** | **2008**   | ** ** | **2007**   | ** ** |
|----------------------------------------|------------|------------|------------|------------|------------|------------|------------|
| Net periodic pension cost:             | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** |
| Service cost                           |       | $          | 544        |       | $          | 546        |       | $ | 467 |   |
| Interest cost                          |       | 679        |       | 609        |       | 486        |       |
| Expected return on plan  assets        |       | (508       | )          | (641       | )          | (562       | )          |
| Amortization of transition  asset      |       | (3         | )          | (3         | )          | (3         | )          |
| Amortization of prior  service cost    |       | 25         |       | 25         |       | 26         |       |
| Amortization of  unrecognized net loss |       | 339        |       | 57         |       | —     |       |
| Net periodic benefit cost              |       | $          | 1,076      |       | $          | 593        |       | $ | 414 |   |

 

Theestimated net transition asset and prior service cost for the defined benefitpension plan that will be amortized from accumulated other comprehensive income(loss) into net periodic benefit cost over the next fiscal year are $3,000 and$25,000, respectively.

 

**Assumptions**

 

Weighted-averageassumptions used to determine benefit obligations at December 31, 2009,2008, and 2007:

 
| ** **                     | ** ** | **2009** | ** ** | **2008** | ** ** | **2007** | ** ** |
|--------------------------------|------------|----------|------------|----------|------------|----------|------------|
| Discount rate                  |       | 6.00     | %          | 5.75     | %          | 6.00     | %          |
| Rate of compensation  increase |       | 3.00     | %          | 4.75     | %          | 5.00     | %          |

 

Weighted-averageassumptions used to determine net periodic cost for years ended December 31,2009, 2008, and 2007:

 
| ** **                                | ** ** | **2009** | ** ** | **2008** | ** ** | **2007** | ** ** |
|-------------------------------------------|------------|----------|------------|----------|------------|----------|------------|
| Discount rate                             |       | 5.75     | %          | 6.00     | %          | 5.75     | %          |
| Expected long-term return  on plan assets |       | 8.00     | %          | 8.00     | %          | 8.00     | %          |
| Rate of compensation  increase            |       | 4.75     | %          | 5.00     | %          | 4.75     | %          |

 

Theexpected long-term rate of return was estimated using market benchmarks bywhich the plan assets would outperform the market value in the future, based onhistorical experience adjusted for changes in asset allocation and expectationsfor overall lower future returns on similar investments compared to pastperiods.

 

**Plan Assets**

 

ThePlan’s weighted-average asset allocations at December 31, 2009 and 2008 byasset category are as follows:

 
| **Asset Category**      | ** ** | **2009** | ** ** | **2008** | ** ** |
|-------------------------|------------|----------|------------|----------|------------|
| Cash                    |       | 0.4      | %          | 0.3      | %          |
| Fixed income securities |       | 40.0     | %          | 39.2     | %          |
| Equity                  |       | 59.6     | %          | 60.5     | %          |
| Total                   |       | 100.0    | %          | 100.0    | %          |

 

Theinvestment objective for the Plan is to maximize total return with tolerancefor slightly above average risk, meaning the fund is able to tolerateshort-term volatility to achieve above-average returns over the long term.

 

Assetallocation favors equities, with target allocation of approximately 60% equitysecurities, 37.5% fixed income securities and 2.5% cash.  Due to volatility in the market, the targetallocation is not always desirable and asset allocations will fluctuate betweenthe acceptable ranges.  The equityportfolio’s exposure is primarily in 

 

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midand large capitalization domestic equities with limited exposure to smallcapitalization and international stocks.

 

Itis management’s intent to give the investment managers flexibility, within theoverall guidelines, with respect to investment decisions and their timing.However, certain investments require specific review and approval bymanagement.  Management is also informedof anticipated, significant modifications of any previously approvedinvestment, or anticipated use of derivatives to execute investment strategies.

 

The following table setsforth by level, within the fair value hierarchy detailed in Note 20. Fair ValueMeasurements, the Plan’s assets at fair value as of December 31, 2009:

 

| ** **                          | ** ** | **December 31, 2009** | ** ** |
|-------------------------------------|------------|----------------------------|------------|
| **(In Thousands)**                  | ** ** | **Level I**                | ** ** | **Level II** | ** ** | **Level III** | ** ** | **Total** | ** ** |
| Assets:                             |       |                       |       |   |   |   |   |   |   |
| Cash and cash equivalents           |       | $                          | 34         |   | $ | — |   | $ | — |   | $ | 34 |   |
| Mutual Funds - Taxable Fixed Income |       | 3,184                      |       | — |   | — |   | 3,184 |   |
| Mutual Funds - Domestic Equity      |       | 3,782                      |       | — |   | — |   | 3,782 |   |
| Mutual Funds - International Equity |       | 954                        |       | — |   | — |   | 954 |   |
| Total assets at fair value          |       | $                          | 7,954      |   | $ | — |   | $ | — |   | $ | 7,954 |   |

 

Thefollowing benefit payments that reflect expected future service, asappropriate, are expected to be paid:

 

(In Thousands)

 

**Estimatedfuture benefit payments (in thousands):**

 
| 2010      |   | $      | 336    |   |
|-----------|--------|--------|--------|--------|
| 2011      |   | 361    |   |
| 2012      |   | 532    |   |
| 2013      |   | 553    |   |
| 2014      |   | 601    |   |
| 2015-2019 |   | 3,404  |   |
|      |   |   |   |
|      |   | $      | 5,787  |   |

 

Thecompany expects to contribute a minimum of $400,000 to its Pension Plan in2010.

 

**401(k) Savings Plan**

 

TheCompany also offers a 401(k) savings plan in which eligible participatingemployees may elect to contribute up to a maximum percentage allowable not toexceed the limits of Code Sections 401(k), 404, and 415.  The Company may make matching contributionsequal to a discretionary percentage that is determined by the Board ofDirectors.  Participants are at all timesfully vested in their contributions and vest over a period of five yearsregarding the employer contribution. Contribution expense was approximately $112,000, $97,000, and $97,000for the years ended December 31, 2009, 2008, and 2007, respectively.

 

**Deferred Compensation Plan**

 

TheCompany has a deferred compensation plan whereby participating directors electto forego directors’ fees paid in cash. Under this plan, the Company will make payments for a ten-year periodbeginning at age 65 in most cases or at death, if earlier, at which timepayments would be made to their designated beneficiaries.

 

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Tofund benefits under the deferred compensation plan, the Company has acquiredbank-owned life insurance policies on the lives of the participating directorsfor which insurance benefits are payable to the Company. The Company incurredexpenses related to the plan of $96,000, $96,000, and $85,000 for the yearsended December 31, 2009, 2008, and 2007, respectively.  Benefits paid under the plan wereapproximately $161,000, $180,000, and $125,000 in 2009, 2008, and 2007,respectively.

 

**NOTE 13 - EMPLOYEE STOCK PURCHASE PLAN**

 

EffectiveApril 26, 2006, the Company implemented the Penns Woods Bancorp, Inc.2006 Employee Stock Purchase Plan (“Plan”). The Plan is intended to encourageemployee participation in the ownership and economic progress of the Company.The Plan allows for up to 1,000,000 shares to be purchased by employees.  The purchase price of the shares is 95% ofmarket value with an employee eligible to purchase up to the lesser of 15% ofbase compensation or $12,000 in market value annually. There were 2,614 and3,264 shares issued under the plan for the years ended December 31, 2009and 2008, respectively.

 

**NOTE 14 - STOCK OPTIONS**

 

In1998, the Company adopted the 1998 Stock Option Plan (“1998 Plan”) for keyemployees and directors.  Incentive stockoptions and nonqualified stock options may be granted to eligible employees ofthe Bank and nonqualified options may be granted to directors of theCompany.  Incentive nonqualified stockoptions granted under the 1998 Plan may be exercised not later than ten yearsafter the date of grant.  Each optiongranted under the 1998 Plan shall be exercisable only after the expiration ofsix months following the date of grant of such options.

 

Asummary of the status of the Company’s common stock option plans are presentedbelow:

 
| ** **                       | ** ** | **2009**   | ** ** | **2008**     | ** ** |
|----------------------------------|------------|------------|------------|--------------|------------|
| ** **                       | ** ** | ** ** | ** ** | **Weighted** | ** ** | ** ** | ** ** | **Weighted** | ** ** |
| ** **                       | ** ** | ** ** | ** ** | **Average**  | ** ** | ** ** | ** ** | **Average** | ** ** |
| ** **                       | ** ** | ** ** | ** ** | **Exercise** | ** ** | ** ** | ** ** | **Exercise** | ** ** |
| ** **                       | ** ** | **Shares** | ** ** | **Price**    | ** ** | **Shares** | ** ** | **Price** | ** ** |
|                             |       |       |       |         |       |   |   |   |   |
| Outstanding, beginning of  year  |       | 1,980      |       | $            | 28.27      |   | 10,913 |   | $ | 37.60 |   |
| Granted                          |       | —     |       | —       |       | — |   | — |   |
| Exercised                        |       | —     |       | —       |       | (330 | ) | 31.82 |   |
| Forfeited                        |       | (990       | )          | 31.82        |       | (8,603 | ) | 39.97 |   |
|                             |       |       |       |         |       |   |   |   |   |
| Outstanding, end of year         |       | 990        |       | 24.72        |       | 1,980 |   | 28.27 |   |
|                             |       |       |       |         |       |   |   |   |   |
| Options exercisable at  year-end |       | 990        |       | $            | 24.72      |   | 1,980 |   | $ | 28.27 |   |

 

Thefollowing table summarizes information about nonqualified and incentive stockoptions outstanding at December 31, 2009:

 
| ** **         | ** **  | **Outstanding** | ** ** | **Exercisable** | ** ** |
|--------------------|-------------|-----------------|------------|-----------------|------------|
| ** **         | ** **  | ** **      | ** ** | ** **      | ** ** | **Average** | ** ** | ** ** | ** ** | **Average** | ** ** |
| ** **         | ** **  | ** **      | ** ** | **Average**     | ** ** | **Exercise** | ** ** | ** ** | ** ** | **Exercise** | ** ** |
| **Exercise Price** | ** **  | **Shares**      | ** ** | **Life**        | ** ** | **Price** | ** ** | **Shares** | ** ** | **Price** | ** ** |
| $                  |  24.72 |            | 990        |            | 1          |   | $ | 24.72 |   | 990 |   | $ | 24.72 |   |
|                    |             |                 |            |                 |            |  |  |  |  |  |  |  |  |  |

 

**NOTE 15 - RELATED PARTY TRANSACTIONS**

 

Certaindirectors and executive officers of the Company and the Bank, including theirimmediate families and 

 

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companiesin which they are principal owners (more than ten percent), are indebted to theCompany.  Such indebtedness was incurredin the ordinary course of business on the same terms and at those rates prevailingat the time for comparable transactions with others.

 

A summary of loan activity with executiveofficers, directors, principal shareholders, and associates of such persons islisted below for the years ended December 31, 2009 and 2008:

 
| ** **         | ** ** | **Beginning** | ** ** | ** **    | ** ** | ** **   | ** ** | **Other**   | ** ** | **Ending**  | ** ** |
|--------------------|------------|---------------|------------|---------------|------------|--------------|------------|-------------|------------|-------------|------------|
| **(In Thousands)** | ** ** | **Balance**   | ** ** | **Additions** | ** ** | **Payments** | ** ** | **Changes** | ** ** | **Balance** | ** ** |
|               |       |          |       |          |       |         |       |        |       |        |       |
| 2009               |       | $             | 8,942      |          | $          | 980          |       | $           | (1,178     | )           | $          | — |   | $ | 8,744 |   |
| 2008               |       | 9,335         |       | 1,626         |       | (1,776       | )          | (243        | )          | 8,942       |       |
|                    |            |               |            |               |            |              |            |             |            |             |            |  |  |  |  |  |

 

Depositsfrom related parties held by the Bank amounted to $7,576,000 at December 31,2009 and $7,377,000 at December 31, 2008.

 

**NOTE 16 — COMMITMENTS AND CONTINGENT LIABILITIES**

 

Thefollowing schedule shows future minimum rental payments under operating leaseswith noncancellable terms in excess of one year as of December 31, 2009:

 

(In Thousands)

 
| 2010       |   | $     | 383    |   |
|------------|--------|-------|--------|--------|
| 2011       |   | 317   |   |
| 2012       |   | 296   |   |
| 2013       |   | 227   |   |
| 2014       |   | 181   |   |
| Thereafter |   | 1,522 |   |
| Total      |   | $     | 2,926  |   |

 

TheCompany’s operating lease obligations represent short and long-term lease andrental payments for facilities.  Totalrental expense for all operating leases for the years ended December 31,2009, 2008, and 2007 were $392,000, $406,000, and $423,000.

 

TheCompany is subject to lawsuits and claims arising out of its business.  There are no such legal proceedings or claimscurrently pending or threatened other than those encountered during the normalcourse of business.

 

**NOTE 17 - OFF-BALANCE SHEET RISK**

 

TheCompany is a party to financial instruments with off-balance sheet risk in thenormal course of business to meet the financing needs of its customers. Thesefinancial instruments include commitments to extend credit and standby lettersof credit.  These instruments involve, tovarying degrees, elements of credit, interest rate, or liquidity risk in excessof the amount recognized in the consolidated balance sheet. The contractamounts of these instruments express the extent of involvement the Company hasin particular classes of financial instruments.

 

TheCompany’s exposure to credit loss from nonperformance by the other party to thefinancial instruments for commitments to extend credit and standby letters ofcredit is represented by the contractual amount of these instruments.  The Company uses the same credit policies inmaking commitments and conditional obligations as it does for on-balance sheetinstruments.  The Company may requirecollateral or other security to support financial instruments with off-balancesheet credit risk.

 

Financialinstruments whose contract amounts represent credit risk are as follows at December 31,2009 and 2008:

 

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| **(In Thousands)**           | ** ** | **2009** | ** ** | **2008** | ** ** |
|------------------------------|------------|----------|------------|----------|------------|
| Commitments to extend credit |       | $        | 80,061     |     | $          | 85,871 |   |
| Standby letters of credit    |       | 1,334    |       | 841      |       |
|                              |            |          |            |          |            |  |  |

 

Commitmentsto extend credit are legally binding agreements to lend to customers.  Commitments generally have fixed expirationdates or other termination clauses and may require payment of fees.  Since many of the commitments are expected toexpire without being drawn upon, the total commitment amounts do notnecessarily represent future liquidity requirements.  The Company evaluates each customer’s creditworthiness on a case-by-case basis.  Theamount of collateral obtained, if deemed necessary by the Company, on anextension of credit is based on management’s credit assessment of thecounterparty.

 

Standbyletters of credit represent conditional commitments issued by the Company toguarantee the performance of a customer to a third party.  These instruments are issued primarily tosupport bid or performance related contracts. The coverage period for these instruments is typically a one year periodwith an annual renewal option subject to prior approval by management.  Fees earned from the issuance of theseletters are recognized upon expiration of the coverage period.  For secured letters of credit, the collateralis typically Bank deposit instruments or customer business assets.

 

**NOTE 18 - CAPITAL REQUIREMENTS**

 

Federalregulations require the Company and the Bank to maintain minimum amounts ofcapital.  Specifically, each is requiredto maintain certain minimum dollar amounts and ratios of Total and Tier 1capital to risk-weighted assets and of Tier 1 capital to average total assets.

 

Inaddition to the capital requirements, the Federal Deposit Insurance CorporationImprovement Act (“FDICIA”) established five capital categories ranging from “wellcapitalized” to “critically undercapitalized.” Should any institution fail to meet the requirements to be considered “adequatelycapitalized,” it would become subject to a series of increasingly restrictiveregulatory actions.

 

Asof December 31, 2009 and 2008, the FDIC categorized the Bank as wellcapitalized under the regulatory framework for prompt corrective action.  To be classified as a well capitalizedfinancial institution, Total risk-based, Tier 1 risk-based, and Tier 1 leveragecapital ratios must be at least 10%, 6%, and 5%, respectively.

 

TheCompany’s and the Bank’s actual capital ratios are presented in the followingtables, which shows that both met all regulatory capital requirements.

 

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**ConsolidatedCompany**

 
| ** **                     | ** ** | **2009**   | ** ** | **2008**  | ** ** |
|--------------------------------|------------|------------|------------|-----------|------------|
| **(In  Thousands)**            | ** ** | **Amount** | ** ** | **Ratio** | ** ** | **Amount** | ** ** | **Ratio** | ** ** |
| **Total Capital**              |       |       |       |      |       |   |   |   |   |
| **(to Risk-weighted Assets)**  |       |       |       |      |       |   |   |   |   |
| Actual                         |       | $          | 67,738     |      | 15.4       | % | $ | 66,891 |   | 16.0 | % |
| For  Capital Adequacy Purposes |       | 35,094     |       | 8.0       |       | 33,410 |   | 8.0 |   |
| To  Be Well Capitalized        |       | 43,867     |       | 10.0      |       | 41,763 |   | 10.0 |   |
|                           |       |       |       |      |       |   |   |   |   |
| **Tier I Capital**             |       |       |       |      |       |   |   |   |   |
| **(to Risk-weighted Assets)**  |       |       |       |      |       |   |   |   |   |
| Actual                         |       | $          | 62,709     |      | 14.3       | % | $ | 62,540 |   | 15.0 | % |
| For  Capital Adequacy Purposes |       | 17,547     |       | 4.0       |       | 16,705 |   | 4.0 |   |
| To  Be Well Capitalized        |       | 26,320     |       | 6.0       |       | 25,058 |   | 6.0 |   |
|                           |       |       |       |      |       |   |   |   |   |
| **Tier I Capital**             |       |       |       |      |       |   |   |   |   |
| **(to Average Assets)**        |       |       |       |      |       |   |   |   |   |
| Actual                         |       | $          | 62,709     |      | 9.3        | % | $ | 62,540 |   | 9.7 | % |
| For  Capital Adequacy Purposes |       | 26,914     |       | 4.0       |       | 25,773 |   | 4.0 |   |
| To  Be Well Capitalized        |       | 33,642     |       | 5.0       |       | 32,216 |   | 5.0 |   |

 

**Bank**

 
| ** **                     | ** ** | **2009**   | ** ** | **2008**  | ** ** |
|--------------------------------|------------|------------|------------|-----------|------------|
| **(In  Thousands)**            | ** ** | **Amount** | ** ** | **Ratio** | ** ** | **Amount** | ** ** | **Ratio** | ** ** |
| **Total Capital**              |       |       |       |      |       |   |   |   |   |
| **(to Risk-weighted Assets)**  |       |       |       |      |       |   |   |   |   |
| Actual                         |       | $          | 58,024     |      | 13.4       | % | $ | 56,876 |   | 13.9 | % |
| For  Capital Adequacy Purposes |       | 34,632     |       | 8.0       |       | 32,799 |   | 8.0 |   |
| To  Be Well Capitalized        |       | 43,290     |       | 10.0      |       | 40,998 |   | 10.0 |   |
|                           |       |       |       |      |       |   |   |   |   |
| **Tier I Capital**             |       |       |       |      |       |   |   |   |   |
| **(to Risk-weighted Assets)**  |       |       |       |      |       |   |   |   |   |
| Actual                         |       | $          | 53,359     |      | 12.3       | % | $ | 52,520 |   | 12.8 | % |
| For  Capital Adequacy Purposes |       | 17,316     |       | 4.0       |       | 16,399 |   | 4.0 |   |
| To  Be Well Capitalized        |       | 25,974     |       | 6.0       |       | 24,599 |   | 6.0 |   |
|                           |       |       |       |      |       |   |   |   |   |
| **Tier I Capital**             |       |       |       |      |       |   |   |   |   |
| **(to Average Assets)**        |       |       |       |      |       |   |   |   |   |
| Actual                         |       | $          | 53,359     |      | 8.0        | % | $ | 52,520 |   | 8.3 | % |
| For  Capital Adequacy Purposes |       | 26,669     |       | 4.0       |       | 25,423 |   | 4.0 |   |
| To  Be Well Capitalized        |       | 33,336     |       | 5.0       |       | 31,778 |   | 5.0 |   |

 

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**NOTE 19 - REGULATORY RESTRICTIONS**

 

ThePennsylvania Banking Code restricts the availability of capital funds forpayment of dividends by all state-chartered banks. Accordingly, at December 31,2009, the balance in the additional paid in capital account totaling$11,657,000 is unavailable for dividends.

 

TheBank is subject to regulatory restrictions, which limit its ability to loanfunds to Penns Woods Bancorp, Inc. At December 31, 2009, the regulatory lending limit amounted toapproximately $8,704,000.

 

**Cash and Due from Banks**

Includedin cash and due from banks are reserves required by the district FederalReserve Bank of $1,064,000 and $1,046,000 at December 31, 2009 and 2008,respectively.  The required reserves arecomputed by applying prescribed ratios to the classes of average depositbalances.  These are held in the form ofcash on hand and a balance maintained directly with the Federal Reserve Bank.

 

**NOTE 20 - FAIR VALUE MEASUREMENTS**

 

Thefollowing disclosures show the hierarchal disclosure framework associated withthe level of pricing observations utilized in measuring assets and liabilitiesat fair value.  The three broad levelsdefined by GAAP are as follows:

 
| Level  I:   |   | Quoted  prices are available in active markets for identical assets or liabilities as  of the reported date.                                                                                                                                                                                                                                                                                     |
|-------------|--------|--------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
|        |   |                                                                                                                                                                                                                                                                                                                                                                                             |
| Level  II:  |   | Pricing  inputs are other than quoted prices in active markets, which are either  directly or indirectly observable as of the reported date. The nature of  these assets and liabilities includes items for which quoted prices are  available but traded less frequently, and items that are fair valued using  other financial instruments, the parameters of which can be directly  observed. |
|        |   |                                                                                                                                                                                                                                                                                                                                                                                             |
| Level  III: |   | Valuations  derived from valuation techniques in which one or more significant inputs or  significant value drivers are unobservable.                                                                                                                                                                                                                                                            |

 

Thishierarchy requires the use of observable market data when available.

 

Thefollowing table presents the assets reported on the balance sheet at their fairvalue on a recurring basis as of December 31, 2009 and 2008, by levelwithin the fair value hierarchy. As required by GAAP, financial assets andliabilities are classified in their entirety based on the lowest level of inputthat is significant to the fair value measurement.

 

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| ** **                                 | ** ** | **2009**    | ** ** |
|--------------------------------------------|------------|-------------|------------|
| **(In  Thousands)**                        | ** ** | **Level I** | ** ** | **Level II** | ** ** | **Level III** | ** ** | **Total** | ** ** |
|                                       |       |        |       |   |   |   |   |   |   |
| Assets  Measured on a Recurring Basis:     |       |        |       |   |   |   |   |   |   |
| Investment  securities, available for sale |       |        |       |   |   |   |   |   |   |
| U.S.  Government and agency securities     |       | $           | —     |   | $ | 39,136 |   | $ | — |   | $ | 39,136 |   |
| State  and political securities            |       | —      |       | 144,877 |   | — |   | 144,877 |   |
| Other  debt securties                      |       | —      |       | 12,976 |   | — |   | 12,976 |   |
| Equity  securities                         |       | 11,779      |       | — |   | — |   | 11,779 |   |
|                                            |            |             |            |  |  |  |  |  |  |  |  |  |  |

 
| ** **                                 | ** ** | **2008**    | ** ** |
|--------------------------------------------|------------|-------------|------------|
| **(In  Thousands)**                        | ** ** | **Level I** | ** ** | **Level II** | ** ** | **Level III** | ** ** | **Total** | ** ** |
|                                       |       |        |       |   |   |   |   |   |   |
| Assets  Measured on a Recurring Basis:     |       |        |       |   |   |   |   |   |   |
| Investment  securities, available for sale |       |        |       |   |   |   |   |   |   |
| U.S.  Government and agency securities     |       | $           | —     |   | $ | 47,586 |   | $ | — |   | $ | 47,586 |   |
| State  and political securities            |       | —      |       | 131,842 |   | — |   | 131,842 |   |
| Other  debt securties                      |       | —      |       | 15,554 |   | — |   | 15,554 |   |
| Equity  securities                         |       | 13,269      |       | — |   | — |   | 13,269 |   |
|                                            |            |             |            |  |  |  |  |  |  |  |  |  |  |

 

Thefollowing table presents the assets reported on the balance sheet at their fairvalue on a non-recurring basis as of December 31, 2009 and 2008, by levelwithin the fair value hierarchy. As required by GAAP, financial assets andliabilities are classified in their entirety based on the lowest level of inputthat is significant to the fair value measurement.

 
| ** **                                 | ** ** | **2009**    | ** ** |
|--------------------------------------------|------------|-------------|------------|
| **(In  Thousands)**                        | ** ** | **Level I** | ** ** | **Level II** | ** ** | **Level III** | ** ** | **Total** | ** ** |
|                                       |       |        |       |   |   |   |   |   |   |
| Assets  Measured on a Non-recurring Basis: |       |        |       |   |   |   |   |   |   |
| Impaired  Loans                            |       | $           | —     |   | $ | 7,510 |   | $ | — |   | $ | 7,510 |   |
| Other  real estate owned                   |       | —      |       | 672 |   | — |   | 672 |   |
|                                            |            |             |            |  |  |  |  |  |  |  |  |  |  |

 
| ** **                                 | ** ** | **2008**    | ** ** |
|--------------------------------------------|------------|-------------|------------|
| **(In  Thousands)**                        | ** ** | **Level I** | ** ** | **Level II** | ** ** | **Level III** | ** ** | **Total** | ** ** |
|                                       |       |        |       |   |   |   |   |   |   |
| Assets  Measured on a Non-recurring Basis: |       |        |       |   |   |   |   |   |   |
| Impaired  Loans                            |       | $           | —     |   | $ | 4,876 |   | $ | — |   | $ | 4,876 |   |
| Other  real estate owned                   |       | —      |       | 466 |   | — |   | 466 |   |
|                                            |            |             |            |  |  |  |  |  |  |  |  |  |  |

 

**NOTE 21 - FAIR VALUE OF FINANCIAL INSTRUMENTS**

 

TheCompany is required to disclose fair values for its financial instruments.  Fair values are made at a specific point intime, based on relevant market information and information about the financialinstrument.  These fair values do notreflect any premium or discount that could result from offering for sale at onetime the Company’s entire holdings of a particular financial instrument.  Also, it is the Company’s general practiceand intention to hold most of its financial instruments to maturity and not toengage in trading or sales activities. Because no market exists for a significant portion of the Company’sfinancial instruments, fair values are based on judgments regarding futureexpected loss experience, current economic conditions, risk characteristics ofvarious financial instruments, and other factors.  These fair values are subjective in natureand involve uncertainties and matters of significant judgment and thereforecannot be determined with precision. Changes in assumptions can significantly affect the fair values.

 

Fairvalues have been determined by the Company using historical data and anestimation methodology suitable for each category of financialinstruments.  The Company’s fair values,methods, and assumptions are set forth below for the Company’s other financialinstruments.

 

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Ascertain assets and liabilities, such as deferred tax assets, premises andequipment, and many other operational elements of the Company, are notconsidered financial instruments but have value, the fair value of financialinstruments would not represent the full market value of the Company.

 

Thefair values of the Company’s financial instruments are as follows at December 31,2009 and 2008:

### ** **

| ** **                   | ** ** | **2009**     | ** ** | **2008**  | ** ** |
|------------------------------|------------|--------------|------------|-----------|------------|
| ** **                   | ** ** | **Carrying** | ** ** | **Fair**  | ** ** | **Carrying** | ** ** | **Fair** | ** ** |
| **(In  Thousands)**          | ** ** | **Value**    | ** ** | **Value** | ** ** | **Value** | ** ** | **Value** | ** ** |
| Financial assets:            |       |         |       |      |       |   |   |   |   |
| Cash and cash equivalents    |       | $            | 13,788     |      | $          | 13,788 |   | $ | 16,581 |   | $ | 16,581 |   |
| Investment securities:       |       |         |       |      |       |   |   |   |   |
| Available for sale           |       | 208,768      |       | 208,768   |       | 208,251 |   | 208,251 |   |
| Held to maturity             |       | 107          |       | 108       |       | 135 |   | 136 |   |
| Loans held for sale          |       | 4,063        |       | 4,063     |       | 3,622 |   | 3,622 |   |
| Loans, net                   |       | 400,872      |       | 403,279   |       | 377,122 |   | 380,771 |   |
| Bank-owned life insurance    |       | 14,942       |       | 14,942    |       | 14,546 |   | 14,546 |   |
| Accrued interest receivable  |       | 3,523        |       | 3,523     |       | 3,614 |   | 3,614 |   |
|                         |       |         |       |      |       |   |   |   |   |
| Financial liabilities:       |       |         |       |      |       |   |   |   |   |
| Interest-bearing deposits    |       | $            | 417,388    |      | $          | 408,056 |   | $ | 345,333 |   | $ | 347,657 |   |
| Noninterest-bearing deposits |       | 79,899       |       | 79,899    |       | 76,035 |   | 76,035 |   |
| Short-term borrowings        |       | 18,354       |       | 18,354    |       | 73,946 |   | 73,946 |   |
| Long-term borrowings, FHLB   |       | 86,778       |       | 89,082    |       | 86,778 |   | 88,188 |   |
| Accrued interest payable     |       | 1,073        |       | 1,073     |       | 1,317 |   | 1,317 |   |

 

**Cash and Cash Equivalents,Loans Held for Sale, Accrued Interest Receivable, Short-term Borrowings, andAccrued Interest Payable:**

The fair value is equal to the carrying value.

 

**Investment Securities:**

Thefair value of investment securities available for sale and held to maturity isequal to the available quoted market price. If no quoted market price isavailable, fair value is determined by using the quoted market price forsimilar securities.  Regulatory stocks’fair value is equal to the carrying value.

 

**Loans:**

Fairvalues are determined for portfolios of loans with similar financialcharacteristics.  Loans are segregated bytype such as commercial, commercial real estate, residential real estate,construction real estate, and other consumer. Each loan category is further segmented into fixed and adjustable rateinterest terms and by performing and nonperforming categories.

 

The fair value of performing loans is calculated by discounting scheduledcash flows through the estimated maturity using market discount rates thatreflect the credit and interest rate risk inherent in the loan.  The estimate of maturity is based on theCompany’s historical experience with repayments for each loan classification,modified, as required, by an estimate of the effect of current economic andlending conditions.

 

Fair value forsignificant nonperforming loans is based on recent external appraisals.  If appraisals are not available, estimatedcash flows are discounted using a rate commensurate with the risk associatedwith the estimated cash flows. Assumptions regarding credit risk, cash flows, and discounted rates arejudgmentally determined using available market information and specificborrower information.

 

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**Bank-Owned Life Insurance:**

Thefair value is equal to the cash surrender value of the life insurance policies.

 

**Deposits:**

Thefair value of deposits with no stated maturity, such as noninterest-bearingdemand deposits, savings, NOW, and money market accounts, is equal to theamount payable on demand as of December 31, 2009 and 2008.  The fair value of certificates of deposit isbased on the discounted value of contractual cash flows.

 

Thefair values above do not include the benefit that results from the low-costfunding provided by the deposit liabilities compared to the cost of borrowingfunds in the market, commonly referred to as the core deposit intangible.

 

**LongTerm Borrowings:**

Thefair value of long term borrowings is based on the discounted value ofcontractual cash flows.

 

**Commitments to Extend Credit,Standby Letters of Credit, and Financial Guarantees Written:**

There is no material difference between the notional amount and the fairvalue of off-balance sheet items at December 31, 2009 and 2008.  The contractual amounts of unfundedcommitments and letters of credit are presented in Note 17.

 

**NOTE 22 — PARENT COMPANY ONLY FINANCIAL STATEMENTS**

 

Condensed financial information for Penns Woods Bancorp, Inc.follows:

 

**CONDENSED BALANCE SHEET, DECEMBER 31,**

(In Thousands)

 
| ** **                                    | ** ** | **2009** | ** ** | **2008** | ** ** |
|-----------------------------------------------|------------|----------|------------|----------|------------|
|                                          |       |     |       |     |       |
| ASSETS:                                       |       |     |       |     |       |
| Cash                                          |       | $        | 103        |     | $          | 94 |   |
| Investment in subsidiaries:                   |       |     |       |     |       |
| Bank                                          |       | 55,117   |       | 49,327   |       |
| Nonbank                                       |       | 11,553   |       | 11,463   |       |
| Other assets                                  |       | 223      |       | 225      |       |
|                                          |       |     |       |     |       |
| Total Assets                                  |       | $        | 66,996     |     | $          | 61,109 |   |
|                                          |       |     |       |     |       |
| LIABILITIES AND SHAREHOLDERS’ EQUITY:    |       |     |       |     |       |
| Other liabilities                             |       | $        | 80         |     | $          | 82 |   |
| Shareholders’ equity                     |       | 66,916   |       | 61,027   |       |
|                                          |       |     |       |     |       |
| Total liability and shareholders’ equity |       | $        | 66,996     |     | $          | 61,109 |   |

 

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**CONDENSED STATEMENT OF INCOME**

**FOR THE YEARS ENDED DECEMBER 31,**

(In Thousands)

 
| ** **                                       | ** ** | **2009** | ** ** | **2008** | ** ** | **2007** | ** ** |
|--------------------------------------------------|------------|----------|------------|----------|------------|----------|------------|
|                                             |       |     |       |     |       |     |       |
| Operating income:                                |       |     |       |     |       |     |       |
| Dividends from subsidiaries                      |       | $        | 7,283      |     | $          | 8,763    |       | $ | 8,039 |   |
| Security gains                                   |       | 1        |       | —   |       | —   |       |
| Equity in undistributed earnings of subsidiaries |       | (897     | )          | (485     | )          | 1,152    |       |
|                                             |       |     |       |     |       |     |       |
| Operating expenses:                              |       | (294     | )          | (275     | )          | (314     | )          |
|                                             |       |     |       |     |       |     |       |
| Net income                                       |       | $        | 6,093      |     | $          | 8,003    |       | $ | 8,877 |   |

 

**CONDENSED STATEMENT OF CASH FLOWS**

**FOR THE YEARS ENDED DECEMBER 31,**

 

(In Thousands)

 
| ** **                                                                         | ** ** | **2009** | ** ** | **2008** | ** ** | **2007** | ** ** |
|------------------------------------------------------------------------------------|------------|----------|------------|----------|------------|----------|------------|
|                                                                               |       |     |       |     |       |     |       |
| OPERATING ACTIVITIES:                                                              |       |     |       |     |       |     |       |
| Net income                                                                         |       | $        | 6,093      |     | $          | 8,003    |       | $ | 8,877 |   |
| Adjustments to reconcile net income to net cash  provided by operating activities: |       |     |       |     |       |     |       |
| Equity in undistributed earnings of subsidiaries                                   |       | 897      |       | 485      |       | (1,152   | )          |
| Other, net                                                                         |       | —   |       | (43      | )          | 67       |       |
| Net cash provided by operating activities                                          |       | 6,990    |       | 8,445    |       | 7,792    |       |
|                                                                               |       |     |       |     |       |     |       |
| INVESTING ACTIVITIES:                                                              |       |     |       |     |       |     |       |
| Investment in subsidiaries                                                         |       | —   |       | —   |       | —   |       |
|                                                                               |       |     |       |     |       |     |       |
| FINANCING ACTIVITIES:                                                              |       |     |       |     |       |     |       |
| Dividends paid                                                                     |       | (7,052   | )          | (7,096   | )          | (6,953   | )          |
| Issuance of common stock                                                           |       | 71       |       | 90       |       | 99       |       |
| Stock options exercised                                                            |       | —   |       | 11       |       | 8        |       |
| Purchase of treasury stock                                                         |       | —   |       | (1,371   | )          | (972     | )          |
| Net cash used for financing activities                                             |       | (6,981   | )          | (8,366   | )          | (7,818   | )          |
|                                                                               |       |     |       |     |       |     |       |
| NET INCREASE (DECREASE) IN CASH                                                    |       | 9        |       | 79       |       | (26      | )          |
| CASH, BEGINNING OF YEAR                                                            |       | 94       |       | 15       |       | 41       |       |
| CASH, END OF YEAR                                                                  |       | $        | 103        |     | $          | 94       |       | $ | 15 |   |

 

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**NOTE 23 —CONSOLIDATED QUARTERLY FINANCIAL DATA (UNAUDITED)**

 

(InThousands, Except Per Share Data)

** **
| ** **                                   | ** ** | **For The Three Months Ended** | ** ** |
|----------------------------------------------|------------|--------------------------------|------------|
| **2009**                                     | ** ** | **March 31,**             | ** ** | **June 30,** | ** ** | **Sept. 30,** | ** ** | **Dec. 31,** | ** ** |
| Interest income                              |       | $                              | 8,917      |   | $ | 9,013 |   | $ | 9,113 |   | $ | 9,148 |   |
| Interest expense                             |       | 3,080                          |       | 3,208 |   | 3,168 |   | 2,942 |   |
|                                         |       |                           |       |   |   |   |   |   |   |
| Net interest income                          |       | 5,837                          |       | 5,805 |   | 5,945 |   | 6,206 |   |
|                                         |       |                           |       |   |   |   |   |   |   |
| Provision for loan losses                    |       | 126                            |       | 186 |   | 270 |   | 335 |   |
| Non-interest income                          |       | 1,593                          |       | 1,694 |   | 1,888 |   | 1,958 |   |
| Securities gains (losses), net               |       | (2,369                         | )          | (2,086 | ) | (507 | ) | 116 |   |
| Non-interest expense                         |       | 4,645                          |       | 4,885 |   | 5,097 |   | 5,185 |   |
|                                         |       |                           |       |   |   |   |   |   |   |
| Income before income tax (benefit) provision |       | 290                            |       | 342 |   | 1,959 |   | 2,760 |   |
| Income tax (benefit) provision               |       | (549                           | )          | (490 | ) | 37 |   | 260 |   |
|                                         |       |                           |       |   |   |   |   |   |   |
| Net income                                   |       | $                              | 839        |   | $ | 832 |   | $ | 1,922 |   | $ | 2,500 |   |
|                                         |       |                           |       |   |   |   |   |   |   |
| Earnings per share - basic                   |       | $                              | 0.22       |   | $ | 0.22 |   | $ | 0.50 |   | $ | 0.65 |   |
|                                         |       |                           |       |   |   |   |   |   |   |
| Earnings per share - diluted                 |       | $                              | 0.22       |   | $ | 0.22 |   | $ | 0.50 |   | $ | 0.65 |   |

 
| **2008**                                     | ** ** | **March 31,** | ** ** | **June 30,** | ** ** | **Sept. 30,** | ** ** | **Dec. 31,** | ** ** |
|----------------------------------------------|------------|--------------------|------------|-------------------|------------|---------------|------------|-------------------|------------|
| Interest income                              |       | $                  | 9,048      |              | $          | 8,936         |       | $                 | 9,108      |   | $ | 9,016 |   |
| Interest expense                             |       | 4,167              |       | 3,780             |       | 3,595         |       | 3,290             |       |
|                                         |       |               |       |              |       |          |       |              |       |
| Net interest income                          |       | 4,881              |       | 5,156             |       | 5,513         |       | 5,726             |       |
|                                         |       |               |       |              |       |          |       |              |       |
| Provision for loan losses                    |       | 60                 |       | 60                |       | 110           |       | 145               |       |
| Non-interest income                          |       | 1,876              |       | 1,872             |       | 1,976         |       | 1,763             |       |
| Securities gains (losses), net               |       | 38                 |       | (251              | )          | (1,504        | )          | (314              | )          |
| Non-interest expense                         |       | 4,445              |       | 4,511             |       | 4,451         |       | 4,542             |       |
|                                         |       |               |       |              |       |          |       |              |       |
| Income before income tax provision (benefit) |       | 2,290              |       | 2,206             |       | 1,424         |       | 2,488             |       |
| Income tax provision (benefit)               |       | 159                |       | 149               |       | (128          | )          | 225               |       |
|                                         |       |               |       |              |       |          |       |              |       |
| Net income                                   |       | $                  | 2,131      |              | $          | 2,057         |       | $                 | 1,552      |   | $ | 2,263 |   |
|                                         |       |               |       |              |       |          |       |              |       |
| Earnings per share - basic                   |       | $                  | 0.55       |              | $          | 0.53          |       | $                 | 0.40       |   | $ | 0.59 |   |
|                                         |       |               |       |              |       |          |       |              |       |
| Earnings per share - diluted                 |       | $                  | 0.55       |              | $          | 0.53          |       | $                 | 0.40       |   | $ | 0.59 |   |

 

**NOTE 24****—****SUBSEQUENT EVENTS**

 

TheCompany assessed events occurring subsequent to December 31, 2009 through March 9,2010 for potential recognition and disclosure in the consolidated financialstatements.  No events have occurred thatwould require adjustment to or disclosure in the consolidated financialstatements which were issued on March 9, 2010.

 

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**ITEM 9****                  ****CHANGES IN AND DISAGREEMENTS WITHACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE**

 

None.

 

**ITEM9A****               ****CONTROLS AND PROCEDURES**

 

TheCompany, under the supervision and with the participation of the Company’smanagement, including the Company’s President and Chief Executive Officer alongwith the Company’s Chief Financial Officer, conducted an evaluated of theeffectiveness as of December 31, 2009 of the design and operation of theCompany’s disclosure controls and procedures, as such term is defined under Rule 13a-15(e) promulgatedunder the Securities Exchange Act of 1934, as amended (the “Exchange Act”).  Based upon that evaluation, the Company’sPresident and Chief Executive Officer along with the Company’s Chief FinancialOfficer concluded that the Company’s disclosure controls and procedures wereeffective as of December 31, 2009.

 

Therehave been no changes in the Company’s internal control over financial reportingduring the fourth quarter of 2009 that have materially affected, or arereasonably likely to materially affect, the Company’s internal control overfinancial reporting.

 

**Management’s Report on Internal Control Over Financial Reporting**

Managementof the Company is responsible for establishing and maintaining adequateinternal control over financial reporting as defined in Rules 13a-15(f) and15d-15(f) under the Exchange Act. The Company’s internal control overfinancial reporting is designed to provide reasonable assurance regarding thereliability of financial reporting and the preparation of financial statementsfor external purposes in accordance with generally accepted accountingprinciples.

 

Becauseof its inherent limitations, internal control over financial reporting may notprevent or detect misstatements. Also, projections of any evaluation ofeffectiveness to future periods are subject to the risk that controls maybecome inadequate because of changes in conditions, or that the degree ofcompliance with the policies or procedures may deteriorate.

 

Amaterial weakness is a significant deficiency (as defined in Public CompanyAccounting Oversight Board Auditing Standard No. 2), or a combination ofsignificant deficiencies, that results in there being more than a remotelikelihood that a material misstatement of the annual or interim financialstatements will not be prevented or detected on a timely basis by management oremployees in the normal course of performing their assigned functions.

 

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Managementassessed the effectiveness of the Company’s internal control over financialreporting as of December 31, 2009. Management’s assessment did notidentify any material weaknesses in the Company’s internal control overfinancial reporting.

 

Inmaking this assessment, management used the criteria set forth by the Committeeof Sponsoring Organizations of the Treadway Commission (COSO) in InternalControl-Integrated Framework. Because there were no material weaknessesdiscovered, management believes that, as of December 31, 2009, the Company’sinternal control over financial reporting was effective.

 

S.R.Snodgrass, A.C. an independent registered public accounting firm, has auditedthe consolidated financial statements included in this Annual Report on Form 10-K,as part of the audit, has issued  areport, which appears below, on the effectiveness of the Company’s internalcontrol over financial reporting as of December 31, 2009.

 
| Date:  March 9, 2010 | /s/  Ronald A. Walko     |   | /s/  Brian L. Knepp      |
|---------------------------|--------------------------|--------|--------------------------|
|                      | Chief  Executive Officer |   | Chief  Financial Officer |

 

**REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM**

 

 

Boardof Directors and Shareholders

PennsWoods Bancorp, Inc.

 

Wehave audited Penns Woods Bancorp, Inc. and subsidiaries’ internal controlover financial reporting as of December 31, 2009, based on criteriaestablished in *Internal Control — Integrated Framework*issuedby the Committee of Sponsoring Organizations of the Treadway Commission.  Penns Woods Bancorp, Inc. management isresponsible for maintaining effective internal control over financial reportingand for its assessment of the effectiveness of internal control over financialreporting included in the accompanying Report on Management’s Assessment of InternalControl Over Financial Reporting.  Ourresponsibility is to express an opinion on the Company’s internal control overfinancial reporting based on our audit.

 

Weconducted our audit in accordance with the standards of the Public CompanyAccounting Oversight Board (United States). Those standards require that we plan and perform the audits to obtainreasonable assurance about whether effective internal control over financialreporting was maintained in all material respects.  Our audit included obtaining an understandingof internal control over financial reporting, assessing the risk that amaterial weakness exists, and testing and evaluating the design and operatingeffectiveness of internal control based on the assessed risk.  Our audits also included performing suchother procedures as we considered necessary in the circumstances.  We believe that our audit provides areasonable basis for our opinion.

 

A company’s internal controlover financial reporting is a process designed to provide reasonable assuranceregarding the reliability of financial reporting and the preparation offinancial statements for external purposes in accordance with generallyaccepted accounting principles.  Acompany’s internal control over financial reporting includes those policies andprocedures that (1) pertainto the maintenance of records that, in reasonable detail, accurately and fairlyreflect the transactions and dispositions of the assets of the company; (2) provide reasonable assurancethat transactions are recorded as necessary to permit preparation of financialstatements in accordance with generally accepted accounting principles, andthat receipts and expenditures of the company are being made only in accordancewith authorizations of management and directors of the company; and (3) provide reasonable assuranceregarding prevention or timely detection of unauthorized acquisition, use, ordisposition of the company’s assets that could have a material effect on thefinancial statements.

 

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Because of its inherentlimitations, internal control over financial reporting may not prevent ordetect misstatements.  Also, projectionsof any evaluation of effectiveness to future periods are subject to the riskthat controls may become inadequate because of changes in conditions, or thatthe degree of compliance with the policies or procedures may deteriorate.

 

Inour opinion, Penns Woods Bancorp, Inc. maintained, in all materialrespects, effective internal control over financial reporting as of December 31,2009, based on criteria established in *InternalControl — Integrated Framework* issued by the Committee of SponsoringOrganizations of the Treadway Commission.

 

Wehave also audited, in accordance with the standards of the Public CompanyAccounting Oversight Board (United States), the consolidated balance sheets of Penns Woods Bancorp, Inc. as of December 31,2009 and 2008, and the related consolidated statements of income,comprehensive income, stockholders’ equity, and cash flows for each of thethree years in the period ended December 31, 2009, and our report dated March 9,2010, expressed an unqualified opinion.

 

Wexford, Pennsylvania

March 9, 2010

 

**ITEM 9B — OTHER INFORMATION**

 

None.

 

**PART III**

 

**ITEM10    DIRECTORS, EXECUTIVE OFFICERS ANDCORPORATE GOVERNANCE**

 

The information appearingunder the captions “The Board of Directors and Committees,” “Election ofDirectors,” “Section 16(a) Beneficial Ownership Reporting Compliance,”“Principal Officers of the Corporation,” and “Certain Transactions” in theCompany’s Proxy Statement dated March 24, 2010 (the “Proxy Statement”) isincorporated herein by reference.

 

**ITEM 11    EXECUTIVE COMPENSATION**

 

Information appearingunder the captions “Compensation of Directors,” “Compensation CommitteeInterlocks and Insider Participation,” “Compensation Discussion and Analysis,” “CompensationCommittee and Benefits Committee Report,” and “Executive Compensation” in theProxy Statement is incorporated herein by reference.

 

**ITEM12    SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS ANDMANAGEMENT AND RELATED STOCKHOLDER MATTERS**

 

The information appearingunder the caption “Security Ownership of Certain Beneficial Owners andManagement” in the Proxy Statement is incorporated herein by reference.

 

**ITEM 13CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS, AND DIRECTOR INDEPENDENCE**

 

The information appearingunder the captions “Election of Directors” and “Certain Transactions” in theProxy Statement is incorporated herein by reference.

 

**ITEM 14PRINCIPAL ACCOUNTANT FEES AND SERVICES**

 

The information appearingin the Proxy Statement under the captions, “Audit Fees,” “Audit-Related Fees,” “TaxFees,” “All Other Fees,” and “Audit Committee Pre-Approval Policies andProcedures” is incorporated herein by reference.

 

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**PART IV**

** **

**ITEM15     EXHIBITS AND FINANCIAL STATEMENTSCHEDULES**

 

(a)1.  Financial Statements

The followingconsolidated financial statements and reports are set forth in Item 8:

Report ofIndependent Auditors

Consolidated BalanceSheet

Consolidated Statement ofIncome

Consolidated Statement ofChanges in Shareholders’ Equity

Consolidated Statement ofCash Flows

Notes to the ConsolidatedFinancial Statements

 

2.  FinancialStatement Schedules

Financial statementschedules are omitted because the required information is either notapplicable, not required or is shown in the respective financial statements orin the notes thereto.

 

(b) Exhibits
| (3)   (i) |   | Articles of  Incorporation of the Registrant, as presently in effect (incorporated by  reference to Exhibit 3(i) of the Registrant’s Annual Report on  Form 10-K for the year ended December 31, 2005).                                                                 |
|---------------------|--------|--------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
| (3)   (ii)     |   | Bylaws of the  Registrant as presently in effect (incorporated by reference to  Exhibit 3(ii) of the Registrant’s Current Report on Form 8-K  filed on June 17, 2005).                                                                                                  |
| (10) (i)       |   | Employment Agreement,  dated August, 1991, between Jersey Shore State Bank and Ronald A. Walko  (incorporated by reference to Exhibit 10.3 of the Registrant’s  Registration Statement on form S-4, No. 333-65821).*                                                              |
| (10) (ii)      |   | Employee Severance  Benefit Plan, dated May 30, 1996, for Ronald A. Walko (incorporated by  reference to Exhibit 10.4 of the Registrant’s Registration Statement on  form S-4, No. 333-65821).*                                                                              |
| (10) (iii)     |   | Penns Woods  Bancorp, Inc. 1998 Stock Option Plan (incorporated by reference to  Exhibit 10.1 of the Registrant’s Registration Statement on form S-4,  No. 333-65821).*                                                                                                      |
| (10) (iv)      |   | Form of First  Amendment to the Jersey Shore State Bank Amendment and Restatement of the  Director Fee Agreement, dated as of October 1, 2004 (incorporated by  reference to Exhibit 10.7 of the Registrant’s Current Report on  Form 8-K filed on June 29, 2006). |
| (10) (v)       |   | Consulting Agreement,  dated July 18, 2005 between Hubert A. Valencik and Penns Woods  Bancorp, Inc. (incorporated by reference to Exhibit 10.1 of the  Registrant’s Current Report on Form 8-K filed on July 18, 2005).                                           |
| (10) (vi)      |   | Employment Agreement,  dated January 11, 1999, among Penns Woods Bancorp, Inc., Jersey  Shore State Bank and William H. Rockey (incorporated by reference to  Exhibit 10.7 of the Registrant’s Annual Report on 10-K filed on  March 14, 2008).*                        |
| (21)                |   | Subsidiaries of the  Registrant.                                                                                                                                                                                                                                                                 |
| (23)                |   | Consent of Independent  Certified Public Accountants.                                                                                                                                                                                                                                            |
| (31)  (i)           |   | Rule 13a-14(a)/Rule 15d-14(a) Certification  of Chief Executive Officer.                                                                                                                                                                                                          |
| (31)  (ii)          |   | Rule 13a-14(a)/Rule 15d-14(a) Certification  of Principal Financial Officer.                                                                                                                                                                                                      |
| (32)  (i)           |   | Section 1350  Certification of Chief Executive Officer.                                                                                                                                                                                                                                     |
| (32)  (ii)          |   | Section 1350  Certification of Principal Financial Officer.                                                                                                                                                                                                                                 |

 

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*Denotes compensatory plan or arrangement.

 

**EXHIBITINDEX**

 
| (21)         | Subsidiaries of the  Registrant.                                                            |
|--------------|---------------------------------------------------------------------------------------------|
| (23)         | Consent of Independent  Certified Public Accountants.                                       |
| **(**31) (i) | Rule 13a-14(a)/Rule 15d-14(a) Certification  of Chief Executive Officer.     |
| (31)  (ii)   | Rule 13a-14(a)/Rule 15d-14(a) Certification  of Principal Financial Officer. |
| (32)  (i)    | Section 1350  Certification of Chief Executive Officer.                                |
| (32)  (ii)   | Section 1350  Certification of Principal Financial Officer.                            |

 

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Table of Contents

 

**SIGNATURES**

 

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

 
| March 9, 2010 | PENNS WOODS BANCORP,  INC. |
|--------------------|----------------------------|
|               | BY:                        | /s/ RONALD A. WALKO, President &  Chief Executive Officer |

 

Pursuant to therequirements of the Securities and Exchange Act of 1934, this report has beensigned below by the following persons on behalf of the Registrant and in thecapacities and on the dates indicated:

 

 
| /s/ Ronald A. Walko                                                    |               |               |
|------------------------------------------------------------------------|--------------------|--------------------|
| Ronald A. Walko,  President, Chief Executive                           |               | March 9, 2010 |
| Officer  and Director (Principal Executive Officer)                    |               |
|                                                                   |               |               |
| /s/ Brian L. Knepp                                                     |               |               |
| Brian  L. Knepp, Chief Financial Officer (Principal Financial Officer) | March 9, 2010 |
|                                                                   |               |               |
| /s/ Michael J. Casale                                                  |               |               |
| Michael J.  Casale, Jr., Director                                 |               | March 9, 2010 |
|                                                                   |               |               |
| /s/ H. Thomas  Davis, Jr.                                         |               |               |
| H. Thomas  Davis, Jr., Director                                   |               | March 9, 2010 |
|                                                                   |               |               |
| /s/ James M. Furey II                                                  |               |               |
| James M. Furey II,  Director                                           |               | March 9, 2010 |
|                                                                   |               |               |
| /s/ D. Michael Hawbaker                                                |               |               |
| D. Michael Hawbaker,  Director                                         |               | March 9, 2010 |
|                                                                   |               |               |
| /s/ Leroy H. Keiler III                                                |               |               |
| Leroy H. Keiler III,  Director                                         |               | March 9, 2010 |
|                                                                   |               |               |
| /s/ R. Edward  Nestlerode, Jr.                                    |               |               |
| R. Edward Nestlerode, Jr.,  Director                              |               | March 9, 2010 |
|                                                                   |               |               |
| /s/ James E. Plummer                                                   |               |               |
| James E. Plummer,  Director                                            |               | March 9, 2010 |
|                                                                   |               |               |
| /s/ William H. Rockey                                                  |               |               |
| William  H. Rockey, Sr. Vice President & Director        | March 9, 2010 |
|                                                                   |               |               |
| /s/ Hubert A. Valencik                                                 |               |               |
| Hubert A. Valencik, Director                                           |               | March 9, 2010 |

 

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