**UNITED
      STATES**


**SECURITIES
      AND EXCHANGE COMMISSION**


**WASHINGTON,
      D. C. 20549**




**FORM
      10-Q**


**____________________________________**


(Mark
      One)





x
            QUARTERLY
                REPORT PURSUANT TO SECTION 13 OR 15(d) OF THESECURITIES
                EXCHANGE ACT OF 1934 for the quarterly period ended**March
                31, 2007**





OR





o
            TRANSITION
                REPORT PURSUANT TO SECTION 13 OR 15 (d) OF THESECURITIES
                EXCHANGE ACT OF 1934





For
      the
      transition period from ____________ to ____________





**Commission
                File No. 000-50426**





(Exact
                Name of Registrant as Specified in its
                Charter)





Pennsylvania
            
            38-3681905(State
                or Other Jurisdiction of Incorporation or Organization)
            (I.R.S.
                Employer Identification No.)





**90
                Highland Avenue, Bethlehem, PA**
            
            **18017**(Address
                of Principal Executive Office)
            
            (Zip
                Code)





Registrant’s
      Telephone Number, Including Area Code: **610-861-5000**





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





Indicate
      by check mark whether the registrant is a large accelerated filer, an
      accelerated filer, or a non-accelerated filer. See definition of “accelerated
      filer and large accelerated filer” in Rule 12b-2 of the Exchange Act. (Check
      one):





Large
                accelerated filer
            o
            Accelerated
                filer
            x
            Non-accelerated
                filer
            o





Indicate
      by check mark whether the registrant is a shell company as defined in Rule
      12b-2
      of the Exchange Act. YES
o NO
x








Indicate
      the number of shares outstanding of each of the issuer’s classes of common stock
      as of the latest practicable date : As
      of  April
      30, 2007, 27,585,177 shares
      of the Registrant’s common stock were outstanding.












**KNBT
      BANCORP, INC. AND SUBSIDIARIES**






**INDEX**






Page**PART
                  I - FINANCIAL INFORMATION**Item
                  1.
              Financial
                  Statements
              1Consolidated
                  Balance Sheets
              1Consolidated
                  Statements of IncomeConsolidated
                  Statement of Changes in Shareholders’ Equity
              3Consolidated
                  Statements of Cash Flows
              4Notes
                  to Interim Consolidated Financial Statements
              5Item
                  2.
              Management’s
                  Discussion and Analysis of Financial Condition and Results of
                  Operations
              15Item
                  3.
              Quantitative
                  and Qualitative Disclosures about Market Risk
              26Item
                  4.
              Controls
                  and Procedures
              27**PART
                  II - OTHER INFORMATION**Item
                  1.
              Legal
                  Proceedings
              27Item
                  1A.
              Risk
                  Factors
              27Item
                  2.
              Unregistered
                  Sales of Equity Securities and Use of Proceeds
              27Item
                  3.
              Defaults
                  Upon Senior Securities
              28Item
                  4.
              Submission
                  of Matters to a Vote of Security Holders
              28Item
                  5.
              Other
                  Information
              28Item
                  6.
              Exhibits
              28**Signatures**
              29







**PART
      I.**





**Item
      1.**  **Financial
      Statements**


**KNBT
      BANCORP, INC. AND SUBSIDIARIES**


**CONSOLIDATED
      BALANCE
      SHEETS**




March
                31,
            
            December
                31,*(dollars
                in thousands, except share data)*
            
            2007
            
            2006(unaudited)**ASSETS**Cash
                and due from banks
            
            $
            49,396
            
            $
            53,202Interest-bearing
                deposits with banks
            
            
            1,984
            
            
            2,171Federal
                funds sold
            
            
            38,250
            
            
            4,800Cash
                and cash equivalents
            
            
            89,630
            
            
            60,173Investment
                securities available-for-sale
            
            
            741,291
            
            
            858,854Investment
                securities held to maturity(Fair
                value of $32,162 at March 31, 2007 and $33,048 December 31,
                2006)
            
            
            32,452
            
            
            33,532FHLBank
                Pittsburgh stock
            
            
            27,996
            
            
            30,724Mortgage
                loans held-for-sale
            
            
            605
            
            
            1,994Loans
            
            
            1,721,439
            
            
            1,620,166Less:
                Allowance for loan losses
            
            
            (16,667
            )
            
            (17,044
            )Net
                loans
            
            
            1,704,772
            
            
            1,603,122Bank
                owned life insurance
            
            
            79,222
            
            
            78,361Premises
                and equipment, net
            
            
            47,992
            
            
            48,228Accrued
                interest receivable
            
            
            9,777
            
            
            10,293Goodwill
            
            
            106,996
            
            
            105,854Other
                intangible assets, net
            
            
            28,377
            
            
            29,387Other
                assets
            
            
            37,719
            
            
            38,305TOTAL
                ASSETS
            
            $
            2,906,829
            
            $
            2,898,827**LIABILITIES**Non-interest-bearing
                deposits
            
            $
            200,350
            
            $
            206,972Interest-bearing
                deposits
            
            
            1,739,775
            
            
            1,700,575Total
                deposits
            
            
            1,940,125
            
            
            1,907,547Securities
                sold under agreements to repurchase
            
            
            78,103
            
            
            45,296Advances
                from the FHLBank of Pittstburgh
            
            
            457,992
            
            
            519,161Subordinated
                debt
            
            
            38,286
            
            
            38,406Accrued
                interest payable
            
            
            10,867
            
            
            11,924Other
                liabilities
            
            
            19,854
            
            
            20,467TOTAL
                LIABILITIES
            
            
            2,545,227
            
            
            2,542,801**SHAREHOLDERS'
                EQUITY**Preferred
                stock, par value $0.01 per share; authorized 20,000,000 shares, none
                issued
            
            
            -
            
            
            -Common
                stock, par value $0.01 a share; authorized 100,000,000 shares, 33,964,352
                and33,963,910
                shares issued at March 31, 2007 and December 31, 2006 ,
                respectively
            
            
            330
            
            
            330Additional
                paid-in capital
            
            
            339,204
            
            
            338,406Retained
                earnings, substantially restricted
            
            
            145,854
            
            
            142,519Treasury
                stock, at cost; 6,333,734 and 6,285,342 shares atMarch
                31, 2007 and December 31, 2006, respectively
            
            
            (101,963
            )
            
            (101,247
            )Unallocated
                common stock held by Employee Stock Ownership Plan
            
            
            (13,354
            )
            
            (13,556
            )Accumulated
                other comprehensive loss, net
            
            
            (8,469
            )
            
            (10,426
            )TOTAL
                SHAREHOLDERS' EQUITY
            
            
            361,602
            
            
            356,026TOTAL
                LIABILITIES AND SHAREHOLDERS' EQUITY
            
            $
            2,906,829
            
            $
            2,898,827The
                accompanying notes are an integral part of these financial
                statements.


1


**KNBT
      BANCORP, INC. AND SUBSIDIARIES**


**CONSOLIDATED
      STATEMENTS OF INCOME**





Three
                Months Ended March 31,*(dollars
                in thousands, except per share data)*
            
            2007
            
            2006(unaudited)**INTEREST
                INCOME**Loans,
                including fees
            
            $
            26,139
            
            $
            22,599Investment
                securities:Taxable
            
            
            10,822
            
            
            12,670Tax-exempt
            
            
            -
            
            
            777Other
                interest
            
            
            81
            
            
            225Total
                interest income
            
            
            37,042
            
            
            36,271**INTEREST
                EXPENSE**Deposits
            
            
            13,397
            
            
            9,789Securities
                sold under agreements to repurchase
            
            
            596
            
            
            595Advances
                from FHLBank Pittsburgh
            
            
            5,037
            
            
            6,514Subordinated
                debt
            
            
            711
            
            
            638Total
                interest expense
            
            
            19,741
            
            
            17,536**NET
                INTEREST INCOME**
            
            
            17,301
            
            
            18,735Provision
                for loan losses
            
            
            -
            
            
            750Net
                interest income after provision for loan losses
            
            
            17,301
            
            
            17,985**NON-INTEREST
                INCOME**Trust
                revenue
            
            
            1,434
            
            
            1,063Brokerage
                services revenue
            
            
            941
            
            
            857Benefit
                services revenue
            
            
            1,478
            
            
            1,277Insurance
                services revenue
            
            
            811
            
            
            648Deposit
                service charges
            
            
            1,607
            
            
            1,400Lending
                fees
            
            
            312
            
            
            270Check
                card/ATM card fees
            
            
            859
            
            
            786Bank
                owned life insurance
            
            
            861
            
            
            774Net
                gain on sale of investment securities
            
            
            536
            
            
            138Net
                gain on sale of residential mortgage loans
            
            
            118
            
            
            48Net
                loss on sale of other assets
            
            
            (10
            )
            
            -Net
                loss on sale of other real estate owned
            
            
            -
            
            
            (7
            )Net
                gain on extinguishment of debt
            
            
            -
            
            
            1,179Other
                non-interest operating income
            
            
            756
            
            
            648Total
                non-interest income
            
            
            9,703
            
            
            9,081**NON-INTEREST
                EXPENSE**Compensation
                and employee benefits
            
            
            11,214
            
            
            10,674Net
                occupancy and equipment expense
            
            
            2,977
            
            
            3,264Professional
                fees
            
            
            518
            
            
            762Advertising
            
            
            252
            
            
            414Data
                processing
            
            
            657
            
            
            613Telecommunication
            
            
            344
            
            
            344Office
                supplies and postage
            
            
            499
            
            
            587Amortization
                of mortgage servicing rights
            
            
            90
            
            
            100Amortization
                of intangible assets
            
            
            963
            
            
            892Other
                operating expenses
            
            
            1,461
            
            
            1,864Total
                non-interest expense
            
            
            18,975
            
            
            19,514Income
                before income taxes
            
            
            8,029
            
            
            7,552Income
                tax expense
            
            
            2,543
            
            
            2,072NET
                INCOME
            
            $
            5,486
            
            $
            5,480**PER
                SHARE DATA**Net
                income- basic
            
            $
            0.21
            
            $
            0.20Net
                income- diluted
            
            $
            0.21
            
            $
            0.19Cash
                dividends per common share
            
            $
            0.08
            
            $
            0.07The
                accompanying notes are an integral part of these financial
                statements.




2


**KNBT
      BANCORP, INC. AND SUBSIDIARIES**


**CONSOLIDATED
      STATEMENT OF CHANGES IN
      SHAREHOLDERS’ EQUITY**





Three
                Months Ended March 31,***(dollars
                in thousands, except share data)***
            
            2007
            
            2006(unaudited)Common
                stock number of sharesBeginning
                balance
            
            
            33,166,591
            
            
            33,080,609Allocated
                Employee Stock Ownership Plan shares
            
            
            11,900
            
            
            11,900Shares
                issued upon exercise of stock options
            
            
            442
            
            
            740Ending
                balance
            
            
            33,178,933
            
            
            33,093,249Treasury
                stock number of sharesBeginning
                balance
            
            
            (6,285,342
            )
            
            (3,861,000
            )Repurchase
                of common stock
            
            
            (48,392
            )
            
            (937,900
            )Ending
                balance
            
            
            (6,333,734
            )
            
            (4,798,900
            )Common
                stock valueBeginning
                balance
            
            $
            330
            
            $
            330Shares
                issued upon exercise of stock options
            
            
            -
            
            
            -Ending
                balance
            
            
            330
            
            
            330Additional
                paid in capitalBeginning
                balance
            
            
            338,406
            
            
            342,144Reclass
                of unearned compensation upon adoption of SFAS 123R
            
            
            -
            
            
            (7,130
            )Unallocated
                Employee Stock Ownership Plan shares
            
            
            (27
            )
            
            (17
            )Shares
                issued upon exercise of stock options
            
            
            2
            
            
            5Share-based
                compensation expense
            
            
            302
            
            
            277Amortization
                of compensation related to the Management Recognition and Retention
                Plan
            
            
            521
            
            
            533Ending
                balance
            
            
            339,204
            
            
            335,812Retained
                earnings, substantially restrictedBeginning
                balance
            
            
            142,519
            
            
            127,471Net
                income
            
            
            5,486
            
            
            5,480Cash
                dividends paid
            
            
            (2,151
            )
            
            (2,006
            )Ending
                balance
            
            
            145,854
            
            
            130,945Unallocated
                common stock held by the Employee Stock Ownership PlanBeginning
                balance
            
            
            (13,556
            )
            
            (14,366
            )Allocation
                of Employee Stock Ownership Plan stock
            
            
            202
            
            
            202Ending
                balance
            
            
            (13,354
            )
            
            (14,164
            )Unearned
                common stock held by the Management Recognition and Retention
                PlanBeginning
                balance
            
            
            -
            
            
            (7,130
            )Reclass
                of unearned compensation upon adoption of SFAS 123R
            
            
            -
            
            
            7,130Ending
                balance
            
            
            -
            
            
            -Accumulated
                other comprehensive income (loss)Beginning
                balance
            
            
            (10,426
            )
            
            (9,898
            )Other
                comprehensive income (loss) net of taxes and reclassification
                adjustments
            
            
            1,957
            
            
            (6,007
            )Ending
                balance
            
            
            (8,469
            )
            
            (15,905
            )Treasury
                stockBeginning
                balance
            
            
            (101,247
            )
            
            (61,999
            )Repurchase
                of common stock
            
            
            (716
            )
            
            (15,246
            )Ending
                balance
            
            
            (101,963
            )
            
            (77,245
            )Total
                Shareholders' Equity
            
            $
            361,602
            
            $
            359,773The
                accompanying notes are an integral part of these financial
                statements.


3


**KNBT
      BANCORP, INC. AND SUBSIDIARIES**


**CONSOLIDATED
      STATEMENTS OF CASH FLOWS**





Three
                Months Ended March 31,*(dollars
                in thousands)*
            
            2007
            
            2006(unaudited)**OPERATING
                ACTIVITIES:**Net
                income
            
            $
            5,486
            
            $
            5,480Adjustments
                to reconcile net income to net cash provided by operating
                activities:Provision
                for loan losses
            
            
            -
            
            
            750Depreciation
                and amortization
            
            
            2,244
            
            
            2,277Compensation
                expense, stock option plan
            
            
            302
            
            
            277Management
                Recognition and Retention Plan expense
            
            
            521
            
            
            533ESOP
                expense
            
            
            175
            
            
            185Amortization
                and accretion of securities premiums and discounts, net
            
            
            (83
            )
            
            (40
            )Loss
                on sale of other real estate owned
            
            
            -
            
            
            7Gain
                on sales of investment securities, net
            
            
            (536
            )
            
            (138
            )Loss
                on sale of other assets
            
            
            10
            
            
            -Gain
                on sale of mortgage loans
            
            
            (118
            )
            
            (48
            )Gain
                on extinguishment of debt
            
            
            -
            
            
            (1,179
            )Mortgage
                loans originated for sale
            
            
            (8,912
            )
            
            (5,138
            )Mortgage
                loan sales
            
            
            10,419
            
            
            5,742Changes
                in assets and liabilities:Increase
                in bank owned life insurance
            
            
            (861
            )
            
            (774
            )Decrease
                in accrued interest receivable
            
            
            516
            
            
            294Increase
                in other assets
            
            
            (950
            )
            
            (2,051
            )Decrease
                in other liabilities and accrued interest payable
            
            
            (2,570
            )
            
            (556
            )Net
                cash provided by operating activities
            
            
            5,643
            
            
            5,621**INVESTING
                ACTIVITIES:**Proceeds
                from calls and maturities of securities available-for-sale
            
            
            34,251
            
            
            44,555Proceeds
                from calls and maturities of securities held-to-maturity
            
            
            1,096
            
            
            2,356Proceeds
                from sales of securities available-for-sale
            
            
            87,667
            
            
            9,940Purchase
                of securities available-for-sale
            
            
            (741
            )
            
            (5,712
            )Purchase
                of FHLBank Pittsburgh stock
            
            
            -
            
            
            (342
            )Redemption
                of FHLBank Pittsburgh stock
            
            
            2,728
            
            
            4,172Net
                increase in loans
            
            
            (101,650
            )
            
            (9,144
            )Cash
                paid for acquisitions
            
            
            -
            
            
            (5,300
            )Cash
                and cash equivalents obtained through acquisitions
            
            
            -
            
            
            1,249Purchase
                of premises and equipment
            
            
            (1,112
            )
            
            (1,041
            )Proceeds
                from the sale of other assets
            
            
            185
            
            
            527Proceeds
                from the sale of other real estate owned
            
            
            -
            
            
            58Net
                cash provided by investing activities
            
            
            22,424
            
            
            41,318**FINANCING
                ACTIVITIES:**Net
                increase in deposits
            
            
            32,578
            
            
            23,108Net
                increase in repurchase agreements
            
            
            32,807
            
            
            45Payment
                on extinguishment of debt, net
            
            
            -
            
            
            (49,595
            )Proceeds
                from long-term debt
            
            
            -
            
            
            38,000Payments
                on long-term debt
            
            
            (61,130
            )
            
            (74,054
            )Purchase
                of treasury stock
            
            
            (716
            )
            
            (15,246
            )Proceeds
                from the exercise of stock options
            
            
            2
            
            
            5Cash
                dividends paid
            
            
            (2,151
            )
            
            (2,006
            )Net
                cash provided by (used in) financing activities
            
            
            1,390
            
            
            (79,743
            )Increase
                (decrease) in cash and cash equivalents
            
            
            29,457
            
            
            (32,804
            )Cash
                and cash equivalents January 1,
            
            
            60,173
            
            
            106,259Cash
                and cash equivalents March 31,
            
            $
            89,630
            
            $
            73,455Supplemental
                disclosure of cash flow informationCash
                paid during the period forIncome
                taxes
            
            $
            2,500
            
            $
            -Interest
                on deposits, advances and other borrowed money
            
            $
            20,798
            
            $
            16,285Supplemental
                disclosure of non-cash investing activitiesReclassification
                of loans receivable to other real estate owned
            
            $
            9
            
            $
            130The
                accompanying notes are an integral part of these financial
                statements.


4


**KNBT
      BANCORP, INC. AND SUBSIDIARIES**


**NOTES
      TO INTERIM CONSOLIDATED FINANCIAL STATEMENTS**(unaudited)








**NOTE
                A**
            **PRINCIPLES
                OF CONSOLIDATION AND BASIS OF
                PRESENTATION**




KNBT
        Bancorp, Inc. (“KNBT” or the “Company”) is a Pennsylvania corporation
        headquartered in Bethlehem, Pennsylvania. The Company is the registered bank
        holding company for Keystone Nazareth Bank & Trust Company (the “Bank”), a
        Pennsylvania-chartered savings bank.
 
 The
        accompanying consolidated financial statements were prepared in accordance
        with
        instructions to Form 10-Q, and therefore, do not include information or
        footnotes necessary for a complete presentation of financial position, results
        of operations and cash flows in conformity with generally accepted accounting
        principles used in the United States (“GAAP”). However, all normal, recurring
        adjustments that, in the opinion of management, are necessary for a fair
        presentation of these financial statements have been included. These financial
        statements should be read in conjunction with the audited consolidated financial
        statements and the notes thereto for the Company for the year ended December
        31,
        2006, which are included in the Company’s Annual Report on Form 10-K for the
        year ended December 31, 2006. The results for the interim periods presented
        are
        not necessarily indicative of the results that may be expected for the year
        ended December 31, 2007.
 
 The
        financial information presented herein is unaudited; however, in the opinion
        of
        management, all adjustments (which include normal recurring adjustments)
        necessary to present fairly the unaudited financial information have been
        made.
        The Company has prepared its accompanying consolidated financial statements
        in
        accordance with GAAP as applicable to the banking industry. Certain amounts
        in
        prior years are reclassified for comparability to the current year’s
        presentation. Such reclassifications, when applicable, have no effect on
        net
        income. The consolidated financial statements include the balances of the
        Company and its wholly owned subsidiaries. All material intercompany balances
        and transactions have been eliminated in consolidation. References to the
        Company include the Bank and its subsidiaries unless otherwise
        noted.
 
 In
        preparing the consolidated financial statements, the Company is required
        to make
        estimates and assumptions that affect the reported amounts of assets and
        liabilities as of the date of the statement of financial condition and revenue
        and expense for the period. The principal estimates that are particularly
        susceptible to significant change in the near term relate to the allowance
        for
        loan losses, the evaluation of impairment of goodwill and the evaluation
        of
        deferred tax asset. The evaluation of the adequacy of the allowance for loan
        losses includes an analysis of the individual loans and overall risk
        characteristics and size of the different loan portfolios, and takes into
        consideration current economic and market conditions, the capability of specific
        borrowers to pay specific loan obligations, as well as current loan collateral
        values. However, actual losses on specific loans, which also are encompassed
        in
        the analysis, may vary from estimated losses.
 
 In
        addition to the Bank, KNBT’s subsidiaries include KNBT Inv. I and KNBT Inv. II,
        and the Bank’s wholly owned subsidiaries KLVI, Inc., KLV, Inc., KNBT Settlement
        Services, LLC, Caruso Benefits Group, Inc. (“Caruso”), Higgins Insurance
        Associates, Inc. (“Higgins”), and KNBT Securities, Inc.




5


**NOTE
                B**
            **ACQUISITIONS**




**The
        Trust Company of Lehigh Valley**
  O n
        February 28, 2006, the Bank completed its acquisition of Paragon Group, Inc.
        (“Paragon”), the parent holding company for the Trust Company of Lehigh Valley
        (“TCLV”), a Pennsylvania-chartered non-depository bank located in Allentown,
        Pennsylvania. TCLV provided estate, personal trust and investment management
        services, estate and financial planning and employee retirement benefits
        administration and had approximately $400 million in assets under administration
        and management at the time of its acquisition by the Bank. Paragon and TCLV
        were
        merged into the Bank in connection with the completion of the acquisition.
        The
        results of the acquired trust operations have been included in KNBT’s results
        since March 1, 2006.
  Under
        the
        terms of the definitive merger agreement, the Bank acquired all of the capital
        stock of Paragon for a purchase price of $5.3 million in cash of which $4.3
        million was paid at time of closing and $1.0 million was held in escrow.
        As a
        result of satisfaction of certain conditions set forth in the merger agreement,
        50% of the escrow including interest earned was disbursed on February 28,
        2007.
        Assuming the remaining conditions are met, the balance will be paid upon
        the
        eighteenth-month anniversary of the completion of the acquisition of Paragon.
 
 The
        acquisition price resulted in the recording of $2.6 million in goodwill,
        which
        is the excess cost of the entity over the net of the amounts assigned to
        assets
        acquired and liabilities assumed and $2.6 million of other intangible assets.
        The intangible assets consist of $1.7 million for Paragon’s customer list,
        $610,000 for a restrictive covenant agreement with the principals of Paragon
        and
        $280,000 for employment agreements with the principals of Paragon. The
        amortization periods for the intangible assets are 15 years, 5 years and
        2.7
        years, respectively. Amortization expense relating to these assets was $91,000
        and $14,000 the three months ended March 31, 2007 and 2006,
        respectively.
  **Caruso
        Benefits Group, Inc.**
 
 On
        April
        1, 2005, the Bank acquired Caruso, a benefits management firm based in
        Bethlehem, Pennsylvania. Caruso specializes in benefits management with an
        emphasis on group medical, life and disability. Caruso’s results of operations
        have been included in KNBT’s results since the date of acquisition. Caruso
        operates as a wholly owned subsidiary of the Bank.
 
 Under
        the
        terms of the stock purchase agreement, the Bank acquired all of the capital
        stock of Caruso for a purchase price of $28.0 million in cash of which $20.0
        million was paid at the time of closing and $8.0 million will be payable
        over a
        three-year period, subject to Caruso maintaining certain levels of
        profitability. KNBT paid $2.7 million to Caruso during the second quarter
        of
        2006 that represented the aggregate obligation through September 30, 2006.
        The
        payment was made pursuant to the terms of the stock purchase agreement relating
        to the purchase price contingency.
 
 The
        acquisition resulted in the recording of approximately $13.1 million of
        goodwill. KNBT also recorded an identifiable intangible asset for Caruso’s
        customer list of $9.9 million that is being amortized on a straight line
        basis
        over 15 years. The expense related to the amortization of the identifiable
        intangible asset arising from the Caruso acquisition totaled $165,000 during
        each of the three-month periods ended March 31, 2007 and 2006.
 
 Additional
        information and disclosures concerning the Paragon and Caruso acquisitions
        can
        be found in the Company’s Form 10-K for the year ended December 31,
        2006.
 
 6




**NOTE
                C**
            **EARNINGS
                PER SHARE**





The
      Company calculates earnings per share as provided by the provisions of SFAS
      No.
      128, “Earnings Per Share” (SFAS No. 128). Basic and diluted earnings per share
      for the three months ended March 31, 2007 and 2006 were calculated as
      follows:





For
                the Three Months Ended March 31,2007
            
            2006Net
            
            Average
            
            
            
            Net
            
            AverageIncome
            
            Shares
            
            Per
                Share
            
            Income
            
            Shares
            
            Per
                Share*(in
                thousands, except per share data)*
            
            (numerator)
            
            (denominator)
            
            Amount
            
            (numerator)
            
            (denominator)
            
            AmountBasic
                earnings per shareIncome
                available to common shareholders
            
            $
            5,486
            
            
            26,311,289
            
            $
            0.21
            
            $
            5,480
            
            
            28,045,012
            
            $
            0.20Effect
                of dilutive securitiesStock
                options
            
            
            
            
            
            162,291
            
            
            -
            
            
            
            
            
            148,669
            
            
            -Management
                Recognition and Retention Plan shares
            
            
            
            
            
            112,467
            
            
            -
            
            
            
            
            
            232,053
            
            
            -Total
                effect of dilutive securities
            
            
            
            
            
            274,758
            
            
            -
            
            
            
            
            
            380,722
            
            
            (0.01
            )Diluted
                earnings per share
            
            
            
            
            
            
            
            
            -
            
            
            
            
            
            
            
            
            -Income
                available to common shareholdersplus
                assumed exercise of options
            
            $
            5,486
            
            
            26,586,047
            
            $
            0.21
            
            $
            5,480
            
            
            28,425,734
            
            $
            0.19




KNBT
        had
        outstanding stock options for the three months ended March 31, 2007 to purchase
        1,649,536 shares of common stock with exercise prices ranging from $15.82
        to
        $16.56 per share. These options were not included in the computation of diluted
        earnings per share because the option exercise price was greater than the
        average market price. At March 31, 2006, KNBT had options to purchase 1,242,392
        shares at $16.50 to $16.56 per share that were anti-dilutive.
 
 Common
        stock outstanding for the purpose of calculating basic earnings per share
        does
        not include 785,419 and 833,020 unallocated shares held by the Employee Stock
        Ownership Pan (“ESOP”) at March 31, 2007 and March 31, 2006, respectively. The
        exclusion of these unallocated shares held by the ESOP is in accordance with
        the
        provisions of Statement of Position (“SOP”) 93-6, “Employer’s Accounting for
        Employee Stock Ownership Plans”, issued by the Accounting Standards Division of
        the American Institute of Certified Public Accountants (“AICPA”).
 
 Unearned
        and uncommitted shares of common stock held in the Management Recognition
        and
        Retention Plan (“MRRP”) are not considered to be outstanding for basic earnings
        per share calculations. At March 31, 2007, unearned MRRP shares totaled 511,300
        and uncommitted MRRP shares totaled 45,747. At March 31, 2006, unearned MRRP
        shares totaled 505,600 and uncommitted MRRP shares totaled 176,547.
 7


**NOTE
                D**
            **INVESTMENT
                SECURITIES**





The
      amortized cost, unrealized gains and losses and fair value of KNBT’s investment
      securities held-to-maturity and available-for-sale at March 31, 2007 (unaudited)
      and December 31, 2006 are as follows:





At
                March 31, 2007Gross
            
            GrossAmortized
            
            Unrealized
            
            Unrealized
            
            Fair*(in
                thousands)*
            
            Cost
            
            Gains
            
            Losses
            
            ValueHeld
                to maturity:Mortgage-backed
                securities
            
            $
            32,452
            
            $
            -
            
            $
            (290
            )
            $
            32,162Total
                investments held to maturity
            
            
            32,452
            
            
            -
            
            
            (290
            )
            
            32,162Available
                for sale:U.S.
                Government and agencies
            
            
            64,401
            
            
            -
            
            
            (489
            )
            
            63,912Asset-managed
                funds
            
            
            4,960
            
            
            -
            
            
            (162
            )
            
            4,798Mortgage-backed
                securities
            
            
            655,972
            
            
            184
            
            
            (12,332
            )
            
            643,824Corporate
                and other debt securities
            
            
            26,746
            
            
            85
            
            
            (296
            )
            
            26,535Equity
                securities
            
            
            2,241
            
            
            52
            
            
            (71
            )
            
            2,222Total
                investments available for sale
            
            
            754,320
            
            
            321
            
            
            (13,350
            )
            
            741,291Total
                investment securities
            
            $
            786,772
            
            $
            321
            
            $
            (13,640
            )
            $
            773,453At
                December 31, 2006Gross
            
            
            GrossAmortized
            
            
            Unrealized
            
            
            Unrealized
            
            
            Fair*(in
                thousands)*
            
            
            Cost
            
            
            Gains
            
            
            Losses
            
            
            ValueHeld
                to maturity:Mortgage-backed
                securities
            
            $
            33,532
            
            $
            -
            
            $
            (484
            )
            $
            33,048Total
                investments held to maturity
            
            
            33,532
            
            
            -
            
            
            (484
            )
            
            33,048Available
                for sale:U.S.
                Government and agencies
            
            
            95,523
            
            
            2
            
            
            (949
            )
            
            94,576Asset-managed
                funds
            
            
            5,171
            
            
            -
            
            
            (167
            )
            
            5,004Mortgage-backed
                securities
            
            
            703,648
            
            
            439
            
            
            (15,595
            )
            
            688,492Corporate
                and other debt securities
            
            
            68,461
            
            
            277
            
            
            (100
            )
            
            68,638Equity
                securities
            
            
            2,091
            
            
            79
            
            
            (26
            )
            
            2,144Total
                investments available for sale
            
            
            874,894
            
            
            797
            
            
            (16,837
            )
            
            858,854Total
                investment securities
            
            $
            908,426
            
            $
            797
            
            $
            (17,321
            )
            $
            891,902




Unrealized
        losses are due primarily to changes in market interest rates and other temporary
        changes in market conditions. Management has reviewed the securities listed
        in
        the above tables and believes all unrealized losses to be
        temporary.
 
 
 **NOTE
                  E**
              **STOCK
                  BASED COMPENSATION**
 
 Stock
        Option Plans
 
 KNBT
        maintains the 2004 Stock Option Plan (“2004 Plan”), as well as the stock option
        plans from prior acquisitions. The 2004 Plan allows KNBT to grant options
        covering up to an aggregate of 2,020,118 shares of common stock to key employees
        and directors. The options have a term of up to ten years when they are issued
        and typically vest over a five-year period, except for some options granted
        to
        directors that vest over an eight-year period. The exercise price of each
        option
        is the market price of KNBT’s stock on the date of grant.
 8


On
      January 1, 2006, KNBT adopted SFAS No. 123(R) (revised 2004), “Share-Based
      Payment”. Statement 123(R) replaces SFAS No. 123, “Accounting for Stock-Based
      Compensation” and supersedes Accounting Principles Board (“APB”) Opinion No. 25,
“Accounting for Stock Issued to Employees”. SFAS No. 123(R) established
      accounting and disclosure requirements using a fair-value based method of
      accounting for stock-based employee compensation plans. Prior to January 1,
      2006, KNBT accounted for stock options using APB Opinion No. 25 and included
      disclosures of pro forma net income and earnings per share, as if the fair
      value-based method of accounting defined in SFAS No. 123 had been used. KNBT
      elected the modified prospective transition method for adopting SFAS No. 123(R).
      Under SFAS No. 123(R), all forms of share-based payments to employees, including
      stock options, are treated the same as other forms of compensation by
      recognizing the related cost in the income statement. The provisions apply
      to
      all awards granted after the required effective date as well as existing awards
      not vested, or which are modified, repurchased, or canceled after that
      date.





As
      of
      January 1, 2006, KNBT began to expense these grants as required by SFAS No.
      123(R). Stock-based employee compensation cost pertaining to stock options
      is
      reflected in net income with the fair value of each option being estimated
      as of
      the date of grant using the Black-Scholes option valuation model. The
      Black-Scholes model incorporates variable assumptions, which include: the
      expected volatility, which is based on the historical volatility of KNBT’s
      traded stock and peer group comparisons; the expected term calculated using
      the
      simplified method; the expected dividend yield based on historical patterns
      and
      peer group performance; and the risk free interest rate, based on the U.S.
      Treasury yield curve at the time of the grant. KNBT used historical data to
      estimate option exercises and forfeitures within the valuation model. KNBT
      used
      the following assumptions:


For
                  the Three Months EndedMarch
                  31,2007
              
              2006Expected
                  dividend yield
              
              2.50%
              
              2.50%Expected
                  volatility
              
              22.81%
              
              22.63%Range
                  of risk-free interest rates (1)
              
              4.87%
              
              4.31%
                  to 4.61%Range
                  of expected option lives (1)
              
              6.5
                  years
              
              6.5
                  to 7 yearsRange
                  of fair values (1)
              
              $4.05
              
              $3.77
                  to $3.85


During
        the quarters ended March 31, 2007 and 2006, KNBT issued 180,050 and 217,400
        new
        options, respectively, to certain employees and directors under the 2004
        Plan.
        These options vest ratably over a five-year period.
 
 A
        summary
        of all of the stock option plans as of March 31, 2007 and 2006 and changes
        during the quarters are as follows :


For
                the Three Months Ended March 31,2007
            
            2006Weighted
                Average
            
            
            
            Weighted
                AverageShares
            
            Exercise
                Price
            
            Shares
            
            Exercise
                PriceOutstanding
                as of beginning of year
            
            
            1,961,432
            
            $
            14.07
            
            
            1,796,338
            
            $
            13.58Issued
            
            
            180,050
            
            
            16.40
            
            
            217,400
            
            
            16.51Exercised
            
            
            (442
            )
            
            4.27
            
            
            (740
            )
            
            6.44Forfeited
            
            
            -
            
            
            -
            
            
            (5,000
            )
            
            16.37Expired
            
            
            -
            
            
            -
            
            
            -
            
            
            -Outstanding
                as of end of quarter
            
            
            2,141,040
            
            $
            14.27
            
            
            2,007,998
            
            $
            13.89Options
                exercisable as of end of quarter
            
            
            892,141
            
            $
            11.28
            
            
            678,378
            
            $
            8.98


9


The
      following table summarizes information concerning KNBT’s stock options
      outstanding and exercisable at March 31, 2007:





For
                the Three Months Ended March 31, 2007Options
                Outstanding
            
            Options
                ExercisableRange
                of
            
            Stock
                Options
            
            Weighted
                Average
            
            Stock
                Options
            
            Weighted
                AverageExercise
                Prices
            
            Outstanding
            
            Life
                (in Years)
            
            Exercise
                Price
            
            Exercisable
            
            Exercise
                Price$3.73
                - $4.35
            
            
            47,755
            
            
            4.09
            
            $
            4.20
            
            
            47,755
            
            $
            4.20$4.36
                - $6.37
            
            
            315,425
            
            
            4.72
            
            
            5.67
            
            
            315,425
            
            
            5.67$6.38
                - $8.36
            
            
            61,380
            
            
            4.79
            
            
            6.72
            
            
            61,380
            
            
            6.72$11.35
                - $16.56
            
            
            1,716,480
            
            
            7.71
            
            
            16.40
            
            
            467,581
            
            
            16.392,141,040
            
            
            
            
            
            
            
            
            892,141





The
      aggregate intrinsic value of the options outstanding as of March 31, 2007 and
      2006 was $4.3 million and $5.0 million, respectively. The aggregate intrinsic
      value represents the total pre-tax intrinsic value (the difference between
      KNBT’s closing stock price on the last trading day of the quarter ended and the
      exercise price, multiplied by the number of options outstanding). The aggregate
      intrinsic value of options currently exercisable as of March 31, 2007 was $4.3
      million and $4.9 million as of March 31, 2006. The weighted average remaining
      contractual life is 6.09 years for exercisable options outstanding at March
      31,
      2007. The total intrinsic value of stock options exercised during the quarter
      ended March 31, 2007 and 2006 was $4,700 and $7,300, respectively.





Compensation
      cost is generally recognized over the stated vesting period as provided in
      terms
      of the option grants. As of March 31, 2007, there was $4.5 million of
      unrecognized compensation cost related to unvested stock options, which is
      expected to be recognized over a weighted-average period of approximately 2.18
      years.




Management
      Recognition and Retention Plan





The
      MRRP,
      which is a stock-based incentive plan, provides for the ability to grant up
      to
      808,047 restricted shares of KNBT’s common stock to the Company’s directors,
      advisory directors, officers and employees. KNBT, for the benefit of the MRRP
      Trust, purchased 808,047 shares of KNBT common stock at an average price of
      $16.44 per share, which was treated as a reduction of additional
      paid-in-capital. Shares awarded to date under the MRRP are generally earned
      by
      recipients at a rate of 20% per year beginning on the first anniversary date
      of
      the grant. (Certain grants made in 2006 vest 60% on the third anniversary and
      20% per year thereafter.) On May 6, 2004, 638,000 restricted shares were
      awarded. For the year ended December 31, 2005, 10,000 additional MRRP shares
      were awarded. On January 26, 2007, 35,000 additional MRRP shares were awarded.
      Since the inception of the MRRP, awards covering 19,700 shares were forfeited
      and made available for future grants. Except as discussed below, compensation
      expense for this plan is being recorded over the vesting period and is based
      on
      the market value of KNBT’s stock as of the date the awards were made. The
      remaining cost of the MRRP shares granted is $4.7 million and the periodic
      amortization of such cost is recorded as an increase in shareholders’ equity.
      Expense under this plan for the three months ended March 31, 2007 and March
      31,
      2006 was $521,000 and $533,000, respectively.





The
      MRRP
      also provides for the ability to issue performance-based share awards. There
      were no additional performance-based shares awarded in during the first quarter
      of 2007. During the year ended December 31, 2006, the Board of Directors awarded
      performance-based restricted grants covering 85,000 shares subject to increase
      as described below. These shares are earned if corporate performance targets
      are
      achieved for fiscal year 2008. If the targets are achieved, on the third
      anniversary of the date of grant, 60% of the shares granted will be earned
      with
      the remaining 40% being earned pro rata on the fourth and fifth anniversary
      dates of the grant assuming the recipient remains employed by KNBT at each
      of
      such dates. Furthermore, if the Company exceeds its target goals for the fiscal
      year 2008, the awards will increase in the aggregate by 14,000 shares. The
      grants specifically exclude accelerated vesting in the event of a change in
      control. To date, KNBT has not recorded any compensation expense related to
      these performance-based awards.


10


In
      January 2007, upon further consideration of the grants of the performance-based
      restricted share awards, the grantees agreed to forfeit any right to receive
      40%
      of the shares subject to the performance-based MRRP grants made in 2006 that
      would vest on the fourth and fifth anniversary of the grant of such awards
      (assuming the performance targets are met). In return for such forfeitures,
      each
      grantee agreed to receive a cash bonus in an amount equal to the fair market
      value of the remaining shares on the third anniversary of the grant date of
      the
      performance-based restricted stock awards. Such amount will be paid in a lump
      sum within five days of the third anniversary of the grant date of the
      performance-based restricted share awards.








**NOTE
                F**
            **LOANS**





A
      summary
      of KNBT’s loans receivable at March 31, 2007 (unaudited) and December 31, 2006
      is as follows:








March
                31,
            
            December
                31,***(in
                thousands)***
            
            2007
            
            2006Real
                estateResidential
            
            $
            566,393
            
            $
            493,813Commercial
            
            
            364,249
            
            
            362,244Construction
            
            
            61,222
            
            
            61,288Total
                real estate
            
            
            991,864
            
            
            917,345Consumer
                loans
            
            
            518,050
            
            
            509,555Commercial
                (non-real estate)
            
            
            197,622
            
            
            181,103States
                and political subdivisions
            
            
            13,223
            
            
            13,056Total
                gross loans
            
            
            1,720,759
            
            
            1,621,059Mortgage
                loans held-for-sale
            
            
            (605
            )
            
            (1,994
            )Deferred
                fees
            
            
            1,285
            
            
            1,101Total
                loans
            
            
            1,721,439
            
            
            1,620,166Allowance
                for loan losses
            
            
            (16,667
            )
            
            (17,044
            )Total
                net loans
            
            $
            1,704,772
            
            $
            1,603,122





The
      following table shows the amounts of KNBT’s non-performing assets, defined as
      non-accruing loans, accruing loans 90 days or more past due and other real
      estate owned at March 31, 2007 (unaudited) and December 31, 2006.





March
                31,
            
            December
                31,*(dollars
                in thousands )*
            
            2007
            
            2006Non-accruing
                loans
            
            $
            4,280
            
            $
            4,869Accruing
                loans 90 days or more past due
            
            
            391
            
            
            1,058Total
                non-performing loans
            
            
            4,671
            
            
            5,927Other
                real estate owned
            
            
            77
            
            
            32Total
                non-performing assets
            
            $
            4,748
            
            $
            5,959Total
                non-performing loans as a percentage of loans, net
            
            
            0.28
            %
            
            0.37
            %Total
                non-performing loans as a percentage of total assets
            
            
            0.16
            %
            
            0.20
            %Total
                non-performing assets as a percentage of total assets
            
            
            0.16
            %
            
            0.21
            %Net
                charge-offs to average loans (net) during period
            
            
            0.02
            %
            
            0.15
            %Interest
                on non-accrual loans which would have beenrecorded
                at the original rate
            
            $
            493
            
            $
            459Interest
                on non-accrual loans that was reflected in income
            
            
            16
            
            
            46Net
                decrease in interest income
            
            $
            (477
            )
            $
            (413
            )




11


KNBT’s
      recorded investment in impaired loans was $1.0 million at March 31, 2007 and
      $1.6 million at December 31, 2006. The valuation allowance for loan losses
      related to impaired loans is a part of the allowance for loan losses and was
      $179,000 at March 31, 2007 and $323,000 at December 31, 2006. The average
      impaired loan balance for the three months ended March 31, 2007 was $1.3 million
      and $2.1 million for the three months ended March 31, 2006. During the three
      months ended March 31, 2007 and 2006, the Bank received principal payments
      on
      impaired loans of $721,000 and $193,000, respectively. Income on impaired loans
      is recognized by KNBT on a cash basis. KNBT recognized $16,000 in interest
      income on impaired loans for the three-month period ended March 31, 2007, and
      $5,000 in the three-month period ended March 31, 2006.





The
      following table shows the (unaudited) activity in KNBT’s allowance for loan
      losses during the periods indicated:





For
                the Three MonthsEnded
                March 31,*(dollars
                in thousands)*
            
            2007
            
            2006Allowance
                for loan losses, beginning of period
            
            $
            17,044
            
            $
            15,964Provision
                for loan losses
            
            
            -
            
            
            750Charge-offsOne-to
                four-family residential
            
            
            10
            
            
            39Commercial
                and industrial
            
            
            78
            
            
            4Consumer
            
            
            361
            
            
            793Total
                charge-offs
            
            
            449
            
            
            836Recoveries
                on loans previously charged-offOne-to
                four-family residential
            
            
            -
            
            
            19Commercial
                and industrial
            
            
            51
            
            
            15Consumer
            
            
            21
            
            
            51Total
                recoveries
            
            
            72
            
            
            85Net
                loans charged-off
            
            
            377
            
            
            751Allowance
                for loan losses, at period end
            
            $
            16,667
            
            $
            15,963








**NOTE
                G**
            **RETIREMENT
                PLANS**





*1.*
            *Defined
                Benefit Plans*





KNBT
      participates in a multiple employer defined benefit pension plan, which covered
      substantially all employees who had 1,000 hours of service during the plan
      year
      ended October 2003. On October 1, 2003, KNBT froze the future accrual of
      benefits under this plan. KNBT continues to contribute to this plan for benefits
      accrued prior to October 2003. KNBT’s contribution to this plan in the three
      months ended March 31, 2007 and 2006 was $231,000 and $183,000, respectively,
      which is included in compensation and employee benefits expense.





As
      part
      of the NEPF merger, KNBT assumed the multiple employer defined benefit pension
      plan of NEPF. This plan covered all employees who are age 21 or older and have
      one year of service. NEPF had amended the plan and froze the benefits for the
      then current participants of the plan. For the three months ended March 31,
      2007
      and 2006, KNBT contributed approximately $124,000 and $119,000, respectively,
      to
      the NEPF pension plan, which is included in compensation and employee benefits
      expense.





KNBT
      expects to contribute an additional $586,000 in the aggregate to the two pension
      plans through December 31, 2007.


12





*2.*
            *Directors’
                Deferred Plan*





KNBT,
      as
      a part of previous acquisitions, assumed the deferred compensation plan for
      certain former directors of First Colonial. This Plan has been subsequently
      frozen and no future deferrals are permitted. The plan requires annual payments
      for periods of five to fifteen years beginning at age 65 or death. The annual
      benefit is based upon the amount deferred plus interest. KNBT has recorded
      the
      deferred compensation liabilities using the present value method. The net
      periodic defined benefit expense for the three months ended March 31, 2007
      and
      March 31, 2006 was as follows:





March
                31,*(in
                thousands)*
            
            2007
            
            2006Service
                cost
            
            $
            -
            
            $
            -Interest
                cost
            
            
            4
            
            
            4Net
                amortization and deferral of prior service costs
            
            
            -
            
            
            -Amortization
                of net loss
            
            
            -
            
            
            1Net
                periodic benefit cost
            
            $
            4
            
            $
            5





KNBT
      currently expects to contribute a total of approximately $17,000 to this plan
      in
      the year ended December 31, 2007.








**NOTE
                H**
            **NEW
                ACCOUNTING PRONOUNCEMENTS**





On
      February 15, 2007, the FASB issued Statement No. 159 (SFAS 159), “The Fair Value
      Option for Financial Assets and Financial Liabilities,” which gives entities the
      option to measure eligible financial assets and liabilities and firm commitments
      at fair value, on an instrument by instrument basis, that are otherwise not
      permitted to be accounted for at fair value under other accounting standards.
      The election to use the fair value option is available when an entity first
      recognizes a financial asset or liability or upon entering into a firm
      commitment. Subsequent changes in fair value must be recorded in earnings.
      Additionally, SFAS 159 allows for a one-time election for existing positions
      upon early adoption with the transition adjustment recorded to beginning
      retained earnings. The Company did not early adopt SFAS 159 and believes that
      the adoption effective January 1, 2008 will not have a significant effect on
      its
      consolidated financial statements.





In
      September 2006, FASB Issued Statement No. 157 (SFAS 157), “Fair Value
      Measurements” which is effective for fiscal years beginning after November 15,
      2007 and for interim periods within those years. This statement defines fair
      value, establishes a framework for measuring fair value and expands the related
      disclosure requirements. SFAS 157 clarifies that fair value is an exit price,
      representing the amount that would be received to sell an asset or paid to
      transfer a liability in an orderly transaction between market participants.
      Under SFAS 157 fair value measurements are not adjusted for transactions costs. The
      Company is currently evaluating the impact the adoption of SFAS 157 and believes
      it will not have a significant effect on its consolidated financial
      statements .





In
      September 2006, the FASB ratified a consensus opinion reached by the Emerging
      Issues Task Force (“EITF”) on EITF Issue 06-4, “Accounting for Deferred
      Compensation and Postretirement Benefit Aspects of Endorsement Split-Dollar
      Life
      Insurance Arrangements,” which requires employers that enter into endorsement
      split-dollar life insurance arrangements that provide an employee with a
      postretirement benefit to recognize a liability for the future benefits promised
      based on the substantive agreement made with the employee. Whether the accrual
      is based on a death benefit or on the future cost of maintaining the insurance
      would depend on what the employer has effectively agreed to provide during
      the
      employee’s retirement. The purchase of an endorsement-type life insurance policy
      does not qualify as a settlement of the liability. The consensus in EITF Issue
      06-4 is effective for fiscal years beginning after December 15, 2007. The
      Company is currently evaluating the impact of its adoption will have on its
      consolidated financial statements.




13


In
      September 2006, the FASB ratified a consensus opinion reached by the EITF on
      EITF Issue 06-5, “Accounting for Purchases of Life Insurance - Determining the
      Amount That Could Be Realized in Accordance with FASB Technical Bulletin No.
      85-4.” The guidance in EITF Issue 06-5 requires policyholders to consider other
      amounts included in the contractual terms of an insurance policy, in addition
      to
      cash surrender value, for purposes of determining the amount that could be
      realized under the terms of the insurance contract. If it is probable that
      contractual terms would limit the amount that could be realized under the
      insurance contract, those contractual limitations should be considered when
      determining the realizable amounts. The amount that could be realized under
      the
      insurance contract should be determined on an individual policy (or certificate)
      level and should include any amount realized on the assumed surrender of the
      last individual policy or certificate in a group policy. The consensus in EITF
      Issue 06-5 is effective for fiscal years beginning after December 15, 2006.
      The
      Company adopted EITF Issue 06-5 on January 1, 2007. The adoption did not have
      a
      significant effect on its consolidated financial statements.





In
      July
      2006, FASB issued Interpretation 48 (FIN 48), “Accounting for Uncertainty in
      Income Taxes.” In summary, FIN 48 requires that all tax positions subject to
      SFAS No. 109, “Accounting for Income Taxes,” be analyzed using a two-step
      approach. The first step requires an entity to determine if a tax position
      is
      more-likely-than-not to be sustained upon examination. In the second step,
      the
      tax benefit is measured as the largest amount of benefit, determined on a
      cumulative probability basis that is more-likely-than-not to be realized upon
      ultimate settlement. FIN 48 is effective for fiscal years beginning after
      December 15, 2006, with any adjustment in a company’s tax provision being
      accounted for as a cumulative effect of accounting change in beginning equity.
      FIN 48 also addressed how interest and penalties should be accrued for uncertain
      tax positions, requiring that interest expense be recognized in the first period
      interest would be accrued under the tax law. KNBT’s policy, if any uncertain tax
      positions should occur, is that interest and penalties on unrecognized tax
      benefits would be part of income tax expense. KNBT adopted FIN 48 on January
      1,
      2007. The adoption of this standard did not result in a change to its beginning
      equity. As of the date of adoption and as of the quarter ended March 31, 2007,
      KNBT did not have any liabilities for unrecognized tax benefits. KNBT does
      not
      anticipate any significant changes in relation to unrecognized tax benefits
      within the next twelve months. With few exceptions, KNBT is no longer subject
      to
      U.S. Federal or State tax examinations by tax authorities for years before
      2003.





In
      March
      2006, the Financial Accounting Standards Board (FASB) issued Statement No.
      156
      (SFAS 156), “Accounting for Servicing of Financial Assets”. SFAS 156 amends SFAS
      No. 140, “Accounting for Transfers and Servicing of Financial Assets and
      Extinguishments of Liabilities.” SFAS 156 permits, but does not require, an
      entity to choose either the amortization method or the fair value. SFAS 156
      is
      effective for fiscal years beginning after September 15, 2006. The adoption
      of
      SFAS 156 by KNBT in January 2007 did not have a significant effect on the
      Company’s consolidated financial statements.








**NOTE
                I**
            **EXTINGUISHMENT
                OF DEBT**





In
      March
      2006, KNBT repaid $40.0 million of reverse repurchase agreements that had been
      assumed as part of the NEPF acquisition and repaid a $10.0 million Federal
      Home
      Loan Bank advance. The transactions settled at a price less than face value.
      The
      gain on the reverse repurchase agreement transaction was $965,000 and the net
      gain on the repayment of the Federal Home Loan Bank advance was $214,000 and
      included the effect of the write off of intangibles totaling
      $712,000.




14


**NOTE
                J**
            **TREASURY
                STOCK**





On
      October 27, 2004, KNBT’s Board of Directors announced its first share repurchase
      program. Under the initial program, which was completed during the third quarter
      of 2005, KNBT repurchased a total of 3,062,486 shares at an average price per
      share of $15.91. On July 27, 2005, the Board of Directors authorized an
      additional repurchase of 3,151,297 shares, which was completed in July 2006
      at
      an average cost of $16.30 per share. On June 26, 2006, the Board of Directors
      authorized another share repurchase program of up to ten percent or
      approximately 2,807,219 shares of the Company’s outstanding stock. At March 31,
      2007, a total of 119,951 shares pursuant to this plan had been purchased at
      an
      average cost of $15.41.




**NOTE
                  K**
              **SUBSEQUENT
                  EVENTS**


On
      April
      17, 2007, KNBT sold $81.7 million of agency securities, classified as available
      for sale, with an average yield of 4.14% recognizing a pre-tax loss of $2.2
      million. The proceeds will be reinvested in higher yielding loans and
      investments and will improve KNBT’s ability to manage interest rate risk and
      potentially benefit interest income, net income and earnings per share in future
      periods.





On
      April
      23, 2007, KNBT exercised its option to redeem $7.0 million of subordinated
      debentures issued through a pooled trust preferred securities offering. KNBT
      assumed this debt in connection with the NEPF acquisition. The interest rate
      on
      these borrowings was variable and adjusted semi-annually at 370 basis points
      over six-month LIBOR. At April 23, 2007, the interest rate was 9.09%. The
      redemption reflects KNBT’s determination to pay down maturing or callable debt
      rather than refinancing.





KNBT
      has
      requested and received approval from the Federal Reserve Bank of Philadelphia
      to
      exercise its option to redeem $15.0 million of subordinated debentures assumed
      in conjunction with the First Colonial merger. The trust preferred securities
      are callable in June 2007. The interest rate on these securities is variable,
      adjusting quarterly at three-month LIBOR plus 345 basis points. At March 31,
      2007, the interest rate was 8.80%.








**NOTE
                L**
            **RECLASSIFICATIONS**





Certain
      reclassifications of the prior year’s amounts have been made to conform to the
      March 31, 2007 presentation.








**Item
      2.****Management's
      Discussion and Analysis of****Financial
      Condition and****Results
      of Operations**





**Forward
      - Looking Statements**





The
      information contained in this quarterly report on Form 10-Q may contain
      forward-looking statements (as defined in the Securities Exchange Act of 1934
      and the regulations promulgated thereunder) which are not historical facts
      or as
      to KNBT management's intentions, plans, beliefs, expectations or opinions or
      with respect to the operation of the Company or its subsidiaries. These
      statements include, but are not limited to, financial projections and estimates
      and their underlying assumptions; statements regarding plans, objectives and
      expectations with respect to future operations, products and services; and
      statements regarding future performance. Such statements are subject to certain
      risks and uncertainties, many of which are difficult to predict and generally
      beyond the control of KNBT and its management, that could cause actual results
      to differ materially from those expressed in, or implied or projected by, the
      forward-looking information and statements.




15


The
      following factors, among others, could cause actual results to differ materially
      from the anticipated results or other expectations expressed in the
      forward-looking statements:





•
            
            Economic
                and competitive conditions which could affect the volume of loan
                originations, deposit flows and real estate values;





•
            
            The
                levels of non-interest income and expense and the amount of loan
                losses;





•
            
            Competitive
                pressure among depository institutions increases
                significantly;





•
            
            Changes
                in the interest rate environment may further reduce interest
                margins;





•
            
            General
                economic conditions, either nationally or in the markets in which
                KNBT is
                doing business, are less favorable than
                expected;





•
            
            Acquisitions
                may result in large one-time charges to income, may not produce revenue
                enhancements or cost savings at the levels or within the time frames
                originally anticipated and may result in unforeseen integration
                difficulties;





•
            
            Legislation
                or changes in regulatory requirements adversely affect the business
                in
                which KNBT is engaged; and





•
            
            Other
                factors discussed in the documents filed by KNBT with the Securities
                and
                Exchange Commission ("SEC") from time to
                time.





These
      factors should be considered in evaluating the forward-looking statements and
      undue reliance should not be placed on such statements. KNBT undertakes no
      obligation to update these forward-looking statements to reflect events or
      circumstances that occur after the date of the filing of this Form
      10-Q.





**Available
      Information**


The
        Company is a public company and files annual, quarterly and current reports,
        proxy statements and other information with the SEC. The Company maintains
        a
        website at www.knbt.com and
        makes available, free of charge, on its Internet web site copies of its Annual
        Report on Form 10-K, Quarterly Reports on Form 10-Q and Current Reports on
        From
        8-K and any amendments to such documents as soon as reasonably practicable
        after
        the reports have been electronically filed or furnished to the SEC.
  **Critical
        Accounting Policies, Judgments and Estimates**





The
      accounting and reporting policies of KNBT conform with accounting principles
      generally accepted in the United States of America and general practices within
      the financial services industry. The preparation of financial statements in
      conformity with accounting principles generally accepted in the United States
      requires management to make estimates and assumptions that affect the amounts
      reported in the financial statements and the accompanying notes. Actual results
      could differ from those estimates.





KNBT
      considers that the determination of the allowance for loan losses involves
      a
      higher degree of judgment and complexity than its other significant accounting
      policies. The allowance for loan losses is calculated with the objective of
      maintaining a reserve level believed by management to be sufficient to absorb
      the known and inherent losses in the portfolio that are both probable and
      reasonable to estimate. Management’s determination of the adequacy of the
      allowance is based on periodic evaluations of the loan portfolio and other
      relevant factors. However, this evaluation is inherently subjective as it
      requires material estimates, including, among others, expected default
      probabilities, loss given default, expected commitment usage, the amounts and
      timing of expected future cash flows on impaired loans, mortgages, and general
      amounts for historical loss experience. The process also considers economic
      conditions, uncertainties in estimating losses and inherent risks in the loan
      portfolio. All of these factors may be susceptible to significant change. To
      the
      extent actual outcomes differ from management estimates, additional provisions
      for loan losses may be required that would adversely impact earnings in future
      periods.


16




KNBT
        recognizes deferred tax assets and liabilities for future tax effects of
        temporary differences, net operating loss carry forwards and tax credits.
        Deferred tax assets are subject to management’s judgment based upon available
        evidence that future realization is more likely than not. In 2005, a valuation
        allowance of $1.1 million was established to write down the deferred tax
        asset
        to its net realizable value. Management believes this valuation allowance
        is
        reasonable.
 
 Goodwill
        and other identifiable intangible assets are subject to impairment testing
        at
        least annually to determine whether write-downs of the recorded balance are
        necessary. KNBT tests for impairment based on the goodwill maintained at
        each
        defined reporting unit. A fair value is determined for each reporting unit
        based
        on at least one of three different market valuation methodologies. If the
        fair
        values of the reporting units exceed their book values, no write-down of
        recorded goodwill is necessary. If the fair value of the reporting unit is
        less,
        an expense may be required to be recognized on KNBT’s books to write down the
        related goodwill to the proper carrying value. As of March 31, 2007, KNBT’s
        recorded goodwill totaled $107.0 million compared to $105.9 million at December
        31, 2006. During the first quarter of 2007, KNBT finalized its valuations
        with
        respect to the Paragon acquisition.





On
      January 1, 2006, KNBT changed accounting policy related to share-based
      compensation in connection with the adoption of SFAS No.123(R). As a part of
      the
      transition to SFAS No.123(R), KNBT elected to use the modified version of
      prospective application (“modified prospective application”). Under modified
      prospective application, as it is applicable to KNBT, SFAS No. 123(R) applies
      to
      new awards and to awards which are modified, repurchased or cancelled after
      January 1, 2006. Additionally, compensation expense for the portion of each
      award for which the requisite service period has not been rendered, (generally
      referring to nonvested awards) that was outstanding as of January 1, 2006,
      is now recognized as the remaining requisite service is rendered. Compensation
      expense for such awards granted prior to January 1, 2006 is based on the same
      method and on the same grant date fair values previously determined for the
      pro
      forma disclosures required for all companies that did not previously adopt
      the
      fair value accounting method for share-based compensation.





The
      fair
      value of our stock option grants is estimated at the date of grant using the
      Black-Scholes option-pricing model. The Black-Scholes option valuation model
      was
      developed for use in estimating the fair value of traded options which have
      no
      vesting restrictions and are fully transferable. In addition, option valuation
      models require the input of highly subjective assumptions. KNBT utilizes the
      following assumptions when estimating fair value of its stock option grants
      under SFAS No. 123(R): expected volatility, based on historical volatility
      of
      KNBT’s traded stock and peer group comparisons; expected term, calculated using
      the simplified method; expected dividend yield, based on historical patterns
      and
      peer group performance; and the risk free interest rate, based on the U.S.
      Treasury yield curve at the time of the grant. KNBT uses historical data to
      estimate the likelihood of option exercise and employee termination within
      the
      valuation model.




17


**Comparison
      of Financial Condition as of March 31, 2007 and December 31,
      2006**





**Assets.** KNBT’s
      total assets were $2.9 billion at March 31, 2007, an increase of $8.0 million
      or
      0.3% compared to December 31, 2006. The increase was primarily due to loan
      growth, and an increase in cash and cash equivalents. These increases were
      partially offset by a $117.6 million or 13.7% decline in investment securities
      available for sale. KNBT’s total net loans receivable increased by $101.7
      million or 6.3% to $1.7 billion at March 31, 2007, compared to $1.6 billion
      at
      December 31, 2006. The growth in loans receivable was primarily due to an
      increase of $72.6 million or 14.7% in residential real estate loans and an
      increase of $16.5 million or 9.1% in commercial and business loans. During
      the
      quarter ending March 31, 2007, KNBT leveraged its expertise in the 1-4 family
      residential real estate lending by purchasing $72.8 million of 1-4 family
      residential real estate loans. Cash and cash equivalents increased $29.5 million
      or 49.0% due to liquidity created by the sale of investments and increased
      deposits at March 31, 2007. Total investment securities decreased $118.6 million
      or 13.3% at March 31, 2007 to $773.7 million compared to $892.4 million at
      December 31, 2006. For the same periods, the available-for-sale category
      decreased $117.6 million or 13.7%, which was primarily attributable to a
      decrease of $44.7 million or 6.5% in mortgage-backed securities, a decrease
      of
      $30.7 million or 32.4% in U.S. Government and agency securities and a decrease
      of $42.1 million or 61.3% in corporate and other debt securities. The primary
      reason for the decrease in investment securities available for sale was to
      fund
      the growth in the loan portfolio, maturing Federal Home Loan Bank (“FHLB”)
      advances and KNBT’s anticipated redemption of $22.0 million of subordinated debt
      during the second quarter of 2007.





**Non-Performing
      Assets.** On
      loans
      where the collection of principal or interest payments is doubtful, the accrual
      of interest income ceases (“non-accrual” loans). On loans 90 days or more past
      due as to principal and interest payments, KNBT’s policy, with certain limited
      exceptions, is to discontinue accruing interest. On occasion, this action may
      be
      taken earlier if the financial condition of the borrower raises significant
      concern with regard to the borrower’s ability to service the debt in accordance
      with the terms of the loan agreement. Interest income is not accrued on these
      loans until the borrowers’ financial condition and payment record demonstrate an
      ability to service the debt. Real estate that is acquired as a result of
      foreclosure is classified as other real estate owned. Other real estate owned
      is
      recorded at the lower of cost or fair value less estimated selling costs. Costs
      associated with acquiring and improving a foreclosed property may be capitalized
      to the extent that the carrying value does not exceed fair value less estimated
      selling costs. Holding costs are charged to expense. Gains and losses on the
      sale of other real estate owned are credited or charged to operations, as
      incurred.


Non-performing
        loans decreased $1.3 million or 21.2% to $4.7 million at March 31, 2007 compared
        to $5.9 million at December 31, 2006. The decrease was primarily due to a
        decline of $565,000 or 26.1% in non-performing residential mortgage loans,
        a
        decrease of $443,000 or 28.6% in non-performing commercial loans and a decrease
        of $247,000 or 11.2% in non-performing consumer loans. Total non-performing
        loans as a percentage of net loans declined to 0.28% at March 31, 2007 compared
        to 0.37% at December 31, 2006.


**Allowance
      for Loan Losses.** The
      allowance for loan losses is established through a provision for loan losses.
      KNBT maintains the allowance at a level believed, to the best of management’s
      knowledge, to cover all known and inherent losses in the portfolio that are
      both
      probable and reasonable to estimate at each reporting date. Management reviews
      on a monthly basis all loans that are delinquent and performs regular reviews
      of
      the portfolio in order to identify those inherent losses and assess the overall
      adequacy of the allowance. Such reviews consist of a quantitative analysis
      by
      loan category, using historical loss experience and consideration of a series
      of
      qualitative loss factors. KNBT’s evaluation process includes, among other
      things, an analysis of delinquency trends, non-performing loan trends, the
      level
      of charge-offs and recoveries, prior loss experience, total loans outstanding,
      the volume of loan originations, the type, size and geographic concentration
      of
      its loans, the value of collateral securing the loan, the borrower’s ability to
      repay and repayment performance, the number of loans requiring heightened
      management oversight, local economic conditions and industry
      experience.


18




In
        addition, in establishing the allowance for loan losses, KNBT’s management uses
        a ten point internal rating system for all loans originated by the Commercial
        Lending Department. At the time of origination, each commercial loan is assigned
        a rating based on the assumed risk elements of the loan. Such risk ratings
        are
        periodically reviewed by management and revised as deemed
        appropriate.
 
 The
        establishment of the allowance for loan losses is significantly affected
        by
        management’s judgment and uncertainties and there is likelihood that different
        amounts would be reported under different conditions or assumptions. Various
        regulatory agencies, as an integral part of their examination process,
        periodically review KNBT’s allowance for loan losses. Such agencies may require
        KNBT to make additional provisions for estimated loan losses based upon
        judgments different from those of management. As of March 31, 2007, KNBT’s
        allowance for loan losses was 0.97% of total loans receivable compared to
        1.05%
        at December 31, 2006.
 
 KNBT
        will
        continue to monitor and modify its allowance for loan losses as conditions
        dictate. No assurances can be given that its level of allowance for loan
        losses
        will cover all of the inherent losses on its loans or that future adjustments
        to
        the allowance for loan losses will not be necessary if economic and other
        conditions differ substantially from the economic and other conditions used
        by
        management to determine the current level of the allowance for loan
        losses.
 
 **Liabilities.** KNBT’s
        total liabilities were $2.5 billion at March 31, 2007, a decrease of $2.4
        million or 0.1% compared to December 31, 2006 due to a decline in FHLB advances
        offset in large part by an increase in total deposits. Total deposits increased
        $32.6 million or 1.7% to $1.9 billion at March 31, 2007 compared to December
        31,
        2006. The increase reflects in part, KNBT’s continuing efforts to boost the
        level of checking accounts, money market accounts and other core deposits.
        Core
        deposits consist of all deposits other than certificates of deposit. FHLB
        advances declined $61.2 million or 11.8% to $458.0 million at March 31, 2007
        compared to $519.2 million at December 31, 2006. Maturing advances were the
        primary reason for the decline. Securities sold under agreements to repurchase
        increased $32.8 million or 72.4% to $78.1 million at March 31, 2007 compared
        to
        $45.3 million at December 31, 2006. The primary reason for the increase was
        the
        purchase of a $25.0 million structured repurchase agreement taking advantage
        of
        favorable funding opportunities.
 
 **Shareholders’
        Equity.** Shareholders’
        equity totaled $361.6 million at March 31, 2007 compared to $356.0 million
        at
        December 31, 2006, an increase of $5.6 million or 1.6%. The increase in
        shareholders’ equity was primarily due to $5.5 million in net income and an
        increase in accumulated other comprehensive income relating to unrealized
        gains
        and losses on investment securities available-for-sale. During the three-month
        period ended March 31, 2007, KNBT repurchased 48,392 shares of its common
        stock
        at an aggregate cost of $716,000. Dividends declared and paid during the
        three-month period ended March 31, 2007 reduced retained earnings by $2.2
        million. KNBT committed to release 11,900 shares of the Company’s common stock
        during the three months ended March 31, 2007 pursuant to the ESOP with a
        value
        as calculated in accordance with SOP 93-6 of approximately
        $175,000.
 19


Regulatory
      capital for KNBT and the Bank at March 31, 2007 and December 31, 2006 are shown
      in the following tables.


At
                  March 31, 2007Required
              
              To
                  Be Well CapitalizedFor
                  Capital
              
              Under
                  Prompt CorrectiveActual
              
              Adequacy
                  Purposes
              
              Action
                  Provisions*(in
                  thousands)*
              
              Amount
              
              Ratio
              
              Amount
              
              Ratio
              
              Amount
              
              RatioTotal
                  Capital(To
                  risk-weighted assets)Company
                  (consolidated)
              
              $
              291,305
              
              
              15.06
              %
              $
              154,744
              
              
              8.00
              %
              
              N/A
              
              
              N/ABank
              
              $
              252,016
              
              
              12.82
              %
              $
              157,226
              
              
              8.00
              %
              $
              196,532
              
              
              10.00
              %Tier
                  I Capital(To
                  risk-weighted assets)Company
                  (consolidated)
              
              $
              274,638
              
              
              14.20
              %
              $
              77,372
              
              
              4.00
              %
              
              N/A
              
              
              N/ABank
              
              $
              235,349
              
              
              11.98
              %
              $
              78,613
              
              
              4.00
              %
              $
              117,919
              
              
              6.00
              %Tier
                  I Capital(To
                  average assets, leverage)Company
                  (consolidated)
              
              $
              274,638
              
              
              10.02
              %
              $
              109,679
              
              
              4.00
              %
              
              N/A
              
              
              N/ABank
              
              $
              235,349
              
              
              8.50
              %
              $
              110,753
              
              
              4.00
              %
              $
              138,441
              
              
              5.00
              %
 
 At
                  December 31, 2006Required
              
              To
                  Be Well CapitalizedFor
                  Capital
              
              Under
                  Prompt CorrectiveActual
              
              Adequacy
                  Purposes
              
              Action
                  Provisions(in
                  thousands)
              
              Amount
              
              Ratio
              
              Amount
              
              Ratio
              
              Amount
              
              RatioTotal
                  Capital(To
                  risk-weighted assets)Company
                  (consolidated)
              
              $
              288,207
              
              
              14.83
              %
              $
              155,432
              
              
              8.00
              %
              
              N/A
              
              
              N/ABank
              
              $
              256,766
              
              
              13.23
              %
              $
              155,320
              
              
              8.00
              %
              $
              194,151
              
              
              10.00
              %Tier
                  I Capital(To
                  risk-weighted assets)Company
                  (consolidated)
              
              $
              271,163
              
              
              13.96
              %
              $
              77,716
              
              
              4.00
              %
              
              N/A
              
              
              N/ABank
              
              $
              239,722
              
              
              12.35
              %
              $
              77,660
              
              
              4.00
              %
              $
              116,490
              
              
              6.00
              %Tier
                  I Capital(To
                  average assets, leverage)Company
                  (consolidated)
              
              $
              271,163
              
              
              9.77
              %
              $
              111,068
              
              
              4.00
              %
              
              N/A
              
              
              N/ABank
              
              $
              239,722
              
              
              8.55
              %
              $
              112,157
              
              
              4.00
              %
              $
              140,196
              
              
              5.00
              %
  **Liquidity.** KNBT’s
        primary sources of funds are from deposits, amortization of loans, loan
        prepayments and the maturity of loans, mortgage-backed securities and other
        investments, and other funds provided from operations. While scheduled payments
        from the amortization of loans and mortgage-backed securities and maturing
        investment securities are relatively predictable sources of funds, deposit
        flows
        and loan prepayments can be greatly influenced by general interest rates,
        economic conditions and competition. KNBT also maintains excess funds in
        short-term, interest-bearing assets that provide additional liquidity and
        also
        utilizes outside borrowings, primarily from the FHLB, as an additional funding
        source.  KNBT
        uses its liquidity to fund existing and future loan commitments, to fund
        maturing certificates of deposit and demand deposit withdrawals, to invest
        in
        other interest-earning assets, and to meet operating expenses. In addition
        to
        cash flow from loan and securities payments and prepayments as well as from
        sales of available-for-sale securities and mortgage loans, KNBT has significant
        borrowing capacity available to fund liquidity needs. The average balance
        of
        FHLB advances and Federal funds purchased were $495.1 million and $8.5 million,
        respectively, for the three months ended March 31, 2007 and $692.5 million
        and
        $1.4 million, respectively, for the three months ended March 31, 2006. To
        date,
        KNBT’s borrowings have consisted primarily of advances from the FHLB of
        Pittsburgh and overnight funds from banks.




20


**“GAP”
      Analysis.** The
      following interest rate sensitivity “GAP” table sets forth the amounts of KNBT’s
      interest-earning assets and interest-bearing liabilities outstanding at March
      31, 2007, which are expected, based upon certain assumptions, to reprice or
      mature in each of the future time periods shown. Except as stated below, the
      amount of assets and liabilities shown which reprice or mature during a
      particular period were determined in accordance with the earlier of term to
      repricing or the contractual maturity of the asset or liability. The table
      sets
      forth an approximation of the projected repricing of assets and liabilities
      at
      March 31, 2007, on the basis of contractual maturities, anticipated prepayments,
      and scheduled rate adjustments within a three-month period and subsequent
      selected time intervals. The loan amounts in the table reflect principal
      balances expected to be repaid and/or repriced as a result of contractual
      amortization and anticipated prepayments of adjustable-rate loans and fixed-rate
      loans, and as a result of contractual rate adjustments on adjustable-rate loans.
      Annual prepayment rates for adjustable-rate and fixed-rate single-family and
      multi-family mortgage loans are assumed to range from 14% to 32%. The annual
      prepayment rate for mortgage-backed securities is assumed to range from 12%
      to
      32%. During the first quarter of 2007, the Company reevaluated the decay rates
      of its savings, interest-bearing checking and money market deposit accounts.
      Money market deposit accounts, savings accounts and interest-bearing checking
      accounts are assumed to have annual rates of withdrawal, or “decay rates,” in
      the first year of the analysis of 11%, 11% and 12%, respectively.


At
                  March 31, 2007More
                  than
              
              More
                  than
              
              More
                  than
              
              More
                  than3
                  Months
              
              3
                  Months
              
              6
                  Months
              
              1
                  Year
              
              3
                  Years
              
              More
                  than***(dollars
                  in thousands)***
              
              or
                  Less
              
              to
                  6 Months
              
              to
                  1 Year
              
              to
                  3 Years
              
              to
                  5 Years
              
              5
                  Years
              
              TotalInterest-earning
                  assets (1):Deposits
                  at other institutions
              
              $
              40,234
              
              $
              -
              
              $
              -
              
              $
              -
              
              $
              -
              
              $
              -
              
              $
              40,234Loans
                  receivable (2)
              
              
              352,331
              
              
              79,600
              
              
              156,566
              
              
              497,796
              
              
              298,509
              
              
              337,242
              
              
              1,722,044Investment
                  securities, debt
              
              
              71,916
              
              
              55,162
              
              
              102,417
              
              
              262,801
              
              
              157,366
              
              
              121,810
              
              
              771,472Investment
                  securities, equity
              
              
              -
              
              
              -
              
              
              -
              
              
              -
              
              
              -
              
              
              30,267
              
              
              30,267Total
                  interest-earning assets
              
              $
              464,481
              
              $
              134,762
              
              $
              258,983
              
              $
              760,597
              
              $
              455,875
              
              $
              489,319
              
              $
              2,564,017Cumulative
                  total interest-earning
                  assets
              
              $
              464,481
              
              $
              599,243
              
              $
              858,226
              
              $
              1,618,823
              
              $
              2,074,698
              
              $
              2,564,017
              
              $
              2,564,017Interest-bearing
                  liabilities:Savings
                  deposits
              
              $
              6,295
              
              $
              6,108
              
              $
              13,148
              
              $
              39,948
              
              $
              31,386
              
              $
              115,058
              
              $
              211,943Interest-bearing
                  checking deposits
              
              
              7,348
              
              
              7,130
              
              
              13,630
              
              
              46,998
              
              
              51,148
              
              
              121,141
              
              
              247,395Money
                  market deposits
              
              
              17,011
              
              
              16,506
              
              
              31,555
              
              
              108,804
              
              
              247,735
              
              
              151,127
              
              
              572,738Certificates
                  of deposit
              
              
              176,586
              
              
              127,389
              
              
              261,713
              
              
              124,481
              
              
              16,423
              
              
              1,107
              
              
              707,699FHLB
                  advances and otherborrowings
              
              
              204,175
              
              
              34,392
              
              
              80,504
              
              
              155,673
              
              
              46,042
              
              
              53,595
              
              
              574,381Total
                  interest-bearingliabilities
              
              $
              411,415
              
              $
              191,525
              
              $
              400,550
              
              $
              475,904
              
              $
              392,734
              
              $
              442,028
              
              $
              2,314,156Cumulative
                  total interest-bearing
                  liabilities
              
              $
              411,415
              
              $
              602,940
              
              $
              1,003,490
              
              $
              1,479,394
              
              $
              1,872,128
              
              $
              2,314,156
              
              $
              2,314,156Interest-earning
                  assetsless
                  interest-bearingliabilities
              
              $
              53,066
              
              $
              (56,763
              )
              $
              (141,567
              )
              $
              284,693
              
              $
              63,141
              
              $
              47,291
              
              $
              249,861Cumulative
                  interest-ratesensitivity
                  gap (3)
              
              $
              53,066
              
              $
              (3,697
              )
              $
              (145,264
              )
              $
              139,429
              
              $
              202,570
              
              $
              249,861Cumulative
                  interest-rate gap as apercentage
                  of total assets atMarch
                  31, 2007
              
              
              1.83
              %
              
              (0.13
              %)
              
              (5.00
              %)
              
              4.80
              %
              
              6.97
              %
              
              8.60
              %Cumulative
                  interest-earning assetsas
                  a percentage ofcumulative
                  interest-bearingliabilities
                  at March 31, 2007
              
              
              112.90
              %
              
              99.39
              %
              
              85.52
              %
              
              109.42
              %
              
              110.82
              %
              
              110.80
              %(1)
                  Interest-earning assets are included in the period in which the
                  balances
                  are expected to be redeployed and/or repriced as a result of anticipated
                  prepayments, scheduled rate adjustment and contractual
                  maturity.(2)
                  For purposes of the gap analysis, loans receivable includes non-performing
                  loans, gross of the allowance for loan losses, undisbursed loan
                  funds and
                  deferred loan fees.(3)
                  Interest-rate sensitivity gap represents the difference between
                  net
                  interest-earning assets and interest-bearing
                  liabilities.


21


**Comparison
      of Operating Results for the three months ended March 31, 2007 and
      2006**


**Results
        of Operations.** Net
        income is affected by five major elements: (1) net interest income, or the
        difference between interest income earned on loans and investments and interest
        expense paid on deposits and borrowed funds; (2) the provision for loan losses,
        or the amount added to the allowance for loan losses to provide reserves
        for
        inherent losses on loans; (3) noninterest income, which is made up primarily
        of
        certain fees, wealth management income and gains and losses from sales of
        securities or other transactions; (4) noninterest expense, which consists
        primarily of salaries, employee benefits and other operating expenses; and
        (5)
        income taxes. Each of these major elements will be reviewed in more detail
        in
        the following discussion.


**Net
      Interest Income.** Net
      interest income represents the difference between income on interest-earning
      assets and expense paid on interest-bearing liabilities. Net interest income
      also depends upon the relative amounts of interest-earning assets and
      interest-bearing liabilities and the interest rate earned or paid on them.
      Net
      interest income is the primary source of earnings for KNBT. Therefore, the
      interest rate environment has material impact on KNBT’s earnings. The
      traditional view of the banking business holds that banks pay interest on their
      deposits based upon shorter term interest rates while making loans tied to
      longer term interest rates. As a result, KNBT is able to increase net interest
      income at a faster pace when the spread between short-term and long-term U.S.
      Treasury rates is positive. This embraces the traditional view that funding
      costs are more directly tied to shorter term rates, while loan rates are more
      tied to intermediate and longer term rates. However, in 2004, the yield curve
      flattened and remained so during 2005 and 2006 and through the period ended
      March 31, 2007, resulting in a compressed net interest margin since long-term
      rates were the same as or, increased less than short-term rates (an inverted
      yield curve). This factor, along with intense competition, has applied pressure
      to yields on KNBT’s interest-earning assets.





For
      the
      three months ended March 31, 2007, KNBT’s net interest income was $17.3 million,
      a decrease of $1.4 million or 7.7% compared to $18.7 million for the same period
      in 2006. The decrease was mainly the result of the effects resulting from the
      flat to inverted yield curve that has persisted over this timeframe, combined
      with a continued shift in deposit mix away from lower-cost deposit products
      to
      higher-cost consumer and other time deposits. KNBT’s average interest-earning
      assets totaled $2.5 billion for the three months ended March 31, 2007 compared
      to $2.7 billion for the same period in 2006. Average interest-bearing
      liabilities were $2.3 billion for the three months ended March 31, 2007 compared
      to $2.4 billion for the comparable period in 2006. The decrease in
      interest-earning assets and in interest-bearing liabilities was primarily the
      result of KNBT’s continuing efforts to reduce debt through paying-off rather
      than refinancing maturing FHLB advances, extinguishing debt as it did in its
      debt extinguishment transaction in March 2006 and repurchasing shares as part
      of
      its ongoing share repurchase programs.





KNBT’s
      average interest rate spread on a tax equivalent basis was 2.47% for the
      three-month period ended March 31, 2007, compared to 2.63% for the three-month
      period ended March 31, 2006. The effective tax rate used for the taxable
      equivalent adjustment was 35%. The net interest margin, a measure of net
      interest income performance, is determined by dividing net interest income
      on a
      tax equivalent basis by the average balance of total interest-earning assets.
      The net interest margin on a tax-equivalent basis for the first quarter of
      2007
      was 2.77%, compared to 2.89% for the same period in 2006. KNBT’s net interest
      margin and average interest rate spread has contracted from the comparable
      2006
      levels due to increased deposit costs and the flat to inverted yield curve
      which
      has increased short-term funding costs at a faster rate than yields on
      interest-earning assets. The flattening of the yield curve that was experienced
      in 2006 as well as through the first quarter of 2007 and the associated impact
      of funding KNBT’s ongoing share repurchase programs has negatively impacted our
      margin and compressed the interest rate spread between our longer term assets
      and our shorter term liabilities.




22


KNBT
      presents its net interest margin on a tax-equivalent basis because management
      believes that presentation of its net interest margin and average interest
      rate
      spread on a tax-equivalent basis provides information that is useful for a
      proper understanding of the operating results of KNBT's business. These
      disclosures should not be viewed as a substitute for operating results
      determined in accordance with generally accepted accounting principles (“GAAP”)
      nor are they necessarily comparable to non-GAAP performance measures, which
      may
      be presented by other companies. Without the adjustment for tax-free income,
      the
      net interest margin was 2.74% for the three-month period ended March 31, 2007
      and 2.80% for the same period in 2006. See “- **Average
      Balances, Net Interest Income, and Yields Earned and Rates
      Paid** .”





**Interest
      Income.** KNBT’s
      total interest income was $37.0 million for the three-month period ended March
      31, 2007, a $771,000 or 2.1% increase compared to $36.3 million in total
      interest income for the three-month period ended March 31, 2006. The
      increase in total interest income was primarily attributable to an increase
      in
      interest income on loans. Interest income on loans totaled $26.1 million for
      the
      three months ended March 31, 2007, an increase of $3.5 million, or 15.7%,
      compared to $22.6 million for the three months ended March 31, 2006. Additionally,
      the average balance of loans for the three-month period ended March 31, 2007
      increased $162.5 million or 10.9% to $1.65 billion compared to $1.49 billion
      for
      the three-month period ended March 31, 2006.





Interest
      income on investment securities for the three months ended March 31, 2007 was
      $10.8 million, a $2.6 million or 19.5% decrease compared to $13.4 million for
      the same period in 2006. The decrease in interest income on investment
      securities was primarily driven by a decrease in the average balance of
      investment securities caused by the sale of investment securities. The sales
      were conducted to fund the growth in the loan portfolio and maturing FHLB
      advances and to provide funds to purchase common stock pursuant to KNBT’s stock
      repurchase programs. The average balance of investment securities for the
      three-month period ended March 31, 2007 decreased $291.0 million or 24.7% to
      $887.4 million compared to $1.18 billion for the three-month period ended March
      31, 2006.


**Interest
        Expense.** KNBT’s
        total interest expense for the three months ended March 31, 2007 was $19.7
        million, an increase of $2.2 million or 12.6%, compared to $17.5 million
        for the
        same period in 2006. The growth in interest expense reflected the continued
        implementation of KNBT’s strategy of increasing the portion of its funding needs
        satisfied through the use of deposits, in particular, core deposits rather
        than
        borrowing. Interest expense on deposits totaled $13.4 million for the three
        months ended March 31, 2007; an increase of $3.6 million or 36.9%, compared
        to
        $9.8 million for the three months ended March 31, 2006. Interest on FHLB
        advances, subordinated debt and securities sold under agreements to repurchase
        decreased by an aggregate of $1.4 million or 18.1% to $6.3 million for the
        three
        months ended March 31, 2007 compared to $7.7 million for the same period
        in
        2006.





The
      increase in interest expense on deposits for the three months ended March 31,
      2007 compared to the three months March 31, 2006 was primarily due to the
      increase in the average rate paid on deposits. The Federal Reserve’s increases
      in short-term rates which increased market rates generally have resulted in
      KNBT
      having to increase rates paid on deposits. Consequently, due to the increase
      in
      short-term rates, and despite intense competitive pressure, higher cost,
      short-term time deposits have now become a more favorable funding source to
      short- term borrowing obligations. The average rates paid on deposits increased
      75 basis points to 3.15% for the three-month period ended March 31, 2007
      compared to the same period in 2006. The average balance of interest-bearing
      deposits increased $71.8 million or 4.4% to $1.7 billion for the three months
      ended March 31, 2007 compared to $1.6 billion for the same period in 2006.
      Interest expense on FHLB advances, securities sold under agreements to purchase
      and subordinated debt decreased $1.4 million or 18.1% for the three-month period
      ended March 31, 2007 compared to the same period in 2006 primarily due to the
      extinguishment of debt and the repayment of FHLB advances.




23


**Average
      Balances, Net Interest Income, and Yields Earned and Rates
      Paid.** The
      following tables show for the periods indicated the total dollar amount of
      interest from average interest-earning assets and the resulting yields, as
      well
      as the interest expense on average interest-bearing liabilities, expressed
      both
      in dollars and rates, and the net interest margin. The table includes
      information adjusted to a tax-equivalent basis for the Company’s tax-exempt
      investment securities and loans. The presentation on a tax-equivalent basis
      may
      be considered to include non-GAAP information.





For
                the Three Months Ended March 31,2007
            
            2006Interest
            
            Average
            
            
            
            Interest
            
            AverageAverage
            
            Income/
            
            Yield/
            
            Average
            
            Income/
            
            Yield/*(dollars
                in thousands)*
            
            Balance
            
            Expense
            
            Rate
            
            Balance
            
            Expense
            
            RateInterest-earning
                assetsInterest-bearing
                balances with banks
            
            $
            1,998
            
            $
            23
            
            
            4.60
            %
            $
            22,622
            
            $
            225
            
            
            3.98
            %Federal
                funds sold
            
            
            5,156
            
            
            58
            
            
            4.50
            %
            
            -
            
            
            -Investment
                securitiesTaxable
                (1)
            
            
            887,402
            
            
            10,822
            
            
            4.88
            %
            
            1,111,077
            
            
            12,670
            
            
            4.56
            %Tax-exempt
                (2)
            
            
            -
            
            
            -
            
            
            -
            
            
            67,291
            
            
            1,196
            
            
            7.11
            %Loans
                receivable (2) (3)
            
            
            1,649,553
            
            
            26,348
            
            
            6.39
            %
            
            1,487,095
            
            
            22,773
            
            
            6.13
            %Allowance
                for loan losses
            
            
            (17,022
            )
            
            -
            
            
            
            
            
            (15,882
            )
            
            -Net
                loans
            
            
            1,632,531
            
            
            26,348
            
            
            6.46
            %
            
            1,471,213
            
            
            22,773
            
            
            6.19
            %Total
                interest-earning assets
            
            
            2,527,087
            
            
            37,251
            
            
            5.90
            %
            
            2,672,203
            
            
            36,864
            
            
            5.52
            %Non-interest-earning
                assets
            
            
            350,028
            
            
            -
            
            
            
            
            
            346,673
            
            
            -Total
                assets, interest income
            
            $
            2,877,115
            
            
            37,251
            
            
            
            
            $
            3,018,876
            
            
            36,864Interest-bearing
                liabilitiesDemand
                deposits
            
            $
            234,133
            
            $
            504
            
            
            0.86
            %
            $
            229,219
            
            $
            279
            
            
            0.49
            %Money
                market deposits
            
            
            541,947
            
            
            4,969
            
            
            3.67
            %
            
            370,750
            
            
            2,614
            
            
            2.82
            %Savings
                deposits
            
            
            212,175
            
            
            264
            
            
            0.50
            %
            
            260,759
            
            
            285
            
            
            0.44
            %Certificates
                of deposit
            
            
            712,308
            
            
            7,660
            
            
            4.30
            %
            
            768,051
            
            
            6,611
            
            
            3.44
            %Total
                interest-bearing deposits
            
            
            1,700,563
            
            
            13,397
            
            
            3.15
            %
            
            1,628,779
            
            
            9,789
            
            
            2.40
            %Securities
                sold under agreementsto
                repurchase
            
            
            58,657
            
            
            596
            
            
            4.06
            %
            
            68,182
            
            
            595
            
            
            3.49
            %Federal
                funds purchased
            
            
            8,482
            
            
            112
            
            
            5.28
            %
            
            1,419
            
            
            17
            
            
            4.79
            %FHLB
                advances
            
            
            495,139
            
            
            4,925
            
            
            3.98
            %
            
            692,536
            
            
            6,497
            
            
            3.75
            %Other
                debt
            
            
            38,358
            
            
            711
            
            
            7.41
            %
            
            38,831
            
            
            638
            
            
            6.57
            %Total
                interest-bearing liabilities
            
            
            2,301,199
            
            
            19,741
            
            
            3.43
            %
            
            2,429,747
            
            
            17,536
            
            
            2.89
            %Non-interest-bearing
                liabilitiesNon-interest-bearing
                deposits
            
            
            189,910
            
            
            -
            
            
            
            
            
            185,614
            
            
            -Other
                liabilities
            
            
            27,194
            
            
            -
            
            
            
            
            
            33,120
            
            
            -Total
                liabilities
            
            
            2,518,303
            
            
            19,741
            
            
            
            
            
            2,648,481
            
            
            17,536Shareholders'
                equity
            
            
            358,812
            
            
            -
            
            
            
            
            
            370,395
            
            
            -Total
                liabilitiesand
                shareholders' equity, interest expense
            
            $
            2,877,115
            
            
            19,741
            
            
            
            
            $
            3,018,876
            
            
            17,536Net
                interest income ontax-equivalent
                basis (2)
            
            
            
            
            
            17,510
            
            
            
            
            
            
            
            
            19,328Net
                interest spread ontax-equivalent
                basis (4)
            
            
            
            
            
            
            
            
            2.47
            %
            
            
            
            
            
            
            
            2.63
            %Net
                interest margintax-equivalent
                basis (5)
            
            
            
            
            
            
            
            
            2.77
            %
            
            
            
            
            
            
            
            2.89
            %Tax-exempt
                adjustment
            
            
            
            
            
            (209
            )
            
            (0.03
            %)
            
            
            
            
            (593
            )
            
            (0.09
            %)Net
                interest income and margin (4) (5)
            
            
            
            
            $
            17,301
            
            
            2.74
            %
            
            
            
            $
            18,735
            
            
            2.80
            %Average
                interest-earning assetsto
                average interest-bearing liabilities
            
            
            
            
            
            
            
            
            109.82
            %
            
            
            
            
            
            
            
            109.98
            %(1)
                Includes Federal Home Loan Bank stock.(2)
                The indicated interest income and average yields are presented on
                a
                tax-equivalent basis. The tax-equivalentadjustments
                included above are $209,000 and $593,000 for the three months ended
                March
                31, 2007 and 2006, respectively.The
                effective tax rate used for the tax-equivalent adjustment was 35%.(3)
                Loan (expenses) fees of $(115,108) and $49,192 for the three months
                ended
                March 31, 2007 and 2006, respectively, areincluded
                in interest income. Average loan balances include non-accruing loans
                of
                $4.3 million and $6.9 million andaverage
                loans held-for-sale of $1.9 million and $559,000 for the three months
                ended March 31, 2007 and 2006, respectively.(4)
                Net interest spread is the arithmatic difference between yield on
                interest-earning assets, adjusted to a tax-equivalent basis,and
                the rate paid on interest-bearing liabilities. On a GAAP basis, the
                Company's net interest spread was 2.44% and 2.54%for
                the three months ended March 31, 2007 and 2006.(5)
                Net interest margin is computed on a GAAP basis by dividing net interest
                income by average interest-earning
                assets.


24


Management
      believes that it is common industry practice in the banking industry to present
      such information on a fully tax-equivalent basis and that such information
      is
      useful to investors in making peer comparisons. However, these non-GAAP
      financial measures should not be considered an alternative to GAAP. The
      reconciliation of these non-GAAP measures from GAAP is presented
      below.





For
                the Three Months EndedMarch
                31, 2007
            
            March
                31, 2006Average
            
            
            
            Average*(dollars
                in thousands)*
            
            Interest
            
            Yield/Cost
            
            Interest
            
            Yield/CostInvestment
                securities - nontaxable
            
            $
            -
            
            
            -
            %
            $
            777
            
            
            4.62
            %Tax-equivalent
                adjustments
            
            
            -
            
            
            
            
            
            419Investment
                securities - nontaxable to a taxable equivalent yield
            
            $
            -
            
            
            -
            %
            $
            1,196
            
            
            7.11
            %Loans
                receivable - nontaxable
            
            $
            387
            
            
            4.12
            %
            $
            323
            
            
            3.91
            %Tax-equivalent
                adjustments
            
            
            209
            
            
            
            
            
            174Loans
                receivable - nontaxable to a taxable equivalent yield
            
            $
            596
            
            
            6.34
            %
            $
            497
            
            
            6.02
            %Net
                interest income
            
            $
            17,301
            
            
            
            
            $
            18,735Tax-equivalent
                adjustment
            
            
            209
            
            
            
            
            
            593Net
                interest income, tax equivalent
            
            $
            17,510
            
            
            
            
            $
            19,328Net
                interest rate spread, no tax adjustment
            
            
            
            
            
            2.44
            %
            
            
            
            
            2.54
            %Net
                interest margin, no tax adjustment
            
            
            
            
            
            2.74
            %
            
            
            
            
            2.80
            %





**Rate
      Volume Analysis.** The
      following table shows the extent to which changes in interest rates and changes
      in the volume of interest-earning assets and interest-bearing liabilities
      affected KNBT’s interest income and expense during the periods indicated. For
      each category of interest-earning assets and interest-bearing liabilities,
      information is provided on changes attributable to (1) changes in rate, which
      is
      the change in rate multiplied by prior year volume, and (2) changes in volume,
      which is the change in volume multiplied by prior year rate. The combined effect
      of changes in both rate and volume has been allocated proportionately to the
      change due to rate and the change due to volume. The table includes information
      adjusted to a tax-equivalent basis for the Company’s tax-exempt investment
      securities and loans. The presentation on a tax-equivalent basis may be
      considered to include non-GAAP information.





Three
                months Ended March 31, 2007Compared
                to Three Months Ended March 31, 2006Increase
                (Decrease)
            
            TotalDue
                to
            
            Increase*(in
                thousands)*
            
            Rate
            
            Volume
            
            (Decrease)Interest
                Income:Interest-bearing
                deposits with banks
            
            $
            3
            
            $
            (205
            )
            $
            (202
            )Federal
                funds sold
            
            
            -
            
            
            58
            
            
            58Investment
                securities (1)
            
            
            380
            
            
            (3,424
            )
            
            (3,044
            )Loans
                receivable, net (2)
            
            
            1,078
            
            
            2,497
            
            
            3,575Total
                interest-earning assets
            
            
            1,461
            
            
            (1,074
            )
            
            387Interest
                Expense:Demand
                deposits
            
            
            219
            
            
            6
            
            
            225Money
                market deposits
            
            
            1,148
            
            
            1,207
            
            
            2,355Savings
                deposits
            
            
            32
            
            
            (53
            )
            
            (21
            )Certificates
                of deposit
            
            
            1,529
            
            
            (480
            )
            
            1,049Total
                interest-bearing deposits
            
            
            2,928
            
            
            680
            
            
            3,608Securities
                sold under agreements to repurchase
            
            
            84
            
            
            (83
            )
            
            1FHLB
                advances and other borrowings
            
            
            280
            
            
            (1,852
            )
            
            (1,572
            )Federal
                funds purchased
            
            
            10
            
            
            85
            
            
            95Other
                debt
            
            
            81
            
            
            (8
            )
            
            73Total
                interest-bearing liabilities
            
            
            3,383
            
            
            (1,178
            )
            
            2,205(Decrease)
                increase in net interest income (3)
            
            $
            (1,922
            )
            $
            104
            
            $
            (1,818
            )(1)
                Total decrease in interest income on investment securities on a nontaxable
                equivalent basis would be $2.6 million for the three month
                comparison.(2)
                Total increase in interest income on loans receivable on a nontaxable
                equivalent basis would be $3.5 million for the three month
                comparison.(3)
                Total decrease in net interest income on a nontaxable equivalent
                basis
                would be $1.4 million for the three month
                comparison.


25


**Provision
      for Loan Losses** **.** The
      provision for loan losses is determined by management’s review and analysis of
      the loan portfolio. This evaluation process includes, among other things, an
      analysis of delinquent and non-performing loans, the level of charge-offs and
      recoveries, the value of collateral securing loans, borrowers’ ability to repay,
      repayment performance and local economic conditions. The valuation also takes
      into consideration performing loans that may have certain weaknesses as
      identified by management in its review of loans.





K  NBT
      did
      not have a provision for loan losses for the three months ended March 31, 2007
      compared to $750,000 for the three months ended March 31, 2006. Continued
      improvement in the overall credit quality of the loan portfolio resulted in
      no
      provision for the quarter. KNBT has made provisions in order to maintain the
      allowance for loan losses at a level that to the best of our knowledge covers
      all known and inherent losses that are both probable and reasonable to estimate
      at the dates presented in KNBT’s loan portfolio. The allowance for loan loss to
      total loans at March 31, 2007 was 0.97% compared to 1.05% at December 31, 2006.
      For the three months ended March 31, 2007, charge-offs were primarily related
      to
      consumer loans. Non-performing loans totaled $4.7 million and $5.9 million
      at
      March 31, 2007 and December 31, 2006, respectively. At March 31, 2007, KNBT’s
      allowance for loan losses was 356.8% of non-performing loans compared to 287.6%
      at December 31, 2006.





**Non-Interest
      Income.** Non-interest
      income increased $622,000 or 6.9% to $9.7 million for the three months ended
      March 31, 2007 compared to $9.1 million for the three months ended March 31,
      2006.  The
      increase during the three-month period ended March 31, 2007 over the comparable
      period in 2006 was primarily the result of an increase of $371,000 or 34.9%
      in
      trust revenue, an increase of $201,000 or 15.7% from Caruso, an increase of
      $163,000 from Higgins and an increase of $207,000 or 14.8% in deposit fees.
      The
      increase in trust revenue was the primarily the result of additional revenues
      resulting from the acquisition of TCLV in March 2006 which substantially
      increased the amount of assets under management. The Caruso and Higgins
      increases were primarily the result of the effective use of synergies created
      by
      cross selling initiatives by the integrated KNBT organization. Deposit fees
      increased due to an increasing number of accounts and increased fees. These
      increases helped offset the $1.2 million net gain on extinguishment of debt
      during the three months ended March 31, 2006. The lower level of tax-free income
      was the result of selling tax advantaged securities as part of a tax planning
      strategy done primarily to utilize the charitable contribution carry
      forward.





**Non-Interest
      Expense.** Non-interest expense decreased by $539,000 or 2.8%, to $19.0 million for the
      three months ended March 31, 2007 compared to $19.5 million for the three months
      ended March 31, 2006. Continued emphasis on cost control initiatives implemented
      during the 2006 were primarily responsible for the decrease of non-interest
      expense compared to the three-month period ended March 31, 2006. For the
      three-month period ended March 31, 2007 as compared to the three-month period
      ended March 31, 2006, net occupancy and equipment expense decreased $287,000
      or
      8.8%, professional fees decreased $244,000 or 32.0%, advertising expenses
      decreased $162,000 or 39.1% and other operating expenses decreased $403,000,
      or
      21.6%. The decline in other operating expenses was due to the settlement of
      a
      lawsuit in the first quarter of 2006 and increased credits for FAS 91 costs.
      These decreases were partially offset by an increase of $540,000 or 5.1 % in
      compensation and employee benefits.




**Income
      Tax Expense.** KNBT’s
      income tax expense increased by $471,000 to $2.5 million for the three months
      ended March 31, 2007 compared to three months ended March 31, 2006. The
      effective income tax rate for the three months ended March 31, 2007 was 31.7%
      and compared to 27.4% for the same period in 2006. The primary reason for the
      increase in the effective tax rate was lower level of tax-free income combined
      with higher levels of taxable income.





**Item
                3.**
            **Quantitative
                and Qualitative Disclosures About Market
                Risk**





For
      a
      discussion of KNBT’s asset and liability management policies as well as the
      methods used to manage its exposure to the risk of loss from adverse changes
      in
      market prices and interest rates see “Management’s Discussion and Analysis of
      Financial Condition and Results of Operations - Market Risk and Interest Rate
      Sensitivity” in KNBT’s Annual Report on Form 10-K for the year ended December
      31, 2006. There have been no material changes in KNBT’s assessment of its
      sensitivity to market risk since December 31, 2006.


26


**Item
                4.**
            **Controls
                and
                Procedures**





**Evaluation
      of Disclosure Controls and Procedures.** KNBT’s
      management evaluated, with the participation of its Chief Executive Officer
      and
      Chief Financial Officer, the effectiveness of its disclosure controls and
      procedures (as defined in Rule 13a-15(e) or 15d-15(e) under the Securities
      Exchange Act of 1934, as amended) as of the end of the period covered by this
      report. Based on such evaluation, KNBT’s Chief Executive Officer and Chief
      Financial Officer have concluded that its disclosure controls and procedures
      are
      designed to ensure that information required to be disclosed in the reports
      that
      it files or submits under the Securities Exchange Act of 1934 is recorded,
      processed, summarized and reported within the time periods specified in the
      SEC’s rules and regulations and are operating in an effective
      manner.





**Changes
      in Internal Control Over Financial Reporting.** No
      change in KNBT’s internal control over financial reporting (as defined in Rules
      13a-15(f) or 15d-15(f) under the Securities Exchange Act of 1934, as amended)
      occurred during the quarter ended March 31, 2007 that has materially affected
      or
      is reasonably likely to materially affect, KNBT’s internal control over
      financial reporting.








**PART
                II**
            **OTHER
                INFORMATION**





**Item
                1.**
            **Legal
                Proceedings**





There
        are
        no matters required to be reported under this item.


**Item
                1A.**
            **Risk
                Factors**





There
      have been no material changes from the risk factors disclosed in KNBT’s Annual
      Report on Form 10-K for the year ended December 31, 2006.





**Item
                2.**
            **Unregistered
                Sales of Equity
                Securities and Use of
                Proceeds**


(a)
            Not
                applicable.


(b)
            Not
                applicable.


(c)
            The
                following table sets forth information regarding KNBT’s repurchases of its
                common stock during the quarter ended March 31,
                2007.





Period
            
            Total
                Number of Shares Purchased
            
            Average
                Price Paid
              Per
                Share
            
            Total
                Number of Shares Purchased as Part of Publicly Announced Plans or
                Programs
            
            Maximum
                Number of Shares that may yet be Purchased Under the Plan or Program(s)
                (1)January
                1 - 31, 2007
            
            
            0
            
            $
            0.00
            
            
            0
            
            
            2,735,660February
                - 28, 2007
            
            
            10,000
            
            $
            15.39
            
            
            10,000
            
            
            2,725,660March
                1 - 31, 2007
            
            
            38,392
            
            $
            14.66
            
            
            38,392
            
            
            2,687,268Total
            
            
            48,392
            
            $
            14.81
            
            
            48,392
            
            
            N/A(1)
                On June 26, 2006, the Board of Directors authorized a repurchase
                of
                2,807,219 shares of which 119,951 shares had been repurchased as
                of March
                31, 2007. There is no expiration date for this
                program.





27


**Item
                3.**
            **Defaults
                Upon Senior Securities Risk
                Factors**


(a)
            There
                were no matters required to be reported under this
                item.


(b)
            There
                were no matters required to be reported under this
                item.








**Item
                4.**
            **Submission
                of Matters to a Vote of Security
                Holders**





On
        May 3,
        2007, the Company held its Annual Meeting of Shareholders to obtain approval
        for
        two proxy proposals submitted on behalf of the Company’s Board of Directors.
        Shareholders of record as of March 16, 2007 received proxy materials and
        were
        considered eligible to vote on these proposals. The following is a brief
        summary
        of each proposal and the result of the vote.


1.
            The
                following directors were elected by the requisite plurality of the
                votes
                cast to serve on the Company’s Board of
                Directors:





For
            
            WithheldThomas
                L. Kennedy
            
            22,748,028
            
            867,627Christian
                F. Martin, IV
            
            22,769,298
            
            846,357R.
                Chadwick Paul, Jr.
            
            22,723,255
            
            892,400Kenneth
                R. Smith
            
            22,685,430
            
            930,225R.
                Charles Stehly
            
            22,683,411
            
            932,244





2.
            To
                ratify the appointment of Grant Thornton LLP as independent auditors
                for
                the year ended December 31, 2007.





For
            
            Against
            
            Abstain23,266,007
            
            235,761
            
            113,887





**Item
                5.**
            **Other
                Information**


(a)
            There
                were no matters required to be reported under this
                item.


(b)
            There
                were no matters required to be reported under this
                item.








**Item
                6.**
            **Exhibits**


(a)
            List
                of exhibits:


31.1
      Section 302 Certification of the Chief Executive Officer


31.2
      Section 302 Certification of the Chief Financial Officer


32.1
      Certification Pursuant to 18 U.S.C. Section 1350 as Adopted Pursuant  to
      Section 906 of the Sarbanes-Oxley Act of 2002.


28


**SIGNATURES**








Pursuant
      to the requirements of the Securities Exchange Act of 1934, the registrant
      has
      duly caused this report to be signed on its behalf by the undersigned, thereunto
      duly authorized.








**KNBT
      BANCORP, INC.**





DATE:
            May
                10, 2007
            
            BY:
            /S/
                Scott V. FainorScott
                V. FainorPresident
                and Chief Executive OfficerDATE:
            May
                10, 2007
            
            BY:
            /S/
                Eugene T. SobolEugene
                T. SobolSenior
                Executive Vice President, Chief FinancialOfficer
                and Treasurer