**UNITED STATES**

**SECURITIES AND EXCHANGECOMMISSION**

**WASHINGTON,DC 20549**

 

**FORM 10-K**

 

**ý****  ****ANNUAL REPORT PURSUANT TO SECTION 13OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934**

 

**For the fiscal year ended December 31,2005**

 

**OR**

 

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

 

**For the transition period from                                    to**

 

**Commission file number 0-17077**

 

**PENNS WOODS BANCORP, INC.**

(exact name of registrant asspecified in its charter)

 

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

 

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

 

Securities registered pursuant to Section 12(b) of the Act:

 

| ** **               | ** ** | **Name of each exchange** |
|--------------------------|------------|---------------------------|
| **Title of  each class** | ** ** | **which registered**      |
| **None**                 |       | **None**                  |

 

Securities to be registered pursuant to Section 12(g) of theAct:

 

**CommonStock, par value $8.33 per share**

(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  ý 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  ý No

 

Indicate by check mark whether the registrant (1) has filed allreports required to be filed by Section 13 or 15(d) of the SecuritiesExchange Act of 1934 during the preceding 12 months (or for such shorter periodthat the registrant was required to file such reports) and (2) has beensubject to such filing requirements for the past 90 days. Yes                                                               ý         No        o

 

Indicate by check mark if disclosure of delinquent filers pursuant toItem 405 of Regulation S-K is not contained herein, and will not be contained,to the best of registrant’s knowledge, in definitive proxy or informationstatements incorporated by reference in Part III of this Form 10-K orany amendment to this Form 10-K.      ý

 

Indicateby check mark whether the registrant is a large accelerated filer, anaccelerated filer, or a non-accelerated filer. See definition of “acceleratedfiler and large accelerated filer” in Rule 12b-2 of the Exchange Act. (Checkone):

Large accelerated filer o    Accelerated filer  ý Non-accelerated filer o

 

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

o Yes  ý No

 

State the aggregate market value of the voting stock held bynon-affiliates of the registrant **$124,212,908 at June 30,2005.**

 

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

 

| **Class**                          | ** ** | **Outstanding at March 7, 2006** |
|------------------------------------|------------|---------------------------------------|
| **Common  Stock, $8.33 Par Value** |       | **3,955,787  Shares**                 |

** **

**DOCUMENTS INCORPORATED BY REFERENCE**

** **

Portions of the registrant’s definitive proxy statement prepared inconnection with its annual meeting of shareholders to be held on April 26,2006 are incorporated by reference in Part III hereof.

 

 

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**PART I**

 

**ITEM 1  BUSINESS**

 

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

##### ** **

##### **On January 7,1983, Penns Woods Bancorp, Inc. (the “Company”) was incorporated under thelaws of the Commonwealth of Pennsylvania as a bank holding company. The JerseyShore State Bank (the “Bank”) became a wholly owned subsidiary of the Company,and each outstanding share of Bank common stock was converted into one share ofCompany common stock. This transaction was approved by the shareholders of theBank on April 11, 1983 and was officially effective on July 12, 1983.The Company’s business has consisted primarily of managing and supervising theBank, and its principal source of income has been dividends paid by the Bank. TheCompany’s two other wholly-owned subsidiaries are Woods Real Estate DevelopmentCo, Inc. and Woods Investment Co., Inc.**

##### ** **

The Bank is engaged in commercial and retail banking and the taking oftime and regular savings and demand deposits, the making of commercial andconsumer loans and mortgage loans, and safe deposit services. Auxiliaryservices, such as cash management, are provided to commercial customers. TheBank operates full banking services with twelve branch offices in NorthcentralPennsylvania.

 

In October 2000, the Bank acquired The M Group, Inc. D/B/AThe Comprehensive Financial Group (“The M Group”). The M Group, which operatesas a subsidiary of the Bank, offers insurance and securities brokerageservices. Securities are offered by The M Group through ING Financial Partners, Inc.,a registered broker-dealer.

 

Neither the Company nor the Bank anticipates thatcompliance with environmental laws and regulations will have any materialeffect on capital expenditures, earnings, or on its competitive position. TheBank is not dependent on a single customer or a few customers, the loss of whomwould have a material effect on the business of the Bank.

 

The Bank employed approximately 189 persons as of December 31,2005 in either a full-time or part-time capacity. The Company does not have anyemployees. The principal officers of the Bank also serve as officers of theCompany.

 

A copy of the Code of Ethics and Code of Conduct for the Corporationcan be requested from Brian Knepp, Vice President of Finance, at 300 MarketStreet, Williamsport, PA 17701. A link with access to the Corporation’s SEC 10Kfilings, annual reports, and quarterly filings can be found at www.jssb.com.

 

##### **B. Regulation and Supervision**

##### ** **

The Company is also subject to the provisions of the Bank HoldingCompany Act of 1956, as amended (the “BHCA”) and to supervision and examinationby the Board of Governors of the Federal Reserve System (the “FRB”). The Bankis subject to the supervision and examination by the Federal Deposit InsuranceCorporation (the “FDIC”), as its primary federal regulator and as the insurerof the Bank’s deposits. The Bank is also regulated and examined by thePennsylvania Department of Banking (the “Department”).

 

The insurance activities of The M Group are subject to regulation bythe insurance departments of the various states in which The M Group conductsbusiness including principally the Pennsylvania Department of Insurance. Thesecurities brokerage activities of The M Group are subject to regulation byfederal and state securities commissions.

 

The FRB has issued regulations under the BHCA that require a bankholding company to serve as a source of financial and managerial strength toits subsidiary banks. As a result, the FRB, pursuant to such regulations, may requirethe Company to stand ready to use its resources to provide adequate capitalfunds to the Bank during periods of financial stress or adversity. The BHCArequires the Company to secure the prior approval of the FRB before it canacquire all or substantially all of the assets of any bank, or acquireownership or control of 5% or more of any voting shares of any bank. Such atransaction would also require approval of the Department.

 

A bank holding company is prohibited under the BHCA from engaging in,or acquiring direct or indirect control of, more than 5% of the voting sharesof any 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. 

 

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Under the BHCA, the FRB has the authority to require a bank holdingcompany to terminate any activity or relinquish control of a non-bank subsidiary(other than a non-bank subsidiary of a bank) upon the FRB’s determination thatsuch activity or control constitutes a serious risk to the financial soundnessand stability of any bank subsidiary of the bank holding company.

 

Bank holding companies are required to comply with the FRB’s risk-basedcapital guidelines. The risk-based capital rules are designed to makeregulatory capital requirements more sensitive to differences in risk profilesamong banks and bank holding companies and to minimize disincentives forholding liquid assets. Currently, the required minimum ratio of total capitalto risk-weighted assets (including certain off-balance sheet activities, suchas standby letters of credit) is 8%. At least half of the total capital isrequired to be Tier 1 capital, consisting principally of common shareholders’equity, less certain intangible assets. The remainder (“Tier 2 capital”) may consistof certain preferred stock, a limited amount of subordinated debt, certainhybrid capital instruments and other debt securities, 45% of net unrealizedgains on marketable equity securities, and a limited amount of the general loanloss allowance. The risk-based capital guidelines are required to take adequateaccount of interest rate risk, concentration of credit risk, and risks ofnontraditional activities.

 

In addition to the risk-based capital guidelines, the FRB requires eachbank holding company to comply with the leverage ratio, under which the bankholding company must maintain a minimum level of Tier 1 capital to averagetotal consolidated assets of 3% for those bank holding companies which have thehighest regulatory examination ratings and are not contemplating orexperiencing significant growth or expansion. All other bank holding companiesare expected to maintain a leverage ratio of at least 4% to 5%. The Bank issubject to similar capital requirements adopted by the FDIC.

 

**C. Regulation of the Bank**

 

From time to time, various types of federal and state legislation havebeen proposed that could result in additional regulation of, and restrictionsof, the business of the Bank. It cannot be predicted whether any suchlegislation will be adopted or how such legislation would affect the businessof the Bank. As a consequence of the extensive regulation of commercial bankingactivities in the United States, the Bank’s business is particularlysusceptible to being affected by federal legislation and regulations that may increasethe costs of doing business.

 

**Prompt Corrective Action**- The FDIC 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 institution;and (2) the placement of a hold on increases in assets, number ofbranches, or lines of business. If capital has reached the significantly orcritically undercapitalized levels, further material restrictions can beimposed, including restrictions on interest payable on accounts, dismissal ofmanagement and (in critically undercapitalized situations) appointment of areceiver. For well-capitalized institutions, the FDIA provides authority forregulatory intervention where the institution is deemed to be engaging inunsafe or unsound practices or receives a less than satisfactory examinationreport rating for asset quality, management, earnings or liquidity.

 

**Deposit Insurance** -There are presently two deposit insurance funds administered by the FDIC - theSavings Association Insurance Fund (“SAIF”) and the Bank Insurance Fund (“BIF”).The Bank’s deposits are insured under the BIF; however, the deposits assumed bythe Bank in connection with the merger of Lock Haven Savings Bank are treatedand assessed as SAIF-insured deposits. The FDIC has implemented a risk-relatedpremium schedule for all insured depository institutions that results inthe assessment of premiums based on capital and supervisory measure. Under therisk-related premium schedule, the FDIC assigns, on a semiannual basis, eachinstitution to one of three capital groups (well-capitalized, adequatelycapitalized or undercapitalized) and further assigns such institution to one ofthree subgroups within a capital group. The institution’s subgroup assignmentis based upon the FDIC’s judgment of the institution’s strength in light ofsupervisory evaluations, including examination reports, statistical analyses,and other information relevant to gauging the risk posed by the institution. Onlyinstitutions with a total capital to risk-adjusted assets ratio of 10.0% orgreater, a Tier 1 capital to risk-adjusted assets ratio of 6.0% or greater anda Tier 1 leverage ratio of 5.0% or greater, are assigned to thewell-capitalized group. As of December 31, 2005, the Bank’s ratios werewell above required minimum ratios.

 

The BIF and SAIF assessment rates range from zero for thoseinstitutions with the least risk, to $0.27 for every $100 of insured depositsfor institutions deemed to have the highest risk. The Bank is in the categoryof institutions that presently pay nothing for deposit insurance. While theBank presently pays no premiums for deposit insurance, it is subject to

 

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assessments to pay the interest on Financing Corporation (“FICO”) bonds.FICO was created by Congress to issue bonds to finance the resolution of failedthrift institutions. The current annual FICO assessment for the Bank (and allbanks) is $.0132 per $100 of BIF deposits.

 

InFebruary 2006, deposit insurance modernization legislation was enacted. Whenthe new law becomes effective ( different sections to take effect in the thirdand fourth quarters of 2006), it will merge the BIF and SAIF into a singleDeposit Insurance Fund, increase deposit insurance coverage for IRAs to$250,000, provide for the future increase of deposit insurance on all accountsby authorizing the FDIC to index the coverage to the rate of inflation,authorize the FDIC to set the reserve ratio of the combined Deposit InsuranceFund at a level between 1.15% and 1.50%, and permit the FDIC to establishassessments to be paid by insured banks to maintain the minimum ratios. Newdeposit insurance assessment rates will not be known until the FDIC conductsextensive research and issues new assessment rates. While the possibleassessment rates are unknown, the FDIC has stated that it expects that allbanks will be assessed some amount for deposit insurance based upon presentexpectations. Banks in existence prior to 1996 will receive a partial creditfor past deposit insurance premiums paid, but the amount of the credit for aspecific bank will not be known until new regulations implementing theassessments and the credits are adopted.

 

##### **Other Legislation**

 

TheFair and Accurate Credit Transactions Act (“FACT”) was signed into law on December 4,2003. This law extends the previously existing Fair Credit Reporting Act. Newprovisions added by FACT address the growing problem of identity theft. Consumerswill be able to initiate a fraud alert when they are victims of identity theft,and credit reporting agencies will have additional duties. Consumers will alsobe entitled to obtain free credit reports, and will be granted certainadditional 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. The Sarbanes-Oxley Act generally applies to allcompanies, including the Company, that file or are required to file periodicreports with the Securities and Exchange Commission under the SecuritiesExchange Act of 1934, or the Exchange Act. The legislation includes provisions,among other things, governing the services that can be provided by a publiccompany’s independent auditors and the procedures for approving such services,requiring the chief executive officer and principal accounting officer tocertify certain matters relating to the company’s periodic filings under theExchange Act, requiring expedited filings of reports by insiders of theirsecurities transactions and containing other provisions relating to insiderconflicts of interest, increasing disclosure requirements relating to criticalfinancial accounting policies and their application, increasing penalties forsecurities law violations, and creating a new public accounting oversightboard, a regulatory body subject to SEC jurisdiction with broad powers to setauditing, quality control, and ethics standards for accounting firms. Inresponse to the legislation, the national securities exchanges and NASDAQ haveadopted new rules relating to certain matters, including the independenceof members of a company’s audit committee as a condition to listing orcontinued listing.

 

In addition, Congress is often considering some financial industrylegislation. The Company cannot predict how any new legislation, or new rules adoptedby the federal banking agencies, may affect its business in the future.

 

In addition to federal banking law, the Bank is subject to thePennsylvania Banking Code. The Banking Code was amended in late 2000 to providemore complete “parity” in the powers of state-chartered institutions comparedto national 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**

##### ** **

Environmentally related hazards have become a source of high risk andpotential liability for financial institutions relating to their loans. Environmentallycontaminated properties owned by an institution’s borrowers may result ina drastic reduction in the value of the collateral securing the institution’sloans to such borrowers, high environmental clean up costs to the borroweraffecting its ability to repay the loans, the subordination of any lien infavor of the institution to a state or federal lien securing clean up costs,and liability to the institution for clean up costs if it forecloses on thecontaminated property or becomes involved in the management of the borrower. TheCompany is not aware of any borrower who is currently subject to anyenvironmental investigation or clean up proceeding which is likely to have amaterial adverse effect on the financial condition or results of operations ofthe Company.

 

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##### **Effect of Government Monetary Policies**

##### ** **

The earnings of the Company are and will be affected by domesticeconomic conditions and the monetary and fiscal policies of the United StatesGovernment and its agencies. The monetary policies of the FRB have had, andwill likely continue to have, an important impact on the operating results ofcommercial banks through its power to implement national monetary policy inorder, among other things, to curb inflation or combat a recession. The FRB hasa major effect upon the levels of bank loans, investments, and deposits throughits open market operations in the United States Government securities andthrough its regulation of, among other things, the discount rate on borrowingof member banks and the reserve requirements against member bank deposits. Itis not possible to predict the nature and impact of future changes in monetaryand fiscal policies.

 

##### **DESCRIPTION OF BANK**

##### ** **

**History and Business**

 

Jersey Shore State Bank (“Bank”) was incorporated under the laws of theCommonwealth of Pennsylvania as a state bank in 1934 and became a wholly ownedsubsidiary of the Company on July 12, 1983.

 

As of December 31, 2005, the Bank had total assets of$552,631,000; total shareholders’ equity of $57,170,000 and total deposits of$352,860,000. The Bank’s deposits are insured by the Federal Deposit InsuranceCorporation for the maximum amount provided under current law.

 

The Bank engages in business as a commercial bank, doing business atseveral locations in Lycoming, Clinton, and Centre Counties, Pennsylvania. TheBank offers insurance and securities brokerage services through its whollyowned subsidiary, The M Group, Inc. D/B/A The Comprehensive FinancialGroup.

 

Services offered by the Bank include accepting time, demand and savingsdeposits including Super NOW accounts, regular savings accounts, money marketaccounts, investment certificates, fixed rate certificates of deposit, and clubaccounts. Its services also include making secured and unsecured commercial andconsumer loans, financing commercial transactions, making construction andmortgage loans, and the renting of safe deposit facilities. Additional servicesinclude making residential mortgage loans, revolving credit loans withoverdraft protection, small business loans, etc. Business loans includeseasonal credit collateral loans and term loans.

 

The Bank’s loan portfolio mix can be classified into four principalcategories of 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. Qualified borrowers are defined by policy or byindustry underwriting standards. Owner provided equity requirements range from20% to 30% with a first lien status required. Terms are restricted to between10 and 20 years with the exception of construction and land development, whichis limited to one to five years. Appraisals, verifications, and visitationscomply with industry standards.

 

Financial information that is required on all commercial mortgages includesthe most current three years balance sheets and income statements andprojections on income to be developed through the project. In the case ofcorporations and partnerships, the principals are often asked to indebtthemselves personally as well. Residential mortgages, repayment ability isdetermined from information contained in the application and recent income taxreturns. Emphasis is on credit, employment, income, and residency verification.Broad hazard insurance is always required and flood insurance where applicable.In the case of construction mortgages, builders risk insurance is requested.

 

Agricultural loans for the purchase or improvement of real estate mustmeet the Bank’s real estate underwriting criteria. The only permissibleexception is when a Farmers Home Loan Administration guaranty is obtained. Agriculturalloans made for the purchase of equipment are usually payable in five years, butnever more than seven, depending upon the useful life of the purchased asset. Minimumborrower equity ranges from 20% to 30%. Livestock financing criteria dependsupon the nature of the operation. A dairy herd could be financed over threeyears, but a feeder operation would require cleanup in intervals of less thanone year. Agricultural loans are also made for crop production purposes. Suchloans are structured to repay within the production cycle and not carried overinto a subsequent year. General purpose working capital loans are also apossibility with repayment expected within one year. It is also a generalpolicy to collateralize non-real estate loans

 

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with not only the asset purchased but also junior liens on all otheravailable assets. Insurance and credit criteria is the same as mentioned previously.In addition, annual visits are made to our agricultural customers to determinethe general condition of assets. Personal credit requirements are handled asconsumer loans.

 

Commercial loans are made for the acquisition and improvement of realestate, purchase of equipment, and for working capital purposes on a seasonalor revolving basis. Criteria were discussed under real estate financing forsuch loans, but it is important to note that such loans may be made inconjunction with the Pennsylvania Industrial Development Authority. Caution isalso exercised in taking industrial property for collateral by requiring, on aselective basis, environmental audits.

 

Equipment loans are generally amortized over three to seven years, withan owner equity contribution required of at least 20% of the purchase price. Unusuallyexpensive pieces may be financed for a longer period depending upon theasset’s useful life. The increased cash flow resulting from the additionalpiece, through improved income or greater depreciation expense, serves in establishing the terms. Insurancecoverage with the Bank as loss payee is required, especially in the case wherethe equipment is rolling stock.

 

Seasonal and revolving lines of credit are offered for working capitalpurposes. Collateral for such a loan includes the pledge of inventory and/orreceivables. Drawing availability is usually 50% of inventory and 75% ofeligible receivables. Eligible receivables are defined as invoices less than 90days delinquent. Exclusive reliance is very seldom placed on such collateral;therefore, other lienable assets are also taken into the collateral pool. Wherereliance is placed on inventory and accounts receivable, the applicant mustprovide financial information including agings on a monthly basis. In addition,the guaranty of the principals is usually obtained.

 

It is unusual for the Bank to make unsecured commercial loans. But whensuch a loan is a necessity, credit information in the file must support thatdecision.

 

Letter of Credit availability is limited to standbys where the customeris well known to the Bank. Credit criteria is the same as that utilized inmaking a direct loan and collateral is obtained in most cases, and whenever theexpiration date is for more than one year.

 

Consumer loan products include second mortgages, automobile financing,small loan requests, overdraft check lines, and PHEAA referral loans. Ourpolicy includes standards used in the industry on debt service ratios and termsare consistent with prudent underwriting standards and the use of proceeds. Verificationsare made of employment and residency, along with credit history. Secondmortgages are confined to equity borrowing and home improvements. Terms aregenerally ten years or less and rates are fixed. Loan to collateral valuecriteria is 80% or less and verifications are made to determine values. Automobilefinancing is generally restricted to five years and done on a direct basis. TheBank, as a practice, does not floor plan and therefore does not discount dealerpaper. Small loan requests are to accommodate personal needs such as thepurchase of small appliances or for the payment of taxes. Overdraft check linesare limited to $5,000 or less.

 

The Bank’s investment portfolio is analyzed and priced on a monthlybasis. Investments are made in U.S. Treasuries, U.S. Agency issues, bankqualified municipal bonds, corporate bonds, and corporate stocks which consistof Pennsylvania bank stocks. Bonds with BAA or better ratings are used, unlessa local issue is purchased that has a lesser or no rating.

 

Factors taken into consideration when investments are made includeliquidity, the Company’s tax position, and the policies of the Asset/LiabilityCommittee.

 

Although the Bank has regular opportunities to bid on pools of funds of$100,000 or more in the hands of municipalities, hospitals, and others, it doesnot rely on these monies to fund loans on intermediate or longer-terminvestments. Minor seasonal growth in deposits is experienced at or near theyear-end.

 

The Bank operates twelve full service offices in Lycoming, Clinton, andCentre Counties, Pennsylvania. The economic base of the region is developedaround service, light manufacturing industries, and agriculture. The bankingenvironment in Lycoming, Clinton, and Centre Counties, Pennsylvania is highlycompetitive. The Bank competes for loans and deposits with commercial banks,savings and loan associations, and other financial institutions.

 

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The Bank has a relatively stable deposit base and no material amount ofdeposits is obtained from a single depositor or group of depositors (includingfederal, state, and local governments). The Bank has not experienced anysignificant seasonal fluctuations in the amount of its deposits.

 

**Supervision and Regulation**

 

The earnings of the Bank are affected by the policies of regulatoryauthorities including the FDIC and the FRB. An important function of the FRB isto regulate the money supply and interest rates. Among the instruments used toimplement these objectives are open market operations in U.S. GovernmentSecurities, changes in reserve requirements against member bank deposits, andlimitations on interest rates that member banks may pay on time andsavings deposits. These instruments are used in varying combinations toinfluence overall growth and distribution of bank loans, investments ondeposits, and their use may also affect interest rates charged on loans orpaid for deposits.

 

The policies and regulations of the FRB have had and will probablycontinue to have a significant effect on the Bank’s deposits, loans andinvestment growth, as well as the rate of interest earned and paid, and areexpected to affect the Bank’s operation in the future. The effect of suchpolicies and regulations upon the future business and earnings of the Bankcannot accurately be predicted.

 

**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 arehighly sensitive to many factors which are beyond our control, includinggeneral economic conditions and policies of various governmental and regulatoryagencies and, in particular, the Board of Governors of the Federal ReserveSystem. Changes in monetary policy, including changes in interest rates, willinfluence not only the interest we receive on our loans and investmentsecurities and the amount of interest we pay on deposits and borrowings butwill also affect our ability to originate loans and obtain deposits and thevalue of our investment portfolio. If the rate of interest we pay on ourdeposits and other borrowings increases more than the rate of interest we earnon our loans and other investments, our net interest income, and therefore ourearnings, could be adversely affected. Our earnings also could be adverselyaffected if the rates on our loans and other investments fall more quickly thanthose on our deposits and other borrowings.

 

****Economic conditions either nationally orlocally in areas in which our operations are concentrated may adverselyaffect 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.**

 

Despiteour underwriting criteria, we may experience loan delinquencies and losses.In order to absorb losses associated with nonperforming loans, we maintain anallowance for loan losses based on, among other things, historical experience,an evaluation of economic conditions, and regular reviews of delinquencies andloan portfolio quality. Determination of the allowance inherently involves ahigh degree of subjectivity and requires us to make significant estimates ofcurrent credit risks and future trends, all of which may undergo materialchanges. At any time there are likely to be loans in our portfolio that willresult in losses but that have not been identified as nonperforming orpotential problem credits. We cannot be sure that we will be able to identifydeteriorating credits before they become nonperforming assets or that we willbe able to limit losses on those loans that are identified. We may berequired to increase our allowance for loan losses for any of several reasons. Federalregulators, in reviewing our loan portfolio as part of a regulatoryexamination, may request that we increase our allowance for loan losses. Changesin economic 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-offs in future periods exceed our allowancefor loan losses, we will need additional increases in our allowance for loanlosses. Any increases in our allowance for loan losses will result in

 

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adecrease in our net income and, possibly, our capital, and may materiallyaffect our results of operations in the period in which the allowance isincreased.

 

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

 

In addition to considering the financialstrength and cash flow characteristics of a borrower, we often secure our loanswith real estate collateral. Real estate values and the real estate market aregenerally affected by, among other things, changes in local, regional ornational economic conditions, fluctuations in interest rates and theavailability of loans to potential purchasers, changes in tax laws and othergovernmental statutes, regulations and policies, and acts of nature. The realestate collateral provides an alternate source of repayment in the event ofdefault by the borrower. If real estate prices in our markets decline, thevalue of the real estate collateral securing our loans could be reduced. If weare required to liquidate real estate collateral securing loans during a periodof reduced real estate values to satisfy the debt, our earnings and capitalcould 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 strong competition among financial servicesproviders in our principal service area. Our competitors may have greaterresources, higher lending limits or larger branch systems than we do. Accordingly,they may be able to offer a broader range of products and services as wellas better pricing for those products 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 a result, those nonbank competitors may beable to access funding and provide various services more easily or at less costthan we can, adversely affecting our ability to compete effectively.

 

**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 cannot predict the ultimate effect of these changes, which couldhave a material adverse 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 toproperties securing our loans. If hazardous substances were discovered on anyof these properties, we could be liable to governmental entities or thirdparties for the costs of remediation of the hazard, as well as for personalinjury and property damage. Many environmental laws can impose liabilityregardless of whether we knew of, or were responsible for, the contamination. Inaddition, if we arrange for the disposal of hazardous or toxic substances atanother site, we may be liable for the costs of cleaning up and removingthose substances from the site even if we neither own nor operate the disposalsite. Environmental laws may require us to incur substantial expenses and may materiallylimit use of properties we acquire through foreclosure, reduce their value orlimit our ability to sell them in the event of a default on the loans they secure.In addition, future laws or more stringent interpretations or enforcementpolicies with respect to existing laws may increase our exposure toenvironmental liability.

 

**Failure to implement new technologies in ouroperations may adversely affect 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-

 

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basedbanking and telebanking. Our ability to compete successfully in our markets may dependon the extent to which we are able to exploit such technological changes.However, we can provide no assurance that we will be able properly or timely toanticipate or implement such technologies or properly train our staff to usesuch technologies. Any failure to adapt to new technologies could adverselyaffect 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. Investmentin our common stock is subject to the same market forces that affect the priceof common stock in any company.

 

**ITEM 1B – UNRESOLVED STAFF COMMENTS**

 

None.

 

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

##### ** **

The Company owns and leases its properties. Listed herewith are thelocations of properties owned or leased, in which the banking offices arelocated; all properties are in good condition and adequate for the Bank’spurposes:

 
| **Office**                        | ** ** | **Address**                                                                      |
|-----------------------------------|------------|----------------------------------------------------------------------------------|
| Main                              |       | 115 South Main Street

P.O. Box 5098

Jersey Shore, Pennsylvania 17740      |   | Owned |
|                              |       |                                                                             |   |   |
| Bridge Street                     |       | 112 Bridge Street

Jersey Shore, Pennsylvania 17740                              |   | Owned |
|                              |       |                                                                             |   |   |
| DuBoistown                        |       | 2675 Euclid Avenue

Williamsport, Pennsylvania 17702                             |   | Owned |
|                              |       |                                                                             |   |   |
| Williamsport                      |       | 300 Market Street

P.O. Box 967

Williamsport, Pennsylvania 17703-0967      |   | Owned |
|                              |       |                                                                             |   |   |
| Montgomery                        |       | 9094 Rt 405 Highway

Montgomery, Pennsylvania 17752                              |   | Under Lease |
|                              |       |                                                                             |   |   |
| Lock Haven                        |       | 4 West Main Street

Lock Haven, Pennsylvania 17745                               |   | Owned |
|                              |       |                                                                             |   |   |
| Mill Hall                         |       | (Inside Wal-Mart), 173 Hogan Boulevard

Mill Hall, Pennsylvania 17751            |   | Under Lease |
|                              |       |                                                                             |   |   |
| Spring Mills                      |       | 3635 Penns Valley Road, P.O. Box 66

Spring Mills, Pennsylvania 16875       |   | Owned |
|                              |       |                                                                             |   |   |
| Centre Hall                       |       | 2842 Earlystown Road

Centre Hall, Pennsylvania 16828                            |   | Land Under Lease |
|                              |       |                                                                             |   |   |
| Zion                              |       | 100 Cobblestone Road

Bellefonte, Pennsylvania 16823                             |   | Under Lease |
|                              |       |                                                                             |   |   |
| State College                     |       | (Inside Wal-Mart), 1665 North Atherton  Place

State College, Pennsylvania 16803 |   | Under Lease |
|                              |       |                                                                             |   |   |
| State College                     |       | 2050 North Atherton Street

State College, Pennsylvania 16803                    |   | Land Under Lease |
|                              |       |                                                                             |   |   |
| The M Group, Inc.

D/B/A The |       | 705 Washington Boulevard

Williamsport, Pennsylvania 17701                       |   | Under Lease |

 

9

----

 
| Comprehensive

Financial Group |   |   |   |   |
|--------------------------------|--------|--------|--------|--------|

 

##### **ITEM  3    LEGAL PROCEEDINGS**

##### ** **

The Company is subject to lawsuits and claimsarising out of its business. In the opinion of management, after review andconsultation with counsel, any proceedings that may be assessed will nothave a material adverse effect on the consolidated financial position of theCompany.

 

**ITEM 4    SUBMISSION OF MATTERS TO AVOTE OF SECURITY HOLDERS**

 

No matters were submitted to a vote of security holders during thefourth quarter of 2005.

 

**ITEM 4A EXECUTIVE OFFICERS OF THE REGISTRANT:**

 
| **NAME**           | ** ** | **AGE** | ** ** | **FIVE-YEAR ANALYSIS OF DUTIES**                                                                                                                                                                                                                                                                                 |
|--------------------|------------|---------|------------|------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
| Ronald A. Walko    |       | 59      |       | President and Chief Executive Officer of  the Company; the Bank; The M Group; and Woods Investment Company, Inc.; President  of Woods Real Estate Development Co, Inc.; and Federal Bank examiner  prior to 1986 for an eighteen-year period.                                                          |
|               |       |    |       |                                                                                                                                                                                                                                                                                                             |
| Thomas A. Donofrio |       | 51      |       | Executive Vice President and Chief  Administrative Officer of the Company and Bank; Vice President of Woods Real  Estate Development Co, Inc.; Executive Vice President of Woods  Investment Company, Inc. and President of a bank data processing company  prior to 2005 for a period of three years. |

 

10

----

 

**PART II**

 

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

 

The Common Stock is listed on the Nasdaq National Market under thesymbol “PWOD”. The following table sets forth (1) the quarterly high andlow prices for a share of the Company’s Common Stock during the periodsindicated, and (2) quarterly dividends on a share of the Common Stock withrespect to each quarter since January 1, 2003. The following quotationsrepresent prices between buyers and sellers and do not include retail markup,markdown or commission. They may not necessarily represent actual transactions.

 
| ** **      | ** ** | ** ** | ** ** | ** ** | ** ** | **Dividends** | ** ** |
|-----------------|------------|------------|------------|------------|------------|---------------|------------|
| ** **      | ** ** | **HIGH**   | ** ** | **LOW**    | ** ** | **Declared**  | ** ** |
| **2003**        |       |       |       |       |       |          |       |
| First  quarter  |       | $          | 34.39      |       | $          | 27.38         |       | $ | 0.23 |   |
| Second  quarter |       | 39.53      |       | 31.43      |       | 0.23          |       |
| Third  quarter  |       | 35.27      |       | 32.20      |       | 0.23          |       |
| Fourth  quarter |       | 39.93      |       | 34.04      |       | 0.57          |       |
| **2004**        |       |       |       |       |       |          |       |
| First  quarter  |       | $          | 40.33      |       | $          | 35.92         |       | $ | 0.29 |   |
| Second  quarter |       | 39.09      |       | 35.39      |       | 0.29          |       |
| Third  quarter  |       | 42.29      |       | 36.80      |       | 0.29          |       |
| Fourth  quarter |       | 41.77      |       | 37.72      |       | 0.60          |       |
| **2005**        |       |       |       |       |       |          |       |
| First  quarter  |       | $          | 41.67      |       | $          | 38.58         |       | $ | 0.38 |   |
| Second  quarter |       | 41.58      |       | 37.08      |       | 0.38          |       |
| Third  quarter  |       | 38.30      |       | 36.76      |       | 0.39          |       |
| Fourth  quarter |       | 39.76      |       | 36.67      |       | 0.41          |       |

 

The Bank has paid cash dividends since 1941. The Company has paiddividends since the effective date of its formation as a bank holding company. Itis the present intention of the Registrant’s Board of Directors to continue thedividend payment policy; however, further dividends must necessarily dependupon earnings, financial condition, appropriate legal restrictions and otherfactors relevant at the time the Board of Directors of the Registrant considersdividend policy. Cash available for dividend distributions to shareholders ofthe Registrant must initially come from dividends paid by the Bank to theCompany. Therefore, the restrictions on the Bank’s dividend payments aredirectly applicable to the Company.  Seealso the information appearing in Note 17 to the Consolidated FinancialStatements included elsewhere in the Annual Report for additional informationrelated to dividend restrictions.

 

Under the Pennsylvania Business Corporation Law of 1988 a corporation may notpay a dividend, if after giving effect thereto, the corporation would be unableto pay its debts as they become due in the usual course of business and aftergiving effect thereto the total assets of the corporation would be less thanthe sum of its total liabilities plus the amount that would be needed, if thecorporation were to be dissolved at the time of the distribution, to satisfythe preferential rights upon dissolution of the shareholders whose preferentialrights are superior to those receiving the dividend.

 

As of March 7, 2006, the Registrant hadapproximately 1,255 shareholders of record.

 

11

----

 

Followingis a schedule of the shares of the Company’s common stock purchased by theCompany during the fourth quarter of 2005.

 
| ** **                                          | ** ** | ** **                      | ** ** | ** **                              | ** ** | **Total Number of**       | ** ** | **Maximum Number (or**                    | ** ** |
|-----------------------------------------------------|------------|---------------------------------|------------|-----------------------------------------|------------|-------------------------------------|------------|-----------------------------------------------------|------------|
| ** **                                          | ** ** | ** **                      | ** ** | ** **                              | ** ** | **Shares (or Units)**     | ** ** | **Approximate Dollar Value)**             | ** ** |
| ** **                                          | ** ** | **Total Number of**   | ** ** | **Average Price Paid**        | ** ** | **Purchased as Part**     | ** ** | **of Shares (or Units) that**   | ** ** |
| ** **                                          | ** ** | **Shares (or Units)** | ** ** | **per Share (or Units)** | ** ** | **of Publicly Announced** | ** ** | **May Yet Be Purchased**             | ** ** |
| **Period**                                          | ** ** | **Purchased**                   | ** ** | **Purchased**                           | ** ** | **Plans or Programs**     | ** ** | **Under the Plans or Programs** | ** ** |
| Month#1(October 1-  October 31, 2005)     |       | —                          |       | $                                       | —     |                                | —     |                                                | —     |   |
| Month#2 (November 1-  November 30, 2005)  |       | 7,000                           |       | 39.20                                   |       | 7,000                               |       | 39,693                                              |       |
| Month#3 (December 1,-  December 31, 2005) |       | 4,000                           |       | 38.95                                   |       | 4,000                               |       | 35,693                                              |       |
|                                                     |            |                                 |            |                                         |            |                                     |            |                                                     |            |  |

 

12

----

 

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

##### ** **

The following table sets forth certain financial data as of and foreach of the years in the five-year period ended December 31, 2005.

 
| **(In Thousands, Except Per Share Data)** | ** ** | **2005**  | ** ** | **2004**  | ** ** | **2003**  | ** ** | **2002**  | ** ** | **2001**  | ** ** |
|--------------------------------------------------------------------|------------|-----------|------------|-----------|------------|-----------|------------|-----------|------------|-----------|------------|
|                                                               |       |      |       |      |       |      |       |      |       |      |       |
| Consolidated  Statement of Income Data:                            |       |      |       |      |       |      |       |      |       |      |       |
| Interest  income                                                   |       | $         | 30,903     |      | $          | 29,845    |       | $         | 28,384     |      | $          | 28,465 |   | $ | 27,893 |   |
| Interest  expense                                                  |       | 10,381    |       | 8,768     |       | 9,265     |       | 10,846    |       | 12,481    |       |
| Net interest  income                                               |       | 20,522    |       | 21,077    |       | 19,119    |       | 17,619    |       | 15,412    |       |
| Provision  for loan losses                                         |       | 720       |       | 465       |       | 255       |       | 365       |       | 372       |       |
| Net interest  income after provision for loan losses               |       | 19,802    |       | 20,612    |       | 18,864    |       | 17,254    |       | 15,040    |       |
| Noninterest  income                                                |       | 9,431     |       | 8,918     |       | 9,150     |       | 5,965     |       | 5,829     |       |
| Noninterest  expense                                               |       | 15,108    |       | 14,184    |       | 13,137    |       | 12,086    |       | 11,149    |       |
| Income  before income taxes                                        |       | 14,125    |       | 15,346    |       | 14,877    |       | 11,133    |       | 9,720     |       |
| Applicable  income taxes                                           |       | 3,224     |       | 4,263     |       | 3,703     |       | 2,247     |       | 1,978     |       |
| Net Income                                                         |       | $         | 10,901     |      | $          | 11,083    |       | $         | 11,174     |      | $          | 8,886 |   | $ | 7,742 |   |
|                                                               |       |      |       |      |       |      |       |      |       |      |       |
| Consolidated  Balance Sheet at End of Period:                      |       |      |       |      |       |      |       |      |       |      |       |
| Total assets                                                       |       | $         | 568,668    |      | $          | 546,703   |       | $         | 527,381    |      | $          | 472,206 |   | $ | 424,810 |   |
| Loans                                                              |       | 338,438   |       | 324,505   |       | 275,828   |       | 257,845   |       | 251,623   |       |
| Allowance  for loan losses                                         |       | (3,679    | )          | (3,338    | )          | (3,069    | )          | (2,953    | )          | (2,927    | )          |
| Deposits                                                           |       | 352,529   |       | 356,836   |       | 334,318   |       | 339,848   |       | 305,150   |       |
| Long-term  debt — other                                       |       | 84,478    |       | 75,878    |       | 70,878    |       | 51,778    |       | 41,778    |       |
| Shareholders’  equity                                         |       | 73,919    |       | 73,165    |       | 69,769    |       | 63,142    |       | 55,252    |       |
|                                                               |       |      |       |      |       |      |       |      |       |      |       |
| Per Share  Data:                                                   |       |      |       |      |       |      |       |      |       |      |       |
|                                                               |       |      |       |      |       |      |       |      |       |      |       |
| Earnings per  share - Basic                                        |       | $         | 2.75       |      | $          | 2.78      |       | $         | 2.79       |      | $          | 2.22 |   | $ | 1.92 |   |
| Earnings per  share - Diluted                                      |       | 2.74      |       | 2.78      |       | 2.79      |       | 2.22      |       | 1.92      |       |
| Cash  dividends declared                                           |       | 1.56      |       | 1.47      |       | 1.24      |       | 1.03      |       | 0.93      |       |
| Book value                                                         |       | 18.59     |       | 18.36     |       | 17.50     |       | 15.78     |       | 13.78     |       |
| Number of  shares outstanding, at end of period                    |       | 3,975,787 |       | 3,985,832 |       | 3,985,872 |       | 3,637,595 |       | 3,647,508 |       |
| Average  number of shares outstanding-basic                        |       | 3,971,926 |       | 3,990,008 |       | 3,996,702 |       | 4,003,575 |       | 4,046,214 |       |
| Selected  financial ratios:                                        |       |      |       |      |       |      |       |      |       |      |       |
| Return on  average shareholders’ equity                       |       | 14.54     | %          | 15.49     | %          | 16.60     | %          | 15.00     | %          | 14.38     | %          |
| Return on  average total assets                                    |       | 1.97      | %          | 2.06      | %          | 2.24      | %          | 2.01      | %          | 1.95      | %          |
|                                                               |       |      |       |      |       |      |       |      |       |      |       |
| Net interest  income to average interest earning assets            |       | 4.30      | %          | 4.33      | %          | 4.36      | %          | 4.25      | %          | 4.16      | %          |
| Dividend  payout ratio                                             |       | 57.10     | %          | 52.72     | %          | 44.76     | %          | 46.40     | %          | 48.17     | %          |
| Average  shareholders’ equity to average total assets         |       | 13.56     | %          | 13.30     | %          | 13.51     | %          | 13.39     | %          | 13.54     | %          |
| Loans to  deposits, at end of period                               |       | 96.00     | %          | 90.94     | %          | 82.50     | %          | 75.87     | %          | 82.46     | %          |

 

Per share data and number of shares outstanding havebeen adjusted in each reporting period to give retroactive effect to a 10%stock dividend issued November 13, 2003 and a six for five stock splitissued November 18, 2005.

 

13

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

##### ** **

# **RESULTS OF OPERATIONS**

# ** **

**NET INTEREST INCOME**

 

Net interest income is determined by calculating the difference betweenthe yields earned on interest-earning assets and the rates paid oninterest-bearing liabilities. To compare the tax-exempt asset yields to taxableyields, amounts are adjusted to taxable equivalents based on the marginalcorporate federal tax rate of 34%. The tax equivalent adjustments to netinterest income for 2005, 2004, and 2003 were $1,764,000, $906,000, and$1,367,000, respectively.

 

**2005 vs 2004**

 

Reported net interest income decreased $555,000 or 2.6 % from the yearended December 31, 2004 to 2005. Total interest income increased$1,058,000 and is attributed to the increase of $27,940,000 in the averagebalance of the loan portfolio coupled with an increase of the tax equivalentyield on investment securities of 46 basis points offset partially by adecrease in the average balance of the investment securities of $17,608,000.

 

Ona tax equivalent basis, net interest income increased to $22,286,000 from$21,983,000 for the year ended December 31, 2004. The tax equivalentinterest income on the investment portfolio remained stable despite a decreasein the average balance of the investment portfolio of $17,608,000. Offsettingthe decline in average balance of the portfolio was a shift in the portfolio totax-exempt bonds from taxable. This repositioning was undertaken to provideportfolio call protection, strategic investment at the community level, and as part ofthe Company’s tax strategy. The net growth in the volume of the loan portfoliohas generated additional interest income that has offset the 3 basis point increasein the overall yield of the portfolio.

 

Forthe year ended December 31, 2005, reported interest expense increased$1,613,000 over the same period of 2004. Over half of the increased level ofinterest expense was due to market driven increases in the rates paid ondeposit accounts. The increases are primarily the result of the continued rateincreases enacted by the Federal Open Markets Committee (FOMC) coupled withaggressive pricing competition for deposits. In addition, deposit dollars haveshifted from lower rate transaction based accounts to higher rate time depositsover the past year. This shift has resulted in the average balance of timedeposits increasing $16,051,000 in 2005 as compared to 2004. The shift indollars and the FOMC rate increases resulted in the average rate paid ondeposits increasing to 1.98% from 1.65% for the year ended December 31,2004 with the time deposit portfolio average rate increasing 40 basis pointsover the time period.

 

TheCompany increased long-term borrowing during 2005 through the FHLB to minimizefuture borrowing costs and to enhance liability positioning. These additionalborrowings were utilized by management to replace maturing debt and tosupplement the funding of the growth in the loan portfolio. The increase in theexpense on long-term borrowings is the result of average balances of long-termFHLB borrowings increasing $5,093,000 while the weighted average interest rateon the long-term debt remained constant. Short-term borrowing interestincreased $392,000 as a result of the before mentioned FOMC rate increases andan increase of the average balances outstanding during the year of $460,000.

 

**2004 vs 2003**

 

Reported net interest income increased $1,985,000 or 10.2% from fiscal2003 to 2004. Total interest income increased $1,461,000 and is attributed tothe increase of $41,067,000 in the average balance of the loan portfolio offsetpartially by the decrease in the average balance of the investment securitiesof $2,490,000 and a decrease in the return of loans of 62 basis points.

 

Ona tax equivalent basis, net interest income increased 7.3% or $1,497,000, to$21,983,000 in a period when both average interest earning assets and averageinterest-bearing liabilities increased. The increase of taxable security incomeof $1,216,000 is due to the purchases of U.S. Government securities over thepast year, with the average of these securities increasing $17,221,000, whilethe decrease in the average of tax-exempt State & Political securitiesdecreased tax equivalent interest income $1,366,000. The investment portfoliohas been repositioned from longer term assets to shorter

 

14

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termassets to take advantage of the cash flow opportunities for reinvestment inanticipation of rising rates. The net growth in the volume of the loanportfolio has generated additional interest income that has offset the 29 basispoint decline in the overall earning asset weighted average interest rate.

 

Withinthe loan portfolio, a 62 basis point decrease of the tax equivalent return onloans was offset by an increase of $41,067,000 in the average balance of loanswhen comparing the year 2004 to the year 2003. Variable rate loans within theportfolio and other new loan originations at lower effective rates aided in thereduction of income compared to a year ago because of the historically lowrates.

 

Forthe year ended December 31, 2004, reported interest expense decreased$497,000 or 5.4% over the same period of 2003. Lower rates for all depositaccounts contributed the most substantial decrease in interest expense. Theweighted average rate on deposits declined 38 basis points for 2004 as comparedto 2003. Interest expense on time deposits decreased $538,000 due to both the39 basis point decline in the weighted average rate and the decrease in theaverage balance of $1,020,000.

 

During2004, the Company borrowed an additional $5,000,000 in long term advancesthrough the FHLB to minimize future borrowing costs and to enhance liabilitypositioning. These additional borrowings were utilized by management to fundthe substantial loan growth of 2004. The $273,000 increase in expense onlong-term borrowings is the result of average balances of long term FHLBborrowings increasing $8,442,000 partially offset by the 17 basis point declinein the resulting weighted average interest rate for the year ending December 31,2004 compared to the same period in 2003. Interest paid on short-termborrowings increased $111,000 as a result of an increase of the averagebalances outstanding during the year of $6,866,000. The opportunity to borrowfrom the Federal Home Loan Bank at historically low interest rates was utilizedto assist the funding of the loan portfolio growth and is attributed to theincrease of interest expense paid on borrowings.

 

15

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**AVERAGEBALANCES AND INTEREST RATES**

 

The following tables setforth certain information relating to the Company’s average balance sheet andreflects the average yield on assets and average cost of liabilities for theperiods indicated and the average yields earned and rates paid. Such yields andcosts are derived by dividing income or expense by the average balance ofassets or liabilities, respectively, for the periods presented.

 
| **(In Thousands)**                               | ** ** | **2005**                 | ** ** |
|--------------------------------------------------|------------|--------------------------|------------|
| ** **                                       | ** ** | **Average Balance** | ** ** | **Interest** | ** ** | **Average Rate** | ** ** |
| ASSETS:                                          |       |                     |       |   |   |   |   |
| Tax-exempt  loans                                |       | $                        | 5,370      |   | $ | 307 |   | 5.72 | % |
| All other  loans                                 |       | 325,177                  |       | 21,924 |   | 6.74 | % |
| Total Loans                                      |       | 330,547                  |       | 22,231 |   | 6.73 | % |
|                                             |       |                     |       |   |   |   |   |
| Taxable  securities                              |       | 115,041                  |       | 5,554 |   | 4.83 | % |
| Tax-exempt  securitites                          |       | 72,892                   |       | 4,882 |   | 6.70 | % |
| Total  securities                                |       | 187,933                  |       | 10,436 |   | 5.55 | % |
|                                             |       |                     |       |   |   |   |   |
| Total  interest-earning assets                   |       | 518,480                  |       | 32,667 |   | 6.30 | % |
|                                             |       |                     |       |   |   |   |   |
| Other assets                                     |       | 34,181                   |       |   |   |   |   |
|                                             |       |                     |       |   |   |   |   |
| Total assets                                     |       | $                        | 552,661    |   |   |   |   |   |
|                                             |       |                     |       |   |   |   |   |
| LIABILITIES:                                     |       |                     |       |   |   |   |   |
| Savings                                          |       | $                        | 64,795     |   | 500 |   | 0.77 | % |
| Super Now  deposits                              |       | 50,756                   |       | 438 |   | 0.86 | % |
| Money market  deposits                           |       | 29,317                   |       | 412 |   | 1.41 | % |
| Time  deposits                                   |       | 146,391                  |       | 4,424 |   | 3.02 | % |
| Total  Deposits                                  |       | 291,259                  |       | 5,774 |   | 1.98 | % |
|                                             |       |                     |       |   |   |   |   |
| Short-term  borrowings                           |       | 32,114                   |       | 931 |   | 2.90 | % |
| Long-term  borrowings                            |       | 80,820                   |       | 3,676 |   | 4.55 | % |
| Total  borrowings                                |       | 112,934                  |       | 4,607 |   | 4.08 | % |
|                                             |       |                     |       |   |   |   |   |
| Total  interest-bearing liabilities              |       | 404,193                  |       | 10,381 |   | 2.57 | % |
|                                             |       |                     |       |   |   |   |   |
| Demand  deposits                                 |       | 69,457                   |       |   |   |   |   |
| Other  liabilities                               |       | 4,057                    |       |   |   |   |   |
| Shareholders’  equity                       |       | 74,954                   |       |   |   |   |   |
|                                             |       |                     |       |   |   |   |   |
| TOTAL  LIABILITIES AND SHAREHOLDERS’ EQUITY |       | $                        | 552,661    |   |   |   |   |   |
| Interest  rate spread                            |       |                     |       |   |   | 3.73 | % |
| Net interest  income/margin                      |       |                     |       | $ | 22,286 |   | 4.30 | % |

 

----

*    Fees on loans are included with interest on loans. Loan fees areincluded in interest income as follows: 2005 $149,000, 2004 $171,000, 2003 $184,000 

*    Information on this table has been calculated using average dailybalances to obtain average balances for the year.

*    Nonaccrual loans have been included with loans for the purpose ofanalyzing net interest earnings. 

*    Income and rates on a fully taxable equivalent basis include anadjustment for the difference between annual income from tax-exempt obligationsand the taxable equivalent of such income utilizing a 34% tax rate.

 

16

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|                                             | ** ** | **2004**                 | ** ** | **2003**     | ** ** |
|--------------------------------------------------|------------|--------------------------|------------|--------------|------------|
|                                             | ** ** | **Average Balance** | ** ** | **Interest** | ** ** | **Average Rate** | ** ** | **Average Balance** | ** ** | **Interest** | ** ** | **Average Rate** | ** ** |
| ASSETS:                                          |       |                     |       |         |       |   |   |   |   |   |   |   |   |
| Tax-exempt  loans                                |       | $                        | 1,359      |         | $          | 82 |   | 6.03 | % | $ | 1,008 |   | $ | 68 |   | 6.75 | % |
| All other  loans                                 |       | 301,248                  |       | 20,207       |       | 6.71 | % | 260,532 |   | 19,070 |   | 7.32 | % |
| Total Loans                                      |       | 302,607                  |       | 20,289       |       | 6.70 | % | 261,540 |   | 19,138 |   | 7.32 | % |
|                                             |       |                     |       |         |       |   |   |   |   |   |   |   |   |
| Taxable  securities                              |       | 170,876                  |       | 7,876        |       | 4.61 | % | 153,655 |   | 6,661 |   | 4.34 | % |
| Tax-exempt  securitites                          |       | 34,665                   |       | 2,586        |       | 7.46 | % | 54,376 |   | 3,952 |   | 7.27 | % |
| Total  securities                                |       | 205,541                  |       | 10,462       |       | 5.09 | % | 208,031 |   | 10,613 |   | 5.10 | % |
|                                             |       |                     |       |         |       |   |   |   |   |   |   |   |   |
| Total  interest-earning assets                   |       | 508,148                  |       | 30,751       |       | 6.05 | % | 469,571 |   | 29,751 |   | 6.34 | % |
|                                             |       |                     |       |         |       |   |   |   |   |   |   |   |   |
| Other assets                                     |       | 29,498                   |       |         |       |   |   | 28,809 |   |   |   |   |   |
|                                             |       |                     |       |         |       |   |   |   |   |   |   |   |   |
| Total assets                                     |       | $                        | 537,646    |         |       |   |   |   | $ | 498,380 |   |   |   |   |   |
|                                             |       |                     |       |         |       |   |   |   |   |   |   |   |   |
| LIABILITIES:                                     |       |                     |       |         |       |   |   |   |   |   |   |   |   |
| Savings                                          |       | $                        | 69,796     |         | 578        |   | 0.83 | % | $ | 64,583 |   | 755 |   | 1.17 | % |
| Super Now  deposits                              |       | 54,690                   |       | 391          |       | 0.71 | % | 43,983 |   | 328 |   | 0.75 | % |
| Money market  deposits                           |       | 35,164                   |       | 392          |       | 1.11 | % | 38,602 |   | 621 |   | 1.61 | % |
| Time  deposits                                   |       | 130,340                  |       | 3,414        |       | 2.62 | % | 131,361 |   | 3,952 |   | 3.01 | % |
| Total  Deposits                                  |       | 289,990                  |       | 4,775        |       | 1.65 | % | 278,529 |   | 5,656 |   | 2.03 | % |
|                                             |       |                     |       |         |       |   |   |   |   |   |   |   |   |
| Short-term  borrowings                           |       | 31,857                   |       | 539          |       | 1.69 | % | 25,446 |   | 428 |   | 1.68 | % |
| Long-term  borrowings                            |       | 75,727                   |       | 3,454        |       | 4.56 | % | 67,285 |   | 3,181 |   | 4.73 | % |
| Total  borrowings                                |       | 107,584                  |       | 3,993        |       | 3.71 | % | 92,731 |   | 3,609 |   | 3.89 | % |
|                                             |       |                     |       |         |       |   |   |   |   |   |   |   |   |
| Total  interest-bearing liabilities              |       | 397,574                  |       | 8,768        |       | 2.21 | % | 371,260 |   | 9,265 |   | 2.50 | % |
|                                             |       |                     |       |         |       |   |   |   |   |   |   |   |   |
| Demand  deposits                                 |       | 64,434                   |       |         |       |   |   | 56,672 |   |   |   |   |   |
| Other  liabilities                               |       | 4,091                    |       |         |       |   |   | 3,121 |   |   |   |   |   |
| Shareholders’  equity                       |       | 71,547                   |       |         |       |   |   | 67,327 |   |   |   |   |   |
|                                             |       |                     |       |         |       |   |   |   |   |   |   |   |   |
| TOTAL  LIABILITIES AND SHAREHOLDERS’ EQUITY |       | $                        | 537,646    |         |       |   |   |   | $ | 498,380 |   |   |   |   |   |
| Interest  rate spread                            |       |                     |       |         |       | 3.85 | % |   |   |   |   | 3.84 | % |
| Net interest  income/margin                      |       |                     |       | $            | 21,983     |   | 4.33 | % |   |   | $ | 20,486 |   | 4.36 | % |

 

**Reconcilement of Taxable Equivalent Net InterestIncome**

 
| ** **                                      | ** ** | **2005** | ** ** | **2004** | ** ** | **2003** | ** ** |
|-------------------------------------------------|------------|----------|------------|----------|------------|----------|------------|
|                                            |       |     |       |     |       |     |       |
| Total  interest income                          |       | $        | 30,903     |     | $          | 29,845   |       | $ | 28,384 |   |
| Total  interest expense                         |       | 10,381   |       | 8,768    |       | 9,265    |       |
|                                            |       |     |       |     |       |     |       |
| Net interest  income                            |       | 20,522   |       | 21,077   |       | 19,119   |       |
| Tax  equivalent adjustment                      |       | 1,764    |       | 906      |       | 1,367    |       |
|                                            |       |     |       |     |       |     |       |
| Net interest  income (fully taxable equivalent) |       | $        | 22,286     |     | $          | 21,983   |       | $ | 20,486 |   |

 

**Rate/VolumeAnalysis**

 

The table below sets forth certain information regarding changes in ourinterest income and interest expense for the periods indicated. Forinterest-earning assets and interest-bearing liabilities, information isprovided on changes attributable to (i) changes in volume (changes inaverage volume multiplied by old rate); (ii) changes in rates (changes inrate multiplied by

 

17

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old average volume). Increases and decreases due to both interest rateand volume, which cannot be separated, have been allocated proportionally tothe change due to volume and the change due to interest rate. Income andinterest rates are on a taxable equivalent basis.

 
| ** **                          | ** ** | **Year Ended December 31,** | ** ** |
|-------------------------------------|------------|--------------------------------------------|------------|
| ** **                          | ** ** | **2005 vs 2004**                 | ** ** | **2004 vs 2003** | ** ** |
| ** **                          | ** ** | **Increase (Decrease)**               | ** ** | **Increase (Decrease)** | ** ** |
| ** **                          | ** ** | **Due to**                            | ** ** | **Due to** | ** ** |
| **(In Thousands)**             | ** ** | **Volume**                                 | ** ** | **Rate** | ** ** | **Net** | ** ** | **Volume** | ** ** | **Rate** | ** ** | **Net** | ** ** |
| **Interest  income:**               |       |                                       |       |   |   |   |   |   |   |   |   |   |   |
| Taxable  investment securities      |       | $                                          | (2,681     | ) | $ | 359 |   | $ | (2,322 | ) | $ | 855 |   | $ | 360 |   | $ | 1,215 |   |
| Tax-exempt  investment securities   |       | 2,585                                      |       | (289 | ) | 2,296 |   | (1,467 | ) | 101 |   | (1,366 | ) |
| Loans                               |       | 1,614                                      |       | 103 |   | 1,717 |   | 2,818 |   | (1,681 | ) | 1,137 |   |
| Loans,  tax-exempt                  |       | 229                                        |       | (4 | ) | 225 |   | 22 |   | (8 | ) | 14 |   |
| Total  interest-earning assets      |       | 1,747                                      |       | 169 |   | 1,916 |   | 2,228 |   | (1,228 | ) | 1,000 |   |
|                                |       |                                       |       |   |   |   |   |   |   |   |   |   |   |
| **Interest  expenses:**             |       |                                       |       |   |   |   |   |   |   |   |   |   |   |
| Savings  deposits                   |       | 17                                         |       | (95 | ) | (78 | ) | 57 |   | (234 | ) | (177 | ) |
| Super Now  deposits                 |       | (29                                        | )          | 76 |   | 47 |   | 77 |   | (14 | ) | 63 |   |
| Money market  deposits              |       | (72                                        | )          | 92 |   | 20 |   | (62 | ) | (167 | ) | (229 | ) |
| Time  deposits                      |       | 161                                        |       | 849 |   | 1,010 |   | (31 | ) | (507 | ) | (538 | ) |
| Short-term  borrowings              |       | 8                                          |       | 384 |   | 392 |   | 116 |   | (5 | ) | 111 |   |
| Long-term  borrowings               |       | 231                                        |       | (9 | ) | 222 |   | 388 |   | (115 | ) | 273 |   |
| Total  interest-bearing liabilities |       | 316                                        |       | 1,297 |   | 1,613 |   | 545 |   | (1,042 | ) | (497 | ) |
| Change in  net interest income      |       | $                                          | 1,431      |   | $ | (1,128 | ) | $ | 303 |   | $ | 1,683 |   | $ | (186 | ) | $ | 1,497 |   |

 

**PROVISIONFOR LOAN LOSSES**

 

**2005 vs 2004**

 

The provision for loan losses is based upon management’s quarterlyreview 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 aggressiveprogram of problem loan identification and resolution.

 

The allowance is calculated by applying loss factors to outstandingloans by type, excluding loans for which a specific allowance has been determined.Loss factors are based on management’s consideration of the nature of theportfolio segments, changes in mix and volume of the loan portfolio, andhistorical 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 the best informationavailable to make such determinations and that the allowance for loan losses isadequate at December 31, 2005, future adjustments could be necessary ifcircumstances or economic conditions differ substantially from the assumptionsused in making the initial determinations. A downturn in the local economy,employment, and delays in receiving financial information from borrowers couldresult in increased levels of nonperforming assets and charge-offs, increasedloan loss provisions and reductions in income. Additionally, as an integral part ofthe examination process, bank regulatory agencies periodically review the Bank’sloan loss allowance. The banking regulators could require the recognition ofadditions to the loan loss allowance based on their judgment of informationavailable to them at the time of their examination.

 

The allowance for loan losses increased from $3,338,000 at December 31,2004 to $3,679,000 at December 31, 2005. At December 31, 2005,allowance for loan losses was 1.09% of total loans compared to 1.03% of

 

18

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total loans at December 31, 2004. Management’s conclusion is thatthe allowance for loan losses is adequate to provide for probable lossesinherent in its loan portfolio as of the balance sheet date.

 

The provision for loan losses totaled $720,000 for the year ended December 31,2005. The provision for the same period in 2004 was $465,000. Managementconcluded that the increase of the provision was appropriate when consideringthe loan growth experienced during 2005 and economic changes during the year. 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.

 

**2004 vs 2003**

 

The allowance for loan losses increased 8.8% or $269,000 from fiscal2003 after net charge-offs of $196,000 contributed to a year-end allowance forloan losses of $3,338,000 or 1.03% of total loans. Based upon this analysis, aswell as the others noted above, senior management has concluded that theallowance for loan losses remains at a level adequate to provide for probablelosses inherent in the loan portfolio.

 

Following is a table showing the changes in the allowance for loanlosses for the years ended December 31:

 
| ** **                                                                                 | ** ** | **YEAR ENDED DECEMBER 31,** | ** ** |
|--------------------------------------------------------------------------------------------|------------|--------------------------------------------|------------|
| **(In Thousands)**                                                                    | ** ** | **2005**                                   | ** ** | **2004** | ** ** | **2003** | ** ** | **2002** | ** ** | **2001** | ** ** |
| Balance at  beginning of period                                                            |       | $                                          | 3,338      |   | $ | 3,069 |   | $ | 2,953 |   | $ | 2,927 |   | $ | 2,879 |   |
| Charge-offs:                                                                               |       |                                       |       |   |   |   |   |   |   |   |   |
| Real estate                                                                                |       | 132                                        |       | 121 |   | 63 |   | 262 |   | 154 |   |
| Commercial  and industrial                                                                 |       | 206                                        |       | 50 |   | 37 |   | 80 |   | 122 |   |
| Installment  loans to individuals                                                          |       | 108                                        |       | 112 |   | 116 |   | 60 |   | 82 |   |
| Total  charge-offs                                                                         |       | 446                                        |       | 283 |   | 216 |   | 402 |   | 358 |   |
| Recoveries:                                                                                |       |                                       |       |   |   |   |   |   |   |   |   |
| Real estate                                                                                |       | 45                                         |       | 50 |   | 42 |   | 25 |   | 9 |   |
| Commercial  and industrial                                                                 |       | 8                                          |       | 4 |   | 16 |   | 21 |   | 8 |   |
| Installment  loans to individuals                                                          |       | 14                                         |       | 33 |   | 19 |   | 17 |   | 17 |   |
| Total  recoveries                                                                          |       | 67                                         |       | 87 |   | 77 |   | 63 |   | 34 |   |
| Net  charge-offs                                                                           |       | 379                                        |       | 196 |   | 139 |   | 339 |   | 324 |   |
| Additions  charged to operations                                                           |       | 720                                        |       | 465 |   | 255 |   | 365 |   | 372 |   |
| Balance at  end of period                                                                  |       | $                                          | 3,679      |   | $ | 3,338 |   | $ | 3,069 |   | $ | 2,953 |   | $ | 2,927 |   |
| Ratio of net  charge-offs during the period to average loans outstanding during the period |       | 0.11                                       | %          | 0.06 | % | 0.05 | % | 0.13 | % | 0.13 | % |

 

**NON-INTERESTINCOME**

 

**2005 vs 2004**

 

Total non-interest income increased $513,000 from fiscal 2004 to 2005. Excludingsecurity gains and the gain on sale of loans, non-interest income increased$604,000. Service charges increased $245,000 due to the implementation of a newoverdraft protection program that was started in May 2005. Earnings onbank-owned life insurance increased $274,000 due in large part to thereceipt of a $196,000 to a death benefit claim. Commissions earned on the saleof insurance products increased $45,000 as The M Group continues to expand itsmarket area by adding sales representatives to meet commitments made with otherfinancial institutions to provide these same services to their customers. Gainon sale of loans decreased as the volume of loans sold decreased as compared to2004. The increase in other income was primarily due to increases in cardrevenues from both ATM and debit cards offset by decreases in other areas ofother income. Transaction

 

19

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volume increases attributed to our customers increased utilization ofdebit cards resulted in debit card fees increasing $74,000.

 
| **(In Thousands)**    | ** ** | **2005** | ** ** | **2004** | ** ** | **$ Change** | ** ** | **% Change** | ** ** |
|----------------------------|------------|----------|------------|----------|------------|-------------------|------------|-------------------|------------|
| Service  charges           |       | $        | 2,228      |     | $          | 1,983             |       | $                 | 245        |   | 12.36 | % |
| Securities  gains, net     |       | 2,190    |       | 2,176    |       | 14                |       | 0.64              | %          |
| Bank-owned  life insurance |       | 568      |       | 294      |       | 274               |       | 93.20             | %          |
| Insurance  commissions     |       | 2,327    |       | 2,282    |       | 45                |       | 1.97              | %          |
| Gain on sale  of loans     |       | 864      |       | 969      |       | (105              | )          | -10.84            | %          |
| Other income               |       | 1,254    |       | 1,214    |       | 40                |       | 3.29              | %          |
| Total  Non-Interest Income |       | $        | 9,431      |     | $          | 8,918             |       | $                 | 513        |   | 5.75 | % |

 

**2004 vs 2003**

 

Total non-interest income decreased $232,000 from fiscal 2003 to 2004. Securitygains realized decreased $1,303,000. Excluding security gains and the gain onsale of loans, non-interest income increased $798,000. Service chargesincreased $66,000 due to an increased fee structure. Earnings on bank-ownedlife insurance decreased $110,000 due to the decrease of the average creditingrate paid on the policies as a result of the low rate environment. Commissionsearned on the sales of insurance increased $684,000 due to the expanded staffand market area of the sales. The majority of the increase in other income of$158,000 was attributed to commissions generated from the new addition of thetitle insurance to the bank’s product line.

 
| **(In Thousands)**    | ** ** | **2004** | ** ** | **2003** | ** ** | **$ Change** | ** ** | **% Change** | ** ** |
|----------------------------|------------|----------|------------|----------|------------|-------------------|------------|-------------------|------------|
| Service  charges           |       | $        | 1,983      |     | $          | 1,917             |       | $                 | 66         |   | 3.44 | % |
| Securities  gains, net     |       | 2,176    |       | 3,479    |       | (1,303            | )          | -37.45            | %          |
| Bank-owned  life insurance |       | 294      |       | 404      |       | (110              | )          | -27.23            | %          |
| Insurance  commissions     |       | 2,282    |       | 1,598    |       | 684               |       | 42.80             | %          |
| Gain on sale  of loans     |       | 969      |       | 696      |       | 273               |       | 39.22             | %          |
| Other income               |       | 1,214    |       | 1,056    |       | 158               |       | 14.96             | %          |
| Total  Non-Interest Income |       | $        | 8,918      |     | $          | 9,150             |       | $                 | (232       | ) | -2.54 | % |

 

**NON-INTERESTEXPENSES**

 

**2005 vs 2004**

 

Total non-interest expenses increased $924,000 from the year ended December 31,2004 to December 31, 2005. Salaries and employee benefits increased by$510,000 and was the result of increased staffing due in part to a newbranch in the State College area, standard wage increases, and increasedpension and health insurance costs. Occupancy expense increased due primarilyto the new State College office which was operational since May 2005. Furnitureand equipment expenses declined due in part to the reduction of severalcomputer, hardware, and equipment maintenance contracts deemed unnecessary. Otherexpenses increased $286,000 due to general increases in the cost of businessspecifically ATM transaction processing, advertising, telephone, stationary,and office supplies.

 
| **(In Thousands)**           | ** ** | **2005** | ** ** | **2004** | ** ** | **$ Change** | ** ** | **% Change** | ** ** |
|-----------------------------------|------------|----------|------------|----------|------------|-------------------|------------|-------------------|------------|
| Salaries and  employee benefits   |       | $        | 8,314      |     | $          | 7,804             |       | $                 | 510        |   | 6.54 | % |
| Occupancy  expense, net           |       | 1,089    |       | 959      |       | 130               |       | 13.56             | %          |
| Furniture  and equipment expenses |       | 973      |       | 1,016    |       | (43               | )          | -4.23             | %          |
| Pennsylvania  shares tax expense  |       | 549      |       | 508      |       | 41                |       | 8.07              | %          |
| Other  expenses                   |       | 4,183    |       | 3,897    |       | 286               |       | 7.34              | %          |
| Total  Non-Interest Expenses      |       | $        | 15,108     |     | $          | 14,184            |       | $                 | 924        |   | 6.51 | % |

 

20

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**2004 vs 2003**

 

Total non-interest expenses increased $1,047,000 or 7.97% from the yearended December 31, 2003 to December 31, 2004. Salaries and employeebenefits increase of $694,000 was the result of the increase in commissionearned by the M Group and standard cost of living increases. Expenses relatedto the new State College Atherton Street branch caused the majority of the$82,000 increase in occupancy expense. Increased maintenance and repairscontributed to the $17,000 increase to furniture and equipment expense. Pennsylvaniashares taxes increased $53,000 from 2003 to 2004. Other expenses increased$201,000. This increase was primarily the increase of computer softwareamortization due to the implementation of teller machines, the increase oflegal, audit, and consultant fees in relation to Sarbanes-Oxley compliance, andexpenses on the new product title insurance.

 
| **(In Thousands)**           | ** ** | **2004** | ** ** | **2003** | ** ** | **$ Change** | ** ** | **% Change** | ** ** |
|-----------------------------------|------------|----------|------------|----------|------------|-------------------|------------|-------------------|------------|
| Salaries and  employee benefits   |       | $        | 7,804      |     | $          | 7,110             |       | $                 | 694        |   | 9.76 | % |
| Occupancy  expense, net           |       | 959      |       | 877      |       | 82                |       | 9.35              | %          |
| Furniture  and equipment expenses |       | 1,016    |       | 999      |       | 17                |       | 1.70              | %          |
| Pennsylvania  shares tax expense  |       | 508      |       | 455      |       | 53                |       | 11.65             | %          |
| Other  expenses                   |       | 3,897    |       | 3,696    |       | 201               |       | 5.44              | %          |
| Total  Non-Interest Expenses      |       | $        | 14,184     |     | $          | 13,137            |       | $                 | 1,047      |   | 7.97 | % |

 

**INCOMETAXES**

 

**2005 vs 2004**

 

Theprovision for income taxes for the year ended December 31, 2005 resultedin an effective income tax rate of 22.8% compared to 27.8% for 2004. Thisdecrease is the result of a shift in the investment portfolio from taxablemortgage-backed bonds to tax-exempt municipal bonds.

 

**2004 vs 2003**

 

Theprovision for income taxes for the year ended December 31, 2004 resultedin an effective income tax rate of 27.8% compared to 24.9% for 2003. Thisincrease is the result of an overall decline in revenue from tax-exempt loansand investment securities as compared to revenue as a whole.

 

**FINANCIAL CONDITION**

 

**INVESTMENTS**

 

**2005**

 

The investment portfolio increased $2,562,000 or 1.39% from December 31,2004 to 2005. During 2005 the investment portfolio components were shifted fromtaxable bonds to tax-exempt municipal bonds. This shift was part of astrategy to increase yield, provide call protection, and to reduce the Company’soverall effective tax rate. This strategy resulted in state and politicalholdings increasing $47,023,000 or 100% from year end 2004 to 2005, while theinvestment in government agencies has decreased by $40,076,000 or 38.5%.

 

**2004**

 

The investment portfolio decreased $35,194,000 or 16.15% in 2004. Thedecline in the investments is attributed to a $45,847,000 decrease in U.S.Treasury and Agency securities, $13,117,000 increase in states and politicalsecurities and a $296,000 decrease in other debt. The proceeds from the sale ofsecurities were utilized to fund loan growth. The total realized gains on thesecurities for 2004 was $2,176,000 a decrease of $1,303,000 from December 31,2003.

 

21

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The carrying amounts of investment securities at the dates indicatedare summarized as follows for the years ended December 31:

 
| ** **                            | ** ** | **2005**    | ** ** | **2004**             | ** ** | **2003**    | ** ** |
|---------------------------------------|------------|-------------|------------|----------------------|------------|-------------|------------|
| **(In Thousands)**               | ** ** | **Balance** | ** ** | **% Portfolio** | ** ** | **Balance** | ** ** | **% Portfolio** | ** ** | **Balance** | ** ** | **% Portfolio** | ** ** |
| U.S. Treasury  securities:            |       |        |       |                 |       |        |       |   |   |   |   |   |   |
| Available  for Sale                   |       | $           | —     |                 | —     |        | $          | 1,024 |   | 0.55 | % | $ | 3,128 |   | 1.44 | % |
| U.S.  Government agencies:            |       |        |       |                 |       |        |       |   |   |   |   |   |   |
| Held to  Maturity                     |       | 28          |       | 0.01                 | %          | 32          |       | 0.02 | % | 75 |   | 0.03 | % |
| Available  for Sale                   |       | 63,953      |       | 34.15                | %          | 103,001     |       | 55.76 | % | 146,701 |   | 67.32 | % |
| State and  political subdivisions:    |       |        |       |                 |       |        |       |   |   |   |   |   |   |
| Held to  Maturity                     |       | —      |       | —               |       | 248         |       | 0.13 | % | 347 |   | 0.16 | % |
| Available  for Sale                   |       | 94,091      |       | 50.24                | %          | 47,068      |       | 25.48 | % | 33,852 |   | 15.53 | % |
| Other bonds,  notes and debentures:   |       |        |       |                 |       |        |       |   |   |   |   |   |   |
| Held to  Maturity                     |       | 237         |       | 0.13                 | %          | 278         |       | 0.15 | % | 264 |   | 0.12 | % |
| Available  for Sale                   |       | 1,719       |       | 0.92                 | %          | 1,342       |       | 0.73 | % | 1,652 |   | 0.76 | % |
| Total bonds,  notes and debentures    |       | 160,028     |       | 85.45                | %          | 152,993     |       | 82.82 | % | 186,019 |   | 85.37 | % |
| Corporate  stock - Available for Sale |       | 27,255      |       | 14.55                | %          | 31,728      |       | 17.18 | % | 31,896 |   | 14.64 | % |
| Total                                 |       | $           | 187,283    |                 | 100.00     | %           | $          | 184,721 |   | 100.00 | % | $ | 217,915 |   | 100.00 | % |

 

The following table shows the maturities and repricing of investmentsecurities at December 31, 2005 and the weighted average yields (fortax-exempt obligations on a fully taxable basis assuming a 34% tax rate) ofsuch:

 
| ** **                          | ** ** | **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.  Treasury securities:          |       |       |       |                |       |                |       |      |       |          |       |
| HTM Amount                          |       | $          | —     |                | $          | —              |       | $         | —     |          | $          | — |   | $ | — |   |
| Yield                               |       | —     |       | —              |       | —              |       | —    |       | —        |       |
| AFS Amount                          |       | —     |       | —              |       | —              |       | —    |       |          |       |
| Yield                               |       | —     |       | —              |       | —              |       | —    |       | —        |       |
| U.S.  Government agencies:          |       |       |       |                |       |                |       |      |       |          |       |
| HTM Amount                          |       | —     |       | —              |       | —              |       | 28        |       | 28            |       |
| Yield                               |       | —     |       | —              |       | —              |       | 8.96      | %          | 8.96          | %          |
| AFS Amount                          |       | —     |       | 790                 |       | 1,500               |       | 63,206    |       | 65,496        |       |
| Yield                               |       | —     |       | 5.16                | %          | 5.14                | %          | 5.07      | %          | 5.07          | %          |
| State and  political subdivisions:  |       |       |       |                |       |                |       |      |       |          |       |
| HTM Amount                          |       | —     |       | —              |       | —              |       | —    |       | —        |       |
| Yield                               |       | —     |       | —              |       | —              |       | —    |       | —        |       |
| AFS Amount                          |       | —     |       | —              |       | 6,180               |       | 87,589    |       | 93,769        |       |
| Yield                               |       | —     |       | —              |       | 5.48                | %          | 6.70      | %          | 6.62          | %          |
| Other bonds,  notes and debentures: |       |       |       |                |       |                |       |      |       |          |       |
| HTM Amount                          |       | 25         |       | 75                  |       | 137                 |       | —    |       | 237           |       |
| Yield                               |       | 7.20       | %          | 6.52                | %          | 6.11                | %          | —    |       | 6.35          | %          |
| AFS Amount                          |       | 25         |       | —              |       | —              |       | 1,725     |       | 1,750         |       |
| Yield                               |       | 7.26       | %          | —              |       | —              |       | 6.74      | %          | 6.75          | %          |
| Total Amount                        |       | $          | 50         |                | $          | 865                 |       | $         | 7,817      |          | $          | 152,548 |   | $ | 161,280 |   |
| Total Yield                         |       | 7.20       | %          | 5.28                | %          | 5.43                | %          | 6.12      | %          | 6.09          | %          |
|                                |       |       |       |                |       |                |       |      |       |          |       |
| Equity  Securities                  |       |       |       |                |       |                |       |      |       | $             | 24,715     |   |
| Total  Investment Portfolio Value   |       |       |       |                |       |                |       |      |       | $             | 185,995    |   |
| Total  Investment Portfolio Yield   |       |       |       |                |       |                |       |      |       | 5.28          | %          |

 

All yields represent weighted average yields expressed on a taxequivalent basis. They are calculated on the basis of the cost, adjusted foramortization of premium and accretion of discount, and effective yieldsweighted for the scheduled maturity of each security. The taxable equivalentadjustment represents the difference between annual income from tax-exemptobligations and the taxable equivalent of such income at the standard 34% taxrate (derived by dividing tax-exempt interest by 66%).

 

22

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**LOAN PORTFOLIO**

 

**2005**

 

Grossloans for the year ended December 31, 2005, increased 4.29% to $338,438,000from $324,505,000 at December 31, 2004. The increase was concentrated in realestate mortgages which increased $8,229,000 as a whole from December 31, 2004to 2005. Commercial and agricultural loans and installment loans increased$4,304,000 and $1,366,000 respectively. The growth in real estate secured loansis part of the Company’s overall lending strategy to underwrite wellcollateralized real estate loans. The opening of the Atherton Street, StateCollege along with a home equity loan campaign also assisted in increasing realestate loans. Commercial and individuals loan categories increased modestly asthe Company broadens its lending base and expands its market coverage.

 

**2004**

 

Grossloans for the year ended December 31, 2004, increased 17.65% to $324,505,000from $275,828,000 at December 31, 2003. Real estate mortgages increased$41,338,000 as a whole with commercial and construction real estate loansincreasing $40,861,000 and $713,000 respectively, while residential loansdecreased $236,000. Commercial and agricultural loans and installment loansincreased $6,580,000 and $915,000 respectively. Net deferred loan feesincreased $156,000. Given the current market conditions, management hasdirected its conservative lending approach toward well collateralized realestate loans. Commercial real estate projects provided the greatest opportunityfor growth in 2004.

 

Theamounts of loans outstanding at the indicted dates are shown in the followingtable according to type of loan:

 
| **(In Thousands)**                | ** ** | **2005** | ** ** | **2004** | ** ** | **2003** | ** ** | **2002** | ** ** | **2001** | ** ** |
|-----------------------------------|------------|----------|------------|----------|------------|----------|------------|----------|------------|----------|------------|
| Commercial and  agricultural      |       | $        | 34,407     |     | $          | 30,103   |       | $        | 23,523     |     | $          | 23,708 |   | $ | 22,629 |   |
| Real estate  mortgage:            |       |     |       |     |       |     |       |     |       |     |       |
| Residential                       |       | 150,000  |       | 147,461  |       | 147,697  |       | 140,724  |       | 140,614  |       |
| Commercial                        |       | 127,131  |       | 123,757  |       | 82,896   |       | 75,892   |       | 67,038   |       |
| Construction                      |       | 10,681   |       | 8,365    |       | 7,652    |       | 3,356    |       | 4,077    |       |
| Installment  loans to individuals |       | 17,281   |       | 15,915   |       | 15,000   |       | 14,934   |       | 17,896   |       |
| Less: Net  deferred loan fees     |       | 1,062    |       | 1,096    |       | 940      |       | 769      |       | 631      |       |
| Gross loans                       |       | $        | 338,438    |     | $          | 324,505  |       | $        | 275,828    |     | $          | 257,845 |   | $ | 251,623 |   |

 

23

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The amounts of domesticloans at December 31, 2005 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                            |       | $               | 11,746     |           | $          | 8,572           |       | $          | 2,155      |   | $ | 22,473 |   |
| 1 through 5  years                        |       | 14,586          |       | 3,468          |       | 202             |       | 18,256     |       |
| 5 through 10  years                       |       | 27,284          |       | 2,504          |       | 23              |       | 29,811     |       |
| After 10 years                            |       | 172,968         |       | 2,033          |       | 119             |       | 175,120    |       |
| Total floating  interest rate loans       |       | 226,584         |       | 16,577         |       | 2,499           |       | 245,660    |       |
| Loans with  predetermined interest rates: |       |            |       |           |       |            |       |       |       |
| 1 year or less                            |       | 4,114           |       | 713            |       | 1,051           |       | 5,878      |       |
| 1 through 5  years                        |       | 18,460          |       | 7,750          |       | 10,333          |       | 36,543     |       |
| 5 through 10  years                       |       | 22,035          |       | 9,243          |       | 3,413           |       | 34,691     |       |
| After 10 years                            |       | 15,542          |       | 124            |       | —          |       | 15,666     |       |
| Total  predetermined interest rate loans  |       | 60,151          |       | 17,830         |       | 14,797          |       | 92,778     |       |
| Total                                     |       | $               | 286,735    |           | $          | 34,407          |       | $          | 17,296     |   | $ | 338,438 |   |

 

----

•      The loan maturity information is based uponoriginal 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, as to principalamount at interest rates prevailing at the date of renewal.

 

•      Scheduled repayments are reported in maturitycategories in which the payment is due.

 

TheBank does not make loans that provide for negative amortization nor do anyloans contain conversion features. The Bank does not have any foreign loansoutstanding at December 31, 2005.

 

**ALLOWANCE FOR LOAN LOSSES**

 

**2005**

 

The allowance for loan losses represents the amountwhich management estimates is adequate to provide for probable losses inherentin its loan portfolio, as of the balance sheet date. The allowance method isused in providing for loan losses. Accordingly, all loan losses are charged tothe allowance and all recoveries are credited to it. The allowance for loanlosses is established through a provision for loan losses charged to operations.The provision for loanlosses is based upon management’s quarterly review of the loan portfolio. Thepurpose of the review is to assess loan quality, identify impaired loans,analyze delinquencies, ascertain loan growth, evaluate potential charge-offsand recoveries, and assess general economic conditions in the markets served. Anexternal independent loan review is also performed annually for the Bank. Managementremains committed to an aggressive program of problem loan identification andresolution.

 

Theallowance is calculated by applying loss factors to outstanding loans by type,excluding loans for which a specific allowance has been determined. Lossfactors are based on management’s consideration of the nature of the portfoliosegments, changes in mix and volume of the loan portfolio, and historical loanloss experience. In addition, management considers industry standards and trendswith respect to nonperforming loans and its knowledge and experience withspecific lending segments.

 

24

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Althoughmanagement believes that it uses the best information available to make suchdeterminations and that the allowance for loan losses is adequate at December31, 2005, future adjustments could be necessary if circumstances or economicconditions differ substantially from the assumptions used in making the initialdeterminations. A downturn in the local economy, employment and delays inreceiving financial information from borrowers could result in increasedlevels of nonperforming assets and charge-offs, increased loan loss provisionsand reductions in income. Additionally, as an integral part of the examinationprocess, bank regulatory agencies periodically review the Bank’s loan lossallowance. The banking agencies could require the recognition of additions to the loan loss allowance basedon their judgment of information available to them at the time of theirexamination.

 

Theallowance for loan losses increased from $3,338,000 at December 31, 2004 to$3,679,000 at December 31, 2005. At December 31, 2005, allowance for loanlosses was 1.09% of total loans compared to 1.03% of total loans at December31, 2004. This percentage is consistent with the Bank’s historical experienceand peer banks. Management’s conclusion is that the allowance for loan lossesis adequate to provide for probable losses inherent in its loan portfolio as ofthe balance sheet date.

 

Basedupon this analysis, as well as the others noted above, senior management hasconcluded that the allowance for loan losses remains at a level adequate toprovide for probable losses inherent in its loan portfolio.

 

**2004**

 

AtDecember 31, 2004, the allowance for loan losses as a percent of total loansdeclined to 1.03% from 1.11% at December 31, 2003. Gross loans increased by$48,677,000 from $257,828,000 at December 31, 2003 to $324,505,000 at December31, 2004.

 

Basedon management’s loan-by-loan review, the past performance of the borrowers andcurrent economic conditions, including recent business closures and bankruptcylevels, management does not anticipate any current losses related tononaccrual, nonperforming, or classified loans above that have already beenconsidered in its overall judgment of the adequacy of the reserve.

 

**NONPERFORMINGLOANS**

 

Nonaccrual loans decreased $841,000 from year-end 2004 as several commercial realestate loans were foreclosed during 2005. Overall nonperforming loans decreased$1,123,000 to $603,000 from fiscal year end 2004.

 

Thefollowing table presents information concerning nonperforming loans. Theaccrual of interest will be discontinued when the principal or interest of aloan is in default for 90 days or more, or as soon as payment is questionable,unless the loan is well secured and in the process of collection. Consumerloans and residential real estate loans secured by 1 to 4 family dwellingsshall ordinarily not be subject to those guidelines. The reversal of previouslyaccrued but uncollected interest applicable to any loan placed in a nonaccrualstatus and the treatment of subsequent payments of either principal or interestwill be handled in 

 

25

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accordancewith U.S. generally accepted accounting principles. These principles do notrequire a write-off of previously accrued interest if principal and interestare ultimately protected by sound collateral values. A nonperforming loan maybe restored to an accruing status when:

 

1.     Principal and interest is no longer due andunpaid.

2.     It becomes well secured and in the process ofcollection.

3.     Prospects for future contractual payments areno longer in doubt.

 
| ** **         | ** ** | **TOTAL NONPERFORMING LOANS** | ** ** |
|--------------------|------------|-------------------------------|------------|
| ** **         | ** ** | ** **                    | ** ** | **90 DAYS** | ** ** | ** ** | ** ** |
| **(In Thousands)** | ** ** | **NONACCRUAL**                | ** ** | **PAST DUE** | ** ** | **TOTAL** | ** ** |
| 2005               |       | $                             | 540        |   | $ | 63 |   | $ | 603 |   |
| 2004               |       | 1,381                         |       | 345 |   | 1,726 |   |
| 2003               |       | 827                           |       | 429 |   | 1,256 |   |
| 2002               |       | 871                           |       | 1,225 |   | 2,096 |   |
| 2001               |       | 281                           |       | 338 |   | 619 |   |
|                    |            |                               |            |  |  |  |  |  |  |  |

 

Thelevel of nonaccruing loans continues to fluctuate annually and is attributed tothe various economic factors experienced both regionally and nationally. Overallthe portfolio is well secured with a majority of the balance making regularpayments or scheduled to be satisfied in the near future. Presently there areno significant 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’sjudgment in determining the amount of the additions to the allowance charged tooperating expense considers the following factors:

 

1.     Economic conditions and the impact on theloan portfolio.

2.     Analysis of past loan charge-offs experiencedby category and comparison to outstanding loans.

3.     Problem loans on overall portfolio quality.

4.     Reports of examination of the loan portfolioby the Pennsylvania State Banking Department and the Federal Deposit InsuranceCorporation.

 

26

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**ALLOCATIONIN THE ALLOWANCE FOR LOAN LOSSES**

 
| ** **                              | ** ** | ** ** | ** ** | **PERCENT OF**  | ** ** |
|-----------------------------------------|------------|------------|------------|-----------------|------------|
| ** **                              | ** ** | ** ** | ** ** | **LOANS IN**    | ** ** |
| ** **                              | ** ** | ** ** | ** ** | **EACH**        | ** ** |
| ** **                              | ** ** | ** ** | ** ** | **CATEGORY TO** | ** ** |
| **(In Thousands)**                      | ** ** | **AMOUNT** | ** ** | **TOTAL LOANS** | ** ** |
| **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      |       | 37.4            | %          |
| Construction                            |       | 79         |       | 3.1             | %          |
| Installment  loans to individuals       |       | 192        |       | 5.1             | %          |
| Unallocated                             |       | 237        |       | —          |       |
| Total                                   |       | $          | 3,679      |            | 100.0      | % |
| **DECEMBER 31, 2004:**                  |       |       |       |            |       |
| Balance at end of period applicable to: |       |       |       |            |       |
| Commercial and  agricultural            |       | $          | 361        |            | 9.1        | % |
| Real estate  mortgage:                  |       |       |       |            |       |
| Residential                             |       | 1,280      |       | 46.1            | %          |
| Commercial                              |       | 1,399      |       | 37.5            | %          |
| Construction                            |       | 75         |       | 2.5             | %          |
| Installment  loans to individuals       |       | 207        |       | 4.8             | %          |
| Unallocated                             |       | 16         |       | —          |       |
| Total                                   |       | $          | 3,338      |            | 100.0      | % |
| **DECEMBER 31, 2003:**                  |       |       |       |            |       |
| Balance at end of period applicable to: |       |       |       |            |       |
| Commercial and  agricultural            |       | $          | 353        |            | 8.5        | % |
| Real estate  mortgage:                  |       |       |       |            |       |
| Residential                             |       | 1,483      |       | 53.4            | %          |
| Commercial                              |       | 916        |       | 29.9            | %          |
| Construction                            |       | 77         |       | 2.8             | %          |
| Installment  loans to individuals       |       | 240        |       | 5.4             | %          |
| Total                                   |       | $          | 3,069      |            | 100.0      | % |
| **DECEMBER 31, 2002:**                  |       |       |       |            |       |
| Balance at end of period applicable to: |       |       |       |            |       |
| Commercial and  agricultural            |       | $          | 471        |            | 9.2        | % |
| Real estate  mortgage:                  |       |       |       |            |       |
| Residential                             |       | 1,162      |       | 54.4            | %          |
| Commercial                              |       | 1,082      |       | 29.3            | %          |
| Construction                            |       | 66         |       | 1.3             | %          |
| Installment  loans to individuals       |       | 172        |       | 5.8             | %          |
| Total                                   |       | $          | 2,953      |            | 100.0      | % |
| **DECEMBER 31, 2001:**                  |       |       |       |            |       |
| Balance at end of period applicable to: |       |       |       |            |       |
| Commercial and  agricultural            |       | $          | 414        |            | 9.0        | % |
| Real estate  mortgage:                  |       |       |       |            |       |
| Residential                             |       | 1,379      |       | 55.8            | %          |
| Commercial                              |       | 763        |       | 26.5            | %          |
| Construction                            |       | 74         |       | 1.6             | %          |
| Installment  loans to individuals       |       | 271        |       | 7.1             | %          |
| Unallocated  general allowance          |       | 26         |       | —          |       |
| Total                                   |       | $          | 2,927      |            | 100.0      | % |

 

**DEPOSITS**

 

**2005 vs 2004**

 

Total average depositswere $360,716,000 for 2005, an increase of $6,292,000 or 1.78% from 2004. Noninterestbearing deposits increased $5,023,000 or 7.80% year over year. Time depositsincreased $16,051,000 or 12.31% as deposits shifted 

 

27

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from transaction accountsto time deposits in light of the increasing spread in interest rates betweenthe deposit types. Increases in rates paid were the result of the FOMC rateincreases over the past year and increased competition for deposits.

 

**2004 vs 2003**

 

Total average depositswere $354,424,000 for 2004, an increase of $19,223,000 or 5.73%. Noninterest-bearingdeposits increased $7,762,000 and NOW and money market accounts increased acombined $7,269,000 or 8.80% . Savings deposits increased $5,123,000 while timedeposits decreased $1,021,000. Low rates have influenced investors away fromlonger term commitments which has resulted in an increase in more liquidaccounts such as demand deposits and savings and a decrease in time depositaccounts.

 

Theaverage amount and the average rate paid on deposits are summarized below:

 
| ** **              | ** ** | **2005**    | ** ** | **2004**    | ** ** | **2003**    | ** ** |
|-------------------------|------------|-------------|------------|-------------|------------|-------------|------------|
| ** **              | ** ** | **AVERAGE** | ** ** | **AVERAGE** | ** ** | **AVERAGE** | ** ** |
| **(In Thousands)**      | ** ** | **AMOUNT**  | ** ** | **RATE**    | ** ** | **AMOUNT**  | ** ** | **RATE** | ** ** | **AMOUNT** | ** ** | **RATE** | ** ** |
| Noninterest-bearing     |       | $           | 69,457     |        | 0.00       | %           | $          | 64,434 |   | 0.00 | % | $ | 56,672 |   | 0.00 | % |
| Savings                 |       | 64,795      |       | 0.77        | %          | 69,796      |       | 0.83 | % | 64,583 |   | 1.17 | % |
| Super Now               |       | 50,756      |       | 0.86        | %          | 54,690      |       | 0.71 | % | 43,983 |   | 0.75 | % |
| Money Market            |       | 29,317      |       | 1.41        | %          | 35,164      |       | 1.11 | % | 38,602 |   | 1.61 | % |
| Time                    |       | 146,391     |       | 3.02        | %          | 130,340     |       | 2.62 | % | 131,361 |   | 3.01 | % |
| Total average  deposits |       | $           | 360,716    |        | 1.60       | %           | $          | 354,424 |   | 1.35 | % | $ | 335,201 |   | 1.69 | % |

 

##### **SHAREHOLDERS’EQUITY**

 

**2005**

 

Shareholders’equity increased $754,000 to $73,919,000 at December 31, 2005 as net retainedearnings outpaced a decline in accumulated other comprehensive income of$3,481,000. The decrease in accumulated other comprehensive income is areflection of a decline in market value, unrealized gains and losses, for ourinvestment portfolio, net of gains and losses realized in the available forsale portfolio during the year, at December 31, 2005 as compared to December31, 2004. . The current level of shareholders’ equity equates to a book valueper share of $18.59 as compared to $18.36 at December 31, 2004. During the yearended December 31, 2005 a dividend of $1.56 per share was paid to shareholdersin addition to a 6 for 5 stock split that occurred in December prior to thecash dividend payment. The dividend represented a 6.12% increase over thedividend paid during 2004.

 

**2004**

 

Total shareholders’equity at December 31, 2004 was $73,165,000, increasing $3,396,000 from thebalance at December 31, 2003 of $69,769,000. Net income and the exercising ofstock options contributed $11,083,000 and $194,000, respectively, toshareholders’ equity. The tax effected change in the unrealized appreciation onsecurities available for sale from year end 2003 to 2004 reduced shareholders’equity by $1,801,000. Additional reductions to shareholders’ equity included$5,843,000 in dividends to shareholders and $237,000 for the purchase oftreasury stock.

 

Bank regulators have riskbased capital guidelines. Under these guidelines the Company and Bank arerequired to maintain minimum ratios of core capital and total qualifyingcapital as a percentage of risk weighted assets and certain off-balance sheetitems. At December 31, 2005, both the Company’s and Bank’s required ratios werewell above the minimum ratios as follows:

 
| ** **           | ** ** | ** **  | ** ** | ** ** | ** ** | **2005**      | ** ** |
|----------------------|------------|-------------|------------|------------|------------|---------------|------------|
| ** **           | ** ** | ** **  | ** ** | ** ** | ** ** | **Minimum**   | ** ** |
| ** **           | ** ** | **Company** | ** ** | **Bank**   | ** ** | **Standards** | ** ** |
| Tier 1 capital ratio |       | 12.2        | %          | 9.6        | %          | 4.0           | %          |
| Total capital ratio  |       | 21.0        | %          | 17.0       | %          | 8.0           | %          |

 

28

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For a more comprehensivediscussion of these requirements, see “Regulation and Supervision” in Item 1 ofthe Form 10-K. Management believes that the Company will continue to exceedregulatory 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:

 
| ** **                                                               | ** ** | **2005** | ** ** | **2004** | ** ** | **2003** | ** ** |
|--------------------------------------------------------------------------|------------|----------|------------|----------|------------|----------|------------|
| Percentage of  net income to:                                            |       |     |       |     |       |     |       |
| Average total  assets                                                    |       | 1.97     | %          | 2.06     | %          | 2.24     | %          |
| Average  shareholders’ equity                                       |       | 14.54    | %          | 15.49    | %          | 16.60    | %          |
| Percentage of  dividends declared to net income                          |       | 57.10    | %          | 52.72    | %          | 44.76    | %          |
| Percentage of  average shareholders’ equity to average total assets |       | 13.56    | %          | 13.30    | %          | 13.51    | %          |

 

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

 

Fundamentalobjectives of the Company’s asset/liability management process are to maintainadequate liquidity while minimizing interest rate risk. The maintenance ofadequate liquidity provides the Company with the ability to meet its financialobligations to depositors, loan customers, and shareholders. Additionally, itprovides funds for normal operating expenditures and business opportunities asthey arise. The objective of interest rate sensitivity management is toincrease net interest income by managing interest sensitive assets andliabilities in such a way that they can be repriced in response to changes inmarket interest rates.

 

TheCompany, like other financial institutions, must have sufficient fundsavailable to meet its liquidity needs for deposit withdrawals, loancommitments, and expenses. In order to control cash flow, the bank estimatesfuture flows of cash from deposits and loan payments. The primary sources offunds are deposits, principal and interest payments on loans andmortgage-backed securities, as well as Federal Home Loan Bank borrowings. Fundsgenerated are used principally to fund loans and purchase investment securities.Management believes the Company has adequate resources to meet its normalfunding requirements.

 

Managementmonitors the Company’s liquidity on both a long and short-term basis thereby,providing management necessary information to react to current balance sheettrends. Cash flow needs are assessed and sources of funds are determined. Fundingstrategies consider both customer needs and economical cost. Both short andlong term funding needs are addressed by maturities and sales of available forsale investment securities, loan repayments and maturities, and liquidatingmoney market investments such as federal funds sold. The use of theseresources, in conjunction with access to credit provides core ingredients tosatisfy depositor, borrower, and creditor needs.

 

Managementmonitors and determines the desirable level of liquidity. Consideration isgiven to loan demand, investment opportunities, deposit pricing and growthpotential as well as the current cost of borrowing funds. The Company has acurrent borrowing capacity at the Federal Home Loan Bank of $83,457,000. Inaddition to this credit arrangement the Company has additional lines of creditwith correspondent banks of $25,500,000. The Company’s management believes thatit has sufficient liquidity to satisfy estimated short-term and long-termfunding needs. Federal Home Loan Bank borrowings totaled $123,218,000 as ofDecember 31, 2005.

 

Interestrate sensitivity, which is closely related to liquidity management, is afunction of the repricing characteristics of the Company’s portfolio of assetsand liabilities. Asset/liability management strives to match maturities andrates between loan and investment security assets with the deposit liabilitiesand borrowings that fund them. Successful asset/liability management results ina 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 fromrepriceable liabilities, for a specific time period to determine the “gap”, ordifference. Once known, the gap is managed based on predictions about futuremarket interest rates. Intentional mismatching, or gapping, can enhance netinterest income if market rates move as predicted. However, if market ratesbehave in a manner contrary to predictions, net interest income will suffer. Gaps,therefore, contain an element of risk and must be prudently managed. Inaddition to gap management, the Company has an asset liability 

 

29

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managementpolicy which incorporates a market value at risk calculation which is used todetermine the effects of interest rate movements on shareholders’ equity and asimulation analysis to monitor the effects of interest rate changes on theCompany’s balance sheets.

 

**INTEREST RATE SENSITIVITY**

 

Inthis analysis the Company examines the result of a 100 and 200 basis pointchange in market interest rates and the effect on net interest income. It isassumed that the change is instantaneous and that all rates move in a parallelmanner. Assumptions are also made concerning prepayment speeds on mortgageloans and mortgage securities.

 

Thefollowing is a rate shock forecast for the twelve month period ended December31, 2006 assuming a static balance sheet as of December 31, 2005 (inthousands).

 
| ** **          | ** ** | **Parallel Rate Shock in Basis Points** | ** ** |
|---------------------|------------|-----------------------------------------|------------|
| ** **          | ** ** | **-200**                                | ** ** | **-100** | ** ** | **Static** | ** ** | **+100** | ** ** | **+200** | ** ** |
| Net interest income |       | $                                       | 19,849     |   | $ | 20,382 |   | $ | 20,404 |   | $ | 19,550 |   | $ | 18,053 |   |
| Change from static  |       | (555                                    | )          | (22 | ) | — |   | (854 | ) | (2,351 | ) |
|                     |            |                                         |            |  |  |  |  |  |  |  |  |  |  |  |  |  |

 

Themodel utilized to create the report presented above makes various estimates ateach level of interest rate change regarding cash flow from principal repaymenton loans and mortgage-backed securities and or call activity on investmentsecurities. Actual results could differ significantly from these estimateswhich would result in significant differences in the calculated projectedchange. In addition, the limits stated above do not necessarily represent thelevel of change under which management would undertake specific measures torealign its portfolio in order to reduce the projected level of change. Generally,management believes the Company is well positioned to respond expeditiouslywhen the market interest rate outlook changes.

 

##### **INFLATION**

 

##### **The asset and liability structureof a financial institution is primarily monetary in nature, therefore, interestrates rather than inflation have a more significant impact on the Company’sperformance. Interest rates are not always affected in the same direction ormagnitude as prices of other goods and services, but are reflective of fiscalpolicy initiatives or economic factors that are not measured by a price index.**

 

**CRITICALACCOUNTING POLICIES**

 

The Company’s accountingpolicies are integral to understanding the results reported. The accountingpolicies are described in detail in Note 1 of the consolidated financialstatements. Our most complex accounting policies require management’s judgmentto ascertain the valuation of assets, liabilities, commitments, andcontingencies. We have established detailed policies and control proceduresthat are intended to ensure valuation methods are well controlled and appliedconsistently from period to period. In addition, the policies and proceduresare intended to ensure that the process for changing methodologies occurs in anappropriate manner. The following is a brief description or our currentaccounting policies involving significant management valuation judgments.

 

*OtherThan Temporary Impairment of Equity Securities*

 

Equity securities areevaluated periodically to determine whether a decline in their value is otherthan temporary, management utilizes criteria such as the magnitude and durationof the decline, in addition to the reason underlying the decline, to determinewhether the loss in value is other than temporary. The term “other thantemporary” is not intended to indicate that the decline is permanent. Itindicates that the prospects for a near term recovery of value are notnecessarily favorable, or that there is a lack of evidence to support fairvalues equal to, or greater than, the carrying value of the investment. Once adecline in value is determined to be other than temporary, the value of thesecurity is reduced and a corresponding charge to earnings is recognized. For afull discussion of the Company’smethodology of assessing impairment, refer to Note 3 of “Notes andConsolidated Financial Statements” of theForm 10-K.

 

30

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*Allowancefor Loan Losses*

 

Arriving at anappropriate level of allowance for loan losses involves a high degree ofjudgment. The Company’s allowance for loan losses provides for probable lossesbased upon evaluations of known, and inherent risks in the loan portfolio.

 

Management useshistorical information to assess the adequacy of the allowance for loan lossesas well as the prevailing business environment; as it is affected by changingeconomic conditions and various external factors, which may impact theportfolio in ways currently unforeseen. The allowance is increased byprovisions for loan losses and by recoveries of loans previously charged-offand reduced by loans charged-off. For a full discussion of the Company’s methodology of assessing theadequacy of the reserve for loan losses, refer to Note 1 of “Notes andConsolidated Financial Statements” of the Form 10-K.

 

*Goodwilland Other Intangible Assets*

 

As discussed in Note 6 ofthe consolidated financial statements, the Company must assess goodwill andother intangible assets each year for impairment. This assessment involvesestimating cash flows for future periods. If the future cash flows were lessthan the recorded goodwill and other intangible assets balances, we would berequired to take a charge against earnings to write down the assets to thelower value.

 

*DeferredTax Assets*

 

We use an estimate offuture earnings to support our position that the benefit of our deferred taxassets will be realized. If future income should prove non-existent or lessthan the amount of the deferred tax assets within the tax years to which theymay be applied, the asset may not be realized and our net income will bereduced. Our deferred tax assets are described further in Note 10 of theconsolidated financial statements.

 

**CONTRACTUALOBLIGATIONS**

 

The Corporation hasvarious financial obligations, including contractual obligations which mayrequire future cash payments. The following table presents in thousands, as ofDecember 31, 2005, significant fixed and determinable contractual obligationsto third parties by payment date. Further discussion of the nature of eachobligation is included in the referenced note to the consolidated financialstatements.

 
| ** **                          | ** ** | **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 |       | $                   | 204,985    |   | $ | — |   | $ | — |   | $ | — |   | $ | 204,985 |   |
| Time Deposits                       |       | 81,460              |       | 55,065 |   | 9,709 |   | 1,310 |   | 147,544 |   |
| Security  repurchase agreements     |       | 7,296               |       | — |   | — |   | 7,967 |   | 15,263 |   |
| Short-term  borrowings, FHLB        |       | 38,740              |       | — |   | — |   | — |   | 38,740 |   |
| Long-term  borrowings, FHLB         |       | 1,600               |       | 41,100 |   | 10,000 |   | 31,778 |   | 84,478 |   |
| Operating leases                    |       | 334                 |       | 466 |   | 229 |   | 1,269 |   | 2,298 |   |
|                                     |            |                     |            |  |  |  |  |  |  |  |  |  |  |  |  |  |

 

The Corporation’s operating lease obligations represent short andlong-term lease and rental payments for branch facilities. The Bank leasescertain facilities under operating leases which expire on various dates through2019. Renewal options are available on these leases.

 

31

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**CAUTIONARY STATEMENT FOR PURPOSESOF THE PRIVATE SECURITIES LITIGATION REFORM ACT OF 1995**

 

This Report containscertain “forward-looking statements” including statements concerning plans,objectives, future events or performance and assumptions and other statementswhich are other than statements of historical fact.

 

The Private SecuritiesLitigation Reform Act of 1995 provides a safe harbor for forward-lookingstatements. In order to comply with the terms of the safe harbor, the Companynotes that a variety of factors could cause the Company’s actual results andexperience to differ materially from the anticipated results or otherexpectations expressed in the Company’s forward-looking statements. The risksand uncertainties that may affect the operations, performance, development andresults of the Company’s business include the following: general economicconditions and changes in interest rates including their impact on capital expenditures;business conditions in the banking industry; the regulatory environment;rapidly changing technology and evolving banking industry standards; the effectof changes in accounting policies and practices, including increasedcompetition with community, regional and national financial institutions; newservice and product offerings by competitors and price pressures; changes inthe Company’s organization, compensation and benefit plans; and similar items.

 

**Item 7A.Quantitative and Qualitative Disclosure About Market Risk**

 

Marketrisk for the Company is comprised primarily from interest rate risk exposureand liquidity risk. Interest rate risk and liquidity risk management isperformed at the Bank level as well as the Company level. The Company’s interestrate sensitivity is monitored by management through selected interest rate riskmeasures produced internally. Additional information and details are providedin the Interest Sensitivity section of Item 2. 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.

 

##### **ITEM  8   FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA**

##### ** **

The report of independentregistered public accounting firm, S.R. Snodgrass, A.C., follows.

 

REPORT OFINDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM

 

Board of Directors andShareholders

Penns Woods Bancorp, Inc.

 

We have audited theconsolidated balance sheet of Penns Woods Bancorp, Inc. and subsidiaries as ofDecember 31, 2005 and 2004, and the related consolidated statements of income,changes in stockholders’ equity, and cash flows for each of the three years inthe period ended December 31, 2005. These financial statements are theresponsibility of the Company’s management. Our responsibility is to express anopinion on these financial statements based on our audits.

 

We conducted our auditsin accordance with the standards of the Public Company Accounting OversightBoard (United States). Those standards require that we plan and perform theaudit to obtain reasonable assurance about whether the financial statements arefree of material misstatement. An audit includes examining, on a test basis,evidence supporting the amounts and disclosures in the financial statements. Anaudit also includes assessing the accounting principles used and significantestimates made by management, as well as evaluating the overall financialstatement presentation. We believe that our audits provide a reasonable basisfor our opinion.

 

In our opinion, theconsolidated financial statements referred to above present fairly, in allmaterial respects, the financial position of Penns Woods Bancorp, Inc. andsubsidiaries as of December 31, 2005 and 2004, and the consolidated results oftheir operations and cash flows for each of the three years in the period endedDecember 31, 2005, in conformity with U.S. generally accepted accountingprinciples.

 

32

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Wealso have audited, in accordance with the standards of the Public CompanyAccounting Oversight Board (United States), the effectiveness of PennsWoods Bancorp, Inc. and subsidiaries’ internal control over financial reporting as of December 31, 2005,based on criteria established in “InternalControl—Integrated Framework” issued by the Committee of SponsoringOrganizations of the Treadway Commission (COSO). Our report dated March9, 2006 expressed an unqualified opinion on management’s assessment of theeffectiveness of Penns Woods Bancorp, Inc. and subsidiaries’ internal control over financial reportingand an opinion that Penns Woods Bancorp, Inc. and subsidiaries’ had not maintained effective internalcontrol over financial reporting as of December 31, 2005, based on criteriaestablished in “Internal Control-Integrated Framework” issued by COSO.

 
| /s/ S.R.  Snodgrass, A.C. |   |
|--------------------------------|--------|
| Wexford, Pennsylvania          |
| March 9, 2006                  |

 

33

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**PENNS WOODS BANCORP, INC.**

**CONSOLIDATED BALANCE SHEET**

 
| ** **                                                                                            | ** ** | **December 31,** | ** ** | **December 31,** | ** ** |
|-------------------------------------------------------------------------------------------------------|------------|------------------|------------|------------------|------------|
| **(In Thousands, Except Share  Data)**                                                                | ** ** | **2005**         | ** ** | **2004**         | ** ** |
|                                                                                                  |       |             |       |             |       |
| ASSETS:                                                                                               |       |             |       |             |       |
| Noninterest-bearing  balances                                                                         |       | $                | 14,065     |             | $          | 12,602 |   |
| Interest-bearing  deposits in other financial institutions                                            |       | 25               |       | 24               |       |
| Total cash and  cash equivalents                                                                      |       | 14,090           |       | 12,626           |       |
|                                                                                                  |       |             |       |             |       |
| Investment  securities, available for sale, at fair value                                             |       | 187,018          |       | 184,163          |       |
| Investment  securities held to maturity (fair value of $238 and $561)                                 |       | 265              |       | 558              |       |
| Loans held for  sale                                                                                  |       | 3,545            |       | 4,624            |       |
|                                                                                                  |       |             |       |             |       |
| Loans                                                                                                 |       | 338,438          |       | 324,505          |       |
| Less: Allowance  for loan losses                                                                      |       | 3,679            |       | 3,338            |       |
| Loans, net                                                                                            |       | 334,759          |       | 321,167          |       |
|                                                                                                  |       |             |       |             |       |
| Premises and  equipment, net                                                                          |       | 6,409            |       | 4,882            |       |
| Accrued interest  receivable                                                                          |       | 2,828            |       | 2,246            |       |
| Bank-owned life  insurance                                                                            |       | 10,718           |       | 10,976           |       |
| Goodwill                                                                                              |       | 3,032            |       | 3,032            |       |
| Other assets                                                                                          |       | 6,004            |       | 2,429            |       |
| TOTAL ASSETS                                                                                          |       | $                | 568,668    |             | $          | 546,703 |   |
|                                                                                                  |       |             |       |             |       |
| LIABILITIES:                                                                                          |       |             |       |             |       |
| Interest-bearing  deposits                                                                            |       | $                | 281,150    |             | $          | 282,786 |   |
| Noninterest-bearing  deposits                                                                         |       | 71,379           |       | 74,050           |       |
| Total deposits                                                                                        |       | 352,529          |       | 356,836          |       |
|                                                                                                  |       |             |       |             |       |
| Short-term  borrowings                                                                                |       | 54,003           |       | 36,475           |       |
| Long-term  borrowings, Federal Home Loan Bank (FHLB)                                                  |       | 84,478           |       | 75,878           |       |
| Accrued interest  payable                                                                             |       | 1,108            |       | 850              |       |
| Other  liabilities                                                                                    |       | 2,631            |       | 3,499            |       |
| TOTAL  LIABILITIES                                                                                    |       | 494,749          |       | 473,538          |       |
|                                                                                                  |       |             |       |             |       |
| SHAREHOLDERS’  EQUITY:                                                                           |       |             |       |             |       |
| Common stock,  par value $8.33, 10,000,000 shares authorized;   4,002,159 and 3,998,204 shares issued |       | 33,351           |       | 33,318           |       |
| Additional  paid-in capital                                                                           |       | 17,772           |       | 17,700           |       |
| Retained  earnings                                                                                    |       | 22,938           |       | 18,262           |       |
| Accumulated  other comprehensive income                                                               |       | 850              |       | 4,331            |       |
| Less: Treasury  stock at cost, 26,372 and 12,372 shares                                               |       | (992             | )          | (446             | )          |
| TOTAL  SHAREHOLDERS’ EQUITY                                                                      |       | 73,919           |       | 73,165           |       |
| TOTAL  LIABILITIES AND SHAREHOLDERS’ EQUITY                                                      |       | $                | 568,668    |             | $          | 546,703 |   |

 

See AccompanyingNotes to the Consolidated Financial Statements

 

34

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PENNS WOODS BANCORP, INC.

CONSOLIDATED STATEMENT OFINCOME

 
| ** **                                           | ** ** | **Year Ended December 31,** | ** ** |
|------------------------------------------------------|------------|-----------------------------|------------|
| **(In Thousands, Except Per Share  Data)**           | ** ** | **2005**                    | ** ** | **2004** | ** ** | **2003** | ** ** |
|                                                 |       |                        |       |   |   |   |   |
| INTEREST AND  DIVIDEND INCOME:                       |       |                        |       |   |   |   |   |
| Loans including  fees                                |       | $                           | 22,126     |   | $ | 20,261 |   | $ | 19,115 |   |
| Investment  Securities:                              |       |                        |       |   |   |   |   |
| Taxable                                              |       | 4,376                       |       | 6,690 |   | 5,955 |   |
| Tax-exempt                                           |       | 3,223                       |       | 1,708 |   | 2,608 |   |
| Dividend                                             |       | 1,178                       |       | 1,186 |   | 706 |   |
|                                                 |       |                        |       |   |   |   |   |
| TOTAL INTEREST  AND DIVIDEND INCOME                  |       | 30,903                      |       | 29,845 |   | 28,384 |   |
|                                                 |       |                        |       |   |   |   |   |
| INTEREST  EXPENSE:                                   |       |                        |       |   |   |   |   |
| Deposits                                             |       | 5,774                       |       | 4,775 |   | 5,656 |   |
| Short-term  borrowings                               |       | 931                         |       | 539 |   | 428 |   |
| Long-term  borrowings                                |       | 3,676                       |       | 3,454 |   | 3,181 |   |
|                                                 |       |                        |       |   |   |   |   |
| TOTAL INTEREST  EXPENSE                              |       | 10,381                      |       | 8,768 |   | 9,265 |   |
|                                                 |       |                        |       |   |   |   |   |
| NET INTEREST  INCOME                                 |       | 20,522                      |       | 21,077 |   | 19,119 |   |
|                                                 |       |                        |       |   |   |   |   |
| PROVISION FOR  LOAN LOSSES                           |       | 720                         |       | 465 |   | 255 |   |
|                                                 |       |                        |       |   |   |   |   |
| NET INTEREST  INCOME AFTER PROVISION FOR LOAN LOSSES |       | 19,802                      |       | 20,612 |   | 18,864 |   |
|                                                 |       |                        |       |   |   |   |   |
| NON-INTEREST  INCOME:                                |       |                        |       |   |   |   |   |
| Service charges                                      |       | 2,228                       |       | 1,983 |   | 1,917 |   |
| Securities  gains, net                               |       | 2,190                       |       | 2,176 |   | 3,479 |   |
| Bank-owned life  insurance                           |       | 568                         |       | 294 |   | 404 |   |
| Insurance  commissions                               |       | 2,327                       |       | 2,282 |   | 1,598 |   |
| Gain on sale of  loans                               |       | 864                         |       | 969 |   | 696 |   |
| Other income                                         |       | 1,254                       |       | 1,214 |   | 1,056 |   |
|                                                 |       |                        |       |   |   |   |   |
| TOTAL  NON-INTEREST INCOME                           |       | 9,431                       |       | 8,918 |   | 9,150 |   |
|                                                 |       |                        |       |   |   |   |   |
| NON-INTEREST  EXPENSES:                              |       |                        |       |   |   |   |   |
| Salaries and  employee benefits                      |       | 8,314                       |       | 7,804 |   | 7,110 |   |
| Occupancy  expense, net                              |       | 1,089                       |       | 959 |   | 877 |   |
| Furniture and  equipment expense                     |       | 973                         |       | 1,016 |   | 999 |   |
| Pennsylvania  shares tax expense                     |       | 549                         |       | 508 |   | 455 |   |
| Other expenses                                       |       | 4,183                       |       | 3,897 |   | 3,696 |   |
|                                                 |       |                        |       |   |   |   |   |
| TOTAL  NON-INTEREST EXPENSES                         |       | 15,108                      |       | 14,184 |   | 13,137 |   |
|                                                 |       |                        |       |   |   |   |   |
| INCOME BEFORE  INCOME TAX PROVISION                  |       | 14,125                      |       | 15,346 |   | 14,877 |   |
|                                                 |       |                        |       |   |   |   |   |
| INCOME TAX  PROVISION                                |       | 3,224                       |       | 4,263 |   | 3,703 |   |
|                                                 |       |                        |       |   |   |   |   |
| NET INCOME                                           |       | $                           | 10,901     |   | $ | 11,083 |   | $ | 11,174 |   |
|                                                 |       |                        |       |   |   |   |   |
| NET INCOME PER  SHARE - BASIC                        |       | $                           | 2.75       |   | $ | 2.78 |   | $ | 2.79 |   |
|                                                 |       |                        |       |   |   |   |   |
| NET INCOME PER  SHARE - DILUTED                      |       | $                           | 2.74       |   | $ | 2.78 |   | $ | 2.79 |   |
|                                                 |       |                        |       |   |   |   |   |
| WEIGHTED AVERAGE  SHARES OUTSTANDING - BASIC         |       | 3,971,926                   |       | 3,990,008 |   | 3,996,702 |   |
|                                                 |       |                        |       |   |   |   |   |
| WEIGHTED AVERAGE  SHARES OUTSTANDING - DILUTED       |       | 3,974,055                   |       | 3,994,352 |   | 4,000,557 |   |

 

See AccompanyingNotes to the Consolidated Financial Statements.

 

35

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PENNS WOODS BANCORP, INC.

CONSOLIDATED STATEMENT OFCHANGES IN SHAREHOLDERS’ EQUITY

 
| ** **                                                                                                        | ** ** | ** **       | ** ** | ** ** | ** ** | ** **     | ** ** | ** **   | ** ** | **Accumulated**   | ** ** | ** **   | ** ** | ** **             | ** ** |
|-------------------------------------------------------------------------------------------------------------------|------------|------------------|------------|------------|------------|----------------|------------|--------------|------------|-------------------|------------|--------------|------------|------------------------|------------|
| ** **                                                                                                        | ** ** | ** **       | ** ** | ** ** | ** ** | **Additional** | ** ** | ** **   | ** ** | **Other**         | ** ** | ** **   | ** ** | **Total**              | ** ** |
| ** **                                                                                                        | ** ** | **Common Stock** | ** ** | ** ** | ** ** | **Paid-in**    | ** ** | **Retained** | ** ** | **Comprehensive** | ** ** | **Treasury** | ** ** | **Shareholders’** | ** ** |
| **(In Thousands, Except Per Share Data)**                                                                         | ** ** | **Shares**       | ** ** | **Amount** | ** ** | **Capital**    | ** ** | **Earnings** | ** ** | **Income (Loss)** | ** ** | **Stock**    | ** ** | **Equity**             | ** ** |
|                                                                                                              |       |             |       |       |       |           |       |         |       |              |       |         |       |                   |       |
| Balance,  December 31, 2002                                                                                       |       | 3,764,198        |       | $          | 31,368     |           | $          | 18,291       |       | $                 | 11,749     |         | $          | 5,145                  |       | $ | (3,411 | ) | $ | 63,142 |   |
|                                                                                                              |       |             |       |       |       |           |       |         |       |              |       |         |       |                   |       |
| Stock split  effected in the form of a 10% dividend                                                               |       | 224,572          |       | 1,871      |       | (793           | )          | (4,900       | )          |              |       | 3,822        |       |                   |       |
| Comprehensive  income:                                                                                            |       |             |       |       |       |           |       |         |       |              |       |         |       |                   |       |
| Net income                                                                                                        |       |             |       |       |       |           |       | 11,174       |       |              |       |         |       | 11,174                 |       |
| Unrealized gain  on available for sale securities, net of reclassification adjustments and tax  of $508           |       |             |       |       |       |           |       |         |       | 987               |       |         |       | 987                    |       |
| Total  comprehensive income                                                                                       |       |             |       |       |       |           |       |         |       |              |       |         |       | 12,161                 |       |
| Dividends  declared, ($1.24 per share)                                                                            |       |             |       |       |       |           |       | (5,001       | )          |              |       |         |       | (5,001                 | )          |
| Stock options  exercised                                                                                          |       | 3,102            |       | 26         |       | 61             |       |         |       |              |       |         |       | 87                     |       |
| Purchase of  treasury stock (17,744 shares)                                                                       |       |             |       |       |       |           |       |         |       |              |       | (620         | )          | (620                   | )          |
|                                                                                                              |       |             |       |       |       |           |       |         |       |              |       |         |       |                   |       |
| Balance,  December 31, 2003                                                                                       |       | 3,991,872        |       | 33,265     |       | 17,559         |       | 13,022       |       | 6,132             |       | (209         | )          | 69,769                 |       |
|                                                                                                              |       |             |       |       |       |           |       |         |       |              |       |         |       |                   |       |
| Comprehensive  income:                                                                                            |       |             |       |       |       |           |       |         |       |              |       |         |       |                   |       |
| Net income                                                                                                        |       |             |       |       |       |           |       | 11,083       |       |              |       |         |       | 11,083                 |       |
| Unrealized gain  on available for sale securities, net of reclassification adjustments and tax  benefit of $926   |       |             |       |       |       |           |       |         |       | (1,801            | )          |         |       | (1,801                 | )          |
| Total  comprehensive income                                                                                       |       |             |       |       |       |           |       |         |       |              |       |         |       | 9,282                  |       |
| Dividends  declared, ($1.47 per share)                                                                            |       |             |       |       |       |           |       | (5,843       | )          |              |       |         |       | (5,843                 | )          |
| Stock options  exercised                                                                                          |       | 6,332            |       | 53         |       | 141            |       |         |       |              |       |         |       | 194                    |       |
| Purchase of  treasury stock (6,372 shares)                                                                        |       |             |       |       |       |           |       |         |       |              |       | (237         | )          | (237                   | )          |
|                                                                                                              |       |             |       |       |       |           |       |         |       |              |       |         |       |                   |       |
| Balance,  December 31, 2004                                                                                       |       | 3,998,204        |       | 33,318     |       | 17,700         |       | 18,262       |       | 4,331             |       | (446         | )          | 73,165                 |       |
|                                                                                                              |       |             |       |       |       |           |       |         |       |              |       |         |       |                   |       |
| Stock split  fractional shares                                                                                    |       | (293             | )          | (2         | )          | 2              |       |         |       |              |       |         |       |                   |       |
| Comprehensive  income:                                                                                            |       |             |       |       |       |           |       |         |       |              |       |         |       |                   |       |
| Net income                                                                                                        |       |             |       |       |       |           |       | 10,901       |       |              |       |         |       | 10,901                 |       |
| Unrealized gain  on available for sale securities, net of reclassification adjustments and tax  benefit of $1,793 |       |             |       |       |       |           |       |         |       | (3,481            | )          |         |       | (3,481                 | )          |
| Total  comprehensive income                                                                                       |       |             |       |       |       |           |       |         |       |              |       |         |       | 7,420                  |       |
| Dividends  declared, ($1.56 per share)                                                                            |       |             |       |       |       |           |       | (6,225       | )          |              |       |         |       | (6,225                 | )          |
| Stock options  exercised                                                                                          |       | 4,248            |       | 35         |       | 70             |       |         |       |              |       |         |       | 105                    |       |
| Purchase of  treasury stock (14,000 shares)                                                                       |       |             |       |       |       |           |       |         |       |              |       | (546         | )          | (546                   | )          |
|                                                                                                              |       |             |       |       |       |           |       |         |       |              |       |         |       |                   |       |
| Balance,  December 31, 2005                                                                                       |       | 4,002,159        |       | $          | 33,351     |           | $          | 17,772       |       | $                 | 22,938     |         | $          | 850                    |       | $ | (992 | ) | $ | 73,919 |   |
|                                                                                                                   |            |                  |            |            |            |                |            |              |            |                   |            |              |            |                        |            |  |  |  |  |  |  |  |  |  |  |  |  |

 
| ** **                                                                     | ** ** | **2005** | ** ** | **2004** | ** ** | **2003** | ** ** |
|--------------------------------------------------------------------------------|------------|----------|------------|----------|------------|----------|------------|
| Components of  comprehensive income (loss):                                    |       |     |       |     |       |     |       |
| Change in net  unrealized gain (loss) on investments available for sale        |       | $        | (2,036     | )        | $          | (365     | )          | $ | 3,283 |   |
| Realized gains  included in net income, net of taxes of $745, $740, and $1,183 |       | (1,445   | )          | (1,436   | )          | (2,296   | )          |
|                                                                           |       |     |       |     |       |     |       |
| Total                                                                          |       | $        | (3,481     | )        | $          | (1,801   | )          | $ | 987 |   |

 

See AccompanyingNotes to the Consolidated Financial Statements.

 

36

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PENNS WOODS BANCORP, INC.

CONSOLIDATED STATEMENT OFCASH FLOWS

 
| ** **                                                                         | ** ** | **Year Ended December 31,** | ** ** |
|------------------------------------------------------------------------------------|------------|-----------------------------|------------|
| **(In Thousands)**                                                                 | ** ** | **2005**                    | ** ** | **2004** | ** ** | **2003** | ** ** |
|                                                                               |       |                        |       |   |   |   |   |
| OPERATING  ACTIVITIES                                                              |       |                        |       |   |   |   |   |
| Net income                                                                         |       | $                           | 10,901     |   | $ | 11,083 |   | $ | 11,174 |   |
| Adjustments to  reconcile net income to net cash provided by operating activities: |       |                        |       |   |   |   |   |
| Depreciation                                                                       |       | 549                         |       | 585 |   | 631 |   |
| Provision for  loan losses                                                         |       | 720                         |       | 465 |   | 255 |   |
| Accretion and  amortization of investment security discounts and premiums          |       | (453                        | )          | (132 | ) | (194 | ) |
| Securities  gains, net                                                             |       | (2,190                      | )          | (2,176 | ) | (3,479 | ) |
| Originations of  loans held for sale                                               |       | (30,353                     | )          | (34,398 | ) | (15,983 | ) |
| Proceeds of  loans held for sale                                                   |       | 32,296                      |       | 35,546 |   | 14,527 |   |
| Gain on sale of  loans                                                             |       | (864                        | )          | (969 | ) | (696 | ) |
| Increases in  bank-owned life insurance                                            |       | (568                        | )          | (294 | ) | (404 | ) |
| Other, net                                                                         |       | 254                         |       | 482 |   | 606 |   |
|                                                                               |       |                        |       |   |   |   |   |
| Net cash  provided by operating activities                                         |       | 10,292                      |       | 10,192 |   | 6,437 |   |
|                                                                               |       |                        |       |   |   |   |   |
| INVESTING  ACTIVITIES                                                              |       |                        |       |   |   |   |   |
| Investment  securities available for sale:                                         |       |                        |       |   |   |   |   |
| Proceeds from  sales                                                               |       | 123,546                     |       | 162,796 |   | 82,489 |   |
| Proceeds from  calls and maturities                                                |       | 12,664                      |       | 28,732 |   | 48,046 |   |
| Purchases                                                                          |       | (141,798                    | )          | (159,295 | ) | (159,363 | ) |
| Investment  securities held to maturity:                                           |       |                        |       |   |   |   |   |
| Proceeds from  calls and maturities                                                |       | 328                         |       | 142 |   | 520 |   |
| Purchases                                                                          |       | (35                         | )          | (14 | ) | (24 | ) |
| Net increase in  loans                                                             |       | (14,745                     | )          | (49,002 | ) | (18,390 | ) |
| Acquisition of  bank premises and equipment                                        |       | (2,076                      | )          | (842 | ) | (400 | ) |
| Proceeds from  the sale of foreclosed assets                                       |       | 329                         |       | 237 |   | 341 |   |
| Proceeds from  bank-owned life insurance death benefit                             |       | 826                         |       | — |   | — |   |
| Purchase of  bank-owned life insurance                                             |       | —                      |       | (1,774 | ) | — |   |
| Investment in  limited partnership                                                 |       | (3,124                      | )          | — |   | — |   |
| Proceeds from  redemption of regulatory stock                                      |       | 4,862                       |       | 3,322 |   | 1,507 |   |
| Purchases of  regulatory stock                                                     |       | (4,760                      | )          | (2,940 | ) | (4,402 | ) |
|                                                                               |       |                        |       |   |   |   |   |
| Net cash used  for investing activities                                            |       | (23,983                     | )          | (18,638 | ) | (49,676 | ) |
|                                                                               |       |                        |       |   |   |   |   |
| FINANCING  ACTIVITIES                                                              |       |                        |       |   |   |   |   |
| Net (decrease)  increase in interest-bearing deposits                              |       | (1,636                      | )          | 13,343 |   | (3,344 | ) |
| Net (decrease)  increase in noninterest-bearing deposits                           |       | (2,671                      | )          | 9,175 |   | (2,186 | ) |
| Net increase  (decrease) in short-term borrowings                                  |       | 17,528                      |       | (10,790 | ) | 33,702 |   |
| Proceeds from  long term borrowings, FHLB                                          |       | 10,000                      |       | 5,000 |   | 20,000 |   |
| Repayment of  long term borrowings, FHLB                                           |       | (1,400                      | )          | — |   | (900 | ) |
| Dividends paid                                                                     |       | (6,225                      | )          | (5,843 | ) | (5,001 | ) |
| Stock options  exercised                                                           |       | 105                         |       | 194 |   | 87 |   |
| Purchase of  treasury stock                                                        |       | (546                        | )          | (237 | ) | (620 | ) |
|                                                                               |       |                        |       |   |   |   |   |
| Net cash  provided by financing activities                                         |       | 15,155                      |       | 10,842 |   | 41,738 |   |
|                                                                               |       |                        |       |   |   |   |   |
| NET INCREASE  (DECREASE) IN CASH AND CASH EQUIVALENTS                              |       | 1,464                       |       | 2,396 |   | (1,501 | ) |
|                                                                               |       |                        |       |   |   |   |   |
| CASH AND CASH  EQUIVALENTS, BEGINNING                                              |       | 12,626                      |       | 10,230 |   | 11,731 |   |
|                                                                               |       |                        |       |   |   |   |   |
| CASH AND CASH  EQUIVALENTS, ENDING                                                 |       | $                           | 14,090     |   | $ | 12,626 |   | $ | 10,230 |   |
|                                                                               |       |                        |       |   |   |   |   |
| SUPPLEMENTAL  DISCLOSURES OF CASH FLOW INFORMATION:                                |       |                        |       |   |   |   |   |
|                                                                               |       |                        |       |   |   |   |   |
| Interest paid                                                                      |       | $                           | 10,123     |   | $ | 8,754 |   | $ | 9,521 |   |
| Income taxes  paid                                                                 |       | 2,625                       |       | 4,350 |   | 3,500 |   |
| Transfer of  loans to foreclosed real estate                                       |       | 433                         |       | 129 |   | 173 |   |

 

See AccompanyingNotes to the Consolidated Financial Statements.

 

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**PENNS WOODS BANCORP, INC.**

**NOTES TO CONSOLIDATED FINANCIAL STATEMENTS**

 

**NOTE 1 - OPERATIONS AND SUMMARYOF SIGNIFICANT ACCOUNTING POLICIES**

 

**Principlesof Consolidation**

 

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

 

**Nature ofBusiness**

 

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 loans, and various types of timeand demand deposits including, but not limited to, checking accounts, savingsaccounts, clubs, money market deposit accounts, certificates of deposit, andIRAs. Deposits are insured by the Federal 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 on behalfof Penns Woods Bancorp, Inc. and the Bank.

 

WoodsInvestment Company, Inc., a Delaware holding company, is engaged in investingactivities.

 

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

 

Operations are managed and financial performance isevaluated on a corporate-wide basis. Accordingly, all financial servicesoperations are considered by management to be aggregated in one reportableoperating segment.

 

# **Useof Estimates**

# ** **

Thepreparation of financial statements in conformity with U.S. generally acceptedaccounting principles requires management to make estimates and assumptionsthat affect the reported amounts of assets and liabilities and disclosure ofcontingent assets and liabilities at the date of the consolidated financialstatements and the reported amounts of revenues and expenses during the reportingperiod. Actual results may differ from those estimates.

 

Materialestimates that are particularly susceptible to significant change relate to thedetermination of the allowance for loan losses, deferred tax assets andliabilities, and the valuation of real estate acquired through, or in lieu of,foreclosure on settlement of debt.

 

**Stock Split**

 

Duringthe fourth quarter of 2005 the Company initiated a 6 for 5 stock split. Previouslyreported share and per share amounts have been adjusted to reflect the split.

 

38

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**Cash andCash Equivalents**

 

Cashequivalents include cash on hand and in banks, interest-earning deposits, andfederal funds sold. Interest-earning deposits mature within one year and arecarried at cost. Net cash flows are reported for loan, deposit, and short termborrowing transactions.

 

**Restrictionson Cash and Cash Equivalents**

 

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

 

**InvestmentSecurities**

 

Investmentsecurities are classified as available for sale or held to maturity.

 

Securitiesheld to maturity include bonds, notes, and debentures for which the Company hasthe positive intent and ability to hold to maturity and are reported atamortized cost.

 

Availablefor sale securities consist of bonds, notes, debentures, and certain equitysecurities not classified as trading securities nor as held to maturitysecurities. Unrealized holding gains and losses, net of tax, on available forsale securities are reported as a net amount in a separate component ofshareholders’ equity until realized.

 

Gainsand losses on the sale of equity securities are determined using the averagecost method, while all other investment securities use the specific costmethod.

 

Allinvestment securities, regardless of classification, are monitored and testedfor impairment. An investment security is considered to be impaired when theunrealized loss is considered to be other than temporary. When this occurs, theinvestment is written down to the current fair market value with the write-downbeing reflected as a realized loss.

 

Premiumsand discounts on all securities are recognized in interest income using thelevel yield method over the period to maturity.

 

Investment securities fair values are based on observedmarket prices. Certain investment securities do not have observed bid pricesand their fair value is based on instruments with similar risk elements. Sinceregulatory stock is redeemable at par, the Company carries it at cost.

 

**Loans**

 

Loans are stated at the principal amount outstanding,net of deferred fees, unamortized loan fees and costs, and the allowance forloan losses. Interest on loans is recognized as income when earned on the accrualmethod. The Company’s general policy has been to stop accruing interest onloans when it is determined a reasonable doubt exists as to the collectibilityof additional interest. Income is subsequently recognized only to the extentthat cash payments are received provided the loan is not delinquent in paymentand, in management’s judgment, the borrower has the ability and intent to makefuture principal payments.

 

Loan origination and commitment fees as well as certaindirect loan origination costs are being deferred and the net amount amortizedas an adjustment to the related loan’s yield. These amounts are being amortizedover the contractual lives of the related loans.

 

**Allowance for Loan Losses**

 

The allowance for loan losses represents the amount whichmanagement estimates is adequate to provide for probable losses inherent in itsloan portfolio, as of the balance sheet date. The allowance method is used inproviding for loan losses. Accordingly, all loan losses are charged to theallowance and all recoveries are credited to it. The allowance for loan lossesis established 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 reviewis to assess loan quality, identify impaired loans, analyze delinquencies,ascertain loan growth, evaluate potential charge-offs and recoveries, andassess general 

 

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economicconditions in the markets served. An external independent loan review is alsoperformed 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. Lossfactors are based on management’s consideration of the nature of the portfoliosegments, changes in mix and volume of the loan portfolio, historical loan lossexperience, and general economic conditions. In addition, management considersindustry standards and trends with respect to nonperforming loans and itsknowledge and experience with specific lending segments.

 

Althoughmanagement believes that it uses the best information available to make suchdeterminations and that the allowance for loan losses is adequate at December31, 2005, future adjustments could be necessary if circumstances or economicconditions differ substantially from the assumptions used in making the initialdeterminations. A downturn in the local economy, employment, and delays inreceiving financial information from borrowers could result in increased levelsof nonperforming assets and charge-offs, increased loan loss provisions, andreductions in income. Additionally, as an integral part of the examinationprocess, bank regulatory agencies periodically review the Bank’s loan lossallowance. The banking agencies could require the recognition of additions tothe loan loss allowance based on their judgment of information available tothem at the time of their examination.

 

Impaired loans are commercial and commercial real estateloans for which it is probable the Company will not be able to collect allamounts due according to the contractual terms of the loan agreement. TheCompany individually evaluates such loans for impairment and does not aggregateloans by major risk classifications. The definition of “impaired loans” is notthe same as the definition of “nonaccrual loans,” although the two categoriesoverlap. The Company may choose to place a loan on nonaccrual status due topayment delinquency or uncertain collectibility, while not classifying the loanas impaired if the loan is not a commercial or commercial real estate loan. Factorsconsidered by management in determining impairment include payment status andcollateral value. The amount of impairment for these types of loans isdetermined by the difference between the present value of the expected cashflows related to the loan, using the original interest rate, and its recordedvalue, or as a practical expedient in the case of collateralized loans, thedifference between the fair value of the collateral and the recorded amount ofthe loans. When foreclosure is probable, impairment is measured based on thefair 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. Managementdetermines the significance of payment delays on a case-by-case basis takinginto consideration all circumstances surrounding the loan and the borrower includingthe length of the delay, the borrower’s prior payment record, and the amount ofshortfall in relation to the principal and interest owed.

 

**Loans Held for Sale**

 

In general, fixed rate residential mortgage loansoriginated by the Bank are held for sale and are carried at cost due to theirshort holding period of under two weeks. Such loans sold are not serviced bythe Bank. Proceeds from the sale of loans in excess of the carrying value areaccounted for as a gain. Total gains on the sale of loans are shown as acomponent of non-interest income within the income statement.

 

# **Foreclosed Assets Held forSale**

# ** **

Foreclosed assets held for sale are carried at the lowerof cost or fair value minus estimated costs to sell. Prior to foreclosure, thevalue of the underlying loan is written down to the fair value of the realestate to be acquired by a charge to the allowance for loan losses, ifnecessary. Any subsequent write-downs are charged against operating expenses. Operatingexpenses of such properties, net of related income, and gains and losses ontheir disposition are included in other expenses.

 

# **Premisesand 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 seven years forfurniture, fixtures, and equipment and thirty-one and a half to forty years forbuildings and improvements. Costs incurred for routine maintenance and repairs arecharged to operations as incurred. Costs of major additions and improvementsare capitalized.

 

40

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# **Bank-OwnedLife Insurance**

# ** **

The Company has purchased life insurance policies oncertain officers, and is the sole beneficiary on those policies. Bank-ownedlife insurance is recorded at its cash surrender value, or the amount that canbe realized. Increases in the cash surrender value are recognized asnon-interest income.

 

# **Goodwill**

# ** **

 The Company accounts for goodwill inaccordance with Statement of Financial Accounting Standards (“FAS”) No. 142, *Goodwill and Other Intangible Assets.*Thisstatement, among other things, requires a two-step process for testing theimpairment of goodwill on at least an annual basis. This approach could causemore volatility in the Company’s reported net income because impairment losses,if any, could occur irregularly and in varying amounts. The Company performs anannual impairment analysis of goodwill for its purchased subsidiary, The MGroup. Based on the fair value of this reporting unit, estimated using theexpected present value of future cash flows, no impairment of goodwill wasrecognized in 2005 and 2004.

 

**Investments in Limited Partnerships**

 

TheCompany is a limited partner in two partnerships at December 31, 2005 thatprovide low income elderly housing in the Company’s geographic market area. Thecarrying value of the Company’s investments in limited partnerships was$3,549,000 at December 31, 2005 and $515,000 at December 31, 2004. The Companyis fully amortizing the investment in the partnership entered into prior to2005 over the fifteen-year holding period. The partnership entered into during2005 is being fully amortized over the ten-year tax credit receipt period utilizingthe effective yield method. The 2005 partnership will begin being amortized in2006 once the project reaches the level of occupancy needed to begin the tenyear tax credit recognition period. Amortization of limited partnershipinvestments totaled $90,000 in 2005, 2004, and 2003, respectively.

 

**Off-Balance Sheet Financial Instruments**

 

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

 

**AdvertisingCost**

 

Advertisingcosts are generally expensed as incurred.

 

# **IncomeTaxes**

# ** **

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.

 

# **EarningsPer Share**

# ** **

TheCompany provides dual presentation of basic and diluted earnings per share. Basicearnings per share is calculated utilizing net income as reported in thenumerator and weighted average shares outstanding in the denominator. Thecomputation of diluted earnings per share differs in that the dilutive effectsof any stock options are adjusted in the denominator.

 

# **Employee Benefits**

# ** **

Pensionand employee benefits include contributions, determined actuarially, to adefined benefit retirement plan covering the eligible employees of the Bank. Theplan is funded on a current basis to the extent that it is deductible underexisting federal tax regulations. Pension and other employee benefits alsoinclude contributions to a defined contribution Section 

 

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401(k)plan covering eligible employees. Contributions matching those made by eligibleemployees and an elective contributions are made annually at the discretion ofthe Board of Directors.

 

**The MGroup Products and Income Recognition**

 

TheM Group product line is comprised primarily of annuities, life insurance, andmutual funds. The revenues generated from life insurance sales are commissiononly as The M Group does not underwrite the policies. Life insurance salesinclude permanent and term policies with the majority of the policies writtenbeing permanent. Term life insurance policies are written for 10, 15, 20, and30 year terms with the majority of the policies being written for 20 years. Noneof these products are offered as an integral part of lending activities.

 

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 isfinal, which is also the time a commission check is received. The completion ofthe sale is not realized until the third party product provider has notifiedthe Company of its acceptance of the application.

 

Lifeinsurance commissions are recognized at varying points based on the paymentoption chosen by the consumer. Commissions from monthly and annual paymentplans are recognized at the start of each annual period for the life insurance,while quarterly and semi-annual premium payments are recognized quarterly andsemi-annually when the earnings process is complete. For example, semi-annualpayments on the first of January and July would result in commissionrecognition on the first of January and July, while payments on the first ofJanuary, April, July, and October would result in commission recognition onthose dates. The potential for chargebacks only exists for those policies on amonthly payment plan due to the income being recognized at the beginning of theannual period versus at the time of each monthly payment. No liability ismaintained for chargebacks as any chargeback is removed from income at the timeof the chargeback.

 

# **StockOptions**

# ** **

TheCompany maintains a stock option plan for directors and certain officers andemployees. When the exercise price of the Company’s stock options is greaterthan or equal to the market price of the underlying stock on the date of thegrant, no compensation expense is recognized in the Company’s financialstatements. Pro forma net income and earnings per share are presented toreflect the impact of the stock option plan assuming compensation expense hadbeen recognized based on the fair value of the stock options granted under theplan.

 

TheCompany applies Accounting Principles Board Opinion No. 25 and relatedinterpretations in accounting for these options. Accordingly, compensationexpense is recognized on the grant date, in the amount equivalent to theintrinsic value of the options (stock price less exercise price, at measurementdate).

 

Hadcompensation costs for these options been determined based on the fair valuesat the grant dates for awards consistent with the method of FAS No. 123, therewould be no effect on the Company’s net income and earnings per share for 2005,2004, and 2003.

 

# **Accumulated OtherComprehensive Income**

# ** **

The Company is required to present accumulated othercomprehensive income in a full set of general-purpose financial statements forall periods presented. Accumulated other comprehensive income is comprisedexclusively of unrealized holding gains (losses) on the available for salesecurities portfolio.

 

**Segment Reporting**

 

Statementof Financial Accounting Standards No. 131, “Disclosure about Segments of anEnterprise and Related Information,” requires that public business enterprisesreport financial and descriptive information about their reportable operatingsegments. Based on the guidance provided by the Statement, the company hasdetermined that its only reportable segment is Community Banking.

 

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**Reclassificationof Comparative Amounts**

 

Certain items previouslyreported have been reclassified to conform to the current year’s reportingformat. Such reclassifications did not affect net income or shareholders’equity.

 

**RecentAccounting Pronouncements**

 

In December 2004, the Financial Accounting Standards Board (“FASB”) issued Statement of Financial Accounting Standards No. 123 (revised 2004), *Share-Based Payment*(FAS No. 123R). FAS No. 123R revised FAS No. 123, *Accounting for Stock-Based Compensation*, and supersedes APB Opinion No. 25, *Accounting for Stock Issued to Employees*, and its related implementation guidance. FAS No. 123R will require compensation costs related to share-based payment transactions to be recognized in the financial statement (with limited exceptions). The amount of compensation cost will be measured based on the grant-date fair value of the equity or liability instruments issued. Compensation cost will be recognized over the period that an employee provides service in exchange for the award.

 

In April 2005, theSecurities and Exchange Commission adopted a new rule that amends thecompliance dates for FAS No. 123R. The Statement requires that compensationcost relating to share-based payment transactions be recognized in financialstatements and that this cost be measured based on the fair value of the equityor liability instruments issued. FAS No. 123R covers a wide range ofshare-based compensation arrangements including share options, restricted shareplans, performance-based awards, share appreciation rights, and employee sharepurchase plans. The Company will adopt FAS No. 123R on January 1, 2006,management has determined that unless additional options are granted, therewill be no impact to future earnings.

 

InMarch 2005, the Securities and Exchange Commission (“SEC”) issued StaffAccounting Bulletin No. 107 (“SAB No. 107”), *Share-Based Payment*, providing guidance on option valuationmethods, the accounting for income tax effects of share-based paymentarrangements upon adoption of FAS No. 123R, and the disclosures inMD&A subsequent to the adoption. The Company will provide SAB No. 107required disclosures upon adoption of FAS No. 123R on January 1,2006.

 

InDecember 2004, FASB issued FAS No. 153, *Exchanges of NonmonetaryAssets - An Amendment of APB Opinion No. 29*. The guidance in APBOpinion No. 29, *Accounting for Nonmonetary Transactions*,is based on the principle that exchanges of nonmonetary assets should bemeasured based on the fair value of the assets exchanged. The guidance in thatOpinion, however, included certain exceptions to that principle. FAS No. 153amends Opinion No. 29 to eliminate the exception for nonmonetary exchanges ofsimilar productive assets and replaces it with a general exception forexchanges of nonmonetary assets that do not have commercial substance. Anonmonetary exchange has commercial substance if the future cash flows of theentity are expected to change significantly as a result of the exchange. Theprovisions of FAS No. 153 are effective for nonmonetary asset exchangesoccurring in fiscal periods beginning after June 15, 2005. Early application ispermitted and companies must apply the standard prospectively. The adoption ofthis standard is not expected to have a material effect on the Company’sresults of operations or financial position.

 

InJune 2005, the FASB issued FAS No. 154, *Accounting Changes and ErrorsCorrections, a replacement of APB Opinion No. 20 and FAS No. 3*. TheStatement applies to all voluntary changes in accounting principle, and changesthe requirements for accounting for and reporting of a change in accountingprinciple. FAS No. 154 requires retrospective application to prior periods’financial statements of a voluntary change in accounting principle unless it isimpractical. APB Opinion No. 20 previously required that most voluntary changesin accounting principle be recognized by including in net income of the periodof the change the cumulative effect of changing to the new accounting principle.FAS No.154 improves the financial reporting because its requirements enhancethe consistency of financial reporting between periods. The provisions of FASNo. 154 are effective for accounting changes and corrections of errors made infiscal years beginning after December 15, 2005. The adoption of this standardis not expected to have a material effect on the Company’s results ofoperations or financial position.

 

**NOTE 2 - PER SHARE DATA**

 

Thereare no convertible securities, which would affect the numerator in calculatingbasic and dilutive earnings per share, therefore, net income as presented onthe consolidated statement of income will be used as the numerator. Thefollowing table sets forth the composition of the weighted average commonshares (denominator) used in the basic and dilutive per share computation. 

 

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| ** **                                                                                                 | ** ** | **2005**  | ** ** | **2004**  | ** ** | **2003**  | ** ** |
|------------------------------------------------------------------------------------------------------------|------------|-----------|------------|-----------|------------|-----------|------------|
|                                                                                                       |       |      |       |      |       |      |       |
| Weighted average  common shares outstanding                                                                |       | 3,986,569 |       | 3,993,336 |       | 4,116,362 |       |
| Average treasury  stock shares                                                                             |       | (14,643   | )          | (3,328    | )          | (119,660  | )          |
| Weighted average  common shares and common stock equivalents used to calculate basic earnings  per share   |       | 3,971,926 |       | 3,990,008 |       | 3,996,702 |       |
| Additional  common stock equivalents (stock options) used to calculate diluted earnings  per share         |       | 2,129     |       | 4,344     |       | 3,855     |       |
| Weighted average  common shares and common stock equivalents used to calculate diluted earnings  per share |       | 3,974,055 |       | 3,994,352 |       | 4,000,557 |       |

 

Optionsto purchase 9,002 shares of common stock at a price of $40.29 were outstandingduring 2005, 10,455 shares of common stock at a price of $40.29 wereoutstanding during 2004, and 13,068 shares of common stock at a price of $40.29were outstanding during 2003, but were not included in the computation ofdiluted earnings per share as they were anti-dilutive due to the strike pricebeing greater than the market price as of the end of each of the fiscal yearspresented above.

 

**NOTE 3 -INVESTMENT SECURITIES**

 

Theamortized cost of investment securities and their approximate fair values areas follows: 

 

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| ** **                            | ** ** | **2005**      | ** ** |
|---------------------------------------|------------|---------------|------------|
| ** **                            | ** ** | ** **    | ** ** | **Gross** | ** ** | **Gross** | ** ** | ** ** | ** ** |
| ** **                            | ** ** | **Amortized** | ** ** | **Unrealized** | ** ** | **Unrealized** | ** ** | **Fair** | ** ** |
| **(In Thousands)**                    | ** ** | **Cost**      | ** ** | **Gains** | ** ** | **Losses** | ** ** | **Value** | ** ** |
|                                  |       |          |       |   |   |   |   |   |   |
| Available for Sale (AFS)              |       |          |       |   |   |   |   |   |   |
| U.S. Government and agency securities |       | $             | 65,496     |   | $ | 30 |   | $ | (1,573 | ) | $ | 63,953 |   |
| State and political securities        |       | 93,769        |       | 1,390 |   | (1,068 | ) | 94,091 |   |
| Other debt securities                 |       | 1,750         |       | 12 |   | (43 | ) | 1,719 |   |
| Total debt  securities                |       | 161,015       |       | 1,432 |   | (2,684 | ) | 159,763 |   |
| Equity securities                     |       | 24,715        |       | 2,951 |   | (411 | ) | 27,255 |   |
| Total Investment Securities AFS       |       | $             | 185,730    |   | $ | 4,383 |   | $ | (3,095 | ) | $ | 187,018 |   |
|                                  |       |          |       |   |   |   |   |   |   |
| Held to Maturity (HTM)                |       |          |       |   |   |   |   |   |   |
| U.S. Government and agency securities |       | $             | 28         |   | $ | 2 |   | $ | — |   | $ | 30 |   |
| State and political securities        |       | —        |       | — |   | — |   | — |   |
| Other debt securities                 |       | 237           |       | — |   | (29 | ) | 208 |   |
| Total Investment Securities HTM       |       | $             | 265        |   | $ | 2 |   | $ | (29 | ) | $ | 238 |   |

 
| ** **                            | ** ** | **2004**      | ** ** |
|---------------------------------------|------------|---------------|------------|
| ** **                            | ** ** | ** **    | ** ** | **Gross** | ** ** | **Gross** | ** ** | ** ** | ** ** |
| ** **                            | ** ** | **Amortized** | ** ** | **Unrealized** | ** ** | **Unrealized** | ** ** | **Fair** | ** ** |
| ** **                            | ** ** | **Cost**      | ** ** | **Gains** | ** ** | **Losses** | ** ** | **Value** | ** ** |
|                                  |       |          |       |   |   |   |   |   |   |
| Available for Sale (AFS)              |       |          |       |   |   |   |   |   |   |
| U.S. Government and agency securities |       | $             | 104,248    |   | $ | 207 |   | $ | (430 | ) | $ | 104,025 |   |
| State and political securities        |       | 46,829        |       | 766 |   | (527 | ) | 47,068 |   |
| Other debt securities                 |       | 1,302         |       | 47 |   | (7 | ) | 1,342 |   |
| Total debt  securities                |       | 152,379       |       | 1,020 |   | (964 | ) | 152,435 |   |
| Equity securities                     |       | 25,221        |       | 6,579 |   | (72 | ) | 31,728 |   |
| Total Investment Securities AFS       |       | $             | 177,600    |   | $ | 7,599 |   | $ | (1,036 | ) | $ | 184,163 |   |
|                                  |       |          |       |   |   |   |   |   |   |
| Held to Maturity (HTM)                |       |          |       |   |   |   |   |   |   |
| U.S. Government and agency securities |       | $             | 32         |   | $ | — |   | $ | — |   | $ | 32 |   |
| State and political securities        |       | 248           |       | 3 |   | — |   | 251 |   |
| Other debt securities                 |       | 278           |       | — |   | — |   | 278 |   |
| Total Investment Securities HTM       |       | $             | 558        |   | $ | 3 |   | $ | — |   | $ | 561 |   |

 

45

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Thefollowing tables show the Company’s gross unrealized losses and fair value,aggregated by investment category and length of time, that the individualsecurities have been in a continuous unrealized loss position, at December 31,2005 and 2004.

 
| ** **                            | ** ** | **2005**                                   | ** ** |
|---------------------------------------|------------|--------------------------------------------|------------|
| ** **                            | ** ** | **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 |       | $                                          | 34,028     |   | $ | 925 |   | $ | 26,038 |   | $ | 648 |   | $ | 60,066 |   | $ | 1,573 |   |
| State and political securities        |       | 46,864                                     |       | 1,063 |   | 586 |   | 5 |   | 47,450 |   | 1,068 |   |
| Other debt securities                 |       | 707                                        |       | 54 |   | 232 |   | 18 |   | 939 |   | 72 |   |
| Total debt securities                 |       | 81,599                                     |       | 2,042 |   | 26,856 |   | 671 |   | 108,455 |   | 2,713 |   |
| Equity securities                     |       | 2,721                                      |       | 249 |   | 1,340 |   | 162 |   | 4,061 |   | 411 |   |
| Total                                 |       | $                                          | 84,320     |   | $ | 2,291 |   | $ | 28,196 |   | $ | 833 |   | $ | 112,516 |   | $ | 3,124 |   |
|                                  |       |                                       |       |   |   |   |   |   |   |   |   |   |   |
| ** **                            | ** ** | **2004**                                   | ** ** |
| ** **                            | ** ** | **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 |       | $                                          | 51,636     |   | $ | 226 |   | $ | 28,598 |   | $ | 204 |   | $ | 80,234 |   | $ | 430 |   |
| State and political securities        |       | 17,339                                     |       | 527 |   | — |   | — |   | 17,339 |   | 527 |   |
| Other debt securities                 |       | 142                                        |       | 3 |   | 146 |   | 4 |   | 288 |   | 7 |   |
| Total debt securities                 |       | 69,117                                     |       | 756 |   | 28,744 |   | 208 |   | 97,861 |   | 964 |   |
| Equity securities                     |       | 1,187                                      |       | 64 |   | 298 |   | 8 |   | 1,485 |   | 72 |   |
| Total                                 |       | $                                          | 70,304     |   | $ | 820 |   | $ | 29,042 |   | $ | 216 |   | $ | 99,346 |   | $ | 1,036 |   |

 

AtDecember 31, 2005 there were a total of 124 and 24 individual securities thatwere in a continuous unrealized loss position for less than twelve months andgreater than twelve months, respectively.

 

The policy of the Company is to recognize other thantemporary impairment of equity securities where the fair value has beensignificantly below cost for four consecutive quarters. For fixed maturityinvestments with unrealized losses due to interest rates where the Company hasthe positive intent and ability to hold the investment for a period of timesufficient to allow a market recovery, declines in value below cost are notassumed to be other than temporary. The Company reviews its position quarterlyand has asserted that at December 31, 2005, the declines outlined in the abovetable represent temporary declines and the Company does have the intent andability to hold those securities either to maturity or to allow a marketrecovery.

 

The Company has concluded that any impairment of itsinvestment securities portfolio is not other than temporary but is the resultof interest rate changes, sector credit rating changes, or company-specificrating changes that are not expected to result in the non-collection ofprincipal and interest during the period.

 

The amortized cost and fair value of debtsecurities at December 31, 2005, by contractual maturity, are shown below. Expectedmaturities will differ from contractual maturities because borrowers may havethe right to call or prepay obligations with or without call or prepaymentpenalties.

 

46

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| ** **                        | ** ** | **Held to Maturity** | ** ** | **Available for Sale** | ** ** |
|-----------------------------------|------------|--------------------------------|------------|----------------------------------|------------|
| ** **                        | ** ** | **Amortized**                  | ** ** | **Fair**                         | ** ** | **Amortized** | ** ** | **Fair** | ** ** |
| **(In Thousands)**           | ** ** | **Cost**                       | ** ** | **Value**                        | ** ** | **Cost** | ** ** | **Value** | ** ** |
| Due in one year or less           |       | $                              | 25         |                             | $          | 25 |   | $ | 25 |   | $ | 25 |   |
| Due after one year to five years  |       | 75                             |       | 75                               |       | 790 |   | 792 |   |
| Due after five years to ten years |       | 137                            |       | 108                              |       | 7,680 |   | 7,519 |   |
| Due after ten years               |       | 28                             |       | 30                               |       | 152,520 |   | 151,427 |   |
| Total                             |       | $                              | 265        |                             | $          | 238 |   | $ | 161,015 |   | $ | 159,763 |   |

 

Total gross proceeds from sales of securitiesavailable for sale were $123,546,000, $162,796,000, and $82,489,000, for 2005,2004, and 2003, respectively. The following table represents gross realizedgains and losses on those transactions:

 
| **(In Thousands)**               | ** ** | **2005** | ** ** | **2004** | ** ** | **2003** | ** ** |
|---------------------------------------|------------|----------|------------|----------|------------|----------|------------|
| Gross realized gains:                 |       |     |       |     |       |     |       |
| U.S. Government and agency securities |       | $        | 128        |     | $          | 459      |       | $ | 254 |   |
| State and political securities        |       | 819      |       | 1,191    |       | 3,345    |       |
| Other debt securities                 |       | —   |       | 1        |       | 27       |       |
| Equity securities                     |       | 2,209    |       | 2,192    |       | 1,015    |       |
| Total gross realized gains            |       | $        | 3,156      |     | $          | 3,843    |       | $ | 4,641 |   |
|                                  |       |     |       |     |       |     |       |
| Gross realized losses:                |       |     |       |     |       |     |       |
| U.S. Government and agency securities |       | $        | 791        |     | $          | 1,623    |       | $ | 742 |   |
| State and political securities        |       | 116      |       | 23       |       | 50       |       |
| Other debt securities                 |       | 59       |       | —   |       | 2        |       |
| Equity securities                     |       | —   |       | 21       |       | 368      |       |
| Total gross realized losses           |       | $        | 966        |     | $          | 1,667    |       | $ | 1,162 |   |

 

In 2003, the Company recorded an investment securitygain of $24,000 resulting from a business combination where the Company receivedthe common stock of the acquirer in a non-monetary exchange. This gain isincluded in the above table. There were no gains of this nature in 2005 or2004.

 

Acharge of $292,000 was recorded in 2003 to recognize other than temporarydeclines in the value of certain marketable equity securities. This loss isincluded in the above table. There were no losses of this nature in 2005 or2004.

 

Investment securities with a carrying valueof approximately $72,642,000 and $71,730,000 at December 31, 2005 and 2004,respectively, were pledged to secure certain deposits, security repurchaseagreements, and for other purposes as required by law.

 

There is no concentration of investments thatexceed ten percent of shareholders’ equity for any individual issuer, excludingthose guaranteed by the U.S. Government.

 

47

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**NOTE 4 – LOANS**

 

Major loan classifications loans aresummarized as follows:

 
| ** **                        | ** ** | **2005**    | ** ** |
|-----------------------------------|------------|-------------|------------|
| ** **                        | ** ** | ** **  | ** ** | ** ** | ** ** | **PAST DUE** | ** ** | ** ** | ** ** | ** ** | ** ** |
| ** **                        | ** ** | ** **  | ** ** | ** ** | ** ** | **90 DAYS** | ** ** | ** ** | ** ** | ** ** | ** ** |
| ** **                        | ** ** | ** **  | ** ** | **PAST DUE** | ** ** | **OR MORE** | ** ** | ** ** | ** ** | ** ** | ** ** |
| ** **                        | ** ** | ** **  | ** ** | **30 TO 90** | ** ** | **& STILL** | ** ** | **NON-** | ** ** | ** ** | ** ** |
| **(In Thousands)**           | ** ** | **CURRENT** | ** ** | **DAYS** | ** ** | **ACCRUING** | ** ** | **ACCRUAL** | ** ** | **TOTAL** | ** ** |
| Commercial  and agricultural      |       | $           | 34,000     |   | $ | 238 |   | $ | — |   | $ | 169 |   | $ | 34,407 |   |
| Real estate  mortgage:            |       |        |       |   |   |   |   |   |   |   |   |
| Residential                       |       | 148,190     |       | 1,413 |   | 34 |   | 363 |   | 150,000 |   |
| Commercial                        |       | 125,587     |       | 1,544 |   | — |   | — |   | 127,131 |   |
| Construction                      |       | 10,599      |       | 79 |   | — |   | 3 |   | 10,681 |   |
| Installment  loans to individuals |       | 16,859      |       | 388 |   | 29 |   | 5 |   | 17,281 |   |
|                              |       | 335,235     |       | $ | 3,662 |   | $ | 63 |   | $ | 540 |   | 339,500 |   |
| Less: Net deferred loan fees      |       | 1,062       |       |   |   |   |   |   |   | 1,062 |   |
| Allowance for loan losses         |       | 3,679       |       |   |   |   |   |   |   | 3,679 |   |
| Loans, net                        |       | $           | 330,494    |   |   |   |   |   |   |   | $ | 334,759 |   |
|                              |       |        |       |   |   |   |   |   |   |   |   |
| ** **                        | ** ** | **2004**    | ** ** |
| ** **                        | ** ** | ** **  | ** ** | ** ** | ** ** | **PAST DUE** | ** ** | ** ** | ** ** | ** ** | ** ** |
| ** **                        | ** ** | ** **  | ** ** | ** ** | ** ** | **90 DAYS** | ** ** | ** ** | ** ** | ** ** | ** ** |
| ** **                        | ** ** | ** **  | ** ** | **PAST DUE** | ** ** | **OR MORE** | ** ** | ** ** | ** ** | ** ** | ** ** |
| ** **                        | ** ** | ** **  | ** ** | **30 TO 90** | ** ** | **& STILL** | ** ** | **NON-** | ** ** | ** ** | ** ** |
| ** **                        | ** ** | **CURRENT** | ** ** | **DAYS** | ** ** | **ACCRUING** | ** ** | **ACCRUAL** | ** ** | **TOTAL** | ** ** |
| Commercial  and agricultural      |       | $           | 29,467     |   | $ | 389 |   | $ | 82 |   | $ | 165 |   | $ | 30,103 |   |
| Real estate  mortgage:            |       |        |       |   |   |   |   |   |   |   |   |
| Residential                       |       | 143,028     |       | 3,530 |   | 254 |   | 649 |   | 147,461 |   |
| Commercial                        |       | 121,951     |       | 1,257 |   | — |   | 549 |   | 123,757 |   |
| Construction                      |       | 8,359       |       | — |   | — |   | 6 |   | 8,365 |   |
| Installment  loans to individuals |       | 15,495      |       | 399 |   | 9 |   | 12 |   | 15,915 |   |
|                              |       | 318,300     |       | $ | 5,575 |   | $ | 345 |   | $ | 1,381 |   | 325,601 |   |
| Less: Net deferred loan fees      |       | 1,096       |       |   |   |   |   |   |   | 1,096 |   |
| Allowance for loan losses         |       | 3,338       |       |   |   |   |   |   |   | 3,338 |   |
| Loans, net                        |       | $           | 313,866    |   |   |   |   |   |   |   | $ | 321,167 |   |
|                                   |            |             |            |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |

 

Loanson which the accrual of interest has been discontinued or reduced amounted toapproximately $540,000 and $1,381,000 at December 31, 2005 and 2004,respectively. If interest had been recorded at the original rate on thoseloans, such income would have approximated $39,000, $64,000, and $55,000 forthe years ended December 31, 2005, 2004, and 2003, respectively. Interestincome on such loans, which is recorded as received, amounted to approximately$18,000, $10,000, and $7,000, for the years ended December 31, 2005, 2004, and2003, respectively.

 

Changes in the allowance for loan losses forthe years ended December 31, are as follows:

 
| **(In Thousands)**         | ** ** | **2005**   | ** ** | **2004**   | ** ** | **2003**   | ** ** |
|---------------------------------|------------|------------|------------|------------|------------|------------|------------|
| ** **                      | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** |
| Balance, beginning of year      |       | $          | 3,338      |       | $          | 3,069      |       | $ | 2,953 |   |
| Provision charged to operations |       | 720        |       | 465        |       | 255        |       |
| Loans charged off               |       | (446       | )          | (283       | )          | (216       | )          |
| Recoveries                      |       | 67         |       | 87         |       | 77         |       |
| Balance, end of year            |       | $          | 3,679      |       | $          | 3,338      |       | $ | 3,069 |   |

 

The Company had a concentration in lending tolessors of residential buildings and lessors of nonresidential buildings atDecember 31, 2005 of 15.70% and 15.76 of total loans, respectively. Aconcentration within these categories also existed at December 31, 2004.

 

The Company grants commercial, industrial,residential, and installment loans to customers throughout north-centralPennsylvania. Although the Company has a diversified loan portfolio at December31, 2005 and 2004, a substantial portion of its debtors’ ability to honor theircontracts is dependent on the economic conditions within this region.

 

48

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**NOTE 5 - PREMISES AND EQUIPMENT**

 

Major classifications of premises andequipment are summarized as follows at December 31:

 
| **(In Thousands)**       | ** ** | **2005**   | ** ** | **2004**   | ** ** |
|-------------------------------|------------|------------|------------|------------|------------|
| ** **                    | ** ** | ** ** | ** ** | ** ** | ** ** |
| Land                          |       | $          | 1,046      |       | $          | 841 |   |
| Premises                      |       | 6,022      |       | 5,015      |       |
| Furniture and equipment       |       | 4,118      |       | 6,756      |       |
| Leasehold improvements        |       | 805        |       | 894        |       |
| Total                         |       | 11,991     |       | 13,506     |       |
| Less accumulated depreciation |       | 5,582      |       | 8,624      |       |
| Net premises and equipment    |       | $          | 6,409      |       | $          | 4,882 |   |

 

Depreciation charged to operations for theyears ended 2005, 2004, and 2003 were $549,000, $585,000, and $631,000,respectively.

 

The Bank has committed to approximately$200,000 for the furniture and equipment of a new branch located in Montoursville,PA. The branch, which will be leased, is scheduled to open during 2006.

 

**NOTE 6 – GOODWILL**

 

As of December 31, 2005, 2004, and 2003goodwill had a gross carrying value of $3,308,000 and accumulated amortizationof $276,000 resulting in a net carrying amount of $3,032,000.

 

The gross carrying amount of goodwill istested for impairment in the third quarter of each fiscal year. Based on fairvalue of the reporting unit, estimated using the expected present value offuture cash flows, no goodwill impairment loss was recognized in the currentyear.

 

**NOTE 7 – TIME DEPOSITS**

 

Timedeposits of $100,000 or more totaled approximately $36,762,000 on December 31,2005 and $30,212,000 on December 31, 2004. Interest expense related to suchdeposits was approximately $1,417,000, $818,000, and $829,000, for the yearsended December 31, 2005, 2004, and 2003, respectively.

 

Maturitieson time deposits of $100,000 or more are as follows:

 
| **(In Thousands)**     | ** ** | **2005**   | ** ** |
|-----------------------------|------------|------------|------------|
| ** **                  | ** ** | ** ** | ** ** |
| Three months or less        |       | $          | 7,649      |   |
| Three months to six months  |       | 4,729      |       |
| Six months to twelve months |       | 7,415      |       |
| Over twelve months          |       | 16,969     |       |
| Total                       |       | $          | 36,762     |   |

 

49

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Totaltime deposits at December 31, 2005 mature as follows:

 
| **(In Thousands)** | ** ** | **2005**   | ** ** |
|-------------------------|------------|------------|------------|
| ** **              | ** ** | ** ** | ** ** |
| 2006                    |       | $          | 81,460     |   |
| 2007                    |       | 42,765     |       |
| 2008                    |       | 12,300     |       |
| 2009                    |       | 9,121      |       |
| 2010                    |       | 588        |       |
| Thereafter              |       | 1,310      |       |
| Total                   |       | $          | 147,544    |   |

 

##### **NOTE8 - SHORT-TERM BORROWINGS**

##### ** **

Short-termborrowings consist of securities sold under agreements to repurchase and FHLBadvances which generally represent overnight or less than six month borrowings.In addition to the outstanding balances noted below, the Bank also hadadditional lines of credit totaling $25,500,000 available from correspondentbanks other than the FHLB. The outstanding balances and related information forshort-term borrowings are summarized as follows:

 
| **(In Thousands)**                     | ** ** | **2005** | ** ** | **2004** | ** ** | **2003** | ** ** |
|---------------------------------------------|------------|----------|------------|----------|------------|----------|------------|
| **Repurchase Agreements:**                  |       |     |       |     |       |     |       |
| Balance at year end                         |       | $        | 15,263     |     | $          | 13,845   |       | $ | 10,225 |   |
| Maximum amount outstanding at any month end |       | 16,754   |       | 15,301   |       | 15,665   |       |
| Average balance outstanding during the year |       | 14,268   |       | 13,317   |       | 13,214   |       |
| Weighted-average interest rate:             |       |     |       |     |       |     |       |
| At year end                                 |       | 2.74     | %          | 1.82     | %          | 1.91     | %          |
| Paid during the year                        |       | 2.19     | %          | 1.77     | %          | 2.07     | %          |
|                                        |       |     |       |     |       |     |       |
| **Open Repo Plus:**                         |       |     |       |     |       |     |       |
| Balance at year end                         |       | $        | 1,740      |     | $          | 22,630   |       | $ | 36,140 |   |
| Maximum amount outstanding at any month end |       | 24,990   |       | 32,480   |       | 36,140   |       |
| Average balance outstanding during the year |       | 10,765   |       | 18,336   |       | 11,537   |       |
| Weighted-average interest rate:             |       |     |       |     |       |     |       |
| At year end                                 |       | 4.25     | %          | 2.24     | %          | 1.06     | %          |
| Paid during the year                        |       | 3.33     | %          | 1.64     | %          | 1.16     | %          |
|                                        |       |     |       |     |       |     |       |
| **Short-Term FHLB:**                        |       |     |       |     |       |     |       |
| Balance at year end                         |       | $        | 37,000     |     | $          | —   |       | $ | 900 |   |
| Maximum amount outstanding at any month end |       | 37,000   |       | 900      |       | 900      |       |
| Average balance outstanding during the year |       | 7,081    |       | 204      |       | 695      |       |
| Weighted-average interest rate:             |       |     |       |     |       |     |       |
| At year end                                 |       | 4.24     | %          | —   |       | 1.40     | %          |
| Paid during the year                        |       | 3.66     | %          | 1.42     | %          | 1.42     | %          |

 

50

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**NOTE 9 – LONG TERM BORROWINGS**

 

The following represents outstandinglong-term borrowings with the FHLB by contractual maturities at December 31,2005 and 2004 (in thousands):

 
| ** **                                                | ** ** | **2005** | ** ** | **2004** | ** ** |
|-----------------------------------------------------------|------------|----------|------------|----------|------------|
|                                                      |       |     |       |     |       |
| Variable rate of 4.49%, maturing in 2007                  |       | $        | 5,000      |     | $          | 5,000 |   |
| Variable rates between 3.14% and 5.56%,  maturing in 2008 |       | 29,600   |       | 29,600   |       |
| Variable rate of 5.06%, maturing in 2009                  |       | 5,000    |       | 5,000    |       |
| Variable rate of 6.65%, maturing in 2010                  |       | 5,000    |       | 5,000    |       |
| Variable rates between 4.25% and 4.72%,  maturing in 2011 |       | 10,000   |       | 10,000   |       |
| Variable rate of 3.68%, maturing in 2012                  |       | 5,000    |       | 5,000    |       |
| Variable rate of 3.74%, maturing in 2013                  |       | 5,000    |       | 5,000    |       |
| Variable rate of 3.97%, maturing in 2015                  |       | 10,000   |       | —   |       |
| Fixed rate of 2.58%, maturing in 2006                     |       | 1,600    |       | 1,600    |       |
| Fixed rates between 2.67% and 3.13%,  maturing in 2007    |       | 6,500    |       | 6,500    |       |
| Fixed rate of 6.92%, maturing in 2011                     |       | 500      |       | 500      |       |
| Fixed rate of 5.87%, maturing in 2013                     |       | 528      |       | 528      |       |
| Fixed rate of 6.92%, maturing in 2015                     |       | 750      |       | 750      |       |
| Fixed rate of 2.02%, matured in 2005                      |       | —   |       | 1,400    |       |
| Total                                                     |       | $        | 84,478     |     | $          | 75,878 |   |

 

The terms of the convertible borrowings allowthe FHLB to convert the interest rate to an adjustable rate based on the threemonth London Interbank Offered Rate (“LIBOR”) at a predetermined anniversarydate of the borrowing’s origination, ranging from three months to five years. Ifthe FHLB converts the interest rate on one of the predetermined dates, the Bankhas the ability to payoff the debt on the conversion date with out incurringthe customary pre-payment penalty.

 

The Bank maintains a credit arrangement, whichincludes a revolving line of credit with the FHLB. Under this creditarrangement, the Bank has a remaining borrowing capacity of $83,457,000 atDecember 31, 2005, is subject to annual renewal, and typically incurs noservice charges. Under terms of a blanket agreement, collateral for the FHLBborrowings must be secured by certain qualifying assets of the Bank whichconsist principally of first mortgage loans.

 

**NOTE 10 - INCOME TAXES**

 

The following temporary differences gave riseto the net deferred tax position at December 31, 2005 and 2004:

 
| **(In Thousands)**                            | ** ** | **2005** | ** ** | **2004** | ** ** |
|----------------------------------------------------|------------|----------|------------|----------|------------|
| Deferred tax assets:                               |       |     |       |     |       |
| Allowance for loan losses                          |       | $        | 1,022      |     | $          | 841 |   |
| Deferred compensation                              |       | 368      |       | 353      |       |
| Pension                                            |       | 249      |       | 515      |       |
| Loan fees and costs                                |       | 356      |       | 368      |       |
| Investment securities allowance                    |       | 97       |       | 98       |       |
| Other                                              |       | 59       |       | 39       |       |
| Total                                              |       | 2,151    |       | 2,214    |       |
|                                               |       |     |       |     |       |
| Deferred tax liabilities:                          |       |     |       |     |       |
| Bond accretion                                     |       | 27       |       | 21       |       |
| Depreciation                                       |       | 96       |       | 205      |       |
| Amortization                                       |       | 301      |       | 225      |       |
| Unrealized gains on available for sale  securities |       | 438      |       | 2,231    |       |
| Total                                              |       | 862      |       | 2,682    |       |
|                                               |       |     |       |     |       |
| Deferred tax asset (liability), net                |       | $        | 1,289      |     | $          | (468 | ) |

 

51

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No valuation allowance was established atDecember 31, 2005 and 2004, in the view of the Company’s ability to carry backtaxes paid in previous years and certain tax strategies, coupled with theanticipated future taxable income as evidenced by the Company’s earningpotential.

 

Theprovision for income taxes is comprised of the following (in thousands):

 
| **(In Thousands)**    | ** ** | **2005**   | ** ** | **2004**   | ** ** | **2003**   | ** ** |
|----------------------------|------------|------------|------------|------------|------------|------------|------------|
| ** **                 | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** |
| Currently payable          |       | $          | 3,188      |       | $          | 4,512      |       | $ | 3,666 |   |
| Deferred (benefit) expense |       | 36         |       | (249       | )          | 37         |       |
|                       |       |       |       |       |       |       |       |
| Total provision            |       | $          | 3,224      |       | $          | 4,263      |       | $ | 3,703 |   |

 

A reconciliation between the expected incometax and the effective income tax rate on income before income tax provisionfollows:

 
| ** **                      | ** ** | **2005**   | ** ** | **2004** | ** ** | **2003**   | ** ** |
|---------------------------------|------------|------------|------------|----------|------------|------------|------------|
| **(In Thousands)**         | ** ** | **AMOUNT** | ** ** | **%**    | ** ** | **AMOUNT** | ** ** | **%** | ** ** | **AMOUNT** | ** ** | **%** | ** ** |
|                            |       |       |       |     |       |       |       |   |   |   |   |   |   |
| Provision at expected rate      |       | $          | 4,803      |     | 34.0       | %          | $          | 5,218 |   | 34.0 | % | $ | 5,058 |   | 34.0 | % |
| Decrease in tax resulting from: |       |       |       |     |       |       |       |   |   |   |   |   |   |
| Tax-exempt income               |       | (1,206     | )          | (8.5     | )          | (632       | )          | (4.1 | ) | (964 | ) | (6.4 | ) |
| Other, net                      |       | (373       | )          | (2.6     | )          | (323       | )          | (2.1 | ) | (391 | ) | (2.6 | ) |
|                            |       |       |       |     |       |       |       |   |   |   |   |   |   |
| Effective income tax and rates  |       | $          | 3,224      |     | 22.9       | %          | $          | 4,263 |   | 27.8 | % | $ | 3,703 |   | 24.9 | % |

 

**NOTE 11 - EMPLOYEE BENEFIT PLANS**

 

### Defined Benefit Pension Plan

 

The Company has a noncontributory definedbenefit pension plan (the “Plan”) for all employees meeting certain age andlength of service requirements and were hired prior to January 1, 2004, atwhich time entrance into the plan was frozen. Benefits are based primarily onyears of service and the average annual compensation during the highest fiveconsecutive years within the final ten years of employment.

 

52

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The following tables show the funded statusand components of net periodic benefit cost from this defined benefit plan:

 
| **(In Thousands)**                         | ** ** | **2005** | ** ** | **2004** | ** ** |
|-------------------------------------------------|------------|----------|------------|----------|------------|
| **Change in benefit obligation**                |       |     |       |     |       |
| Benefit obligation at beginning of year         |       | $        | 7,549      |     | $          | 7,145 |   |
| Service cost                                    |       | 505      |       | 447      |       |
| Interest cost                                   |       | 446      |       | 398      |       |
| Actuarial (gain) loss                           |       | 280      |       | (225     | )          |
| Benefits paid                                   |       | (218     | )          | (216     | )          |
| Other, change in actuarial assumptions          |       | 218      |       | —   |       |
| Benefit obligation at end of year               |       | $        | 8,780      |     | $          | 7,549 |   |
|                                            |       |     |       |     |       |
| **Change in plan assets**                       |       |     |       |     |       |
| Fair value of plan assets at beginning of  year |       | $        | 4,549      |     | $          | 4,042 |   |
| Actual return on plan assets                    |       | 272      |       | 394      |       |
| Employer contribution                           |       | 1,420    |       | 347      |       |
| Benefits paid                                   |       | (218     | )          | (216     | )          |
| Expenses paid                                   |       | (12      | )          | (18      | )          |
| Fair value of plan assets at end of year        |       | 6,011    |       | 4,549    |       |
| Funded status                                   |       | (2,769   | )          | (3,000   | )          |
| Unrecognized net actuarial loss                 |       | 1,849    |       | 1,275    |       |
| Unrecognized prior service cost                 |       | 204      |       | 229      |       |
| Unrecognized transition asset                   |       | (17      | )          | (19      | )          |
| Net Accrued Benefit Cost Recognized             |       | $        | (733       | )        | $          | (1,515 | ) |

 

The accumulated benefit obligation for thedefined benefit pension plan was $6,560,000, and $5,606,000 at December 31,2005 and 2004, respectively. Amounts recognized in the Statement of Incomeconsist of:

 
| **(In Thousands)**               | ** ** | **2005** | ** ** | **2004** | ** ** | **2003** | ** ** |
|---------------------------------------|------------|----------|------------|----------|------------|----------|------------|
| Service cost                          |       | $        | 505        |     | $          | 447      |       | $ | 443 |   |
| Interest cost                         |       | 446      |       | 398      |       | 384      |       |
| Expected return on plan assets        |       | (402     | )          | (376     | )          | (256     | )          |
| Amortization of transition asset      |       | (2       | )          | (3       | )          | (3       | )          |
| Amortization of prior service cost    |       | 25       |       | 26       |       | 26       |       |
| Recognized net actuarial gain         |       | —   |       | 109      |       | 83       |       |
| Amortization of unrecognized net loss |       | 65       |       | —   |       | —   |       |
| Net periodic benefit cost             |       | $        | 637        |     | $          | 601      |       | $ | 677 |   |

 

**Assumptions**

 

Weighted-average assumptions used todetermine benefit obligations at December 31:

 
| ** **                    | ** ** | **2005** | ** ** | **2004** | ** ** | **2003** | ** ** |
|-------------------------------|------------|----------|------------|----------|------------|----------|------------|
| Discount rate                 |       | 5.50     | %          | 5.75     | %          | 6.00     | %          |
| Rate of compensation increase |       | 4.50     | %          | 4.75     | %          | 5.00     | %          |

 

Weighted-average assumptions used todetermine net periodic cost for years ended December 31:

 
| ** **                               | ** ** | **2005** | ** ** | **2004** | ** ** | **2003** | ** ** |
|------------------------------------------|------------|----------|------------|----------|------------|----------|------------|
| Discount rate                            |       | 5.75     | %          | 6.00     | %          | 6.00     | %          |
| Expected long-term return on plan assets |       | 8.00     | %          | 8.00     | %          | 8.00     | %          |
| Rate of compensation increase            |       | 4.75     | %          | 5.00     | %          | 5.00     | %          |

 

53

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The expected long-term rate of return wasestimated using market benchmarks by which the plan assets would outperform themarket value in the future, based on historical experience adjusted for changesin asset allocation and expectations for overall lower future returns onsimilar investments compared to past periods.

 

**Plan Assets**

 

The Company’s pension plan weighted-averageasset allocations at December 31 by asset category are as follows:

 
| ** **              | ** ** | **2005** | ** ** | **2004** | ** ** |
|-------------------------|------------|----------|------------|----------|------------|
| Asset Category          |       |     |       |     |       |
| Cash                    |       | 0.4      | %          | 0.3      | %          |
| Fixed Income securities |       | 39.4     | %          | 37.9     | %          |
| Equity                  |       | 60.2     | %          | 61.8     | %          |
| Total                   |       | 100.0    | %          | 100.0    | %          |

 

The investment objective for the definedpension plan is to maximize total return with tolerance for slightly aboveaverage risk, meaning the fund is able to tolerate short-term volatility toachieve above-average returns over the long term. The portfolio’s targetexposure to equities is 60%, primarily invested in mid and large capitalizationdomestic equities. Exposure to small capitalization and international stocksmay be allowed.

 

Asset allocation favors equities, with targetallocation of approximately 60% equity securities, 37.5% fixed income securitiesand 2.5% cash. Due to violatility in the market, the target allocation is notalways desirable and asset allocations will fluctuate between the acceptableranges.

 

It is management’s intent to give theinvestment managers flexibility within the overall guidelines with respect toinvestment decisions and their timing. However, certain investments requirespecific review and approval by management. Management is also informed ofanticipated, significant modifications of any previously approved investment,or anticipated use of derivatives to execute investment strategies.

 

The following benefit payments, which reflectexpected future cost, are expected to be paid during the year ended December31, 2005 (in thousands):

 

**Estimated future benefit payments:**

 
| 2006      |   |   | $     | 244    |   |
|-----------|--------|--------|-------|--------|--------|
| 2007      |   |   | 277   |   |
| 2008      |   |   | 282   |   |
| 2009      |   |   | 321   |   |
| 2010      |   |   | 365   |   |
| 2011-2015 |   |   | 2,792 |   |

 

The company expects to contribute $500,000 toits Pension Plan in 2006.

 

### 401(k) Savings Plan

 

The Company also offers a 401(k) savings planin which eligible participating employees may elect to contribute up to amaximum percentage allowable not to exceed the limits of Code Sections 401(k),404, and 415. The Company may make matching contributions equal to adiscretionary percentage to be determined by the Board of Directors. Participantsare at all times fully vested in their contributions and vest over a period offive years in the employer contribution. Contribution expense was approximately$80,000, $83,000, and $75,000 for the years ended December 31, 2005, 2004, and2003, respectively.

 

54

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### Deferred Compensation Plan

 

The Company has a deferred compensation planwhereby participating directors elected to forego directors’ fees for a periodof five years. Under this plan, the Company will make payments for a ten-yearperiod beginning at age 65 in most cases or at death, if earlier, at which timepayments would be made to their designated beneficiaries.

 

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 total expensecharged to other expenses was $69,000, $73,000, and $104,000 for the yearsended December 31, 2005, 2004, and 2003, respectively. Benefits paid under theplan were approximately $112,000, $127,000, and $132,000 in 2005, 2004, and2003 respectively.

 

**NOTE 12 - STOCK OPTIONS**

 

Prior to 1998, the Company granted a selectgroup of its officers options to purchase shares of its common stock. Theseoptions, which are immediately exercisable, expire within three to ten yearsafter having been granted. Also, in 1998, the Company adopted the “1998 StockOption Plan” for key employees and directors. Incentive stock options andnonqualified stock options may be granted to eligible employees of the Bank andnonqualified options may be granted to directors of the Company. In addition,non-employee directors are eligible to receive grants of nonqualified stockoptions. Incentive nonqualified stock options granted under the 1998 Plan maybe exercised not later than ten years after 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.

 

A summary of the status of the Company’scommon stock option plans are presented below:

 
| ** **                      | ** ** | **2005**   | ** ** | **2004**     | ** ** |
|---------------------------------|------------|------------|------------|--------------|------------|
| ** **                      | ** ** | ** ** | ** ** | **WEIGHTED** | ** ** | ** ** | ** ** | **WEIGHTED** | ** ** |
| ** **                      | ** ** | ** ** | ** ** | **AVERAGE**  | ** ** | ** ** | ** ** | **AVERAGE** | ** ** |
| ** **                      | ** ** | ** ** | ** ** | **EXERCISE** | ** ** | ** ** | ** ** | **EXERCISE** | ** ** |
| ** **                      | ** ** | **SHARES** | ** ** | **PRICE**    | ** ** | **SHARES** | ** ** | **PRICE** | ** ** |
| Outstanding, beginning of year  |       | 19,158     |       | $            | 33.53      |   | 36,728 |   | $ | 32.83 |   |
| Granted                         |       | —     |       | —       |       | — |   | — |   |
| Exercised                       |       | (4,248     | )          | 24.76        |       | (6,332 | ) | 30.61 |   |
| Forfeited                       |       | (2,938     | )          | 30.43        |       | (11,238 | ) | 32.19 |   |
| Outstanding, end of year        |       | 11,972     |       | 37.41        |       | 19,158 |   | 33.53 |   |
| Options exercisable at year-end |       | 11,972     |       | $            | 37.41      |   | 19,158 |   | $ | 33.53 |   |

 

The following table summarizes informationabout nonqualified and incentive stock options outstanding at December 31,2005:

 
| ** **              | ** ** | **OUTSTANDING** | ** ** | **EXERCISABLE** | ** ** |
|-------------------------|------------|-----------------|------------|-----------------|------------|
| ** **              | ** ** | ** **      | ** ** | ** **      | ** ** | **AVERAGE** | ** ** | ** ** | ** ** | **AVERAGE** | ** ** |
| ** **              | ** ** | ** **      | ** ** | **AVERAGE**     | ** ** | **EXERCISE** | ** ** | ** ** | ** ** | **EXERCISE** | ** ** |
| **EXERCISE PRICE** | ** ** | **SHARES**      | ** ** | **LIFE**        | ** ** | **PRICE** | ** ** | **SHARES** | ** ** | **PRICE** | ** ** |
| $                       | 40.29      |            | 9,002      |            | 3          |   | $ | 40.29 |   | 9,002 |   | $ | 40.29 |   |
| 31.82                   |       | 1,650           |       | 4               |       | 31.82 |   | 1,650 |   | 31.82 |   |
| 24.72                   |       | 1,320           |       | 5               |       | 24.72 |   | 1,320 |   | 24.72 |   |
|                         |            |                 |            |                 |            |  |  |  |  |  |  |  |  |  |

 

**NOTE13 - RELATED PARTY TRANSACTIONS**

** **

Certaindirectors and executive officers of the Company and the Bank, including theirimmediate families and companies in which they are principal owners (more thanten percent), are indebted to the Company. Such indebtedness was incurred inthe ordinary course of business on the same terms and at those rates prevailingat the time for comparable transactions with others.

 

55

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

 
| ** **              | ** ** | **Beginning** | ** ** | ** **    | ** ** | ** **   | ** ** | **Ending**  | ** ** |
|-------------------------|------------|---------------|------------|---------------|------------|--------------|------------|-------------|------------|
| **(In Thousands)** | ** ** | **Balance**   | ** ** | **Additions** | ** ** | **Payments** | ** ** | **Balance** | ** ** |
| ** **              | ** ** | ** **    | ** ** | ** **    | ** ** | ** **   | ** ** | ** **  | ** ** |
| 2005                    |       | $             | 10,295     |          | $          | 781          |       | $           | 1,441      |   | $ | 9,635 |   |
| 2004                    |       | 7,227         |       | 4,320         |       | 1,252        |       | 10,295      |       |
|                         |            |               |            |               |            |              |            |             |            |  |  |  |  |

 

**NOTE 14 - COMMITMENTS AND CONTINGENTLIABILITIES**

 

Thefollowing schedule of future minimum rental payments under operating leaseswith noncancellable terms in excess of one year as of December 31, 2005 :

 

**Year Ending December 31,**

**(In Thousands)**

 
| 2006       |   | $     | 334    |   |
|------------|--------|-------|--------|--------|
| 2007       |   | 302   |   |
| 2008       |   | 164   |   |
| 2009       |   | 119   |   |
| 2010       |   | 110   |   |
| Thereafter |   | 1,269 |   |
| Total      |   | $     | 2,298  |   |

 

The Company’s operating lease obligationsrepresent short and long-term lease and rental payments for facilities.

 

Total rental expense for all operating leases forthe years ended December 31, 2005, 2004, and 2003 were $361,000,$320,000, and $269,000 respectively.

 

The Company is subject to lawsuits and claimsarising out of its business. There are no such legal proceedings or claimscurrently pending or threatened.

 

**NOTE 15 - OFF-BALANCE SHEET RISK**

 

The Company is a party to financialinstruments with off-balance sheet risk in the normal course of business tomeet the financing needs of its customers. These financial instruments includecommitments to extend credit and standby letters of credit. These instrumentsinvolve, to varying degrees, elements of credit, interest rate, or liquidityrisk in excess of the amount recognized in the consolidated balance sheet. Thecontract amounts of these instruments express the extent of involvement theCompany has in particular classes of financial instruments.

 

The Company’s exposure to credit loss fromnonperformance by the other party to the financial instruments for commitmentsto extend credit and standby letters of credit is represented by thecontractual amount of these instruments. The Company uses the same creditpolicies in making commitments and conditional obligations as it does foron-balance sheet instruments.

 

The Company may require collateral or othersecurity to support financial instruments with off-balance sheet credit risk.

 

Financial instruments whose contract amountsrepresent credit risk are as follows at December 31:

 
| **(In Thousands)**      | ** ** | **2005** | ** ** | **2004** | ** ** |
|------------------------------|------------|----------|------------|----------|------------|
| Commitments to extend credit |       | $        | 72,583     |     | $          | 42,537 |   |
| Standby letters of credit    |       | 2,193    |       | 1,321    |       |
|                              |            |          |            |          |            |  |  |

 

56

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Commitments to extend credit are legallybinding agreements to lend to customers. Commitments generally have fixedexpiration dates or other termination clauses and may require payment of fees. Sincemany of the commitments are expected to expire without being drawn upon, thetotal commitment amounts do not necessarily represent future liquidityrequirements. The Company evaluates each customer’s credit worthiness on acase-by-case basis. The amount of collateral obtained, if deemed necessary bythe Company, on extension of credit is based on management’s credit assessmentof the counterparty.

 

Standby letters of credit represent conditional commitments issued bythe Company to guarantee the performance of a customer to a third party. Theseinstruments are issued primarily to support bid or performance relatedcontracts. The coverage period for these instruments is typically a one yearperiod with an annual renewal option subject to prior approval by management. Feesearned from the issuance of these letters are recognized upon expiration of thecoverage period. For secured letters of credit, the collateral is typicallyBank deposit instruments or customer business assets.

 

**NOTE 16 - CAPITAL REQUIREMENTS**

 

Federal regulations require the Company andthe Bank to maintain minimum amounts of capital. 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.

 

In addition to the capital requirements, theFederal Deposit Insurance Corporation Improvement Act (“FDICIA”) establishedfive capital categories ranging from “well capitalized” to “criticallyundercapitalized.”   Should anyinstitution fail to meet the requirements to be considered “adequatelycapitalized,” it would become subject to a series of increasingly restrictiveregulatory actions.

 

As of December 31, 2005 and 2004, the FDIC categorizedthe Bank as well capitalized under the regulatory framework for promptcorrective action. To be classified as a well capitalized financialinstitution, Total risk-based, Tier 1 risk-based and Tier 1 leverage capitalratios must be at least 10%, 6%, and 5%, respectively.

 

The Company’s and the Bank’s actual capitalratios are presented in the following tables, which shows that both met allregulatory capital requirements.

 

57

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**Consolidated Company**

 
| ** **                              | ** ** | **2005**   | ** ** | **2004**  | ** ** |
|-----------------------------------------|------------|------------|------------|-----------|------------|
| **(In Thousands)**                 | ** ** | **Amount** | ** ** | **Ratio** | ** ** | **Amount** | ** ** | **Ratio** | ** ** |
| Total Capital(to Risk-weighted Assets)  |       |       |       |      |       |   |   |   |   |
|                                    |       |       |       |      |       |   |   |   |   |
| Actual                                  |       | $          | 73,210     |      | 21.0       | % | $ | 72,042 |   | 21.8 | % |
| For Capital Adequacy Purposes           |       | 27,937     |       | 8.0       |       | 26,475 |   | 8.0 |   |
| To Be Well Capitalized                  |       | 34,921     |       | 10.0      |       | 33,094 |   | 10.0 |   |
|                                    |       |       |       |      |       |   |   |   |   |
| Tier I Capital(to Risk-weighted Assets) |       |       |       |      |       |   |   |   |   |
|                                    |       |       |       |      |       |   |   |   |   |
| Actual                                  |       | $          | 68,388     |      | 19.6       | % | $ | 65,776 |   | 19.9 | % |
| For Capital Adequacy Purposes           |       | 13,968     |       | 4.0       |       | 13,238 |   | 4.0 |   |
| To Be Well Capitalized                  |       | 20,952     |       | 6.0       |       | 19,856 |   | 6.0 |   |
|                                    |       |       |       |      |       |   |   |   |   |
| Tier I Capital(to Average Assets)       |       |       |       |      |       |   |   |   |   |
|                                    |       |       |       |      |       |   |   |   |   |
| Actual                                  |       | $          | 68,388     |      | 12.2       | % | $ | 65,776 |   | 12.1 | % |
| For Capital Adequacy Purposes           |       | 22,495     |       | 4.0       |       | 21,750 |   | 4.0 |   |
| To Be Well Capitalized                  |       | 28,119     |       | 5.0       |       | 27,187 |   | 5.0 |   |
|                                    |       |       |       |      |       |   |   |   |   |

 

**Bank**

 
| ** **                              | ** ** | **2005**   | ** ** | **2004**  | ** ** |
|-----------------------------------------|------------|------------|------------|-----------|------------|
| **(In Thousands)**                 | ** ** | **Amount** | ** ** | **Ratio** | ** ** | **Amount** | ** ** | **Ratio** | ** ** |
| Total Capital(to Risk-weighted Assets)  |       |       |       |      |       |   |   |   |   |
|                                    |       |       |       |      |       |   |   |   |   |
| Actual                                  |       | $          | 56,604     |      | 17.0       | % | $ | 55,717 |   | 17.6 | % |
| For Capital Adequacy Purposes           |       | 26,716     |       | 8.0       |       | 25,311 |   | 8.0 |   |
| To Be Well Capitalized                  |       | 33,394     |       | 10.0      |       | 31,639 |   | 10.0 |   |
|                                    |       |       |       |      |       |   |   |   |   |
| Tier I Capital(to Risk-weighted Assets) |       |       |       |      |       |   |   |   |   |
|                                    |       |       |       |      |       |   |   |   |   |
| Actual                                  |       | $          | 52,527     |      | 15.7       | % | $ | 51,213 |   | 16.2 | % |
| For Capital Adequacy Purposes           |       | 13,358     |       | 4.0       |       | 12,656 |   | 4.0 |   |
| To Be Well Capitalized                  |       | 20,037     |       | 6.0       |       | 18,983 |   | 6.0 |   |
|                                    |       |       |       |      |       |   |   |   |   |
| Tier I Capital(to Average Assets)       |       |       |       |      |       |   |   |   |   |
|                                    |       |       |       |      |       |   |   |   |   |
| Actual                                  |       | $          | 52,527     |      | 9.6        | % | $ | 51,213 |   | 9.7 | % |
| For Capital Adequacy Purposes           |       | 21,809     |       | 4.0       |       | 21,039 |   | 4.0 |   |
| To Be Well Capitalized                  |       | 27,261     |       | 5.0       |       | 26,299 |   | 5.0 |   |

 

##### **NOTE17 – REGULATORY RESTRICTIONS**

 

The Pennsylvania Banking Code restricts theavailability of capital funds for payment of dividends by all state-charteredbanks to the additional paid in capital of the Bank. Accordingly, at December31, 2005, the balance in the additional paid in capital account totaling$11,657,000 is unavailable for dividends.

 

The Bank is subject to regulatoryrestrictions, which limit its ability to loan funds to Penns Woods Bancorp, Inc.At December 31, 2005, the regulatory lending limit amounted to approximately$5,739,000.

 

**Cash and Due from Banks**

 

Included in cash and due from banks arereserves required by the district Federal Reserve Bank of $1,410,000 and$1,197,000 at December 31, 2005 and 2004. The required reserves are computed byapplying prescribed ratios to the

 

58

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classes of average deposit balances. Theseare held in the form of cash on hand and a balance maintained directly with theFederal Reserve Bank.

 

**NOTE 18 - ESTIMATED FAIR VALUE OF FINANCIALINSTRUMENTS**

 

TheCompany is required to disclose estimated fair values for its financialinstruments. Fair value estimates are made at a specific point in time, basedon relevant market information and information about the financial instrument. Theseestimates do not reflect any premium or discount that could result fromoffering for sale at one time the Company’s entire holdings of a particularfinancial instrument. Also, it is the Company’s general practice and intentionto hold most of its financial instruments to maturity and not to engage intrading or sales activities. Because no market exists for a significant portionof the Company’s financial instruments, fair value estimates are based onjudgments regarding future expected loss experience, current economicconditions, risk characteristics of various financial instruments, and otherfactors. These estimates are subjective in nature and involve uncertainties andmatters of significant judgment and therefore cannot be determined withprecision. Changes in assumptions can significantly affect the estimates.

 

Estimated fair values have been determined bythe Company using historical data and an estimation methodology suitable foreach category of financial instruments. The estimated fair value of the Company’sinvestment securities is described in Note 1. The Company’s fair valueestimates, methods, and assumptions are set forth below for the Company’s otherfinancial instruments.

 

As certain assets and liabilities, such as deferred taxassets, premises and equipment, and many other operational elements of theCompany, are not considered financial instruments but have value, thisestimated fair value of financial instruments would not represent the full marketvalue of the Company.

 

The estimated fair values ofthe Company’s financial instruments are as follows at December 31:

 
| ** **                   | ** ** | **2005**     | ** ** | **2004**  | ** ** |
|------------------------------|------------|--------------|------------|-----------|------------|
| ** **                   | ** ** | **Carrying** | ** ** | **Fair**  | ** ** | **Carrying** | ** ** | **Fair** | ** ** |
| **(In Thousands)**      | ** ** | **Value**    | ** ** | **Value** | ** ** | **Value** | ** ** | **Value** | ** ** |
| Financial assets:            |       |         |       |      |       |   |   |   |   |
| Cash and cash equivalents    |       | $            | 14,090     |      | $          | 14,090 |   | $ | 12,626 |   | $ | 12,626 |   |
| Investment securitites:      |       |         |       |      |       |   |   |   |   |
| Available for sale           |       | 187,018      |       | 187,018   |       | 184,163 |   | 184,163 |   |
| Held to maturity             |       | 265          |       | 238       |       | 558 |   | 561 |   |
| Loans held for sale          |       | 3,545        |       | 3,545     |       | 4,624 |   | 4,624 |   |
| Loans, net                   |       | 334,759      |       | 337,093   |       | 321,167 |   | 331,350 |   |
| Bank-owned life insurance    |       | 10,718       |       | 10,718    |       | 10,976 |   | 10,976 |   |
| Accrued interest receivable  |       | 2,828        |       | 2,828     |       | 2,246 |   | 2,246 |   |
|                         |       |         |       |      |       |   |   |   |   |
| Financial liabilities:       |       |         |       |      |       |   |   |   |   |
| Interest-bearing deposits    |       | $            | 281,150    |      | $          | 262,758 |   | $ | 282,786 |   | $ | 263,509 |   |
| Noninterest-bearing deposits |       | 71,379       |       | 71,379    |       | 74,050 |   | 74,050 |   |
| Short-term borrowings        |       | 54,003       |       | 54,003    |       | 36,475 |   | 36,475 |   |
| Long-term borrowings, FHLB   |       | 84,478       |       | 83,877    |       | 75,878 |   | 77,858 |   |
| Accrued interest payable     |       | 1,108        |       | 1,108     |       | 850 |   | 850 |   |

 

**Cash andCash Equivalents, Loans Held for Sale, Regulatory Stock, Accrued Interest Receivable,Short-term Borrowings, and Accrued 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 estimated using the quoted market price for similarsecurities.

 

59

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# **Loans:**

# ** **

Fair values are estimated for portfolios of loans withsimilar financial characteristics. Loans are segregated by type such ascommercial, commercial real estate, residential real estate, construction realestate, and other consumer. Each loan category is further segmented into fixedand adjustable rate interest terms and by performing and nonperformingcategories.

 

The fair value of performing loans is calculated bydiscounting scheduled cash flows through the estimated maturity using estimatedmarket discount rates that reflect the credit and interest rate risk inherentin the loan. The estimate of maturity is based on the Company’s historicalexperience with repayments for each loan classification, modified, as required,by an estimate of the effect of current economic and lending conditions.

 

Fair value for significant nonperforming loans is basedon recent external appraisals. If appraisals are not available, estimated cashflows are discounted using a rate commensurate with the risk associated withthe estimated cash flows. Assumptions regarding credit risk, cash flows, anddiscounted rates are judgmentally determined using available market information and specific borrower information.

 

**Bank-OwnedLife Insurance:**

 

The fair value is equal to the Cash Surrender Value of the lifeinsurance policies.

 

# **Deposits:**

# ** **

The fair value of deposits with no stated maturity, suchas noninterest-bearing demand deposits, savings, NOW, and money market accounts,is equal to the amount payable on demand as of December 31, 2005 and 2004. Thefair value of certificates of deposit is based on the discounted value ofcontractual cash flows.

 

The fair value estimates above do not include thebenefit that results from the low-cost funding provided by the depositliabilities compared to the cost of borrowing funds in the market, commonlyreferred to as the core deposit intangible.

 

**LongTerm Borrowings:**

 

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

 

#### **Commitmentsto Extend Credit, Standby Letters of Credit, and Financial Guarantees Written:**

#### ** **

There is no material difference between thenotional amount and the estimated fair value of off-balance sheet items atDecember 31, 2005 and 2004, respectively. The contractual amounts of unfundedcommitments and letters of credit are presented in Note 15.

 

**NOTE 19- PARENT COMPANY ONLYFINANCIAL STATEMENTS**

 

Condensed financial information for PennsWoods Bancorp, Inc. follows:

 

60

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**CONDENSED BALANCE SHEET, DECEMBER 31,**

 
| **(In Thousands)**                       |   | **2005** | ** **   | **2004** |   |         |   |
|-----------------------------------------------|--------|----------|--------------|----------|--------|--------------|--------|
|                                          |   |     |         |     |   |         |   |
| ASSETS                                        |   |     |         |     |   |         |   |
| Cash                                          |   | $        | 159          |     | $      |  453    |   |   |   |
| Investment in subsidiaries:                   |   |     |         |     |   |         |   |
| Bank                                          |   | 57,170   |         | 56,743   |   |         |   |
| Nonbank                                       |   | 16,452   |         | 15,980   |   |         |   |
| Other assets                                  |   | 186      |         | 104      |   |         |   |
|                                          |   |     |         |     |   |         |   |
| Total Assets                                  |   | $        |  73,967 |     | $      |  73,280 |   |   |   |
|                                          |   |     |         |     |   |         |   |
| LIABILITIES AND SHAREHOLDERS’ EQUITY     |   |     |         |     |   |         |   |
| Other liabilities                             |   | $        |  48     |     | $      |  115    |   |   |   |
| Shareholders’ equity                     |   | 73,919   |         | 73,165   |   |         |   |
|                                          |   |     |         |     |   |         |   |
| Total liability and shareholders’ equity |   | $        |  73,967 |     | $      |  73,280 |   |   |   |

 

**CONDENSED STATEMENT OF INCOME**

**FOR THE YEARS ENDED DECEMBER 31,**

 
| **(In Thousands)**                             | ** ** | **2005** | ** ** | **2004** | ** ** | **2003** | ** ** |
|-----------------------------------------------------|------------|----------|------------|----------|------------|----------|------------|
|                                                |       |     |       |     |       |     |       |
| Operating income:                                   |       |     |       |     |       |     |       |
| Dividends from subsidiaries                         |       | $        | 7,311      |     | $          | 6,440    |       | $ | 6,651 |   |
| Equity in undistributed net income of  subsidiaries |       | 3,822    |       | 4,833    |       | 4,649    |       |
|                                                |       |     |       |     |       |     |       |
| Operating expenses:                                 |       | (232     | )          | (190     | )          | (126     | )          |
|                                                |       |     |       |     |       |     |       |
| Net income                                          |       | $        | 10,901     |     | $          | 11,083   |       | $ | 11,174 |   |

 

**CONDENSED STATEMENT OF CASH FLOWS**

**FOR THE YEARS ENDED DECEMBER 31,**

 
| **(In Thousands)**                                                            | ** ** | **2005** | ** ** | **2004** | ** ** | **2003** | ** ** |
|------------------------------------------------------------------------------------|------------|----------|------------|----------|------------|----------|------------|
|                                                                               |       |     |       |     |       |     |       |
| OPERATING ACTIVITIES                                                               |       |     |       |     |       |     |       |
| Net income                                                                         |       | $        | 10,901     |     | $          | 11,083   |       | $ | 11,174 |   |
| Adjustments to reconcile net income to net cash  provided by operating activities: |       |     |       |     |       |     |       |
| Equity in undistributed net income of subsidiaries                                 |       | (3,822   | )          | (4,833   | )          | (4,649   | )          |
| Other, net                                                                         |       | (70      | )          | (9       | )          | (64      | )          |
| Net cash provided by operating activities                                          |       | 7,009    |       | 6,241    |       | 6,461    |       |
|                                                                               |       |     |       |     |       |     |       |
| INVESTING ACTIVITIES                                                               |       |     |       |     |       |     |       |
| Additional investment in subsidiaries                                              |       | (637     | )          | (271     | )          | (1,039   | )          |
|                                                                               |       |     |       |     |       |     |       |
| FINANCING ACTIVITIES                                                               |       |     |       |     |       |     |       |
| Dividends paid                                                                     |       | (6,225   | )          | (5,843   | )          | (5,001   | )          |
| Proceeds from exercise of stock options                                            |       | 105      |       | 194      |       | 87       |       |
| Purchase of treasury stock                                                         |       | (546     | )          | (237     | )          | (620     | )          |
| Net cash used for financing activities                                             |       | (6,666   | )          | (5,886   | )          | (5,534   | )          |
|                                                                               |       |     |       |     |       |     |       |
| NET INCREASE (DECREASE) IN CASH                                                    |       | (294     | )          | 84       |       | (112     | )          |
| CASH, BEGINNING OF YEAR                                                            |       | 453      |       | 369      |       | 481      |       |
| CASH, END OF YEAR                                                                  |       | $        | 159        |     | $          | 453      |       | $ | 369 |   |

 

61

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**NOTE 20 – CONSOLIDATED QUARTERLY FINANCIAL DATA (UNAUDITED)**

 
| **(In Thousands, Except Per Share  Data)** | ** ** | **FOR THE THREE MONTHS ENDED** | ** ** |
|--------------------------------------------|------------|--------------------------------|------------|
| **2005**                                   | ** ** | **March 31,**             | ** ** | **June 30,** | ** ** | **Sept. 30,** | ** ** | **Dec. 31,** | ** ** |
| Interest income                            |       | $                              | 7,435      |   | $ | 7,654 |   | $ | 7,816 |   | $ | 7,998 |   |
| Interest expense                           |       | 2,249                          |       | 2,457 |   | 2,701 |   | 2,974 |   |
|                                       |       |                           |       |   |   |   |   |   |   |
| Net interest income                        |       | 5,186                          |       | 5,197 |   | 5,115 |   | 5,024 |   |
|                                       |       |                           |       |   |   |   |   |   |   |
| Provision for loan losses                  |       | 180                            |       | 180 |   | 180 |   | 180 |   |
| Non-interest income                        |       | 1,696                          |       | 1,788 |   | 1,991 |   | 1,766 |   |
| Securities gains, net                      |       | 611                            |       | 687 |   | 556 |   | 336 |   |
| Non-interest expenses                      |       | 3,595                          |       | 3,849 |   | 3,788 |   | 3,876 |   |
|                                       |       |                           |       |   |   |   |   |   |   |
| Income before income tax provision         |       | 3,718                          |       | 3,643 |   | 3,694 |   | 3,070 |   |
| Income tax provision                       |       | 1,003                          |       | 883 |   | 746 |   | 592 |   |
|                                       |       |                           |       |   |   |   |   |   |   |
| Net income                                 |       | $                              | 2,715      |   | $ | 2,760 |   | $ | 2,948 |   | $ | 2,478 |   |
|                                       |       |                           |       |   |   |   |   |   |   |
| Earnings per share - basic                 |       | $                              | 0.68       |   | $ | 0.70 |   | $ | 0.74 |   | $ | 0.63 |   |
|                                       |       |                           |       |   |   |   |   |   |   |
| Earnings per share - diluted               |       | $                              | 0.68       |   | $ | 0.70 |   | $ | 0.74 |   | $ | 0.62 |   |

 
| **(In Thousands, Except Per Share  Data)** | ** ** | **FOR THE THREE MONTHS ENDED** | ** ** |
|--------------------------------------------|------------|--------------------------------|------------|
| **2004**                                   | ** ** | **March 31,**             | ** ** | **June 30,** | ** ** | **Sept. 30,** | ** ** | **Dec. 31,** | ** ** |
| Interest income                            |       | $                              | 7,193      |   | $ | 7,139 |   | $ | 7,613 |   | $ | 7,900 |   |
| Interest expense                           |       | 2,124                          |       | 2,142 |   | 2,229 |   | 2,273 |   |
|                                       |       |                           |       |   |   |   |   |   |   |
| Net interest income                        |       | 5,069                          |       | 4,997 |   | 5,384 |   | 5,627 |   |
|                                       |       |                           |       |   |   |   |   |   |   |
| Provision for loan losses                  |       | 75                             |       | 75 |   | 165 |   | 150 |   |
| Non-interest income                        |       | 1,603                          |       | 1,814 |   | 1,821 |   | 1,504 |   |
| Securities gains, net                      |       | 545                            |       | 583 |   | 407 |   | 641 |   |
| Non-interest expenses                      |       | 3,450                          |       | 3,407 |   | 3,471 |   | 3,856 |   |
|                                       |       |                           |       |   |   |   |   |   |   |
| Income before income tax provision         |       | 3,692                          |       | 3,912 |   | 3,976 |   | 3,766 |   |
| Income tax provision                       |       | 1,019                          |       | 1,108 |   | 1,150 |   | 986 |   |
|                                       |       |                           |       |   |   |   |   |   |   |
| Net income                                 |       | $                              | 2,673      |   | $ | 2,804 |   | $ | 2,826 |   | $ | 2,780 |   |
|                                       |       |                           |       |   |   |   |   |   |   |
| Earnings per share - basic                 |       | $                              | 0.67       |   | $ | 0.71 |   | $ | 0.71 |   | $ | 0.69 |   |
|                                       |       |                           |       |   |   |   |   |   |   |
| Earnings per share - diluted               |       | $                              | 0.67       |   | $ | 0.71 |   | $ | 0.71 |   | $ | 0.69 |   |

 

 

**ITEM 9 CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIALDISCLOSURE**

 

None

 

**ITEM 9A    CONTROLS AND PROCEDURES**

 

The Company, under the supervision and with the participation of theCompany’s management, including the Company’s President and Chief ExecutiveOfficer along with the Company’s Principal Accounting Officer (the PrincipalFinancial Officer), has evaluated the effectiveness as of December 31, 2005 ofthe design and operation of the Company’s disclosure controls and procedures, as such term is defined under Rule13a-15(e) promulgated under 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 PrincipalAccounting Officer concluded that the Company’s disclosure controls and

 

62

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procedures were not effective as of December 31, 2005 , due to thematerial weakness in the Company’s internal control over financial reportingwhich management identified and which is discussed below under “ManagementReport on Internal Control Over Financial Reporting.”

 

There have been no materialchanges in the Company’s internal control over financial reporting during thefourth quarter of 2005 that have materially affected, or are reasonably likelyto materially affect, the Company’s internal control over financial reporting.

 

**Management’s Report on Internal Control Over FinancialReporting**

 

Managementof the Company is responsible for establishing and maintaining adequateinternal control over financial reporting as defined in Rules 13a-15(f)and 15d-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 financial statementswill not be prevented or detected on a timely basis by management or employeesin the normal course by management or employees in the normal course ofperforming their assigned functions.

 

Managementassessed the effectiveness of the Company’s internal control over financialreporting as of December 31, 2005. Management’s assessment identified thefollowing material weakness in the Company’s internal control over financialreporting: 

 

•                  Asof December 31, 2005, the Company did not maintain effective internalcontrol over the preparation of the consolidated statement of cash flowsincluded in the annual report to shareholders. The Company’s internal reviewprocedures failed to identify a reporting error relating to several line itemsincluded in the investing activities section of the statement of cash flows forthe year ended December 31, 2005. This error was identified by the Company’sindependent registered public accounting firm and was corrected prior to therelease of the Company’s annual report to shareholders for the year endedDecember 31, 2005.

 

Inmaking this assessment, management used the criteria set forth by the Committeeof Sponsoring Organizations of the Treadway Commission (COSO) in InternalControl-Integrated Framework. Because of the material weakness described above,management believes that, as of December 31, 2005, the Company’s internalcontrol over financial reporting was not effective.

 

Postyear-end remediation to address the material weakness is as follows: 

 

•                  Duringthe first quarter of 2006, Management implemented and further enhanced itsfinancial reporting control procedures. Specifically, supervisory review andapproval of all supporting financial schedules, tables narratives, andfinancial report content, must be completed by the Vice President of Financeand the Executive Vice President & Chief Administrative Officer. The reviewand approval process will be completed in a timely and well documented mannerprior to any financial report / data circulation with the Company’s CEO, seniormanagement, the Board of Directors, and third parties contracted to providelegal review or audit services. Further, an evaluation regarding thesufficiency of the Finance Department’s staff size and planned continuingeducation for 2006 will be completed during the second quarter of the year, andprior to June 30, 2006.

 

63

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Our management’s assessmentof the effectiveness of our internal control over financial reporting as ofDecember 31, 2005, has been audited by S.R. Snodgrass, A.C., an independentregistered public accounting firm, as stated in its attestation report which isincluded herein.

 
| Date:  March 9, 2006 | /s/  Ronald A. Walko     |                           | /s/  Brian L. Knepp |   |
|----------------------|--------------------------|--------------------------------|---------------------|--------|
|                 | Chief  Executive Officer | Principal  Accounting Officer  |
|                 |                     | (Principal  Financial Officer) |

 

REPORT OF INDEPENDENT REGISTERED PUBLICACCOUNTING FIRM

 

Board of Directors and Shareholders

Penns Woods Bancorp, Inc.

 

Wehave audited management’s assessment, included in the accompanying Report on Management’sAssessment of Internal Control Over Financial Reporting, that Penns WoodsBancorp, Inc. did not maintain effective internal control over financialreporting as of December 31, 2005, because of the effect of a material weakness(as explained further below) based on criteria established in “InternalControl—Integrated Framework” issued by the Committee of SponsoringOrganizations of the Treadway Commission (COSO). Penns Woods Bancorp, Inc.’smanagement is responsible for maintaining effective internal control overfinancial reporting and for its assessment of the effectiveness of internalcontrol over financial reporting. Our responsibility is to express an opinionon management’s assessment and an opinion on the effectiveness of the Company’sinternal control over financial reporting based on our audit.

 

We conductedour audit in accordance with the standards of the Public Company AccountingOversight Board (United States). Those standards require that we plan andperform the audit to obtain reasonable assurance about whether effectiveinternal control over financial reporting was maintained in all materialrespects. Our audit included obtaining an understanding of internal controlover financial reporting, evaluating management’s assessment, testing andevaluating the design and operating effectiveness of internal control, andperforming such other procedures as we considered necessary in thecircumstances. We believe that our audit provides a reasonable basis for ouropinion.

 

Acompany’s internal control over financial reporting is a process designed toprovide reasonable assurance regarding the reliability of financial reportingand the preparation of financial statements for external purposes in accordancewith generally accepted accounting principles. A company’s internal controlover financial reporting includes those policies and procedures that: (1)pertain to the maintenance of records that, in reasonable detail, accuratelyand fairly reflect the transactions and dispositions of the assets of thecompany; (2) provide reasonable assurance that transactions are recorded asnecessary to permit preparation of financial statements in accordance withgenerally accepted accounting principles and that receipts and expenditures ofthe company are being made only in accordance with authorizations of managementand directors of the company; and (3) provide reasonable assurance regardingprevention or timely detection of unauthorized acquisition, use, or dispositionof the Company’s assets that could have a material effect on the financialstatements.

 

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.

 

A materialweakness is a control deficiency, or combination of control deficiencies, thatresults in more than a remote likelihood that a material misstatement of theannual or interim financial statements will not be prevented or detected. Thefollowing material weakness has been identified and included in management’sassessment. As of December 31, 2005, the Company did not maintain effectiveinternal control over the preparation of the consolidated statement of cashflows included in the annual report to shareholders. Management completed itsreview process of the statement, however, as a result of our audit procedures,

 

64

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materialmisstatements were identified by us and corrected by management prior to therelease of the annual report. However, this control deficiency results in morethan a remote likelihood that a material misstatement to the annual or interimfinancial statements will not be prevented or detected. Accordingly, managementhas determined that this condition constitutes a material weakness. Thismaterial weakness was considered in determining the nature, timing, and extentof audit tests applied in our audit of the 2005 consolidated financialstatements, and this report does not affect our report dated March 9, 2006 onthose consolidated financial statements.

 

In ouropinion, management’s assessment that Penns Woods Bancorp, Inc. did notmaintain effective internal control over financial reporting as of December 31,2005, is fairly stated, in all material respects, based on the COSO criteria.Also in our opinion, because of the effect of the material weakness describedabove on the achievement of the objectives of the control criteria, Penns WoodsBancorp, Inc. has not maintained effective internal control over financialreporting as of December 31, 2005, based on the COSO criteria.

 

We do notexpress an opinion or any other form of assurance on management’s statementregarding post year-end remediation actions.

 

We have alsoaudited, in accordance with the standards of the Public Company AccountingOversight Board (United States), the consolidated balance sheet of Penns WoodsBancorp, Inc. and subsidiaries as of December 31, 2005 and 2004, and therelated consolidated statements of income, changes in stockholders’ equity, andcash flows for each of the three years in the period ended December 31, 2005,and our report dated March 9, 2006, expressed an unqualified opinion.

 
| /s/  S.R.  Snodgrass, A.C. |   |
|-------------------------------------------|--------|
| Wexford, Pennsylvania                     |
| March 9, 2006                             |

 

**ITEM 9B– OTHER INFORMATION**

 

None.

 

**PART III**

** **

**ITEM 10    DIRECTORS ANDEXECUTIVE OFFICERS OF THE REGISTRANT**

 

Information appearing in the Proxy Statement under the caption“Election of Directors” is incorporated herein by reference. (a) Identificationof directors. The information appearing under the caption “Election ofDirectors” in the Company’s Proxy Statement dated March 21, 2006 (the “ProxyStatement”) is incorporated herein by reference.

 

##### **ITEM11    EXECUTIVE COMPENSATION**

##### ** **

Information appearing under the caption “Executive Compensation” in theCompany’s Proxy Statement is incorporated herein by reference.

 

**ITEM 12    SECURITY OWNERSHIP OFCERTAIN BENEFICIAL OWNERS AND MANAGEMENT AND RELATED STOCKHOLDER MATTERS**

 

The information appearing under the caption “Security Ownership ofCertain Beneficial Owners and Management” in the Company’s Proxy Statement  is incorporated herein by reference.

 

65

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**Equity Compensation Plan Information**

 
| ** **                                                  | ** ** | ** **               | ** ** | ** **               | ** ** | **Number of**               | ** ** |
|-------------------------------------------------------------|------------|--------------------------|------------|--------------------------|------------|-----------------------------|------------|
| ** **                                                  | ** ** | ** **               | ** ** | ** **               | ** ** | **securities remaining**    | ** ** |
| ** **                                                  | ** ** | **Number of**            | ** ** | ** **               | ** ** | **available for future**    | ** ** |
| ** **                                                  | ** ** | **securities to be**     | ** ** | **Weighted-**            | ** ** | **issuance under**          | ** ** |
| ** **                                                  | ** ** | **issued upon**          | ** ** | **average**              | ** ** | **equity compensation**     | ** ** |
| ** **                                                  | ** ** | **exercise of**          | ** ** | **exercise of**          | ** ** | **plans (excluding**        | ** ** |
| ** **                                                  | ** ** | **outstanding options,** | ** ** | **outstanding options,** | ** ** | **securities reflected in** | ** ** |
| ** **                                                  | ** ** | **warrants and rights**  | ** ** | **warrants and rights**  | ** ** | **column (a))**             | ** ** |
| **Plan Category**                                           | ** ** | **(a)**                  | ** ** | **(b)**                  | ** ** | **(c)**                     | ** ** |
| Equity compensation plans approved by  security holders     |       | 11,972                   |       | $                        | 37.41      |                        | —     |   |
|                                                        |       |                     |       |                     |       |                        |       |
| Equity compensation plans not approved by  security holders |       | —                   |       | —                   |       | —                      |       |
| Total                                                       |       | 11,972                   |       | $                        | 37.41      |                        | —     |   |

 

**ITEM 13    CERTAIN RELATIONSHIPSAND RELATED TRANSACTIONS**

 

There have been no material transactions between the Company and theBank, nor any material transactions proposed, with any Director or ExecutiveOfficer of the Company and the Bank, or any associate of the foregoing persons.The Company and the Bank have had, and intend to continue to have, banking andfinancial transactions in the ordinary course of business with Directors andOfficers of the Company and the Bank and their associates on comparable termsand with similar interest rates as those prevailing from time to time for othercustomers of the Company and the Bank.

 

Total loans outstanding from the Bank at December 31, 2005 to theCompany’s and the Bank’s Officers and Directors as a group and members of theirimmediate families and companies in which they had an ownership interest of 10%or more was $9,635,000 or approximately 13.03% of the total equity capital ofthe Company. Loans to such persons were made in the ordinary course ofbusiness, were made on substantially the same terms, including interest ratesand collateral, as those prevailing at the time for comparable transactionswith other persons, and did not involve more than the normal risk ofcollectability or present other unfavorable features. See also the informationappearing in Note 13 to the Consolidated Financial Statements includedelsewhere in the Annual Report.

 

**ITEM 14     PRINCIPAL ACCOUNTANTFEES AND SERVICES**

 

The information appearing in the Proxy Statement under the captions,“Audit Fees,” “Audit-Related Fees,” “Tax Fees,” “All Other Fees,” and “AuditCommittee Pre-Approval Policies and Procedures” is incorporated herein byreference.

 

**PART IV**

** **

**ITEM 15     EXHIBITS FINANCIALSTATEMENT SCHEDULES**

 
| (a)1. Financial Statements |   |                                                                                                                                                                                            |
|----------------------------|--------|-------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
|                       |   | The following consolidated financial  statements and reports are set forth in Item 8:                                                                                                           |   |   |
|                       |   | Report of  Independent Auditors                                                                                                                                                                 |   |   |
|                       |   | Consolidated  Balance Sheet                                                                                                                                                                     |   |   |
|                       |   | Consolidated  Statement of Income                                                                                                                                                               |   |   |
|                       |   | Consolidated  Statement of Changes in Shareholders’ Equity                                                                                                                                 |   |   |
|                       |   | Consolidated  Statement of Cash Flows                                                                                                                                                           |   |   |
|                       |   | Notes to the  Consolidated Financial Statements                                                                                                                                                 |   |   |
| 2.                         |   | Financial Statement Schedules                                                                                                                                                                   |   |   |
|                       |   | Financial statement schedules are omitted  because the required information is either not applicable, not required or is  shown in the respective financial statements or in the notes thereto. |

 

66

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The schedules not included are omitted because the required matter orconditions are not present, the data is insignificant or the requiredinformation is submitted as part of the consolidated financial statements andnotes thereto.

 

 (b) Exhibits:

 

(3)  (i)                           Articlesof Incorporation of the Registrant, as presently in effect.

 

(3)  (ii)                        Bylawsof the Registrant as presently in effect (incorporated by reference to Exhibit3 (ii) of the Registrant’s Current Report on Form 8-K filed onJune 17, 2005).

 

(10) (i)                           Employment Agreement, datedAugust, 1991, between Jersey Shore State Bank and Ronald A. Walko (incorporatedby reference to Exhibit 10.3 of the Registrant’s Registration Statement on formS-4, No. 333-65821).*

 

(10) (ii)                        Employment Agreement, dated May31, 2005, between Jersey Shore State Bank and Thomas A. Donofrio (incorporatedby reference to Exhibit 10.1 of the Registrant’s Current Report on Form 8-Kfiled on June 3, 2005).*

 

(10) (iii)                     Employee Severance Benefit Plan,dated May 30, 1996, for Ronald A. Walko (incorporated by reference to Exhibit10.4 of the Registrant’s Registration Statement on form S-4, No. 333-65821).*

 

(10) (iv)                    Penns Woods Bancorp, Inc. 1998Stock Option Plan (incorporated by reference to Exhibit 10.1 of theRegistrant’s Registration Statement on form S-4, No. 333-65821).*

 

(10) (v)                       Amendment and Restatement of the Jersey Shore State Bank DirectorDeferred Fee Agreement, dated October 29, 2004, between Jersey Shore StateBank and Philip H. Bower (incorporated by reference to Exhibit 10 (vi) ofthe Registrant’s Annual Report on Form 10-K for the year endedDecember 31, 2004).*

 

(10) (vi)                    Amendment and Restatement of the Jersey Shore State Bank DirectorDeferred Fee Agreement, dated October 29, 2004, between Jersey Shore StateBank and Lynn S. Bowes (incorporated by reference to Exhibit 10 (vii) ofthe Registrant’s Annual Report on Form 10-K for the year endedDecember 31, 2004).*

 

(10) (vii)                 Amendmentand Restatement of the Jersey Shore State Bank Director Deferred Fee Agreement,dated October 29, 2004, between Jersey Shore State Bank and Michael J.Casale (incorporated by reference to Exhibit 10 (viii) of the Registrant’sAnnual Report on Form 10-K for the year ended December 31, 2004).*

 

(10) (viii)              Amendmentand Restatement of the Jersey Shore State Bank Director Deferred Fee Agreement,dated October 29, 2004, between Jersey Shore State Bank and James M. FureyII (incorporated by reference to Exhibit 10 (ix) of the Registrant’sAnnual Report on Form 10-K for the year ended December 31, 2004).*

 

(10) (ix)                      Amendment and Restatement of the Jersey Shore State Bank DirectorDeferred Fee Agreement, dated October 29, 2004, between Jersey Shore StateBank and Jay H. McCormick (incorporated by reference to Exhibit 10 (x) ofthe Registrant’s Annual Report on Form 10-K for the year endedDecember 31, 2004).*

 

(10) (x)                         Amendment and Restatement of the Jersey Shore State Bank DirectorDeferred Fee Agreement, dated October 29, 2004, between Jersey Shore StateBank and William H. Rockey (incorporated by reference to Exhibit 10 (xi)of the Registrant’s Annual Report on Form 10-K for the year endedDecember 31, 2004).*

 

(10) (xi)                      Amendment and Restatement of the Jersey Shore State Bank DirectorDeferred Fee Agreement, dated October 29, 2004, between Jersey Shore StateBank and Ronald A. Walko (incorporated by reference to Exhibit 10 (xii) ofthe Registrant’s Annual Report on Form 10-K for the year endedDecember 31, 2004).*

 

(21)                                         Subsidiariesof the Registrant.

 

(23)                                         Consent ofIndependent 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 Principle AccountingOfficer

 

(32) (i)                           Section 1350  Certification ofChief Executive Officer

 

(32) (ii)                        Section 1350  Certification ofPrinciple Accounting Officer

 

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*Denotes compensatory plan or arrangement.

 

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** **

**SIGNATURES**

 

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

 

 
| March 14, 2006 | PENNS WOODS BANCORP, INC. |
|----------------|---------------------------|
|           | BY:                       |  /s/ RONALD A. WALKO |   |
|           |                      | Ronald A. Walko |
|           |                      | President & Chief Executive Officer |

 

Pursuant to the requirements of the Securities and Exchange Act of1934, this report has been signed below by the following persons on behalf ofthe Registrant and in the capacities and on the dates indicated:

 
| /s/ RONALD A. WALKO                                |   | March 14, 2006 |
|----------------------------------------------------|--------|----------------|
| Ronald A. Walko, President, Chief Executive        |   |           |
| Officer and Director (Principal Executive Officer) |   |           |
|                                               |   |           |
| /s/ BRIAN L. KNEPP                            |   | March 14, 2006 |
| Brian L. Knepp, Principal Accounting Officer       |   |           |
| (Principal Financial Officer)                      |   |           |
|                                               |   |           |
| /s/ PHILLIP H. BOWER                               |   | March 14, 2006 |
| Phillip H. Bower, Director                         |   |           |
|                                               |   |           |
| /s/ LYNN S. BOWES                                  |   | March 14, 2006 |
| Lynn S. Bowes, Director                            |   |           |
|                                               |   |           |
| /s/ MICHAEL J. CASALE, JR.                         |   | March 14, 2006 |
| Michael J. Casale, Jr.,  Director                  |   |           |
|                                               |   |           |
| /s/ H. THOMAS DAVIS, JR.                           |   | March 14, 2006 |
| H. Thomas Davis, Jr., Director                     |   |           |
|                                               |   |           |
| /s/ JAMES M. FUREY II                              |   | March 14, 2006 |
| James M. Furey II, Director                        |   |           |
|                                               |   |           |
| /s/ LEROY H. KEILER III                            |   | March 14, 2006 |
| Leroy H. Keiler III, Director                      |   |           |
|                                               |   |           |
| /s/ JAY H. MCCORMICK                               |   | March 14, 2006 |
| Jay H. McCormick, Director                         |   |           |
|                                               |   |           |
| /s/ R. EDWARD NESTLERODE, JR.                      |   | March 14, 2006 |
| R. Edward Nestlerode, Jr., Director                |   |           |
|                                               |   |           |
| /s/ JAMES E. PLUMMER                               |   | March 14, 2006 |
| James E. Plummer, Director                         |   |           |
|                                               |   |           |
| /s/ WILLIAM H. ROCKEY, SR.                         |   | March 14, 2006 |
| William H. Rockey, Sr., Vice President &       |   |           |
| Director                                           |   |           |
|                                               |   |           |
| /s/ HUBERT A. VALENCIK                             |   | March 14, 2006 |
| Hubert A. Valencik, Director                       |   |           |

 

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