Quarterly
        Summary of Financial Data (Unaudited)
 
 The
        unaudited quarterly results of operations for the years ended December 31,
        2005
        and December 31, 2004 are as follows:
 (Dollars
                  in thousands, except Per Share Amounts)2005First
              Second
              Third
              FourthQuarter
              Quarter
              Quarter
              QuarterInterest
                  income
              $4,014
              $4,027
              $4,089
              $4,054Interest
                  expense
              1,032
              1,077
              1,119
              1,154Net
                  interest income
              2,982
              2,950
              2,970
              2,900Provision/(credit)
                  for loan losses
              (470)
              -
              15
              90Net
                  interest income afterprovision
                  for loan losses
              3,452
              2,950
              2,955
              2,810Other
                  income
              716
              718
              689
              836Other
                  expenses
              2,732
              2,695
              2,582
              2,523Income
                  before income taxes
              1,436
              973
              1,062
              1,123Applicable
                  income taxes
              395
              242
              289
              291Net
                  income
              $1,041
              $731
              $773
              $832Earnings
                  per share, basic
              $.31
              $.21
              $.23
              $.24
 
 2004First
              Second
              Third
              FourthQuarter
              Quarter
              Quarter
              QuarterInterest
                  income
              $4,923
              $4,795
              $4,364
              $4,160Interest
                  expense
              1,654
              1,656
              1,607
              1,034Net
                  interest income
              3,269
              3,139
              2,757
              3,126Provision
                  for loan losses
              56
              (492)
              -
              -Net
                  interest income afterprovision
                  for loan losses
              3,213
              3,631
              2,757
              3,126Net
                  securities gains
              795
              51
              349
              -Other
                  income
              995
              957
              752
              692FHLB
                  prepayment penalty
              -
              -
              4,402
              -Other
                  expenses
              3,643
              3,269
              2,968
              2,624Income(loss)
                  before income taxes
              1,360
              1,370
              (3,512)
              1,194Applicable
                  income taxes(benefit)
              308
              356
              (1,286)
              413Net
                  income(loss)
              $1,052
              $1,014
              $(2,226)
              $781Earnings(loss)
                  per share, basic
              $.31
              $.29
              $(.65)
              $.23
 
  
 Common
        Stock Information
 
 The
        following table sets forth the high and low sales prices for the common stock,
        as reported by The Nasdaq Stock Market, Inc., and the cash dividends declared
        per share on the common stock for the periods indicated.
 
 
 Cash
                  Dividend2005
              
              High
              
              Low
              
              Per
                  ShareFirst
                  Quarter
              $
              23.50
              $
              21.20
              $
              .25Second
                  Quarter
              
              24.30
              
              20.00
              
              .20Third
                  Quarter
              
              21.50
              
              17.89
              
              .20Fourth
                  Quarter
              
              19.25
              
              18.70
              
              .202004First
                  Quarter
              $
              28.40
              $
              25.75
              $
              .25Second
                  Quarter
              
              26.43
              
              21.50
              
              .25Third
                  Quarter
              
              26.00
              
              21.00
              
              .25Fourth
                  Quarter
              
              24.24
              
              22.00
              
              .25
 
 
 Commercial
        National Financial Corporation common stock is traded on The Nasdaq National
        Market under the trading symbol “CNAF” with an additional descriptive listing of
“CmclNat.”
  
  Selected
        Financial Data
 The
        following financial information is not covered by the auditor's report and
        must
        be read in conjunction with the consolidated financial statements and related
        notes along with management's discussion and analysis of financial condition
        and
        results of operations.
  Years
                  Ended December 31,
                (Dollars
                  in thousands, except per share data)2005
              2004
              2003
              2002
              2001Total
                  interest income
              $16,184
              $18,242
              $19,795
              $22,943
              $24,399Total
                  interest expense
              4,382
              5,951
              6,525
              7,575
              9,716Net
                  interest income
              11,802
              12,291
              13,270
              15,368
              14,683Provision/(credit)
                  for loan losses
              (365)
              (436)
              39
              298
              540Net
                  interest income afterprovision
                  for loan losses
              12,167
              12,727
              13,231
              15,070
              14,143Other
                  operating income
              2,959
              4,591
              3,939
              3,290
              2,555Other
                  operating expenses
              10,532
              16,906
              12,772
              11,143
              10,094Income
                  before taxes
              4,594
              412
              4,398
              7,217
              6,604Income
                  taxes expense/(benefit)
              1,217
              (209)
              837
              1,873
              1,699Net
                  income
              $3,377
              $
                  621
              $
                  3,561
              $
                  5,344
              $
                  4,905Per
                  share dataNet
                  income
              $
                  .99
              $
                  .18
              $
                  1.03
              $
                  1.56
              $
                  1.43Dividends
                  declared
              $
                  .85
              $
                  1.00
              $
                  1.00
              $
                  1.00
              $
                  .76Average
                  shares outstanding
              3,413,426
              3,422,881
              3,441,556
              3,425,858
              3,432,389**At
                  end of period**Total
                  assets
              $322,381
              $320,372
              $385,028
              $380,338
              $343,029Securities
              66,117
              99,455
              164,340
              144,726
              117,038Loans,
                  net of unearned income
              207,039
              192,255
              187,382
              169,030
              202,335Allowance
                  for loan losses
              1,636
              1,855
              2,462
              2,707
              2,814Deposits
              277,009
              265,818
              259,216
              270,025
              254,986Long-term
                  borrowings
              -
              -
              55,000
              55,000
              35,000Shareholders'
                  equity
              43,661
              44,660
              49,537
              51,205
              45,970**Key
                  ratios (expressed as %)**Return
                  on average assets
              1.06%
              0.17%
              0.95%
              1.46%
              1.43%Return
                  on average equity
              7.67
              1.36
              6.99
              11.02
              10.90Net
                  loans-to-deposit ratio
              74.15
              71.63
              71.34
              61.59
              78.25Dividend
                  payout ratio (dividendsdeclared
                  divided by net income)
              85.91
              551.21
              96.63
              64.07
              53.16Equity-to-assets
                  ratio (averageequity
                  divided by average total assets)
              13.86
              12.47
              13.63
              13.27
              13.12
  
  **Management’s
        Discussion and Analysis**
 **of**
 **Financial
        Condition and Results of Operations**
 
 **Safe
        Harbor Statement**
 
 *Forward-looking
        statements (statements which are not historical facts) in this Annual Report
        on
        Form 10-K are made pursuant to the safe harbor provisions of the Private
        Securities Litigation Reform Act of 1995. For this purpose, any statements
        contained herein that are not statements of historical fact may be deemed
        to be
        forward-looking statements. Without limiting the generality of the foregoing,
        words such as
“may,”“will,”“to,”“expect,”“believe,”“anticipate,”“intend,”“could,”“would,”“estimate,”
        or “continue” or the negative or other variations thereof or comparable
        terminology are intended to identify forward-looking statements. These
        statements are based on information currently available to Commercial National
        Financial Corporation (the Corporation), and the Corporation assumes no
        obligation to update these statements as circumstances change. Investors
        are
        cautioned that all forward-looking statements involve risk and uncertainties,
        including changes in general economic and financial market conditions,
        unforeseen credit problems, and the Corporation’s ability to execute its
        business plans. The actual results of future events could differ materially
        from
        those stated in any forward-looking statements herein.*
 
  **Critical
        Accounting Policies:**
   Disclosure
        of the Corporation's significant accounting policies is included in Note 1
        to the consolidated financial statements. Certain of these policies are
        particularly sensitive requiring significant judgments, estimates and
        assumptions to be made by management. Additional information is contained
        in
        management's discussion and analysis for the most sensitive of these issues,
        including the provision and allowance for loan losses.
   In
        determining the allowance for loan losses, management makes significant
        estimates. Consideration is given to a variety of factors in establishing
        this
        estimate. In estimating the allowance for loan losses, management considers
        current economic conditions, diversification of the loan portfolio, delinquency
        statistics, results of internal loan reviews, its borrowers' perceived financial
        and managerial strengths, the adequacy of the underlying collateral, if
        collateral dependent, or present value of future cash flows and other relevant
        factors.
  **Overview**
 
 The
        purpose of this discussion and the accompanying financial data is to provide
        aid
        in understanding and evaluating the financial condition and results of
        operations of the Corporation for the years ended December 31, 2005, 2004
        and
        2003. This information should be read in conjunction with the consolidated
        financial statements and related footnotes for the years under
        review.
 
 The
        Corporation is a one-bank holding company, with wholly-owned subsidiaries
        Commercial Bank & Trust of PA (the Bank), and Commercial National Insurance
        Services, Inc. (CNIS). In June 2004, CNIS sold all of its assets and is now
        inactive. See Note 2 to the consolidated financial statements for additional
        information.
 
 The
        Corporation reported net income of $3.4 million or $0.99 per share for the
        year
        ended 2005 compared to $621,000 or $0.18 per share for the year ended 2004.
        The
        Corporation’s return on average assets for 2005 and 2004 were 1.06% and 0.17%,
        respectively. Return on average equity for the same two periods were 7.74%
        and
        1.36%, respectively.
 
 In
        accordance with the strategic direction taken by the Board of Directors in
        January 2004, the Bank has concentrated efforts on core banking business
        of
        loans and deposits and trust and asset management services.
 
 In
        September 2004, the Corporation restructured its balance sheet through the
        prepayment of $55.0 million in borrowings from the Federal Home Loan Bank
        (FHLB). The Corporation incurred prepayment penalties in conjunction with
        its
        prepayment of the borrowings, which resulted in a one-time charge of
        approximately $4.4 million. Funding from cash equivalents and securities
        were
        utilized to pay the advances and the penalties. This action caused earnings
        to
        be materially reduced for the year 2004.
 
 At
        year-end 2004, the Corporation’s wholly owned trust company subsidiary,
        Highview Trust Company, merged into a department of the Bank. With
        this
        merger, the Bank adopted a new name, Commercial Bank & Trust of PA, to
        reflect the Corporation’s primary lines of business.
 
 The
        Corporation’s largest segment of operating results is dependent upon net
        interest income. Net interest income is calculated by what is earned on
        interest-earning assets less interest paid on interest-bearing liabilities.
        For
        the years ended 2005 and 2004, net interest income was $11.8 million and
        $12.3
        million, respectively **.** The
        related tax-equivalent net interest margin for these two years was 4.19%
        and
        3.82%, respectively **.** The
        increase in the margin is mostly due to the decrease in cost of interest
        earning
        liabilities. Other factors that can affect the Corporation’s operating results
        are activity in the loan loss provision and components of non-interest income
        and non-interest expense.
 
 The
        business strategy for 2006 is to continue asset growth through traditional
        loans
        and deposits supplemented by trust products offered to customers in its
        marketplace. Management anticipates continued pressure on net interest income
        during 2006. Loans and deposits will continue to be competitively priced
        by the
        Corporation with the intention of acquiring profitable market share. Operating
        expenses will continue to be scrutinized for the purpose of offsetting a
        potential decline in net interest income.
 
 **Financial
        Condition**
 Total
        assets of the Corporation were $322.4 million on December 31, 2005 compared
        to
        $320.4 million on December 31, 2004. Increases in Loans and Federal funds
        sold
        were offset by a decrease in Investments. The increase in Total Liabilities
        was
        mostly attributed to an increase in Total Deposits, this increase was partially
        offset by the payoff of Short Term borrowings.
 
 The
        loan
        portfolio is comprised mostly of residential and commercial real-estate secured
        loans. These loans consist of residential mortgages, commercial mortgages
        and
        home equity term and lines of credit. Additionally, the loan portfolio includes
        commercial, tax-free and other consumer loans.
 
 The
        total
        loan portfolio increased $14.8 million in 2005 over the total of $192.3 million
        at the end of 2004. Increases in commercial loans of $2.3 million, commercial
        real-estate loans of $5.2 million, consumer real estate loans of $7.5 million
        and consumer installment loans of $2.1 million were offset by a decrease
        in
        municipal loans of $2.4 million. The commercial and consumer loan market
        continues to be very competitive in our market area.
  Total
        investment securities decreased $33.3 million during 2005. This decrease
        is due
        mainly from the repayments on Mortgage Backed Securities, with the bank making
        no significant purchases of investments in 2005. All of the Corporation’s
        securities are held as available for sale. These securities consist of
        mortgage-backed securities, tax-free municipal bonds and U.S. government
        agency
        securities. The Bank also owns restricted Federal Home Loan Bank stock.
        Depending upon market fluctuations or other circumstances that may arise,
        such
        as changes in prepayment rates, the Corporation may sell securities for
        asset/liability management and liquidity purposes.
 
 At
        December 31, 2005, total deposits increased $11.2 million from December 31,
        2004
        to $277.0 million. This increase is due to an increase in non-interest bearing
        deposits, a decrease in savings and money market accounts and an increase
        in
        certificate of deposits.
 Total
        short-term borrowings decreased $7.9 million to $ - 0 - in 2005. These
        borrowings were reduced by monthly cashflows from securities and
        loans.
 
 Shareholders’
        equity was $43.7 million on December 31, 2005 compared to $44.7 million on
        December 31, 2004, a decrease of $1.0 million. The change in shareholders’
        equity consists of net income of $3.4 million being offset by unrealized
        losses
        on securities of $1.5 million and dividends declared of $2.9 million. Book
        value
        per common share at year-end 2005 decreased by 2.2% to $12.79 from $13.08
        at
        year-end 2004.
 
 **Share
        Repurchase**
 
 On
        March
        24, 2006, the Corporation repurchased 362,113 shares of its common stock
        held by
        certain of its shareholders. The repurchased shares represented approximately
        10.6% of the total shares then outstanding. The aggregate purchase price
        for the
        stock is approximately $6.7 million, which is $18.50 per share. All repurchased
        shares will be held as treasury shares.
 
 The
        repurchase of these shares was approved by the Board of Directors based,
        in
        part, upon receiving an opinion from the Corporation's financial advisor,
        SunTrust Robinson Humphrey that the purchase price was fair to the Corporation.
        The Corporation expects the transaction to be accretive to earnings per share
        in
        2006.
 
 A
        more
        complete description of the transaction can be found in the Corporation's
        8-K
        filed with the Commission March 27, 2006.
  
  
 **Results
        of Operations**
 
 Net
        income increased $2.8 million, or 444%, to $3.4 million for the year ended
        December 31, 2005 from $621,000 for the year ended December 31, 2004. The
        increase was primarily due to a $4.4 million charge relating to the prepayment
        of the Corporation’s long-term FHLB borrowings in 2004. Also included in
        operating income is a credit of $365,000 in the provision for loan losses.
        The
        credit is due to the combination of a partial recovery received in 2005 for
        a
        commercial loan charged off in a previous year and the bank received a pay-down
        on a classified loan, lowering the allowance requirements.
 
 Net
        income decreased $2.9 million, or 83%, to $621,000 for the year ended December
        31, 2004 from $3.6 million for the year ended December 31, 2003. The
        decrease was primarily due to a $4.4 million charge relating to the prepayment
        of the Corporation’s long-term FHLB borrowings in the principal amount of $55.0
        million. Included in operating income is a gain of $1.2 million on the sale
        of
        investment securities. These securities were sold to offset a $233,000 executive
        severance expense, to alleviate the Corporation’s alternative minimum tax
        position and to reduce, market and interest rate risks. Also included in
        operating income is a credit of $436,000 in the loan loss provision due to
        specified problem loans that paid off during 2004. These loans had allocated
        loss allowances while they were included in the Corporation’s balance sheet.
        Since they are no longer carried on the balance sheet, the Corporation deemed
        it
        unnecessary to carry this allocated portion of the allowance
 
 **Net
        Interest Income**
 
 In
        2005,
        interest income was $16.2 million compared to $18.2 million in 2004, a decrease
        of $2.0 million. A $2.6 million decline in investment income and other interest
        income was partially offset by an increase in loan interest. The Bank reduced
        securities balances and related securities income as a result of a strategic
        decision to reduce FHLB borrowings in 2004 and not replace mortgage-backed
        securities as they amortize and prepay. Also contributing to the decline
        in
        total interest income were market conditions, specifically the fact that
        the
        yield on the 10-year Treasury note did not move in unison with short-term
        rates,
        which led to a flattening yield curve.
 
 For
        2005,
        total deposits increased by $11.2 million to $277.0 million from $265.8 million
        at the end of 2004. This increase in deposits along with higher certificate
        of
        deposit rates increased overall deposit cost by $698,000, however the FHLB
        borrowing costs were $2.3 million lower in 2005, resulting in a decrease
        in
        interest expense from $6.0 million in 2004 to $4.4 million expense in
        2005.
 
 As
        a
        result of these factors, net interest income in 2005 was $11.8 million compared
        to $12.3 million in 2004, a decrease of $500,000.
  In
        2004,
        interest income was $18.2 million compared to $19.8 million in 2003, a decrease
        of $1.6 million. A $972,000 decline in investment income was the primary
        reason
        for the overall drop in interest income. This was attributed to lower security
        holdings in 2004 as proceeds from sales of securities were used to repay
        long-term FHLB borrowings. Also contributing to the decline in interest income
        was the Corporation’s inability to increase loan interest even though total
        loans grew by more than $4.9 million in 2004. The reason for this decline
        is due
        to lower rates on new loans.
 
  
  The
        following table displays the Corporation’s average balance sheet, annual
        interest earned and paid, and annual yields on interest earning assets and
        interest-bearing liabilities for 2005, 2004 and 2003.
 
 COMMERCIAL
                  NATIONAL FINANCIAL CORPORATIONFinancial
                  ComparisonsConsolidated
                  Average Balance Sheet, Interest Income/Expense and
                  Rates**(Dollars
                  in Thousands)**
 
 2005
              2004
              2003Average
              Interest
              Yield
                  or
              Average
              Interest
              Yield
                  or
              Average
              Interest
              Yield
                  orBalance
              Income/
              Rate(a)
              Balance
              Income/
              Rate(a)
              Balance
              Income/
              Rate
                  (a)Expense
              
              
              Expense
              
              
              ExpenseInterest-earning
                  assetsLoans
                  net of unearned
                income
                  (b) (c)
              $199,505
              $11,565
              5.80%
              $187,918
              $11,086
              5.90%
              $183,628
              $11,674
              6.36%Taxable
                  securities
              77,631
              4,441
              5.72
              126,135
              6,914
              5.48
              108,162
              6,835
              6.32Non-taxable
                  securities
              3,874
              208
              5.36
              10,502
              598
              5.70
              34,611
              2,121
              6.13Interest-bearing
                  deposits with banks
              59
              2
              2.71
              4,998
              63
              1.26
              2,172
              41
              1.89Federal
                  funds sold
              8,417
              301
              3.58
              5,210
              61
              1.17
              12,330
              129
              1.05Total
                  earning assets
              289,486
              16,517
              5.71
              334,763
              18,722
              5.59
              340,903
              20,800
              6.10Non-interest-earning
                  assetsCash
              8,913
              
              
              8,596
              
              
              7,879Allowance
                  for loan losses
              (1,733)
              
              
              (2,165)
              
              
              (2,685)Other
                  assets
              22,627
              
              
              23,881
              
              
              27,399Total
                  non-interest-earning assets
              29,807
              
              
              31,312
              
              
              32,593Total
                  assets
              $319,293
              
              
              $365,075
              
              
              $373,496Liabilities
                  and Shareholders’ EquityInterest-bearing
                  depositsNOW
                  accounts
              $
                  22,147
              34
              0.15
              $
                  23,881
              36
              0.15
              $
                  24,151
              35
              0.14Money
                  Market accounts
              30,485
              239
              0.78
              39,835
              253
              0.64
              43,948
              327
              0.74Savings
                  deposits
              48,408
              284
              0.59
              52,695
              317
              0.60
              56,200
              412
              0.73Time
                  deposits
              107,746
              3,786
              3.51
              92,210
              3,056
              3.31
              86,059
              2,789
              3.24Short-term
                  borrowings
              1,501
              39
              2.60
              10,505
              161
              1.52
              3,977
              49
              1.23Long-term
                  borrowings
              -
              -
              -
              40,123
              2,128
              5.29
              55,000
              2,913
              5.29Total
                  interest-bearing liabilities
              210,287
              4,382
              2.08
              259,249
              5,951
              2.29
              269,335
              6,525
              2.42Non-interest-bearing
                  deposits
              63,250
              
              
              57,904
              
              
              49,583Other
                  liabilities
              1,522
              
              
              2,271
              
              
              3,656Shareholders'
                  equity
              44,234
              
              
              45,651
              
              
              50,922Total
                  non-interest-bearingFunding
                  sources
              109,006
              
              
              105,826
              
              
              104,161Total
                  liabilities andshareholders'
                  equity
              $319,293
              
              
              $365,075
              
              
              $373,496Net
                  interest income and netYield
                  on interest earning assets
              
              $12,135
              4.19%
              
              $12,771
              3.82%
              
              $14,275
              4.19%
 (a)
              Yields
                  on interest earning assets have been computed on a tax-equivalent
                  basis
                  using the 34% federal income tax statutory
                  rate.
 (b)
              Income
                  on non-accrual loans is accounted for on the cash basis, and the
                  loan
                  balances are included in interest earning
                  assets.
 (c)
              Loan
                  income includes net loan
                  fees/costs.
  
  The
        following table illustrates the impact a   The
        following table illustrates the impact and interaction of rate and volume
        changes for the years under review. Yields on earning assets have been computed
        on a tax-equivalent basis using 34% tax rate.
 Analysis
                  of Year-to-Year Changes in Net Interest Income**(Dollars
                  in Thousands)**
 2005
                  Change from 2004
              2004
                  Change from 2003Total
              Change
                  Due
              Change
                  Due
              Total
              Change
                  Due
              Change
                  DueChange
              To
                  Volume
              To
                  Rate
              Change
              To
                  Volume
              To
                  RateInterest-earning
                  assetsLoans
                  net of unearned income
              $
                  479
              $
                  646
              $
                  (167)
              $
                  (588)
              $
                  269
              $
                  (857)SecuritiesTaxable
              (2,473)
              (2,659)
              186
              79
              1,136
              (1,057)Non-taxable
              (390)
              (376)
              (14)
              (1,523)
              (1,478)
              (45)Interest-bearing
                  deposits with banks
              (61)
              (62)
              1
              22
              53
              (31)Federal
                  funds sold
              240
              38
              202
              (68)
              (74)
              6Total
                  interest income
              (2,205)
              (2,413)
              208
              (2,078)
              (94)
              (1,984)Interest-bearing
                  liabilitiesDeposits
              681
              4
              677
              99
              (29)
              128Short-term
                  borrowings
              (122)
              (139)
              17
              112
              80
              32Long-term
                  borrowings
              (2,128)
              (2,128)
              0
              (785)
              (788)
              3Total
                  interest expense
              (1,569)
              (2,263)
              694
              (574)
              (737)
              163Net
                  interest income
              $
                  (636)
              $
                  (150)
              $
                  (486)
              $
                  (1,504)
              $
                  643
              $
                  (2,147)
 
 **Other
        Operating Income and Expense**
 
 Total
        other operating income decreased $1.6 million to $3.0 million for 2005, compared
        to $4.6 million in 2004. The decrease is primarily two items; first, no security
        gains were taken in 2005 compared to the $1.2 million gain in 2004, the second
        being due to the previously mentioned sale of insurance agency, there were
        no
        commissions and fees from insurance sales in 2005 compared to $342,000 in
        2004.
 
 Total
        other operating income for 2004 was $4.6 million, an increase of $700,000
        from
        $3.9 million in 2003. The reason for this increase was the previously mentioned
        gains on the sale of investment securities. Excluding this item, non-interest
        income would have decreased $500,000. Negatively affecting other income was
        a
        decrease in commission income from insurance sales due to the sale of Gooder,
        a
        loss on the sale Gooder assets, a change in deposit fee pricing and the
        introduction of free business checking.
 
 Non-interest
        expense for 2005 decreased $6.4 million to $10.5 million, compared to $16.9
        million in 2004. The majority of this decrease in expenses is the $4.4 million
        prepayment penalty paid to FHLB, which inflated 2004 non-interest expense.
        Also,
        payroll costs were $1.0 million lower in 2005 compared to 2004. This reduction
        is the result of less staffing due to the sale of the Gooder Agency and staffing
        reductions at the Bank. In addition, legal and professional expenses decreased
        by $110,000 in 2005 compared to 2004. In 2004, legal costs were higher due
        to
        the merger of Highview Trust back into the Bank and the sale of the Gooder
        Agency.
 Other
        expenses were lower in 2005 compared to 2004, due to the sale of Gooder Agency
        and general cost controls within the Bank.
 
 
 Non-interest
        expense for 2004 reached $16.9 million, an increase of $4.1 million or 32%
        from
        non-interest expense for 2003. $4.4 million of this increase is due to
        prepayment charges relating to the repayment of the Corporation’s long-term FHLB
        borrowings. Personnel costs rose by $162,000 from 2004 to 2003. This increase
        was attributed to higher insurance costs as an increase in salaries was offset
        by a decrease in other benefits. A $62,000 increase in furniture and equipment
        expense was due to depreciation expense on equipment which was purchased
        in the
        fourth quarter of 2003. Legal and professional expenses were lower by $71,000.
        Reflected in 2003 operating expenses is a $375,000 impairment charge related
        to
        the write down of goodwill on the Corporation’s insurance agency
        subsidiary.
 
 Income
        tax expense/(benefit) was $1,217,000 in 2005, ($209,000) in 2004 and $837,000
        in
        2003. The income tax benefit for 2004 was due to higher tax-free income in
        relation to lower pre-tax income in 2004. Due to this, the Corporation was
        in an
        alternative minimum tax position and has exited this position as of year-end
        2005.
 
 
 
 **Liquidity
        and Capital Resources**
 
 Liquidity
        measurements evaluate the Corporation’s ability to meet the cash-flow needs of
        its depositors and borrowers. 1  The most
        desirable source of liquidity is deposit growth. Additional liquidity is
        provided by the maturity of investments in loans and securities and the
        principal and interest received from those earning assets. Another source
        of
        liquidity is represented by the Corporation’s ability to sell both loans and
        available-for-sale securities. The Bank is a member of the FHLB system. The
        FHLB
        provides an additional source for liquidity for long- and short-term funding.
        Additional sources of funding from financial institutions have been established
        for short-term funding needs.
 
 As
        of
        December 31, 2005, the Corporation had available funding of approximately
        $185.3
        million at the FHLB with an additional $30.0 million of short-term funding
        available through federal funds lines of credit.
 
 The
        Corporation has outstanding commitments to fund loans that are made in the
        normal course of business. At December 31, 2005, the commitments stood at
        $45.5
        million. Since many of the commitments are expected to expire without being
        drawn upon, the total commitment amounts do not necessarily represent future
        cash requirements.
 
 Cash
        flows from operating activities in 2005 increased by $6.8 million to $4.6
        million, from ($2.2) million in 2004.
 The
        change is due principally to the increase in net income and the 2004 securities
        gains of $ 1.2 million.
 
 Cash
        flows provided by investing activities totaled $129,000 in 2005, compared
        to
        cash provided by investing activities in 2004 of $62.1 million. Cash used
        for
        loan and federal funds growth in 2005 offset net inflows from reduction of
        outstanding securities.
 
 Cash
        used
        from financing activities totaled $340,000 in 2005. Cash provided by increase
        in
        deposits was mostly offset by a decrease in short-term borrowings and dividends
        paid.
 
 **Aggregate
        Contractual Obligations**
 
 The
        following table presents contractual obligation payments due by specific
        time
        periods:
 
 (Dollars
                  in thousands)<
                  1 year
              1
                  -
                  3 years
              >
                  3 - 5 years
              >
                  5 years
              TotalCapital
                  lease obligations
              $22
              $
                  40
              
              
              $
                  62Operating
                  lease obligations
              $
                  120
              $145
              $
                  92
              $
                  164
              $
                  521Total
              $142
              $185
              $92
              $164
              $583
 
 1  On
        March
        24, 2006, the Corporation used the proceeds of the sale of certain Federal
        Funds
        investments to complete the Share Repurchase described on Page 6. Such sale
        reduced liquid assets on the balance sheet of the Corporation by $6.7 million.
        The Corporation has concluded that such reduction in liquidity will not have
        a
        material adverse effect on its financial condition or
        operations.
  
   Time
        deposits of $100,000 or more at December 31, 2005 are as follows:
 
 (inAmount
              Percent(in
                  thousands)Remaining
                  maturity:3
                  months or less
              $
                  3,395
              13%Over
                  3 through 6 months
              6,261
              24Over
                  6 months through 12 months
              13,478
              51Over
                  12 months
              3,226
              12Total
              $
                  26,360
              100%
 
 The
        following table shows final loan maturities excluding consumer installment,
        mortgage and nonaccrual loans and before unearned income at December 31,
        2005:
        (in thousands)
 
 Within
              One-Five
              AfterOne
                  Year
              Years
              Five
                  Years
              TotalCommercial
                  and industrial
              $
                  4,471
              
              $
                  12,899
              $
                  866
              $
                  18,236Real
                  estate-construction
              910
              
              -
              -
              910Other
              1,033
              
              738
              6,843
              8,614Totals
              $
                  6,414
              
              $
                  13,637
              $
                  7,709
              $
                  27,760Loans
                  at fixed interest rates
              
              
              $
                  8,012
              $
                  7,709Loans
                  at variable interest rates
              
              
              5,625
              -$
                  13,637
              $
                  7,709
 
 
 
 
 The
        following tables present a five-year summary of loan classifications and
        the
        maturity distribution of securities at December 31 of each such
        year:
 
 Loans
                  by Classification at December 31,(in
                  thousands)2005
              
              2004
              
              2003
              
              2002
              
              2001Commercial
              $18,275
              9%
              $15,933
              8%
              $14,802
              8%
              $12,725
              7%
              $17,251
              9%Real
                  estate - commercial
              60,794
              29
              55,555
              29
              51,006
              27
              54,618
              32
              71,699
              35Real
                  estate - construction
              910
              -
              258
              -
              1,108
              1
              976
              1
              1,629
              1Real
                  estate - other
              115,294
              56
              107,819
              56
              106,121
              57
              86,048
              51
              95,796
              47Consumer
                  - installment
              2,929
              1
              886
              1
              1,405
              1
              1,922
              1
              2,486
              1Municipal
              7,596
              4
              10,002
              5
              10,622
              5
              10,078
              6
              10,990
              6Other
              1,019
              1
              1,579
              1
              2,179
              1
              2,635
              2
              2,555
              1Total
                  loans
              206,817
              100%
              192,032
              100%
              187,243
              100%
              169,002
              100%
              202,406
              100%Net
                  unamortizedcosts/(fees)
              222
              
              223
              
              139
              
              28
              
              (71)Total
                  loans, net ofcosts/(fees)
              $207,039
              
              $192,255
              
              $187,382
              
              $169,030
              
              $202,335
 
 Maturity
                  Distribution of Securities at December 31, 2005(in
                  thousands)U.S.
                  Treasury
              State
                  &
              Total
              Weighted&
                  other U.S. Govt.
              Political
              Amortized
              AverageAgencies
                  & Corp(2)
              Subdivisions
                  (1)
              Cost
              YieldWithin
                  1 year
              $
                  2,025
              $
                  500
              $
                  2,525
              2.46After
                  1 but within 5 years
              -
              601
              601
              5.38After
                  5 but within 10 years
              -
              1,833
              1,833
              6.48After
                  10 years
              59,709
              515
              60,224
              5.89$
                  61,734
              $
                  3,449
              $65,183
              5.77%
 (1)
        Yield
        on tax-exempt obligations has been computed on a fully
 tax-equivalent
        basis (using statutory federal income tax rate of 34%)
 (2)
        Includes mortgage-backed securities
 Fair
                  Values of Securities at December 31,(in
                  thousands)2005
              2004
              2003Obligations
                  of U.S.Treasury
                  & other U.S.Govt.
                  Agencies & Corp.
              $
                  63,779
              $
                  96,365
              $
                  149,539Obligations
                  of State &Political
                  Subdivisions
              2,338
              3,090
              14,801$
                  66,117
              $
                  99,455
              $164,340
 
 Included
        in U.S. Treasury & other U.S. Government Agencies are mortgage-backed
        securities. These securities carry an amortized cost of $59.7 million and
        mature
        based upon their estimated contractual maturities. Expected maturities will
        differ from contractual maturities because borrowers may have the right to
        prepay with or without prepayment penalties.
 
  **Interest
        Sensitivity and Market Risk**
 
 The
        Corporation’s market risk is primarily interest rate risk. Interest rate risk
        arises due to timing differences between interest sensitive assets and
        liabilities. Management monitors its interest sensitivity position with the
        intent of structuring the balance sheet so that movements of interest rates
        on
        assets and liabilities produce a relatively constant net interest margin.
        The
        Corporation’s interest rate risk management is the responsibility of the
        Asset/Liability Management Committee, which reports to the Board of Directors.
        This Committee establishes policies for monitoring and coordinating the
        Corporation’s sources, uses and pricing of funds.
 
 The
        following table lists the amounts and ratio of assets and liabilities subject
        to
        change as of December 31, 2005.
 
 
 Interest
                  Sensitivity Analysis (In Thousands)0-30
                  Days
              
              31-90
                  Days
              
              91-180
                  Days
              
              181-365
                  Days
              
              1-5
                  Years
              
              Over
                  5 YearsInterest-earning
                  assets:Securities
              $
              870
              $
              1,311
              $
              3,116
              $
              6,097
              $
              32,837
              $
              20,952Federal
                  funds sold &other
                  deposits with banks
              
              17,071
              
              -
              
              -
              
              -
              
              -
              
              -Loans
              
              21,129
              
              2,901
              
              5,503
              
              12,446
              
              97,733
              
              65,875Total
                  interest-sensitiveAssets
              
              39,070
              
              4,212
              
              8,619
              
              18,543
              
              130,569
              
              86,827Interest-bearing
                  liabilities:Certificates
                  of deposit
              
              4,354
              
              8,576
              
              16,116
              
              12,511
              
              70,121
              
              404Other
                  interest-bearing deposits
              
              -
              
              3,717
              
              3,717
              
              5,158
              
              36,204
              
              47,105Total
                  interest-sensitiveLiabilities
              
              4,354
              
              12,293
              
              19,833
              
              17,669
              
              106,325
              
              47,509Interest
                  sensitivity gap
              $
              34,716
              $
              (8,081)
              $
              (11,214)
              $
              874
              $
              24,244
              $
              39,318Cumulative
                  gap
              $
              34,716
              $
              26,635
              $
              15,421
              $
              16,295
              $
              40,539
              $
              79,857Ratio
                  of cumulative gap toearning
                  assets
              
              11.97%
              
              9.19%
              
              5.32%
              
              5.62%
              
              13.98%
              
              27.56%
 
 Loan
        and
        security assumptions are based upon contractual maturity and prepayment
        estimates. Included in other interest bearing deposits are savings, money
        market
        and interest-bearing transaction accounts. These accounts are subject to
        immediate withdrawal. However, based upon historical performance, management
        considers a certain portion of the accounts to be stable core
        deposits.
 
 Although
        useful, there are certain deficiencies in this static gap model. Assets and
        liabilities are subject to competitive pressures throughout the Corporation’s
        market area. Additionally, the timing and degree of repricing on assets and
        liabilities may vary significantly as interest rates change.
 
 The
        Corporation also monitors interest rate risk through computer simulations
        that
        project the impact of changing interest rates on earnings. This process projects
        a baseline net interest income (assuming no changes in interest rate levels)
        and
        estimates changes to that baseline net interest income resulting from changes
        in
        interest rate levels. The Corporation utilizes the results of this model
        in
        evaluating its interest rate risk. This model incorporates a number of
        additional factors. These factors include: (1) the expected exercise of call
        features on various assets and liabilities; (2) the expected rates at which
        various rate sensitive assets and liabilities will reprice; (3) the expected
        relative movements in different interest rate indexes that are used as the
        basis
        for pricing or repricing various assets and liabilities; (4) expected changes
        in
        administered rates on interest-bearing transaction, savings, money market
        and
        time deposit accounts and the expected impact of competition on the pricing
        or
        repricing of such accounts; and (5) other factors. Inclusion of these factors
        in
        the model is intended to more accurately project the Corporation’s changes in
        net interest income resulting from an immediate and sustained parallel shift
        in
        interest rates of up 100 basis points (bps), up 200 bps, down 100 bps and
        down
        200 bps. While the Corporation believes this model provides a useful projection
        of its interest rate risk, the model includes a number of assumptions and
        predictions that are subject to continual refinement. These assumptions and
        predictions include inputs to compute baseline net interest income, growth
        rates, competition and a variety of other factors that are difficult to
        accurately predict.
 
 The
        Corporation has established the following guidelines as acceptable ranges
        for
        interest rate risk:
 
 During
        a
        +/- 200 basis point parallel shift in interest rates, net interest income
        may
        not change by more than 20% for a twelve month period.
 
 During
        a
        +/- 200 basis point change in interest rates, balance sheet impact on economic
        value of capital may not change by more than 20% for a twelve month
        period.
 
 The
        following table presents the simulation model's projected impact of an immediate
        and sustained parallel shift in interest rates on the projected baseline
        net
        interest income for a twelve-month period commencing January 1,
        2006.
 
 **%
                  Change in projected**
              **%
                  Change in projected****Change
                  in interest**
              **Baseline**
              **economic****rates**
              **net
                  interest income**
              **value
                  of capital**+200
                  basis points
              (3.9%)
              (10.3%)+100
                  basis points
              (1.8%)
              (4.3%)-100
                  basis points
              .3%
              .1%-200
                  basis points
              (3.7%)
              (2.5%)
 
 In
        the
        event of a shift in interest rates, management may take certain actions intended
        to mitigate the negative impact to net interest income or to maximize the
        positive impact to net interest income. These actions may include, but are
        not
        limited to, restructuring of earning assets and interest-bearing liabilities,
        seeking alternative funding sources or investment opportunities and modifying
        the pricing or terms of loans and deposits.
 
 **Allowance
        for Loan Losses and Credit Review**
 
 Maintaining
        a high quality loan portfolio is of great importance to the Corporation.
        The
        Corporation manages the risk characteristics of the loan portfolio through
        the
        use of prudent lending policies and procedures and monitors risk through
        a
        periodic review process provided by internal auditors, regulatory authorities
        and internal loan review procedures. These reviews include an analysis of
        credit
        quality, diversification of industry, compliance with policies and procedures,
        and current economic conditions. In addition to these reviews, the Corporation
        annually has commercial loan reviews performed by a third party specializing
        in
        this area.
 
 The
        Corporation’s credit culture fosters and actively supports the extension of
        credit on sound, fundamental lending policies. Each credit is to be logical,
        legal, constructive and acceptable within policy guidelines.
 
 The
        allowance for loan losses is a valuation reserve that is intended to account
        for
        credit losses which may be expected in the Corporation’s loan portfolio as a
        result of the credit risk involved in the normal granting of credit. Adequate
        management of the allowance is an integral part of the credit risk management
        process. The Corporation will maintain an adequate allowance in anticipation
        of
        losses reflected as of the evaluation date. Management is cognizant of the
        subjective nature of decisions regarding loan portfolio factors and the
        variability over time of internal and external factors affecting portfolio
        quality, and realizes that an effective asset review system is essential
        to
        establishing the basis for an adequate allowance. To improve the accuracy
        of
        determining the allowance, management will continuously monitor all factors
        and
        current conditions that may affect loss recognition.
 
 The
        amount of the provision/(credit) for loan losses was ($365,000) in 2005,
        ($436,000) in 2004 and $39,000 in 2003. The credit for loan losses in 2005
        is
        due to the combination of a $285,000 recovery received for a commercial loan
        charged off in a previous year and the bank received a pay-down on a classified
        loan, lowering the allowance requirement. The credit in 2004 was from the
        allocations of $3.2 million in classified loans that paid off in the first
        quarter. For each of the same years, the net charge-offs(recoveries) against
        the
        allowance for loan losses was ($146,000), $171,000 and $284,000, respectively.
        The allowance for loan losses is maintained at a level that represents
        management’s best estimates of losses in the loan portfolio at the balance sheet
        date. However, there can be no assurance that the allowance for loan losses
        will
        be adequate to cover losses which may be realized in the future, or that
        additional provisions for losses on loans will not be required.
 
 
 
 The
        table
        below provides an analysis of the allowance for loan losses for each of the
        five
        years ended December 31:
 
 Years
                  Ended December 31,
                (Dollars
                  in thousands)2005
              2004
              2003
              2002
              2001Loans
                  outstanding at beginning of year,net
                  of unearned income
              $192,255
              $187,382
              $169,030
              $202,335
              $207,957Average
                  loans outstanding
              $199,505
              $187,918
              $183,628
              $187,428
              $206,681Allowance
                  for loan losses:Balance,
                  beginning of year
              $
                  1,855
              $
                  2,462
              $
                  2,707
              $
                  2,814
              $
                  2,737Loans
                  charged off:Commercial
                  and tax free
              105
              251
              29
              180
              90Consumer
              30
              41
              32
              31
              55Real
                  estate
              20
              69
              272
              238
              355Total
                  loans charged off
              155
              361
              333
              449
              500Recoveries:Commercial
                  and tax free
              296
              136
              21
              17
              3Consumer
              5
              10
              13
              24
              29Real
                  estate
              0
              44
              15
              3
              5Total
                  recoveries
              301
              190
              49
              44
              37Net
                  loans charged off/(recovered)
              (146)
              171
              284
              405
              463Provision
                  charged/(credited) to expense
              (365)
              (436)
              39
              298
              540Balance,
                  end of year
              $
                  1,636
              $
                  1,855
              $
                  2,462
              $
                  2,707
              $
                  2,814Ratios:Net
                  (recoveries)/charge-offs as apercentage
                  of average loansoutstanding
              (.07)%
              .09%
              .15%
              .22%
              .22%Allowance
                  for loan lossesas
                  a percentage of average loansoutstanding
              .82%
              .99%
              1.34%
              1.44%
              1.36%
 Management’s
        review and evaluation of loan loss experience and loan loss potential on
        outstanding loans occurs on a quarterly basis and includes a review of such
        factors as charge-off history, delinquent loans, loan collateral value, the
        borrower’s financial condition, current economic conditions and the current
        requirements of the appropriate regulatory agencies. As a result of this
        on-going study, management believes that the allowance amount shown for December
        31, 2005 is adequate to offset the losses which may exist as a result of
        under
        collateralization or uncollectibility.
  
  The
        following table summarizes the allocation of the allowance for loan losses
        for
        the past five years.
 
 2005
              2004
              2003
              2002
              2001(Dollars
                  in thousands)Percent
              
              Percent
              
              Percent
              
              Percent
              
              PercentAmount
              Of
                  Loan
              Amount
              Of
                  Loan
              Amount
              Of
                  Loan
              Amount
              Of
                  Loan
              Amount
              Of
                  LoanType
              
              Type
              
              Type
              
              Type
              
              TypeCommercial
              $1,540
              47
              $1,771
              42
              $2,371
              40
              $2,617
              45
              $2,564
              50Residential
              63
              52
              58
              56
              69
              58
              63
              52
              63
              48Consumer
              33
              1
              26
              2
              22
              2
              27
              3
              31
              2Unallocated
              -
              
              -
              
              -
              
              -
              
              156Total
              $1,636
              
              $1,855
              
              $2,462
              
              $2,707
              
              $2,814
 
 The
        following table details, for each of the most recent five years, the year
        end
        loan amounts which were accounted for on a non-accrual basis or were past
        due 90
        days or more:
 
 Dec.
                  31, 2005Loans
                  on non-accrual basis
              $
                  1,308Loans
                  past due 90 days or more
              2Renegotiated
                  loans
              2,860Total
              $
                  4,170Dec.
                  31, 2004Loans
                  on non-accrual basis
              $
                  1,667Loans
                  past due 90 days or more
              12Renegotiated
                  loans
              3,083Total
              $
                  4,762Dec.
                  31, 2003Loans
                  on non-accrual basis
              $
                  2,331Loans
                  past due 90 days or more
              5Renegotiated
                  loans
              -Total
              $
                  2,336Dec.
                  31, 2002Loans
                  on non-accrual basis
              $
                  2,679Loans
                  past due 90 days or more
              3Renegotiated
                  loans
              -Total
              $
                  2,682Dec.
                  31, 2001Loans
                  on non-accrual basis
              $
                  2,492Loans
                  past due 90 days or more
              123Renegotiated
                  loans
              60Total
              $
                  2,675
 
 Loans
        that were past due 90 days or more, or were on non-accrual represented .63%
        of
        total loans on December 31, 2005, which was down from .87% on December 31,
        2004
        and 1.25% on December 31, 2003. The Corporation’s policy is to place a loan on
        non-accrual basis when it becomes 90 days past due provided that the loan
        is
        well collateralized and evidence indicates a reasonable likelihood for
        collection. Also, a loan is placed on non-accrual in the event of a material
        decline in business activity that may hinder the borrower’s ability to repay the
        loan.
 
 As
        of
        December 31, 2005 **,** $1.0
        million of non-accrual loans were paying principal or principal and interest
        with payments recognized on a cash basis. Renegotiated loans decreased to
        $2.9
        million. Of this amount, $2.5 million relates to a single borrower that
        requested a modification of interest and a period of interest only payments.
        The
        request was due to the seasonality of the customer’s business. At
        present, the Corporation has no knowledge of other outstanding loans that
        present a serious doubt in regard to the borrower's ability to comply with
        the
        current loan repayment terms. As of December 31, 2005 the Corporation had
        $740,000 in foreclosed real estate compared to $682,000 at the end of
        2004.
 In
        2005,
        the gross amount of interest that would have been recorded on non-accrual
        loans
        would have been $90,000. The actual interest reflected in income on these
        loans
        was $23,000.
 
 **Capital**
 
 The
        shareholders’ equity or the capital base represents the investment by the
        Corporation’s owners either initially or through retention of earnings (net
        after income tax less dividend payments). This investment acts as a safeguard
        against future uncertainties. The amount of capital which is deemed appropriate
        is dependent upon an assessment of the Corporation’s total assets, the quality
        of its loans and securities, its historical earnings record, its business
        prospects for the near and long term, the management and information systems
        in
        place and the general competence and abilities of the Corporation’s
        management.
 
 The
        Federal Reserve Board’s risk-based capital adequacy standards are designed
        principally as a measure of credit risk. These standards require that (1)
        at
        least 50% of total capital must be common and certain other “core” equity
        capital (“Tier I Capital”); (2) assets and off-balance sheet items must be
        weighted according to risk; (3) the total capital to risk-weighted asset
        ratio
        must be at least 8%; and (4) a minimum 4% leverage ratio of Tier I Capital
        to
        average total assets must be maintained.
 
 As
        of
        December 31, 2005, the Corporation had Tier I and total equity capital to
        risk
        adjusted asset ratios of 21.4% and 22.3%, respectively. In 2005 the leverage
        ratio was 13.3%. At December 31, 2004, the Corporation had Tier I and total
        equity capital to risk adjusted assets ratios of 22.7% and 23.7%, respectively.
        The leverage ratio was 13.0%.
 
 The
        table
        below presents the Corporation’s capital position at December 31,
        2005. 2
 (dollar
        amounts in thousands)
 
 **Percent****of
                  Adjusted****Amount**
              **Assets**Tier
                  I Capital
              $
                  42,410
              21.4%Tier
                  I Capital Requirement
              7,912
              4.0Total
                  Equity Capital
              $
                  44,046
              22.3%Risk-Based
                  Requirement
              15,825
              8.0Leverage
                  Capital
              $
                  42,410
              13.3%Leverage
                  Requirement
              12,757
              4.0
 
 
 **Inflation
        and Changing Prices**
 
 Inflation
        can be significant to a banking institution because of its implication for
        the
        interest rate environment and its influence on personnel expenses and the
        costs
        of supplies and materials needed for daily operations. However, such a large
        portion of the Corporation’s assets and liabilities are represented by monetary
        investments, inflationary impact tends to be dampened except for the differences
        caused by maturity variances. Management efforts to gauge and control these
        variances have been discussed earlier under rate sensitivity. Inflation can
        have
        a more direct impact on non-interest expenses. Expenses are closely monitored
        by
        management and consistent attention is given to controlling these cost areas
        in
        an attempt to limit their increase to manageable levels.
 
 Interest
        rate movements will continue to influence ongoing earnings levels. Even though
        the exact impact of these factors cannot be predicted, the Corporation believes
        that given its financial strength and stability, it will be able to meet
        these
        situations in a positive manner.
 
 2  The
        Corporation’s capital position was impacted by the March 24, 2006 Share
        Repurchase described on Page 6. The Corporation has concluded that, although
        the
        Share Repurchase has the effect of reducing capital, the Corporation and
        the
        Bank will remain in compliance with all capital adequacy requirements and
        the
        Share Repurchase will not have a material adverse effect on the Corporation’s or
        the Bank’s financial condition or operations.
  
  **Market
        Makers**
 
 The
        following firms have committed to make a market in the stock of Commercial
        National Financial Corporation. Inquiries concerning their services should
        be
        directed to:
 
 Ferris
                  Baker Watts Inc
              Knight
                  Equity Markets, LLP100
                  Light Street
              525
                  Washington BoulevardBaltimore,
                  MD 21202
              Jersey
                  City, NJ 07310800-638-7411
              201-222-9400F.J.
                  Morrisey & Co.
              Ryan,
                  Beck & Co.200
                  Barr Harbor Drive
              80
                  Main StreetWest
                  Conshohocken, PA 19428
              West
                  Orange, NJ 07052800-842-8928
              973-597-6020
 
 
 **Transfer
        Agent**
 
 Should
        you need assistance regarding changes in the registration of certificates
        or in
        reporting lost certificates please contact:
 
 Commercial
        National Financial Corporation
 Stock
        Transfer Department
 P.O.
        Box
        429
 Latrobe,
        PA 15650
 (724)537-9923
 (724)539-1137
        (fax)
 
 **Form
        10-K**
 
 **THE
        CORPORATION WILL PROVIDE WITHOUT CHARGE TO ANY SHAREHOLDER A COPY OF ITS
        2005
        ANNUAL REPORT ON FORM 10-K AS REQUIRED TO BE FILED WITH THE SECURITIES AND
        EXCHANGE COMMISSION. REQUESTS SHOULD BE MADE IN WRITING
        TO:**
 
 Commercial
        National Financial Corporation
 Attn:
        Wendy S. Schmucker, Secretary
 P.O.
        Box
        429
 Latrobe,
        PA 15650
 
 
 Report
            of
            Independent Registered Public Accounting Firm
  To
            the
            Board of Directors and Shareholders
  Commercial
            National Financial Corporation and Subsidiaries
  Latrobe,
            Pennsylvania
  We
            have
            audited the accompanying consolidated statements of financial condition
            of
            Commercial National Financial Corporation and its wholly-owned subsidiaries
            as
            of December 31, 2005 and 2004, and the related consolidated statements
            of
            income, shareholders’ equity and cash flows for each of the three years in the
            period ended December 31, 2005. These consolidated financial statements
            are
            the responsibility of the Corporation's management. Our responsibility
            is to
            express an opinion on these consolidated financial statements based on
            our
            audits.
  We
            conducted our audits in accordance with the standards of the Public Company
            Accounting Oversight Board (United States). Those standards require that
            we plan
            and perform the audits to obtain reasonable assurance about whether the
            financial statements are free of material misstatement. The Corporation
            is not
            required to have, nor were we engaged to perform, an audit of its internal
            control over financial reporting. Our audit included consideration of
            internal
            control over financial reporting as a basis for designing audit procedures
            that
            are appropriate in the circumstances, but not for the purpose of expressing
            an
            opinion on the effectiveness of the Corporation’s internal control over
            financial reporting. Accordingly, we express no such opinion. An audit
            also
            includes examining, on a test basis, evidence supporting the amounts
            and
            disclosures in the financial statements, assessing the accounting principles
            used and significant estimates made by management, as well as evaluating
            the
            overall financial statement presentation. We believe that our audits
            provide a
            reasonable basis for our opinion.
  In
            our
            opinion, the consolidated financial statements referred to above present
            fairly,
            in all material respects, the consolidated financial position of Commercial
            National Financial Corporation and its wholly-owned subsidiaries as of
            December 31, 2005 and 2004, and the results of their operations
            and their
            cash flows for each of the three years in the period ended December 31,
            2005 in conformity with accounting principles generally accepted in the
            United
            States of America.
  
 
 
 /s/
            BEARD
            MILLER COMPANY LLP
 
 
 Beard
            Miller Company LLP
 Pittsburgh,
            Pennsylvania
 January
            20, 2006
 
 
 
  **Consolidated
            Statements of Financial Condition**
 
  **December
                      31,****2005**
                  
                  **2004****(Dollars
                      in Thousands, Except per Share
                      Data)**
 **Assets**
  Cash
                      and due from banks
                  **$
                      12,760**
                  
                  $
                      7,685Interest
                      bearing deposits with banks
                  **121**
                  
                  101Cash
                      and Cash Equivalents
                  **12,881**
                  
                  7,786Federal
                      funds sold
                  **16,950**
                  
                  -Securities
                      available for sale
                  **66,117**
                  
                  99,455Restricted
                      investments in bank stock
                  **1,013**
                  
                  1,806Loans
                      receivable, net of allowance for loan losses of $1,636 in 2005
                      and $1,855
                      in 2004
                  **205,403**
                  
                  190,400Premises
                      and equipment
                  **4,301**
                  
                  4,644Accrued
                      interest receivable
                  **862**
                  
                  968Investment
                      in life insurance
                  **12,940**
                  
                  12,443Other
                      assets
                  **1,914**
                  
                  2,870
 
 **Total
                      Assets**
                  **$322,381**
                  
                  $320,372
 
 **Liabilities
            and Shareholders’ Equity**
  **Liabilities**
  Deposits:Non-interest
                      bearing
                  **$
                      69,025**
                  
                  $
                      62,284Interest
                      bearing
                  **207,984**
                  
                  203,534Total
                      Deposits
                  **277,009**
                  
                  265,818Short-term
                      borrowings
                  **-**
                  
                  7,950Other
                      liabilities
                  **1,711**
                  
                  1,944
 
 **Total
                      Liabilities**
                  **278,720**
                  
                  275,712
 
 **Shareholders’
            Equity**
  Common
                      stock, par value $2 per share; authorized 10,000,000 shares;
                      issued
                      3,600,000 shares; outstanding 3,413,426 shares
                  **7,200**
                  
                  7,200Retained
                      earnings
                  **39,422**
                  
                  38,946Accumulated
                      other comprehensive income
                  **617**
                  
                  2,092Treasury
                      stock, at cost, 186,574 shares
                  **(3,578)**
                  
                  (3,578)
 
 **Total
                      Shareholders’ Equity**
                  **43,661**
                  
                  44,660
 
 **Total
                      Liabilities and Shareholders’ Equity**
                  **$322,381**
                  
                  $320,372
 
  *See
                  notes to consolidated financial statements.*
 *2*
   **Consolidated
            Statements of Income** ****
 
  **Years
                      Ended December 31,****2005**
                  
                  **2004**
                  
                  **2003****(In
                      Thousands, Except per Share
                      Amounts)**
 
 **Interest
            Income**
 Interest
                      and fees on loans
                  **$11,303**
                  
                  $10,809
                  
                  $11,390Interest
                      and dividends on securities:Taxable
                  **4,441**
                  
                  6,914
                  
                  6,835Exempt
                      from federal income taxes
                  **137**
                  
                  395
                  
                  1,400Other
                  **303**
                  
                  124
                  
                  170
 
 **Total
                      Interest Income**
                  **16,184**
                  
                  18,242
                  
                  19,795
 
 **Interest
            Expense**
 Deposits
                  **4,343**
                  
                  3,662
                  
                  3,563Short-term
                      borrowings
                  **39**
                  
                  161
                  
                  49Long-term
                      borrowings
                  **-**
                  
                  2,128
                  
                  2,913
 
 **Total
                      Interest Expense**
                  **4,382**
                  
                  5,951
                  
                  6,525
 
 **Net
                      Interest Income**
                  **11,802**
                  
                  12,291
                  
                  13,270
 
 **Provision
                      (Credit) for Loan Losses**
                  **(365)**
                  
                  (436)
                  
                  39
 
 **Net
                      Interest Income after Provision (Credit) for Loan
                      Losses**
                  **12,167**
                  
                  12,727
                  
                  13,231
 
 **Other
            Operating Income**
 Service
                      charges on deposit accounts
                  **604**
                  
                  644
                  
                  859Other
                      service charges and fees
                  **701**
                  
                  726
                  
                  618Net
                      security gains
                  **-**
                  
                  1,195
                  
                  9Trust
                      department income
                  **829**
                  
                  876
                  
                  710Income
                      from investment in life insurance
                  **525**
                  
                  529
                  
                  559Commissions
                      and fees from insurance sales
                  **-**
                  
                  342
                  
                  841Other
                      income
                  **300**
                  
                  279
                  
                  343
 
 **Total
                      Other Operating Income**
                  **2,959**
                  
                  4,591
                  
                  3,939
 
 **Other
            Operating Expenses**
 Salaries
                      and employee benefits
                  **5,196**
                  
                  6,236
                  
                  6,074Net
                      occupancy
                  **722**
                  
                  702
                  
                  714Furniture
                      and equipment
                  **742**
                  
                  809
                  
                  747Professional
                      fees
                  **560**
                  
                  670
                  
                  741Pennsylvania
                      shares tax
                  **559**
                  
                  546
                  
                  500Automated
                      teller machine
                  **315**
                  
                  300
                  
                  297Director
                      fees
                  **382**
                  
                  408
                  
                  462Impairment
                      writedown of goodwill
                  **-**
                  
                  -
                  
                  375FHLB
                      prepayment penalty
                  **-**
                  
                  4,402
                  
                  -Other
                      expenses
                  **2,056**
                  
                  2,833
                  
                  2,862
 
 **Total
                      Other Operating Expenses**
                  **10,532**
                  
                  16,906
                  
                  12,772
 
 **Income
                      before Income Taxes (Benefit)**
                  **4,594**
                  
                  412
                  
                  4,398
 
 **Income
                      Tax Expense (Benefit)**
                  **1,217**
                  
                  (209)
                  
                  837
 
 **Net
                      Income**
                  **$3,377**
                  
                  $
                      621
                  
                  $
                      3,561
 
 **Earnings
                      per Share, Basic**
                  **$0.99**
                  
                  $0.18
                  
                  $
                      1.03
 
  *See
                  notes to consolidated financial statements.*
 *3*
   **Consolidated** **Statements
            of Shareholders’ Equity**
 **Years
            Ended December 31, 2005, 2004 and 2003**
 
  **Common**
                    **Stock**
                  
                  **Retained
                      Earnings**
                  
                  **Accumulated**
                    **Other
                      Comprehensive Income**
                  
                  **Treasury**
                    **Stock**
                  
                  **Total**
                    **Shareholders’**
                    **Equity****(In
                      Thousands, Except per Share
                      Amounts)**
 
 **Balance
                      - December 31, 2002**
                  
                  $7,200
                  
                  $41,628
                  
                  $4,881
                  
                  ($2,504)
                  
                  $51,205Comprehensive
                      income:Net
                      income
                  
                  -
                  
                  3,561
                  
                  -
                  
                  -
                  
                  3,561Change
                      in unrealized net gains on securities
                    available
                      for sale, net of reclassification
                    adjustment
                      and deferred income taxes
                  
                  -
                  
                  -
                  
                  (1,135)
                  
                  -
                  
                  (1,135)**Total
                      Comprehensive Income**
                  
                  
                  
                  
                  
                  
                  
                  
                  
                  2,426Cash
                      dividends declared, $1.00 per share
                  
                  -
                  
                  (3,441)
                  
                  -
                  
                  -
                  
                  (3,441)Issuance
                      of treasury stock
                  
                  -
                  
                  -
                  
                  -
                  
                  4
                  
                  4Purchases
                      of treasury stock
                  
                  -
                  
                  -
                  
                  -
                  
                  (657)
                  
                  (657)**Balance
                      - December 31, 2003**
                  
                  7,200
                  
                  41,748
                  
                  3,746
                  
                  (3,157)
                  
                  49,537Comprehensive
                      loss:Net
                      income
                  
                  -
                  
                  621
                  
                  -
                  
                  -
                  
                  621Change
                      in unrealized net gains on securities
                    available
                      for sale, net of reclassification
                    adjustment
                      and deferred income taxes
                  
                  -
                  
                  -
                  
                  (1,654)
                  
                  -
                  
                  (1,654)**Total
                      Comprehensive Loss**
                  
                  
                  
                  
                  
                  
                  
                  
                  
                  (1,033)Cash
                      dividends declared, $1.00 per share
                  
                  -
                  
                  (3,423)
                  
                  -
                  
                  -
                  
                  (3,423)Purchases
                      of treasury stock
                  
                  -
                  
                  -
                  
                  -
                  
                  (421)
                  
                  (421)**Balance
                      - December 31, 2004**
                  
                  7,200
                  
                  38,946
                  
                  2,092
                  
                  (3,578)
                  
                  44,660Comprehensive
                      income:Net
                      income
                  
                  **-**
                  
                  **3,377**
                  
                  **-**
                  
                  **-**
                  
                  **3,377**Change
                      in unrealized net gains on securities
                    available
                      for sale, net of reclassification
                    adjustment
                      and deferred income taxes
                  
                  **-**
                  
                  **-**
                  
                  **(1,475)**
                  
                  **-**
                  
                  **(1,475)****Total
                      Comprehensive Income**
                  
                  
                  
                  
                  
                  
                  
                  
                  
                  **1,902**Cash
                      dividends declared, $0.85 per share
                  
                  **-**
                  
                  **(2,901)**
                  
                  **-**
                  
                  **-**
                  
                  **(2,901)****Balance
                      - December 31, 2005**
                  
                  **$7,200**
                  
                  **$39,422**
                  
                  **$
                      617**
                  
                  **$(3,578)**
                  
                  **$43,661**
 
 
 
 
  *See
                  notes to consolidated financial statements.*
 *4*
   **Consolidated
            Statements of Cash Flows**
 
  **Years
                      Ended December 31,****2005**
                  
                  **2004**
                  
                  **2003****(In
                      Thousands)**
 
 **Cash
            Flows from Operating Activities**
 Net
                      income
                  **$3,377**
                  
                  $
                      621
                  
                  $
                      3,561Adjustments
                      to reconcile net income to net cash provided by
                    (used
                      in) operating activities:Depreciation
                      and amortization
                  **762**
                  
                  905
                  
                  885Provision
                      (credit) for loan losses
                  **(365)**
                  
                  (436)
                  
                  39Net
                      accretion of securities and loan fees
                  **(66)**
                  
                  (128)
                  
                  (674)Net
                      security gains
                  **-**
                  
                  (1,195)
                  
                  (9)Impairment
                      writedown of goodwill
                  **-**
                  
                  -
                  
                  375(Gain)
                      loss on sale of foreclosed real estate
                  **(97)**
                  
                  38
                  
                  (4)Income
                      from investment in life insurance
                  **(525)**
                  
                  (529)
                  
                  (559)Deferred
                      tax expense (benefit)
                  **430**
                  
                  (439)
                  
                  285(Increase)
                      decrease in accrued interest receivable and
                    other
                      assets
                  **1,015**
                  
                  (448)
                  
                  (142)Increase
                      (decrease) in other liabilities
                  **95**
                  
                  (589)
                  
                  (281)
 
 **Net
                      Cash Provided by (Used in) Operating Activities**
                  **4,626**
                  
                  (2,200)
                  
                  3,476
 
 **Cash
            Flows from Investing Activities**
 (Increase)
                      decrease in federal funds sold
                  **(16,950)**
                  
                  -
                  
                  14,650Purchases
                      of securities
                  **(602)**
                  
                  (110,449)
                  
                  (90,557)Maturities,
                      calls and principal repayments of securities
                  **31,772**
                  
                  40,096
                  
                  69,753Proceeds
                      from sales of securities
                  **-**
                  
                  133,969
                  
                  43Net
                      cash used in acquisitions
                  **-**
                  
                  -
                  
                  (100)Net
                      (increase) decrease in restricted bank stock
                  **793**
                  
                  2,539
                  
                  (727)Net
                      increase in loans
                  **(14,784)**
                  
                  (4,960)
                  
                  (19,248)Net
                      proceeds from sale of assets
                  **215**
                  
                  1,291
                  
                  44Purchases
                      of premises and equipment
                  **(315)**
                  
                  (399)
                  
                  (1,164)
 
 **Net
                      Cash Provided by (Used in) Investing Activities**
                  **129**
                  
                  62,087
                  
                  (27,306)
 
 **Cash
            Flows from Financing Activities**
 Net
                      increase (decrease) in deposits
                  **11,191**
                  
                  6,602
                  
                  (10,809)Net
                      increase (decrease) in short-term borrowings
                  **(7,950)**
                  
                  (9,500)
                  
                  17,450Repayment
                      of long-term borrowings
                  **-**
                  
                  (55,000)
                  
                  -Dividends
                      paid
                  **(2,901)**
                  
                  (3,423)
                  
                  (3,441)Purchase
                      of treasury stock
                  **-**
                  
                  (421)
                  
                  (657)
 
 **Net
                      Cash Provided by (Used in) Financing Activities**
                  **340**
                  
                  (61,742)
                  
                  2,543
 
 **Net
                      Increase (Decrease) in Cash and Cash Equivalents**
                  **5,095**
                  
                  (1,855)
                  
                  (21,287)
 
 **Cash
                      and Cash Equivalents - Beginning**
                  **7,786**
                  
                  9,641
                  
                  30,928
 
 **Cash
                      and Cash Equivalents - Ending**
                  **$12,881**
                  
                  $
                      7,786
                  
                  $
                      9,641
 
 
 
  *See
                  notes to consolidated financial statements.*
 *4*
   **Notes
            to Consolidated Financial Statements**
 
  **Note
            1 - Significant Accounting Policies**
  **General**
  The
            accompanying consolidated financial statements include the accounts of
            Commercial National Financial Corporation (the Corporation) and its wholly-owned
            subsidiaries, Commercial Bank & Trust of PA, and Commercial National
            Insurance Services, Inc. (CNIS). In December 2002, CNIS acquired The
            Gooder
            Agency, Inc. (Gooder) which was subsequently sold in 2004 (see Note 2).
            All
            material intercompany transactions have been eliminated.
  The
            Bank
            operates under a state bank charter and provides full banking services.
            The
            Corporation is subject to regulation by the Federal Reserve Board and
            the Bank
            is subject to regulation by the Federal Deposit Insurance Corporation
            and the
            Pennsylvania Department of Banking. The Bank’s primary business consists of
            taking deposits and granting loans to customers who generally do business
            in the
            area of Westmoreland County, Pennsylvania.
  As
            of
            December 31, 2005, the Corporation employed 110 people in full-time
            and
            part-time positions. Approximately 54 employees are represented by the
            United
            Auto Workers, Local 1799. In 2004, the Corporation and bargaining unit
            employees
            entered into a labor agreement that will expire in December 2008.
  The
            following summary of accounting and reporting policies is presented to
            aid the
            reader in obtaining a better understanding of the consolidated financial
            statements and related financial data of the Corporation and its wholly-owned
            subsidiaries contained in this report. Such policies conform to generally
            accepted accounting principles (GAAP) and to general practice within
            the banking
            industry.
  **Estimates**
  The
            preparation of financial statements in conformity with accounting principles
            generally accepted in the United States of America requires management
            to make
            estimates and assumptions that affect the reported amounts of assets
            and
            liabilities and disclosure of contingent assets and liabilities at the
            date of
            the financial statements and the reported amounts of revenues and expenses
            during the reporting period. Actual results could differ from those
            estimates.
  Material
            estimates that are particularly susceptible to significant change in
            the near
            term relate to the determination of the allowance for loan losses, the
            valuation
            of real estate acquired in connection with foreclosures or in satisfaction
            of
            loans, and the evaluation of other than temporary impairment of securities.
  **Significant
            Concentrations of Credit Risk**
  Most
            of
            the Corporation’s activities are with customers located within Westmoreland
            County of Pennsylvania. Note 4 discusses the types of securities
            that the
            Corporation invests in. Note 5 discusses the types of lending
            that the
            Corporation engages in. The Corporation does not have any significant
            concentrations to any one industry or customer. Although the Corporation
            has a
            diversified loan portfolio, exposure to credit loss can be adversely
            impacted by
            downturns in local economic and employment conditions.
  
  
 
   *6*
   **Note
            1 - Significant Accounting Policies (Continued)**
  **Securities**
  Debt
            and
            equity securities are classified as “securities available for sale” and reported
            at fair value, with unrealized gains and losses excluded from earnings
            and
            reported as a separate component of shareholders’ equity, net of the related
            deferred income tax effect.
  Purchase
            premiums and discounts are recognized in interest income using the interest
            method over the terms of the securities. Declines in the fair value of
            available
            for sale securities below their cost that are deemed to be other than
            temporary
            are reflected in earnings as realized losses. In estimating other-than-temporary
            impairment losses, management considers (1) the length of time and the
            extent to
            which the fair value has been less than cost, (2) the financial condition
            and
            near-term prospects of the issuer, and (3) the intent and ability of
            the
            Corporation to retain its investment in the issuer for a period of time
            sufficient to allow for any anticipated recovery in fair value. Gains
            and losses
            on the sale of securities are recorded on the trade date and are determined
            using the specific identification method.
  **Restricted
            Investments in Bank Stock**
  Federal
            law requires the Bank, a member institution of the Federal Home Loan
            Bank
            system, to hold stock of its district Federal Home Loan Bank according
            to a
            predetermined formula. This restricted stock is carried at cost.
  **Loans**
  Loans
            receivable that management has the intent and ability to hold for the
            foreseeable future or until maturity or payoff are stated at their outstanding
            unpaid principal balances. Interest income is accrued on the unpaid principal
            balance. Loan origination fees, net of associated direct costs, are deferred
            and
            recognized as an adjustment of the yield (interest income) of the related
            loans.
            The Corporation is generally amortizing these amounts over the contractual
            life
            of the loan.
  The
            accrual of interest is generally discontinued when the contractual payment
            of
            principal or interest has become 90 days past due or management has serious
            doubts about further collectibility of principal or interest, even though
            the
            loan is currently performing. A loan may remain on accrual status if
            it is in
            the process of collection and is either guaranteed or well secured. When
            a loan
            is placed on nonaccrual status, unpaid interest credited to income in
            the
            current year is reversed and unpaid interest accrued in prior years is
            charged
            against the allowance for loan losses. Interest received on nonaccrual
            loans
            generally is either applied against principal or reported as interest
            income,
            according to management’s judgment as to the collectibility of principal.
            Generally, loans are restored to accrual status when the obligation is
            brought
            current, has performed in accordance with the contractual terms for a
            reasonable
            period of time and the ultimate collectibility of the total contractual
            principal and interest is no longer in doubt.
   *7*
 
 ***Commercial
                  National Financial Corporation***
 **Notes
                  to Consolidated Financial Statements**
  **Note
            1 - Significant Accounting Policies (Continued)**
  **Allowance
            for Loan Losses**
  The
            allowance for loan losses is established through provisions for loan
            losses
            charged against income. Loans deemed to be uncollectible are charged
            against the
            allowance for loan losses, and subsequent recoveries, if any, are credited
            to
            the allowance.
  The
            allowance for loan losses is maintained at a level considered adequate
            to
            provide for losses that can be reasonably anticipated. Management’s periodic
            evaluation of the adequacy of the allowance is based on the Corporation’s past
            loan loss experience, known and inherent risks in the portfolio, adverse
            situations that may affect the borrower’s ability to repay, the estimated value
            of any underlying collateral, composition of the loan portfolio, current
            economic conditions and other relevant factors. This evaluation is inherently
            subjective as it requires material estimates that may be susceptible
            to
            significant change, including the amounts and timing of future cash flows
            expected to be received on impaired loans.
  The
            allowance consists of specific, general and unallocated components. The
            specific
            component relates to loans that are classified as either doubtful, substandard
            or special mention. For such loans that are also classified as impaired,
            an
            allowance is established when the discounted cash flows (or collateral
            value or
            observable market price) of the impaired loan is lower than the carrying
            value
            of that loan. The general component covers non-classified loans and is
            based on
            historical loss experience adjusted for qualitative factors. An unallocated
            component is maintained to cover uncertainties that could affect management’s
            estimate of probable losses. The unallocated component of the allowance
            reflects
            the margin of imprecision inherent in the underlying assumptions used
            in the
            methodologies for estimating specific and general losses in the portfolio.
  A
            loan is
            considered impaired when, based on current information and events, it
            is
            probable that the Corporation will be unable to collect the scheduled
            payments
            of principal or interest when due according to the contractual terms
            of the loan
            agreement. Factors considered by management in determining impairment
            include
            payment status, collateral value and the probability of collecting scheduled
            principal and interest payments when due. Loans that experience insignificant
            payment delays and payment shortfalls generally are not classified as
            impaired.
            Management determines the significance of payment delays and payment
            shortfalls
            on a case-by-case basis, taking into consideration all of the circumstances
            surrounding the loan and the borrower, including the length of the delay,
            the
            reasons for the delay, the borrower’s prior payment record and the amount of the
            shortfall in relation to the principal and interest owed. Impairment
            is measured
            on a loan by loan basis for commercial and construction loans by either
            the
            present value of expected future cash flows discounted at the loan’s effective
            interest rate, the loan’s obtainable market price or the fair value of the
            collateral if the loan is collateral dependent.
  Large
            groups of smaller balance homogeneous loans are collectively evaluated
            for
            impairment. Accordingly, the Corporation does not separately identify
            individual
            consumer and residential loans for impairment disclosures, unless such
            loans are
            the subject of a restructuring agreement.
  **Off-Balance
            Sheet Financial Instruments**
  In
            the
            ordinary course of business, the Corporation has entered into off-balance
            sheet
            financial instruments consisting of commitments to extend credit and
            letters of
            credit. Such financial instruments are recorded in the balance sheet
            when they
            are funded.
  
  *7*
 
 ***Commercial
                  National Financial Corporation***
 **Notes
                  to Consolidated Financial Statements**
  **Note
            1 - Significant Accounting Policies (Continued)**
  **Foreclosed
            Real Estate**
  Foreclosed
            real estate is comprised of property acquired through a foreclosure proceeding
            or acceptance of a deed in lieu of foreclosure and loans classified as
            in-substance foreclosure. A loan is classified as in-substance foreclosure
            when
            the Bank has taken possession of the collateral regardless of whether
            formal
            foreclosure proceedings take place. Foreclosed assets initially are recorded
            at
            fair value, net of estimated selling costs, at the date of foreclosure
            establishing a new cost basis. After foreclosure, valuations are periodically
            performed by management and the assets are carried at the lower of cost
            or fair
            value minus estimated costs to sell. Revenues and expenses from operations
            and
            changes in the valuation allowance are included in other expenses. Foreclosed
            real estate at December 31, 2005 and 2004 was $740,000 and $682,000,
            respectively, and is included in other assets.
  **Intangible
            Assets**
  The
            Corporation has amortizable intangible assets related to core deposit
            intangibles acquired in 2002 through the acquisition of a branch office.
            These
            intangible assets are being amortized on a straight-line basis over a
            period of
            ten years. The balance of these amortizable intangible assets at
            December 31, 2005 was $634,000, net of accumulated amortization
            of
            $341,000, which is included in other assets. Amortization expense of
            $98,000,
            $145,000, and $202,000 was recorded for the years ended December 31,
            2005,
            2004, and 2003, respectively. Included in the 2004 and 2003 expense was
            $47,000
            and $104,000, respectively, related to Gooder’s customer list (see Note 2).
            Amortization expense is estimated to be $98,000 per year for the next
            five
            years.
  **Premises
            and Equipment**
  Premises
            and equipment are carried at cost less accumulated depreciation and
            amortization. For financial statement reporting and income tax purposes,
            depreciation is computed both on straight-line and accelerated methods
            over the
            estimated useful life of the premises and equipment. Charges for maintenance
            and
            repairs are expensed as incurred. Amortization is charged over the term
            of the
            respective lease or the estimated useful life of the asset, whichever
            is
            shorter.
  **Bank
            Owned Life Insurance**
  The
            Corporation invests in bank owned life insurance (BOLI) as a source of
            funding
            for employee benefit expenses. BOLI involves the purchasing of life insurance
            by
            the Corporation on a chosen group of employees. The Corporation is the
            owner and
            beneficiary of the policies. This life insurance investment is carried
            at the
            cash surrender value of the underlying policies. Income from the investment
            in
            the policies is included in other income on the income statement.
  **Advertising
            Costs**
  The
            Corporation follows the policy of charging the costs of advertising to
            expense
            as incurred. Total advertising expense for the years ended December 31,
            2005, 2004 and 2003 was $152,000, $192,000, and $187,000,
            respectively.
  **Trust
            Operations**
  Trust
            income is recorded on the cash basis, which approximates the accrual
            basis.
            Securities and other property held by the Corporation in a fiduciary
            or agency
            capacity for customers of the Trust Department are not assets of the
            Corporation
            and, accordingly, are not included in the accompanying consolidated financial
            statements. Assets under management in the trust department totaled
            $126,126,000, $132,431,000 and $132,187,000 at December 31, 2005,
            2004 and
            2003, respectively.
   *7*
 
 ***Commercial
                  National Financial Corporation***
 **Notes
                  to Consolidated Financial Statements**
  **Note
            1 - Significant Accounting Policies (Continued)**
  **Income
            Taxes**
  Deferred
            income tax assets and liabilities are determined based on the differences
            between financial statement carrying amounts and the tax basis of existing
            assets and liabilities. These differences are measured at the enacted
            tax rates
            that will be in effect when these differences reverse. Deferred tax assets
            are
            reduced by a valuation allowance when, in the opinion of management,
            it is more
            likely than not that some portion of the deferred tax assets will not
            be
            realized. As changes in tax laws or rates are enacted, deferred tax assets
            and
            liabilities are adjusted through the provision for income taxes. The
            Corporation
            and its subsidiaries file a consolidated federal income tax return.
  **Earnings
            per Share**
  Basic
            earnings per share have been calculated on the weighted average number
            of shares
            outstanding of 3,413,426 in 2005, 3,422,881 in 2004, and 3,441,556 in
            2003. The
            Corporation currently maintains a simple capital structure, thus there
            are no
            dilutive effects on earnings per share.
  **Treasury
            Stock**
  The
            acquisition of treasury stock is recorded under the cost method. At the
            date of
            subsequent reissue, the treasury stock is reduced by the cost of such
            stock on
            the average cost basis, with any excess proceeds being credited to retained
            earnings.
  **Statements
            of Cash Flows**
  For
            purposes of reporting cash flows, the Corporation has defined cash and
            cash
            equivalents as those amounts included in the balance sheet captions,
“Cash and
            due from banks” and “Interest bearing deposits with banks.”
  **Years
                      Ended December 31,****2005**
                  
                  **2004**
                  
                  **2003****(In
                      Thousands)**
 **Supplementary
            Cash Flows Information**
 Interest
                      paid
                  **$
                      4,216**
                  
                  $
                      6,133
                  
                  $
                      6,679
 
 Income
                      taxes paid
                  **$
                      866**
                  
                  $
                      981
                  
                  $
                      608
 
 **Supplementary
            Disclosures of Noncash Investing and**
 **Financing
            Activities**
 Loans
                      transferred to foreclosed real estate
                  **$
                      178**
                  
                  $
                      34
                  
                  $
                      723
 
 **Segment
            Reporting**
  The
            Corporation acts as an independent community financial services provider
            and
            offers traditional banking and related financial services to individual,
            business and government customers. The Corporation offers a full array
            of
            commercial and retail financial services, including the taking of time,
            savings
            and demand deposits, the making of commercial, consumer and mortgage
            loans and
            the providing of other financial services.
  Management
            does not separately allocate expenses, including the cost of funding
            loan
            demand, between the commercial and retail operations of the Corporation.
            As
            such, discrete information is not available and segment reporting would
            not be
            meaningful.
  
  *7*
 
 ***Commercial
                  National Financial Corporation***
 **Notes
                  to Consolidated Financial Statements**
  **Note
            1 - Significant Accounting Policies (Continued)**
  **New
            Accounting Standards**
  In
            March
            2004, the FASB’s Emerging Issues Task Force (EITF) reached a consensus on Issue
            No. 03-1, “The Meaning of Other-Than-Temporary Impairment and Its Application to
            Certain Investments.” EITF 03-1 provides guidance on other-than-temporary
            impairment models for marketable debt and equity securities accounted
            for under
            SFAS 115 and non-marketable equity securities accounted for under the
            cost
            method. The EITF developed a basic three-step model to evaluate whether
            an
            investment is other-than-temporarily impaired. In November 2005, the
            FASB
            approved the issuance of FASB Staff Position FAS No. 115-1 and FAS 124-1,
“The
            Meaning of Other-Than-Temporary Impairment and Its Application to Certain
            Investments.” The FSP addresses when an investment is considered impaired,
            whether the impairment is other-than-temporary and the measurement of
            an
            impairment loss. The FSP also includes accounting considerations subsequent
            to
            the recognition of an other-than-temporary impairment and requires certain
            disclosures about unrealized losses that have not been recognized as
            other-than-temporary. The FSP is effective for reporting periods beginning
            after
            December 15, 2005 with earlier application permitted. For the
            Corporation,
            the effective date will be the first quarter of fiscal 2006. The adoption
            of
            this accounting principle is not expected to have a significant impact
            on our
            financial position or results of operations.
  In
            July
            2005, the FASB issued a proposed interpretation of FAS 109, “Accounting for
            Income Taxes,” to clarify certain aspects of accounting for uncertain tax
            positions, including issues related to the recognition and measurement
            of those
            tax positions. If adopted as proposed, any adjustments required to be
            recorded
            as a result of adopting the interpretation would be reflected as a cumulative
            effect from a change in accounting principle. The adoption of the interpretation
            as proposed is not expected to have a significant impact on our financial
            position or results of operations.
  
 **Note
            2 - Acquisitions And Divestitures**
  In
            June
            2004, the Corporation sold all assets relating to its insurance agency
            subsidiary, Gooder. In the transaction, the Corporation received $950,000.
            A
            $39,000 loss was recognized on the sale of such assets, which is included
            in
            other expenses. The results of operations of Gooder prior to the sale
            were not
            material to the Corporation’s results of operations.
  In
            performing its impairment assessment of the acquired customer lists of
            Gooder in
            the fourth quarter of 2003, management determined that no impairment
            was present
            based on the carrying amount of these intangible assets. However, the
            goodwill
            asset was fully impaired. As a result, the 2003 consolidated financial
            statements reflect a writedown of goodwill in the amount of $375,000
            which is
            included in other operating expenses in the consolidated statement of
            income.
  On
            January 3, 2003, the Corporation acquired certain insurance agency
            accounts
            from an employee of Gooder. The Corporation paid cash of $100,000 for
            the
            accounts. The acquisition was accounted for as a purchase and the $100,000
            was
            allocated to identifiable intangible assets representing the fair value
            of the
            acquired customer list. The results of operations are included in the
            consolidated financial statements from the date of the acquisition until
            the
            sale of Gooder in June 2004. The impact of the acquisition on the Corporation’s
            results of operations for the year ended December 31, 2003 was
            not
            material.
  
  *7*
 
 ***Commercial
                  National Financial Corporation***
 **Notes
                  to Consolidated Financial Statements**
  **Note
            3 - Cash and Due from Banks**
  Regulations
            of the Board of Governors of the Federal Reserve System impose uniform
            reserve
            requirements on all depository institutions with transaction accounts
            and
            non-personal time deposits. Reserves are maintained in the form of vault
            cash or
            a non-interest bearing balance held with the Federal Reserve Bank. The
            Bank also
            maintains deposits with the Federal Reserve Bank and other banks for
            various
            services such as check clearing. The required reserve at December 31,
            2005
            and 2004 was approximately $4,921,000 and $4,393,000, respectively.
  
 **Note
            4 - Securities**
  The
            amortized cost and fair values of securities available for sale are as
            follows:
  **Amortized**
                    **Cost**
                  
                  **Gross**
                    **Unrealized**
                    **Gains**
                  
                  **Gross**
                    **Unrealized**
                    **Losses**
                  
                  **Fair**
                    **Value****(In
                      Thousands)**
 
 **December
                      31, 2005:**Obligations
                      of U.S. Government
                    agencies
                  **$
                      2,026**
                  
                  **$
                      -**
                  
                  **$
                      (34)**
                  
                  **$
                      1,992**Obligations
                      of states and political
                    subdivisions
                  **3,449**
                  
                  **54**
                  
                  **(111)**
                  
                  **3,392**Mortgage-backed
                      securities
                  **59,708**
                  
                  **1,025**
                  
                  **-**
                  
                  **60,733**
 
 **$65,183**
                  
                  **$1,079**
                  
                  **$(145)**
                  
                  **$66,117**
 
 **December
                      31, 2004:**Obligations
                      of U.S. Government
                    agencies
                  $
                      8,386
                  
                  $
                      4
                  
                  $
                      (39)
                  
                  $
                      8,351Obligations
                      of states and political
                    subdivisions
                  4,177
                  
                  94
                  
                  (87)
                  
                  4,184Mortgage-backed
                      securities
                  83,723
                  
                  3,197
                  
                  -
                  
                  86,920
 
 $96,286
                  
                  $3,295
                  
                  $(126)
                  
                  $99,455
 
 The
            amortized cost and fair value of securities at December 31, 2005
            by
            contractual maturity, are shown below. Mortgage-backed securities maturities
            are
            based upon their estimated contractual maturities. Expected maturities
            will
            differ from contractual maturities because borrowers may have the right
            to call
            or prepay obligations with or without call or prepayment penalties.
  **Amortized**
                    **Cost**
                  
                  **Fair**
                    **Value****(In
                      Thousands)**
 
 Due
                      within one year
                  **$
                      2,525**
                  
                  **$
                      2,482**Due
                      after one year through five years
                  **601**
                  
                  **562**Due
                      after five years through ten years
                  **1,833**
                  
                  **1,848**Due
                      after ten years
                  **60,224**
                  
                  **61,225**
 
 **$65,183**
                  
                  **$66,117**
  *7*
 
 ***Commercial
                  National Financial Corporation***
 **Notes
                  to Consolidated Financial Statements**
  **Note
            4 - Securities (Continued)**
  Securities
            with amortized cost and fair values of $16,309,000 and $16,467,000,
            respectively, at December 31, 2005 and $21,097,000 and $21,592,000
            respectively, at December 31, 2004 were pledged to secure public
            deposits
            and for other purposes required or permitted by law.
  Gross
            gains of $-0-, $2,377,000, and $9,000 and gross losses of $-0-, $1,182,000,
            and
            $-0- were realized on sales and calls of securities during 2005, 2004
            and 2003,
            respectively.
  The
            following table shows the Corporation’s gross unrealized losses and fair value,
            aggregated by investment category and length of time that individual
            securities
            have been in a continuous unrealized loss position, at December 31,
            2005
            and 2004:
  **December 31,
                      2005****Less
                      than 12 Months**
                  
                  **12
                      Months or More**
                  
                  **Total****Fair**
                    **Value**
                  
                  **Unrealized
                      Losses**
                  
                  **Fair**
                    **Value**
                  
                  **Unrealized
                      Losses**
                  
                  **Fair**
                    **Value**
                  
                  **Unrealized
                      Losses****(In
                      Thousands)**
 
 Obligations
                      of U.S. Govern- ment agencies
                  **$
                      -**
                  
                  **$
                      -**
                  
                  **$1,992**
                  
                  **$
                      (34)**
                  
                  **$1,992**
                  
                  **$
                      (34)**Obligations
                      of states and political subdivisions
                  **562**
                  
                  **(40)**
                  
                  **1,776**
                  
                  **(71)**
                  
                  **2,338**
                  
                  **(111)**
 
 **$562**
                  
                  **$(40)**
                  
                  **$3,768**
                  
                  **$(105)**
                  
                  **$4,330**
                  
                  **$(145)**
 
 **December 31,
                      2004****(In
                      Thousands)**
 
 Obligations
                      of U.S. Govern- ment agencies
                  $2,036
                  
                  $(22)
                  
                  $
                      987
                  
                  $(17)
                  
                  $3,023
                  
                  $
                      (39)Obligations
                      of states and political subdivisions
                  1,304
                  
                  (43)
                  
                  1,786
                  
                  (44)
                  
                  3,090
                  
                  (87)
 
 $3,340
                  
                  $(65)
                  
                  $2,773
                  
                  $(61)
                  
                  $6,113
                  
                  $(126)
 
 Unrealized
            losses on obligations of U.S. Government agencies and state and political
            subdivisions are due to a change in interest rates subsequent to when
            the
            securities were purchased. At December 31, 2005, all debt securities
            with
            temporarily impaired losses have been rated by either Moody’s and/or S&P
            with an “A” or better debt rating. Management believes the unrealized losses are
            temporary and that the Corporation has the ability to hold the securities
            until
            maturity or market price recovery.
  
  *7*
 
 ***Commercial
                  National Financial Corporation***
 **Notes
                  to Consolidated Financial Statements**
  **Note
            5 - Loans**
  Loans
            are
            summarized as follows:
  **December
                      31,****2005**
                  
                  **2004****(In
                      Thousands)**
 
 Commercial
                      loans
                  
                  **$
                      18,275**
                  
                  $
                      15,933Real
                      estate loans:Commercial
                  
                  **60,794**
                  
                  55,555Construction
                  
                  **910**
                  
                  258Residential
                  
                  **115,294**
                  
                  107,819Municipal
                      loans
                  
                  **7,596**
                  
                  10,002Consumer
                      and other loans
                  
                  **3,948**
                  
                  2,465Net
                      unamortized costs
                  
                  **222**
                  
                  223
 
 **$207,039**
                  
                  $192,255
 
 **Note
            6 - Allowance for Loan Losses**
  Transactions
            in the allowance for loan losses are summarized as follows:
  **Years
                      Ended December 31,****2005**
                  
                  **2004**
                  
                  **2003****(In
                      Thousands)**
 
 Balance,
                      January 1
                  
                  **$1,855**
                  
                  $2,462
                  
                  $2,707Loans
                      charged off
                  
                  **(155)**
                  
                  (361)
                  
                  (333)Recoveries
                      on previously charged off
                    loans
                  
                  **301**
                  
                  190
                  
                  49Provision
                      (credit) for loan losses
                  
                  **(365)**
                  
                  (436)
                  
                  39
 
 Balance
                      at December 31
                  
                  **$1,636**
                  
                  $1,855
                  
                  $2,462
 
 During
            the Corporation’s first quarter 2005 evaluation, management considered the
            allowance for loan losses to be over allocated by $470,000. Due to this
            overage,
            the Corporation reduced the allowance for loan losses by $470,000. The
            overage
            was the result of the Corporation receiving $285,000 representing a recovery
            for
            a commercial loan charged off in a previous year. In addition, the Corporation
            received a pay-down on a classified loan, lowering the allowance requirements
            by
            an additional $185,000. The excess allocation was recorded as a credit
            in the
            provision for loan losses.
  During
            the Corporation’s second quarter 2004 evaluation, management considered the
            allowance for loan losses to be over allocated by $492,000. Due to this
            overage,
            the Corporation reduced the allowance for loan losses by $492,000. The
            reduction
            in the allowance consisted of specific allocations for several classified
            loans,
            totaling $3.2 million, which paid off during the first half of 2004.
            The excess
            allocation was recorded as a credit in the provision for loan losses.
   *7*
 
 ***Commercial
                  National Financial Corporation***
 **Notes
                  to Consolidated Financial Statements**
  **Note
            6 - Allowance for Loan Losses (Continued)**
  At
            December 31, 2005 and 2004, the total recorded investment in loans
            considered to be impaired was $2,670,000 and $3,421,000, respectively.
            The average recorded investment in impaired loans during 2005, 2004 and
            2003 was
            $3,411,000, $4,728,000, and $12,271,000, respectively. Impaired loans
            with
            balances of $511,000 and $958,000 at December 31, 2005 and 2004
            had related
            allowance for loan losses of $161,000 and $503,000, respectively. Interest
            income on impaired loans of $173,000, $190,000, and $723,000 was recognized
            for
            cash payments received in 2005, 2004 and 2003, respectively.
  Loans
            on
            which the accrual of interest has been discontinued amounted to $1,308,000
            and
            $1,667,000 at December 31, 2005 and 2004, respectively. Loan balances
            past
            due 90 days or more and still accruing interest, but which management
            expects
            will eventually be paid in full, amounted to $2,000 and $12,000 at
            December 31, 2005 and 2004, respectively.
  
 **Note
            7 - Financial Instruments with Off-Balance Sheet Risk**
  The
            Corporation is a party to financial instruments with off-balance-sheet
            risk in
            the normal course of business to meet the financing needs of its customers.
            These financial instruments include commitments to extend credit, standby
            letters of credit and financial standby letters of credit. Those instruments
            involve, to varying degrees, elements of credit and interest rate risk
            in excess
            of the amount recognized in the balance sheet. The contract or notional
            amount
            of those instruments reflect the extent of involvement the Corporation
            has in
            particular classes of financial instruments. The Corporation does not
            issue any
            other instruments with significant off-balance-sheet risk.
  The
            Corporation's exposure to credit loss in the event of nonperformance
            by the
            other party to the financial instrument for commitments to extend credit,
            standby letters of credit and financial standby letters of credit written
            is
            represented by the contract or notional amount of those instruments.
            The
            Corporation uses the same credit policies in making such commitments
            and
            conditional obligations as it does for on-balance-sheet instruments.
            The
            following table identifies the contract or notional amount of those instruments:
  **December
                      31,****2005**
                  
                  **2004****(In
                      Thousands)**
 
 Financial
                      instruments whose contract amounts represent credit risk:Commitments
                      to extend credit
                  
                  **$41,342**
                  
                  $34,054Standby
                      letters of credit
                  
                  **399**
                  
                  379Financial
                      standby letters of credit
                  
                  **3,768**
                  
                  4,050
 
  *7*
 
 ***Commercial
                  National Financial Corporation***
 **Notes
                  to Consolidated Financial Statements**
  **Note
            7 - Financial Instruments with Off-Balance Sheet Risk (Continued)**
  Commitments
            to extend credit are agreements to lend to a customer as long as there
            is no
            violation of any condition established in the contract. Commitments generally
            have fixed expiration dates or other termination clauses and may require
            payment
            of a fee. Since many of the commitments are expected to expire without
            being
            drawn upon, the total commitment amounts do not necessarily represent
            future
            cash requirements. The Corporation evaluates each customer's credit worthiness
            on a case-by-case basis. The amount of collateral obtained, if deemed
            necessary
            by the Corporation upon extension of credit, is based on management's
            credit
            evaluation of the counter party. Collateral held varies but may include
            accounts
            receivable, inventory, property, plant and equipment and income-producing
            commercial properties.
  Outstanding
            letters of credit written are conditional commitments issued by the Corporation
            to secure the performance of a customer to a third party. The majority
            of these
            standby letters of credit expire within the next twelve months. The credit
            risk
            involved in issuing letters of credit is essentially the same as that
            involved
            in extending other loan commitments. The Corporation requires collateral
            supporting these letters of credit as deemed necessary. The maximum undiscounted
            exposure related to these commitments at December 31, 2005 was
            $4,167,000
            and the approximate value of underlying collateral upon liquidation that
            would
            be expected to cover this maximum potential exposure was $3,888,000.
            The amount
            of the liability as of December 31, 2005 and 2004 for guarantees
            under
            standby letters of credit issued is not material.
  
 **Note
            8 - Premises and Equipment**
  The
            composition of premises and equipment at December 31, 2005 and
            2004 is as
            follows:
  **2005**
                  
                  **2004****(In
                      Thousands)**
 
 Land
                  
                  **$
                      437**
                  
                  $
                      437Premises
                  
                  **5,789**
                  
                  5,789Leasehold
                      improvements
                  
                  **229**
                  
                  229Furniture
                      and equipment
                  
                  **6,491**
                  
                  6,488**12,946**
                  
                  12,943Accumulated
                      depreciation and amortization
                  
                  **(8,645)**
                  
                  (8,299)
 
 **$
                      4,301**
                  
                  $
                      4,644
 
 Depreciation
            and amortization expense was $664,000, $760,000, and $683,000 for the
            years
            ended December 31, 2005, 2004 and 2003, respectively.
   *7*
 
 ***Commercial
                  National Financial Corporation***
 **Notes
                  to Consolidated Financial Statements**
  **Note
            9 - Interest Bearing Deposits**
  Interest
            bearing deposits include time deposits issued in denominations of $100,000
            or
            more which amounted to $26,360,000, and $22,397,000 at December 31,
            2005
            and 2004, respectively.
  Interest
            bearing deposits at December 31, 2005 and 2004 are detailed as
            follows:
  **2005**
                  
                  **2004****(In
                      Thousands)**
 
 Savings
                      accounts
                  
                  **$
                      45,379**
                  
                  $
                      50,840NOW
                      accounts
                  
                  **21,561**
                  
                  22,182Money
                      market accounts
                  
                  **28,820**
                  
                  32,901Time
                      deposits
                  
                  **112,224**
                  
                  97,611
 
 **$207,984**
                  
                  $203,534
 
 Time
            deposits at December 31, 2005 had the following scheduled maturities
            (in
            thousands):
  2006
                  
                  **$
                      41,695**2007
                  
                  **24,285**2008
                  
                  **25,235**2009
                  
                  **14,426**2010
                  
                  **6,583**
 
 **$112,224**
 
 **Note
            10 - Short-Term Borrowings**
  Short-term
            borrowings at December 31, 2005 and 2004 were as follows:
  **December
                      31,****2005**
                  
                  **2004****(In
                      Thousands)**
 
 Federal
                      funds purchased
                  
                  **$
                      -**
                  
                  $2,950FHLB
                      borrowings
                  
                  **-**
                  
                  5,000**$
                      -**
                  
                  $7,950
 
 
  *7*
 
 ***Commercial
                  National Financial Corporation***
 **Notes
                  to Consolidated Financial Statements**
  **Note
            10 - Short-Term Borrowings (Continued)**
  The
            outstanding balances and related information of short-term borrowings
            are
            summarized as follows:
  **Years
                      Ended December 31,****2005**
                  
                  **2004****(Dollars
                      in Thousands)**
 
 Average
                      balance during the year
                  
                  **$1,501**
                  
                  $10,505Average
                      interest rate during the year
                  
                  **2.60%**
                  
                  1.52%Maximum
                      month-end balance
                  
                  **$9,519**
                  
                  $48,650Weighted
                      average interest rate at end of the year
                  
                  **-%**
                  
                  2.31%
 
 At
            December 31, 2005, the Corporation had approved but unused funding
            availability from lines of credit of $30,000,000.
  
 **Note
            11 - Long-Term Borrowings**
  There
            were no long-term borrowings outstanding at December 31, 2005
            and 2004. In
            September 2004, the Corporation repaid $55,000,000 of FHLB advances with
            proceeds from sales of securities. The repayment of these advances resulted
            in a
            prepayment penalty of $4,402,000.
  Advances
            from the FHLB of Pittsburgh are secured by the Bank’s stock in the FHLB of
            Pittsburgh, qualifying residential mortgage loans, U.S. Government securities,
            U.S. agency securities and mortgage-backed securities. The maximum borrowing
            capacity from the FHLB at December 31, 2005 is $185,294,000.
  
 **Note
            12 - Employee Benefit Plans**
  The
            Corporation sponsors an employee profit sharing plan available to all
            employees
            with at least one year of service. The Corporation contributes to the
            plan, as
            determined by the Board of Directors, in an amount not to exceed 15%
            of
            compensation of eligible participants. The Corporation also has a supplemental
            retirement plan for certain retired employees. The expense for the employee
            benefit plans was $254,000, $249,000, and $628,000 for the years ended
            December 31, 2005, 2004 and 2003, respectively. Expenses in 2005
            and 2004
            were lower due to a lesser allocation by the Board of Directors than
            what was
            allocated in prior years.
   *7*
 
 ***Commercial
                  National Financial Corporation***
 **Notes
                  to Consolidated Financial Statements**
  **Note
            13 - Comprehensive Income (Loss)**
  Accounting
            principles generally require that recognized revenue, expenses, gains
            and losses
            be included in net income. Although certain changes in assets and liabilities,
            such as unrealized gains and losses on available for sale securities,
            are
            reported as a separate component of the equity section of the balance
            sheet,
            such items, along with net income, are components of comprehensive
            income.
  The
            components of other comprehensive income (loss) and related tax effects
            for the
            years ended December 31, 2005, 2004 and 2003 are as follows:
  **2005**
                  
                  **2004**
                  
                  **2003****(In
                      Thousands)**
 
 Gross
                      change in unrealized gains (losses)
                    on
                      securities available for sale
                  
                  **$(2,235)**
                  
                  $(1,311)
                  
                  $(1,710)Less
                      reclassification adjustment for gains realized in income
                  
                  **-**
                  
                  (1,195)
                  
                  (9)**Net
                      Unrealized Losses**
                  
                  **(2,235)**
                  
                  (2,506)
                  
                  (1,719)Tax
                      effect
                  
                  **(760)**
                  
                  (852)
                  
                  (584)**Net
                      of Tax Amount**
                  
                  **$(1,475)**
                  
                  $(1,654)
                  
                  $(1,135)
 
 **Note
            14 - Lease Commitments**
  The
            Corporation rents offices under operating leases that expire through
            2016. Lease
            expense amounted to $140,000, $121,000, and $116,000 in fiscal years
            2005, 2004,
            and 2003, respectively. Maturities of operating lease obligations at
            December 31, 2005 are as follows (in thousands):
  2006
                  
                  
                  **$120**2007
                  
                  
                  **76**2008
                  
                  
                  **69**2009
                  
                  
                  **51**2010
                  
                  
                  **41**Thereafter
                  
                  
                  **164**
 
  *7*
 
 ***Commercial
                  National Financial Corporation***
 **Notes
                  to Consolidated Financial Statements**
  **Note
            15 - Income Taxes**
  The
            components of the net deferred tax liability at December 31, 2005
            and 2004
            are as follows:
  **2005**
                  
                  **2004****(In
                      Thousands)**
 
 Allowance
                      for loan losses
                  
                  **$233**
                  
                  $357Accrued
                      benefits
                  
                  **78**
                  
                  87Other
                  
                  **2**
                  
                  66Alternative
                      minimum tax
                  
                  **-**
                  
                  265**Total
                      Deferred Tax Assets**
                  
                  **313**
                  
                  775Deferred
                      loan fees
                  
                  **76**
                  
                  76Securities
                      accretion
                  
                  **51**
                  
                  60Unrealized
                      net gain on securities available for sale
                  
                  **317**
                  
                  1,077Depreciation
                  
                  **133**
                  
                  156**Total
                      Deferred Tax Liabilities**
                  
                  **577**
                  
                  1,369**Net
                      Deferred Tax Liability**
                  
                  **$(264)**
                  
                  $
                      (594)
 
 The
            income tax provision for the years ended December 31, 2005, 2004
            and 2003
            is summarized as follows:
  **2005**
                  
                  **2004**
                  
                  **2003****(In
                      Thousands)**
 
 Current
                  
                  **$
                      787**
                  
                  $
                      230
                  
                  $552Deferred
                  
                  **430**
                  
                  (439)
                  
                  285**$1,217**
                  
                  $(209)
                  
                  $837
 
 The
            tax
            provision for financial reporting purposes differs from the amount computed
            by
            applying the statutory federal income tax rate of 34% to income before
            income
            taxes. The differences for the years ended December 31, 2005,
            2004 and 2003
            are as follows:
  **2005**
                  
                  **2004**
                  
                  **2003****(In
                      Thousands)**
 
 Tax
                      at statutory rates
                  
                  **$1,562**
                  
                  $140
                  
                  $1,495Increase
                      (decrease) resulting from:Tax-exempt
                      income
                  
                  **(219)**
                  
                  (317)
                  
                  (663)Non-deductible
                      interest expense
                  
                  **18**
                  
                  31
                  
                  60Increase
                      in investment in life insurance
                  
                  **(154)**
                  
                  (156)
                  
                  (170)Writedown
                      of non-deductible goodwill
                  
                  **-**
                  
                  47
                  
                  128Other
                  
                  **10**
                  
                  46
                  
                  (13)**$1,217**
                  
                  $(209)
                  
                  $
                      837
 
  *7*
 
 ***Commercial
                  National Financial Corporation***
 **Notes
                  to Consolidated Financial Statements**
  **Note
            16 - Fair Value of Financial Instruments**
  Below
            are
            various estimated fair values at December 31, 2005 and 2004, as
            required by
            Statement of Financial Accounting Standards No. 107 (FAS 107). Such information,
            which pertains to the Corporation’s financial instruments, is based on the
            requirements set forth in FAS 107 and does not purport to represent the
            aggregate net fair value of the Corporation. It is the Corporation’s general
            practice and intent to hold its financial instruments to maturity, except
            for
            certain securities designated as securities available for sale, and not
            to
            engage in trading activities. Many of the financial instruments lack
            an
            available trading market, as characterized by a willing buyer and seller
            engaging in an exchange transaction. Therefore, the Corporation had to
            use
            significant estimations and present value calculations to prepare this
            disclosure.
  Changes
            in the assumptions or methodologies used to estimate fair values may
            materially
            affect the estimated amounts. Also, management is concerned that there
            may not
            be reasonable comparability between institutions due to the wide range
            of
            permitted assumptions and the methodologies in absence of active markets.
            This
            lack of uniformity gives rise to a high degree of subjectivity in estimating
            financial instrument fair values.
  The
            following methods and assumptions were used by the Corporation in estimating
            financial instrument fair values:
  **Cash
            and Short-Term Investments**
  The
            carrying amounts for cash and short-term investments approximate the
            estimated
            fair values of such assets.
  **Securities**
  Fair
            values for securities available for sale are based on quoted market prices,
            if
            available. If quoted market prices are not available, fair values are
            based on
            quoted market prices of comparable instruments.
  **Restricted
            Investments in Bank Stock**
  The
            carrying amounts of restricted investments in bank stock approximate
            the
            estimated fair value of such assets.
  **Loans
            Receivable**
  Fair
            values of variable rate loans subject to frequent repricing and which
            entail no
            significant credit risk are based on the carrying values. The estimated
            fair
            values of other loans are estimated by discounting the future cash flows
            using
            interest rates currently offered for loans with similar terms to borrowers
            of
            similar credit quality.
  **Deposits**
  For
            deposits which are payable on demand at the reporting date, representing
            all
            deposits other than time deposits, management estimated that the carrying
            value
            of such deposits is a reasonable estimate of fair value. Fair values
            of time
            deposits are estimated by discounting the future cash flows using interest
            rates
            currently being offered and a schedule of aggregate expected
            maturities.
  **Short-Term
            Borrowings**
  The
            carrying amounts for short-term borrowings approximate the estimated
            fair value
            of such liabilities.
   *7*
 
 ***Commercial
                  National Financial Corporation***
 **Notes
                  to Consolidated Financial Statements**
  **Note
            16 - Fair Value of Financial Instruments (Continued)**
  **Accrued
            Interest Receivable and Payable**
  The
            carrying amount of accrued interest receivable and payable is considered
            a
            reasonable estimate of fair value.
  **Off-Balance
            Sheet Instruments**
  The
            fair
            value of commitments to extend credit and for outstanding letters of
            credit is
            estimated using the fees currently charged to enter into similar agreements,
            taking into account market interest rates, the remaining terms and present
            credit worthiness of the counterparties.
  The
            carrying amounts and fair values of the Corporation’s financial instruments as
            of December 31 are presented in the following table:
  **December
                      31, 2005**
                  
                  **December
                      31, 2004****Carrying
                      Amount**
                  
                  **Fair**
                    **Value**
                  
                  **Carrying
                      Amount**
                  
                  **Fair**
                    **Value****(In
                      Thousands)**
 
 Financial
                      assets:Cash
                      and short-term investments
                  **$
                      29,831**
                  
                  **$
                      29,831**
                  
                  $
                      7,786
                  
                  $
                      7,786Securities
                      available for sale
                  **66,117**
                  
                  **66,117**
                  
                  99,455
                  
                  99,455Restricted
                      investments in bank stock
                  **1,013**
                  
                  **1,013**
                  
                  1,806
                  
                  1,806Net
                      loans receivable
                  **205,403**
                  
                  **201,516**
                  
                  190,400
                  
                  190,557Accrued
                      interest receivable
                  **862**
                  
                  **862**
                  
                  968
                  
                  968
 
 Financial
                      liabilities:Deposits
                  **$277,009**
                  
                  **$275,109**
                  
                  $265,818
                  
                  $264,852Short-term
                      borrowings
                  **-**
                  
                  **-**
                  
                  7,950
                  
                  7,950Accrued
                      interest payable
                  **854**
                  
                  **854**
                  
                  688
                  
                  688Off-balance
                      sheet financial instruments
                  **-**
                  
                  **-**
                  
                  -
                  
                  -
 
 **Note
            17 - Related Party Transactions**
  Some
            of
            the Corporation's or the Bank’s directors, principal officers, and their related
            interests had transactions with the Bank in the ordinary course of business.
            All
            loans and loan commitments in such transactions were made on substantially
            the
            same terms, including collateral and interest rates, as those prevailing
            at the
            time for comparable transactions with others. In the opinion of management,
            these transactions with others do not involve more than normal risk of
            collectibility or present other unfavorable features. It is anticipated
            that
            further such extensions of credit will be made in the future. The aggregate
            amount of credit extended to these directors and principal officers was
            approximately $769,000 and $902,000 at December 31, 2005 and 2004,
            respectively.
   *7*
 
 ***Commercial
                  National Financial Corporation***
 **Notes
                  to Consolidated Financial Statements**
  **Note
            17 - Related Party Transactions (Continued)**
  The
            following is an analysis of loans to those parties whose loan balances
            exceeded
            $60,000 during the year ended December 31, 2005 (in thousands):
  Balances
                      at January 1
                  
                  
                  
                  **$179**Advances
                  
                  
                  
                  **190**Repayments
                  
                  
                  
                  **(23)**Balances
                      at December 31
                  
                  
                  
                  **$346**
 
 **Note
            18 - Capital Requirements and Regulatory Restrictions**
  The
            Bank
            is subject to legal limitations on the amount of dividends that can be
            paid to
            the Corporation. The Pennsylvania Banking Code restricts the payment
            of
            dividends, generally to the extent of its retained earnings.
  The
            Corporation and the Bank are subject to various regulatory capital requirements
            administered by the federal banking agencies. Failure to meet minimum
            capital
            requirements can initiate certain mandatory and possibly additional
            discretionary actions by regulators that, if undertaken, could have a
            direct
            material effect on the consolidated financial statements. Under capital
            adequacy
            guidelines and the regulatory framework for prompt corrective action,
            the
            Corporation and the Bank must meet specific capital guidelines that involve
            quantitative measures of the assets, liabilities and certain off-balance-sheet
            items as calculated under regulatory accounting practices. The capital
            amounts
            and classification are also subject to qualitative judgments by the regulators
            about components, risk-weighting and other factors.
  Quantitative
            measures established by regulation to ensure capital adequacy require
            the
            maintenance of minimum amounts and ratios (set forth in the tables below)
            of
            total and Tier 1 capital (as defined in the regulations) to risk-weighted
            assets
            (as defined) and of Tier 1 Capital (as defined) to average assets (as
            defined).
            Management believes, as of December 31, 2005, that the Corporation
            and the
            Bank meet all capital adequacy requirements to which they are subject.
  As
            of
            December 31, 2005, the most recent notification from the regulatory
            agencies categorized the Bank as well capitalized under the regulatory
            framework
            for prompt corrective action. To be categorized as well capitalized,
            the Bank
            must maintain minimum total risk-based, Tier 1 risk-based and Tier 1
            leverage
            ratios as set forth in the table below. There are no conditions or events
            since
            those notifications that management believes have changed those
            categories.
   *7*
 
 ***Commercial
                  National Financial Corporation***
 **Notes
                  to Consolidated Financial Statements**
  **Note
            18 - Capital Requirements and Regulatory Restrictions (Continued)**
  The
            following table presents the risk-based and leverage capital amounts
            and ratios
            at December 31, 2005 and 2004 for the Corporation and the
            Bank:
  **Actual**
                  
                  **For
                      Capital Adequacy Purposes**
                  
                  **To
                      be Well Capitalized Under Prompt Corrective Action
                      Provisions****Amount**
                  
                  **Ratio**
                  
                  **Amount**
                  
                  **Ratio**
                  
                  **Amount**
                  
                  **Ratio****(Dollars
                      in Thousands)**
 
 **As
                      of December 31, 2005**Total
                      capital (to risk-weighted assets):Commercial
                      National Financial Corp.
                  
                  **$44,046**
                  
                  **22.3**
                  **%**
                  **$****3****15,825**
                  
                  **3****8.0**
                  **%**
                  **N/A**
                  
                  **3****10.0**Commercial
                      Bank
                  
                  **44,038**
                  
                  **22.3**
                  
                  **3****15,823**
                  
                  **3****8.0**
                  
                  **3****19,780**
                  
                  **3****10.0**
                  **%**Tier
                      1 capital (to risk-weighted assets):Commercial
                      National Financial Corp.
                  
                  **42,410**
                  
                  **21.4**
                  
                  **3****7,912**
                  
                  **3****4.0**
                  
                  **N/A**
                  
                  **3****6.0**Commercial
                      Bank
                  
                  **42,402**
                  
                  **21.4**
                  
                  **3****7,912**
                  
                  **3****4.0**
                  
                  **3****11,868**
                  
                  **3****6.0**Tier
                      1 capital (to average assets):Commercial
                      National Financial Corp.
                  
                  **42,410**
                  
                  **13.3**
                  
                  **3****12,757**
                  
                  **3****4.0**
                  
                  **N/A**
                  
                  **3****5.0**Commercial
                      Bank
                  
                  **42,402**
                  
                  **13.3**
                  
                  **3****12,757**
                  
                  **3****4.0**
                  
                  **3****15,947**
                  
                  **3****5.0**
 
 
 **As
                      of December 31, 2004**Total
                      capital (to risk-weighted assets):Commercial
                      National Financial Corp.
                  
                  $43,692
                  
                  23.7
                  **%**
                  $314,733
                  
                  38.0
                  **%**
                  N/ACommercial
                      Bank
                  
                  43,678
                  
                  23.7
                  
                  314,740
                  
                  38.0
                  
                  $318,425
                  
                  310.0
                  **%**Tier
                      1 capital (to risk-weighted assets):Commercial
                      National Financial Corp.
                  
                  41,836
                  
                  22.7
                  
                  37,367
                  
                  34.0
                  
                  N/ACommercial
                      Bank
                  
                  41,822
                  
                  22.7
                  
                  37,370
                  
                  34.0
                  
                  311,055
                  
                  36.0Tier
                      1 capital (to average assets):Commercial
                      National Financial Corp.
                  
                  41,836
                  
                  13.0
                  
                  312,899
                  
                  34.0
                  
                  N/ACommercial
                      Bank
                  
                  41,822
                  
                  13.0
                  
                  312,857
                  
                  34.0
                  
                  316,072
                  
                  35.0
 
 
 
  *7*
 
 ***Commercial
                  National Financial Corporation***
 **Notes
                  to Consolidated Financial Statements**
  **Note
            19 - Condensed Financial Information of Commercial National Financial
            Corporation (Parent Only)**
  **Statements
            of Financial Condition**
  **December
                      31,****2005**
                  
                  **2004****(In
                      Thousands)**
 
 **Assets**Investment
                      in bank subsidiary
                  
                  **$43,652**
                  
                  $44,645Investment
                      in other subsidiaries
                  
                  **32**
                  
                  32Other
                      assets
                  
                  **21**
                  
                  10**Total
                      Assets**
                  
                  **$43,705**
                  
                  $44,687**Liabilities
                      and Shareholders’ Equity**Liabilities
                  
                  **$
                      44**
                  
                  $
                      27Shareholders’
                      equity
                  
                  **43,661**
                  
                  44,660**Total
                      Liabilities and Shareholders’ Equity**
                  
                  **$43,705**
                  
                  $44,687
 
 **Statements
            of Income**
  **Years
                      Ended December 31,****2005**
                  
                  **2004**
                  
                  **2003****(In
                      Thousands)**
 
 Dividends
                      from subsidiaries
                  
                  **$2,901**
                  
                  $3,977
                  
                  $6,025Other
                  
                  
                  
                  3
                  
                  5Net
                      securities gains
                  
                  **-**
                  
                  29
                  
                  9Fees
                      from bank subsidiary
                  
                  **418**
                  
                  493
                  
                  278Expenses
                  
                  **(409)**
                  
                  (501)
                  
                  (281)**2,910**
                  
                  4,001
                  
                  6,036Income
                      taxes
                  
                  **15**
                  
                  -
                  
                  3**2,895**
                  
                  4,001
                  
                  6,033Equity
                      in (excess of) undistributed earnings of subsidiaries
                  
                  **482**
                  
                  (3,380)
                  
                  (2,472)**Net
                      Income**
                  
                  **$3,377**
                  
                  $
                      621
                  
                  $3,561
  *7*
 
 ***Commercial
                  National Financial Corporation***
 **Notes
                  to Consolidated Financial Statements**
  **Note
            19 - Condensed Financial Information of Commercial National Financial
            Corporation (Parent Only) (Continued)**
  **Statements
            of Cash Flows**
  **Years
                      Ended December 31,****2005**
                  
                  **2004**
                  
                  **2003****(In
                      Thousands)**
 
 **Cash
                      Flows from Operating Activities**Net
                      income
                  
                  **$3,377**
                  
                  $
                      621
                  
                  $3,561Adjustments
                      to reconcile net income to
                    net
                      cash provided by operating
                    activities:Net
                      security gains
                  
                  **-**
                  
                  (29)
                  
                  (9)Equity
                      in undistributed earnings of
                    subsidiaries
                  
                  **(482)**
                  
                  3,380
                  
                  2,472Issuance
                      of treasury stock for
                    compensation
                  
                  **-**
                  
                  -
                  
                  4Increase
                      in other assets
                  
                  **(11)**
                  
                  (10)
                  
                  -Increase
                      (decrease) in liabilities
                  
                  **17**
                  
                  (10)
                  
                  23**Net
                      Cash Provided by Operating Activities**
                  
                  **2,901**
                  
                  3,952
                  
                  6,051**Cash
                      Flows from Investing Activities**Purchase
                      of investment securities
                  
                  **-**
                  
                  -
                  
                  (833)Net
                      cash used in acquisition
                  
                  **-**
                  
                  -
                  
                  (100)Proceeds
                      from sale of securities
                  
                  **-**
                  
                  829
                  
                  43Investment
                      in subsidiaries
                  
                  **-**
                  
                  (991)
                  
                  (1,014)**Net
                      Cash Used in Investing Activities**
                  
                  **-**
                  
                  (162)
                  
                  (1,904)**Cash
                      Flows from Financing Activities**Dividends
                      paid
                  
                  **(2,901)**
                  
                  (3,423)
                  
                  (3,441)Purchase
                      of treasury stock
                  
                  **-**
                  
                  (421)
                  
                  (657)**Net
                      Cash Used in Financing Activities**
                  
                  **(2,901)**
                  
                  (3,844)
                  
                  (4,098)**Net
                      Increase (Decrease) in Cash**
                  
                  **-**
                  
                  (54)
                  
                  49**Cash
                      - Beginning**
                  
                  **-**
                  
                  54
                  
                  5**Cash
                      - Ending**
                  
                  **$
                      -**
                  
                  $
                      -
                  
                  $
                      54
 
 
 
  *7*
   ***Commercial
            National***
  ***Financial
            Corporation***
  Consolidated
            Financial Report
 
  December
            31, 2005
 
 
  
   **Table
            of Contents**
 
  **Page
            No.**
  **Consolidated
            Financial Statements:**
  Report
            of
            Independent Registered Public Accounting Firm  1
  Consolidated
            Statements of Financial Condition        
            2
  Consolidated
            Statements of Income         3
  Consolidated
            Statements of Shareholders’ Equity       4
  Consolidated
            Statements of Cash Flows        5
  Notes
            to
            Consolidated Financial Statements        6