(INSIDE COVER)

Customer Services

A detailed listing of the services offered by the Company is as follows:

DEPOSIT ACCOUNTS

All Purpose Clubs
Certificates of Deposit
Christmas Clubs
Demand Accounts
Individual Retirement Accounts
Money Market Accounts
NOW Accounts
Savings Accounts
Time Open Accounts
Vacation Clubs

LENDING

Appliance Loans
Automobile Loans
Business Loans
Collateral Loans
Comercial Equipment Leasing
Construction Loans
Cosmic Card (Debit Card, Check Card)
Credit Lines
Educational Loans
Home Equity Loans
Home Repair and Remodeling Loans
Installment Loans
MasterCard and VISA (Credit Card)
Mortgage Loans (Residential and Commercial)
Personal Loans

OTHER SERVICES

ATM Services
Bank Money Orders
Cash Management
Cashier's Checks
College Campus Card Interface
Data Processing Services
Direct Deposit of Recurring Payments
EDI-ACH Service
Foreign Remittance
Home Banking Services
Internet Banking
Investor Services
  (a) Brokerage
  (b) Insurance
Lockbox Services
Night Depository
Point-of-Sale Banking
Repurchase Agreements
Safe Deposit Boxes
Travelers Checks
Trust Department Services
  (a)  Administrator
  (b)  Agent
  (c)  Custodian and Trustee for Pension Plans
  (d)  Executor
  (e)  Guardian
  (f)  Securities Depository Service
  (g)  Trustee
  (h)  Trustee for Public Bond Issues
U.S. Savings Bonds


BRANCH LOCATIONS  (with ATMs)

Abington
1100 Northern Boulevard
Clarks Summit, PA
Carl M. Baruffaldi, Manager
(570) 587-4898

East Scranton
Prescott Avenue & Ash Street
Scranton, PA
Beth S. Wolff, Manager
(570) 342-9101

East Stroudsburg
Route 209 & Route 447
East Stroudsburg, PA
Denise M. Cebular, Manager
(570) 420-0432

Gouldsboro
Main & Second Streets
Gouldsboro, PA
Lori A. Dzwieleski, Manager
(570) 842-6473

Green Ridge
1901 Sanderson Avenue
Scranton, PA
Jeffrey Solimine, Manager
(570) 346-4695

Central City
150 North Washington Avenue
Scranton, PA
Andrew A. Kettel, Jr., Manager
(570) 346-7741

Mount Pocono
Route 611 & Route 940
Mount Pocono, PA
Karyn Gaus Vashlishan, Manager
(570) 839-8732

North Pocono
Main & Academy Streets
Moscow, PA
Deborah A. Wright, Manager
(570) 842-7626

South Scranton
526 Cedar Avenue
Scranton, PA
J. Patrick Dietz, Manager
(570) 343-1151


Other ATM locations

Acorn Market
Route 209
Marshall's Creek, PA

Acorn Market
Route 611
Swiftwater, PA

Convenient Food Mart
Wyoming & Mulberry Streets
Scranton, PA

Meadow Ave. & Hemlock St.
Scranton, PA

Metropolitan Life Insurance Company
Morgan Highway
Clarks Summit, PA

Red Barn Village
Newton Ransom Blvd
Newton, PA

On the Cover

A picture of our lighted Central City Office building appears on the front cover
of this  report.  We  added  exterior  lighting  to  highlight  the  significant
architectural  features of the  building and a new sign  signifying  our holding
company's  logo,  which was placed  atop the  building.  We have  received  many
compliments  from the  community  regarding  this  improvement  to the  downtown
Scranton business  district.  This new "beacon" of progress we hope will provide
impetus to a new administration in Scranton City Hall to lead our community into
a proud and better future.


                              www.pennsecurity.com

<PAGE>

                              Financial Highlights
                              --------------------

In thousands, except
per share data               2001        2000        1999
---------------------------------------------------------
Earnings per share      $    2.62   $    2.21   $    2.17
Dividends per share     $    1.25   $    1.15   $    1.10
Total Capital           $  54,648   $  50,067   $  45,743
Total Deposits          $ 406,531   $ 387,439   $ 367,332
Total Assets            $ 482,551   $ 467,230   $ 428,614


                                    Contents
                                    --------
Customer Services ............................................Inside Front Cover
President's Letter ............................................................2
Board of Directors ............................................................3
Promotions and Appointments ...................................................3
Community Events ..............................................................5

                             Form 10-K

  Part 1, Item 1  Business ....................................................7
          Item 2  Properties ..................................................8
          Item 3  Legal Proceedings ...........................................8
          Item 4  Submission of Matters to a Vote of Security Holders .........8
  Part 2, Item 5  Market for Registrant's Common Equity and
                    Related Stockholder Matters ...............................9
          Item 6  Selected Financial Data ....................................10
          Item 7  Management Discussion and Analysis of Financial Condition
                    and Results of Operations ................................11
          Item 7A Quantitative and Qualitative Disclosures About Market Risk..20
          Item 8  Financial Statements and Supplementary Data ................22
                  Consolidated Balance Sheets ................................22
                  Consolidated Statements of Income ..........................23
                  Consolidated Statements of Stockholders' Equity ............24
                  Consolidated Statements of Cash Flows ......................25
                  General Notes to Financial Statements ......................26
                  Independent Auditor's Report ...............................35
          Item 9  Changes in and Disagreements with Accountants on Accounting
                    and Financial Disclosure .................................36
  Part 3, Item 10 Directors and Executive Officers of the Registrant .........36
          Item 11 Executive Compensation .....................................36
          Item 12 Security Ownership of Certain Beneficial Owners
                    and Management ...........................................36
          Item 13 Certain Relationships and Related Transactions .............36
  Part 4, Item 14 Exhibits, Financial Statement Schedules and
                    Reports on Form 8-K ......................................37
  Signatures .................................................................38
  Index to Exhibits ..........................................................39
Company Officers .............................................................40
Company Board Members .........................................Inside Back Cover

                  Penseco Financial Services Corporation / 2001 Annual Report  1

<PAGE>

                               President's Letter
                               ------------------

Dear Shareholder

     I am pleased to report to you that 2001 was another record year for Penseco
Financial Services  Corporation.  Earnings increased to $2.62 per share for 2001
from $2.21 per share for 2000.  Dividends  increased to $1.25 per share for 2001
from $1.15 per share for 2000.  Total  Assets  increased to $483 million at year
end 2001 from $467 million at year end 2000.  Total  Deposits  increased to $407
million at year end 2001 from $387 million at year end 2000.  Capital  increased
to $54.6 million at year end 2001 from $50.1 million at year end 2000.  Although
we believe our loan portfolio remains strong, the Bank also took steps to handle
the fallout from the declining economy, increasing the allowance for loan losses
by $500,000 or 16%.
     During  2001,  in a concerted  effort to avoid an economic  recession,  the
Federal Reserve Board  concentrated on providing a stimulus to the economy which
started  slowing  dramatically at the end of 2000.  Although  progress was being
made,  the terrorist  attacks on the World Trade Center and Pentagon  pushed the
economy over the edge into recession. During the year, the Federal Discount Rate
and the Federal Funds target rate were lowered 11 times, resulting in the lowest
short-term  rates  experienced in the country in over 40 years.  Prime rate this
year dropped from 9.50% to 4.75%. Long-term rates, however, did not fall as far,
declining by only 1.5%. The modest  repositioning of our investment portfolio in
2000 served us well in this declining rate environment.
     With the tax cuts and spending  increases and slowdown of the economy,  the
anticipated Federal surplus has evaporated.  With the Federal deficits providing
a fiscal stimulus to the economy,  combined with the Federal Reserve moves,  the
country should be out of the recession this year. As a consequence, rates should
be on their way up over the next  several  years,  so we must  prepare  for that
eventuality.
     This year was a busy one for banks.  The  dramatic  reduction  in  interest
rates  led to a  flood  of  borrowers  seeking  to  refinance  their  loans.  To
accommodate this, many loan modification  agreements were entered into to enable
the customer to participate  in the lower rate  structure  without the increased
expense  of a  complete  refinancing.
     During  the year,  several  of our  Branch  managers  completed  investment
licensing so they can discuss investment products with our customers.  They will
work  hand in  hand  with  securities  sales  representatives  in  advising  our
customers  regarding  investment  transactions.  This is the first  step  toward
establishing a fully licensed broker dealer  subsidiary of our holding  company.
     In the first  quarter  of the year,  we  employed  the  services  of a bank
advisory  firm to analyze our  operations  and make  recommendations  of ways to
increase  our  revenues  and  decrease  our  costs.   Much  of  2001  was  spent
implementing   these   recommendations.   I  am  pleased  to  report  that  this
significantly impacted our bottom line and the last recommendation, installation
of a loan and deposit  documentation  processing system, is happening as I write
this  letter.
     This year,  the Enron scandal has called into question the  reliability  of
financial  information  being fed to  investors.I  am  pleased  to tell you that
Penseco Financial  Services  Corporation and its subsidiary,  Penn Security Bank
and Trust Company, have not and will not engage in such deceptive practices.
     The year 2002 is to be a year of  celebration  for Penn  Security  Bank and
Trust Company as it is the 100th year of existence of the Bank.  Special  events
will be  happening  all year  long.  New  Year's  Eve began our  celebration  as
literally  thousands of people celebrated New Years in our Central City Lobby as
we partnered with First Night  Scranton in bringing an evening of  entertainment
for all to downtown Scranton. In anticipation, we added exterior lighting to our
Central City Office highlighting the significant  architectural  features of the
building and a new sign  signifying  our holding  company's logo was placed atop
the building.  A picture of the lighted  building  appears on the front cover of
this report. We have received many compliments from the community regarding this
improvement to the downtown  Scranton  business  district.  This new "beacon" of
progress we hope will impetus to a new  administration  in Scranton City Hall to
lead our community out of economic  distress and into a proud and better future.
We have indicated our  willingness  to participate  and invest our funds in this
renaissance.
     During 2001,  Michael G. Ostermayer was appointed  Vice-President and Chief
Investment Officer,  Trust Services;  also Katherine M. Oven was appointed Trust
Portfolio Manager; and Dominick P. Gianuzzi, Assistant Trust Officer.
     In March of 2001, Ann Kennedy, our Gouldsboro Branch Manager, retired after
29 1/2 years of loyal service to our Bank. We have indeed been fortunate to have
employees of such longevity. Lori A. Dzwieleski has assumed her duties as Branch
Manager.
     In 2001,  the following  promotions  were made:  Patricia A. Bruno,  Branch
Operations  Officer;  Mary Carol  Cicco,  Business  Development  Officer;  Frank
Gardner, Assistant Cashier; Jill Ross, Merchant Officer; Susan Cottle, Assistant
Cashier and Assistant Branch Manager  Gouldsboro  Office;  Jennifer A. Lucchese,
Assistant  Branch  Operations  Officer;  and Carolyn E. Brown,  Assistant Branch
Operations   Officer.  We  congratulate  these  fine  employees  on  their  many
achievements.
     We have  indicated  before that we are interested in providing a wide range
of insurance products to our customers and we continue to pursue that goal.
     We  think  that  our  strong  capital  position,  good  earnings,  advanced
technology and solid customer base,  both in our traditional  geographic  market
and niche national  markets,  provide an excellent  foundation for our continued
success.  In this  endeavor you can help us by  recommending  us to your family,
friends,  and business  organizations.  This is your  institution - let it serve
you.

                                            Sincerely yours,

                                            Otto P. Robinson, Jr.
                                            President

2  Penseco Financial Services Corporation / 2001 Annual Report

<PAGE>

The top of this page of the 2001  Annual  Report to  Shareholders  contains  one
picture. A description of the picture follows:

                               Board of Directors
                               ------------------

Seated left to right:

Edwin J. Butler,  Emily S. Perry,  Attorney Otto P.  Robinson,  Jr.,  President;
Sandra C. Phillips and Russell C. Hazelton

Standing left to right:

P. Frank Kozik,  Secretary;  Steven L.  Weinberger,  Robert W. Naismith,  Ph.D.,
James B.  Nicholas,  James G.  Keisling,  D. William Hume, and Richard E. Grimm,
Executive Vice-President and Treasurer



The bottom of this page of the 2001 Annual Report to Shareholders contains three
pictures. A description of each picture follows, starting from left to right:


                            Promotions & Appointments
                            -------------------------


Michael G. Ostermayer
Vice-President, Chief Investment Officer, Trust Services

Katherine M. Oven
Trust Portfolio Manager

Dominick P. Gianuzzi
Assistant Trust Officer

                  Penseco Financial Services Corporation / 2001 Annual Report  3

<PAGE>

This page of the 2001 Annual Report to Shareholders  contains seven pictures.  A
description of each picture follows, starting at the top, from left to right:

                           Promotions & Appointments
                           -------------------------

Susan Cottle
Assistant Cashier, Assistant Branch Manager

Frank Gardner
Assistant Cashier

Patricia A. Bruno
Branch Operations Officer

Carolyn E. Brown
Assistant Branch Operations Officer

Jennifer A. Lucchese
Assistant Branch Operations Officer

Mary Carol Cicco
Business Development Officer

Jill Ross
Merchant Officer

4  Penseco Financial Services Corporation / 2001 Annual Report

<PAGE>

                                Community Events
                                ----------------

The top portion of the 2001 Annual Report to Shareholders contains two pictures.
Starting at the top, from left to right:

We contributed our former Green Ridge branch office to Neighborhood Housing of
Scranton to make possible the site of the Neighbor Works Home Ownership Center,
which opened on June 9, 2001.

An exterior view of the Central City office lobby is shown which highlights the
significant architectural features of our building during the evening of our
First Night festivities.


The lower porton of this page of the 2001 Annual Report to Shareholders contains
six pictures.

The year 2002 is to be a year of  celebration  for Penn  Security Bank and Trust
Company as it is the 100th year of existence of the Bank. Special events will be
happening  all year  long.  New Year's Eve began our  celebration  as  literally
thousands of people celebrated New Years in our Central City office lobby, as we
partnered with First Night Scranton in bringing an evening of entertainment  for
all to  downtown  Scranton.  The  pictures  shown  below  depict  several of the
festivities  which were  happening in the Penn Security Bank lobby area on First
Night.

                  Penseco Financial Services Corporation / 2001 Annual Report  5

<PAGE>

                                 UNITED STATES
                       SECURITIES AND EXCHANGE COMMISSION
                             WASHINGTON, D.C. 20549


                                   FORM 10-K


 Annual Report Under Section 13 or 15(d) of the Securities Exchange Act of 1934


                  For the Fiscal Year Ended December 31, 2001

                        Commission File Number 000-23777



                     PENSECO FINANCIAL SERVICES CORPORATION



                             Scranton, Pennsylvania
                          Commonwealth of Pennsylvania
                I.R.S. Employer Identification Number 23-2939222
                          150 North Washington Avenue
                       Scranton, Pennsylvania 18503-1848
                         Telephone number 570-346-7741

                          Securities Registered Under
                            Section 12(g) of the Act

                    Common Stock, Par Value $ .01 per share



Indicate by check mark whether the registrant (1) has filed all reports required
to be filed  by  Section  13 or 15 (d) of the  Securities  Exchange  Act of 1934
during the preceding 12 months (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 ( )

Indicate by check mark if disclosure of delinquent  filers  pursuant to Item 405
of Regulation  S-K is not contained  herein,  and will not be contained,  to the
best of registrant's  knowledge,  in definitive proxy or information  statements
incorporated by reference in Part III of this Form 10-K or any amendment to this
Form 10-K. ( )

The aggregate market value of the Company's voting stock held by  non-affiliates
of the registrant on FEBRUARY 15, 2002,  based on the average of the closing bid
and asked  prices of such stock on that date equals  Approximately  $61,218,000.
The number of shares of common stock  outstanding as of FEBRUARY 15, 2002 equals
2,148,000.

Documents Incorporated by Reference

Portions  of  the   Corporation's   2001  Annual  Report  to  Stockholders   are
incorporated by reference in Parts I and II.

Portions of the  Corporation's  definitive proxy statement  relating to the 2002
Annual Meeting of Stockholders are incorporated by reference in Part III.

6  Penseco Financial Services Corporation / 2001 Annual Report

<PAGE>

                     PENSECO FINANCIAL SERVICES CORPORATION

                                     PART I
ITEM 1  Business

GENERAL

PENSECO FINANCIAL SERVICES CORPORATION,  (the "Company"), which is headquartered
in Scranton,  Pennsylvania, was formed under the general corporation laws of the
State of Pennsylvania in 1997 and is registered as a financial  holding company.
The  Company  became  a  holding  company  upon  the  acquisition  of all of the
outstanding shares of Penn Security Bank and Trust Company (the "Bank"), a state
chartered  bank, on December 31, 1997.  The Company is subject to supervision by
the Federal Reserve Board. The Bank, as a state chartered financial institution,
is subject to supervision by the Federal Deposit  Insurance  Corporation and the
Pennsylvania  Department of Banking.
     The Company's  principal  banking office is located at 150 North Washington
Avenue, Scranton, Pennsylvania,  containing trust, investor services, marketing,
audit,  credit card,  human  resources,  executive,  data processing and central
bookkeeping  offices.  There are eight additional offices.
     Through it's banking subsidiary, the Company generates interest income from
it's outstanding loans receivable and it's investment portfolio. Other income is
generated  primarily  from  merchant  transaction  fees,  trust fees and service
charges on deposit  accounts.  The Company's  primary costs are interest paid on
deposits  and  general  operating  expenses.  The Bank  provides  a  variety  of
commercial and retail banking services to business and  professional  customers,
as well as retail customers, on a personalized basis. The Bank's primary lending
products are real estate,  commercial and consumer  loans.  The Bank also offers
ATM access, credit cards, active investment accounts,  trust department services
and other various lending, depository and related financial services. The Bank's
primary   deposit   products  are  savings  and  demand  deposit   accounts  and
certificates  of deposit.
     The  Bank  has a third  party  marketing  agreement  with  Fiserv  Investor
Services,  Inc.  that  allows  the  bank to offer a full  range  of  securities,
brokerage and annuity sales to it's customers. The investor services division is
located in the headquarters building and the services are offered throughout the
entire branch system.
     The Company is not dependent  upon a single  customer,  or a few customers,
the loss of one or more of which  would have a material  adverse  effect on it's
operations.  The operations and earnings of the  Corporation  are not materially
affected by seasonal changes or by Federal, state or local environmental laws or
regulations.

COMPETITION

The Bank operates in a competitive environment in which it must share its market
with many local  independent banks as well as several banks which are affiliates
or  branches  of very large  regional  holding  companies.  The Bank  encounters
competition from diversified financial institutions,  ranging in size from small
banks to the nationwide banks operating in it's region,  and include  commercial
banks,   savings  and  loan  associations,   credit  unions  and  other  lending
institutions.
     The  principal  competitive  factors  among the Bank's  competitors  can be
grouped into two categories: pricing and services. In the Bank's primary service
area, interest rates on deposits,  especially time deposits,  and interest rates
and fees  charged to  customers  on loans are very  competitive.  From a service
perspective,  the Bank competes in areas such as convenience of location,  types
of services, service costs and banking hours.

EMPLOYEES

As  of  February  15,  2002,  the  Company  employed  201  full-time  equivalent
employees.  The employees of the Company are not  represented  by any collective
bargaining  group.  Management  of the  Company  considers  relations  with  its
employees to be good.

SUPERVISION AND REGULATION

The Company is  registered  as a bank  holding  company  under the Bank  Holding
Company Act of 1956,  as amended,  and, as such, is subject to  supervision  and
regulation by the Board of Governors of the Federal Reserve System (the "Federal
Reserve Board" or "FRB").  The Company is required to file quarterly  reports of
its operations with the FRB.

                  Penseco Financial Services Corporation / 2001 Annual Report  7

<PAGE>

     As a  financial  holding  company,  the Company is  permitted  to engage in
banking-related  activities as authorized by the Federal Reserve Board, directly
or through  subsidiaries or by acquiring  companies already  established in such
activities subject to the FRB regulations relating to those activities.
     The Bank,  as a  Pennsylvania  state-chartered  financial  institution,  is
subject to  supervision,  regulation  and  examination  by the  Commonwealth  of
Pennsylvania  Department  of  Banking  and  by  the  Federal  Deposit  Insurance
Corporation  (the  "FDIC"),  which  insures  the Bank's  deposits to the maximum
extent permitted by law.

FORWARD LOOKING INFORMATION

This Form 10-K contains forward-looking informational statements, in addition to
the  historical  financial  information  required by the Securities and Exchange
Commission.  There are certain  risks and  uncertainties  associated  with these
forward-looking statements which could cause actual results to differ materially
from those stated herein. Such differences are discussed in the section entitled
"Management  Discussion  and  Analysis  of  Financial  Condition  and Results of
Operations".  These forward-looking  statements reflect management's analysis as
of this point in time.  Readers  should  review the other  documents the Company
periodically files with the Securities and Exchange  Commission in order to keep
apprised of any material changes.


ITEM 2  Properties

There  are  nine  offices   positioned   throughout  the  greater   Northeastern
Pennsylvania  region.  They are located in the South  Scranton,  East  Scranton,
Green Ridge, and Central City sections of Scranton,  the Borough of Moscow,  the
Town of Gouldsboro, South Abington Township, the Borough of Mount Pocono and the
Borough of East Stroudsburg at Eagle Valley Corners.  Through these offices, the
Company  provides  a full  range of  banking  and trust  services  primarily  to
Lackawanna, Wayne, Monroe and the surrounding counties. All offices are owned by
the Bank or through a wholly owned subsidiary of the Bank, Penseco Realty, Inc.,
with the exception of the Mount Pocono Office, which is owned by the Bank but is
located on land occupied under a long-term lease.
     The principal office,  located at the corner of North Washington Avenue and
Spruce Street in the "Central City" of Scranton's business district,  houses the
operations,   trust,  investor  services,   marketing,  credit  card  and  audit
departments  as well as the  Company's  executive  offices.  Several  remote ATM
locations  are leased by the Bank,  which are  located  throughout  Northeastern
Pennsylvania.  All branches and ATM locations  are equipped with closed  circuit
television monitoring.


ITEM 3  Legal Proceedings

There are no material  pending legal  proceedings,  other than ordinary  routine
litigation incidental to the business of the Company, as to which the Company or
subsidiary is a party or of which any of their property is subject.


ITEM 4  Submission of Matters to a Vote of Security Holders

No  matter  was  submitted  by the  Company  to  its  shareholders  through  the
solicitation  of proxies or  otherwise  during the fourth  quarter of the fiscal
year covered by this report.

8  Penseco Financial Services Corporation / 2001 Annual Report

<PAGE>

                                    PART II

ITEM 5  Market for Registrant's Common Equity and Related Stockholder Matters

This Annual  Report is the  Company's  annual  disclosure  statement as required
under Section 13 or 15(d) of the Securities Exchange Act of 1934.  Questions may
be  directed  to  any  branch  location  of the  Company  or by  contacting  the
Controller's office at:

   Patrick Scanlon, Controller
   Penseco Financial Services Corporation
   150 North Washington Avenue
   Scranton, Pennsylvania 18503-1848
   1-800-327-0394

Management of the Company is aware of the following  securities dealers who make
a market in the Company stock:

   Baird, Patrick & Company, Inc.                Legg Mason Wood Walker, Inc.
   Ferris, Baker, Watts, Inc.                    Monroe Securities, Inc.
   F.J. Morrissey & Company, Inc.                Ryan, Beck & Company, Inc.
   Hopper Soliday & Company, Inc.                Sandler, O'Neill & Partners, LP
   Janney Montgomery Scott, Inc.

The Company's capital stock is traded on the  "Over-the-Counter"  BULLETIN BOARD
under the symbol "PFNS". The following table sets forth the price range together
with  dividends  paid for each of the past two years.  These  quotations  do not
necessarily reflect the value of actual transactions.


                               Dividends Paid
2001              High     Low   Per Share
---------------------------------------------
First Quarter     $ 25    $ 20    $ .25
Second Quarter      25      22      .25
Third Quarter       30      23      .25
Fourth Quarter      32      27      .50
                                 ------
                                 $ 1.25
                                 ======


                               Dividends Paid
2000              High     Low   Per Share
---------------------------------------------
First Quarter     $ 26    $ 21    $ .22
Second Quarter      24      22      .22
Third Quarter       24      20      .22
Fourth Quarter      21      20      .49
                                 ------
                                 $ 1.15
                                 ======


DIVIDENDS PAID (in millions)           YEAR
-------------------------------------------
           $ 2,685                     2001
             2,470                     2000
             2,363                     1999
             2,255                     1998
             2,256                     1997


As of  February 15 , 2002 there were  approximately  1,009  stockholders  of the
Company based on the number of recordholders.

Reference should be made to the information about the Company's  dividend policy
and regulatory guidelines on pages 19 and 33.

TRANSFER AGENT

Penn Security Bank and Trust Company,  Trust  Department,  150 North  Washington
Avenue,  Scranton,  Pennsylvania  18503-1848.  Stockholders' questions should be
directed to the Bank's Trust Department at 570-346-7741.


                      QUARTERLY FINANCIAL DATA (unaudited)
                    (in thousands, except per share amounts)

                             First     Second    Third     Fourth
2001                        Quarter   Quarter   Quarter   Quarter
-----------------------------------------------------------------
Net Interest Income         $ 4,461   $ 4,795   $ 5,124   $ 4,956
Provision for Loan Losses       150       291       284       229
Other Income                  2,680     1,944     2,624     1,938
Other Expenses                5,629     4,631     5,054     4,763
Net Income                    1,088     1,396     1,800     1,338
Earnings Per Share          $   .51   $   .65   $   .84   $   .62


                             First     Second    Third     Fourth
2000                        Quarter   Quarter   Quarter   Quarter
-----------------------------------------------------------------
Net Interest Income         $ 4,158   $ 4,323   $ 4,467   $ 4,397
Provision for Loan Losses        40        32       148        13
Other Income                  2,308     1,180     2,724     2,021
Other Expenses                5,046     4,337     5,241     4,682
Net Income                    1,069       929     1,429     1,316
Earnings Per Share          $   .50   $   .43   $   .67   $   .61

                  Penseco Financial Services Corporation / 2001 Annual Report  9

<PAGE>

ITEM 6  Selected Financial Data

(in thousands, except per share data)

RESULTS OF OPERATIONS:

<TABLE>
<CAPTION>

                                       2001         2000         1999         1998         1997
-----------------------------------------------------------------------------------------------
<S>                             <C>          <C>          <C>          <C>          <C>
Interest Income                 $    31,860  $    31,043  $    28,320  $    29,975  $    30,099
Interest Expense                     12,524       13,698       11,213       13,179       12,385
-----------------------------------------------------------------------------------------------
Net Interest Income                  19,336       17,345       17,107       16,796       17,714
Provision for Loan Losses               954          233           89          595          316
-----------------------------------------------------------------------------------------------
Net Interest Income
  after Provision for
  Loan Losses                        18,382       17,112       17,018       16,201       17,398
Other Income                          9,186        8,233        7,746        6,838        6,285
Other Expenses                       20,077       19,306       18,312       16,986       16,884
Income Tax                            1,869        1,296        1,781        1,772        2,074
-----------------------------------------------------------------------------------------------
Net Income                      $     5,622  $     4,743  $     4,671  $     4,281  $     4,725
===============================================================================================

BALANCE SHEET DATA:
Assets                          $   482,551  $   467,230  $   428,614  $   436,099  $   427,577
Investment Securities           $   128,623  $   125,808  $   106,511  $   118,762  $   125,048
Net Loans                       $   320,208  $   304,641  $   278,577  $   280,389  $   269,446
Deposits                        $   406,531  $   387,439  $   367,332  $   377,526  $   374,488
Stockholders' Equity            $    54,648  $    50,067  $    45,743  $    44,961  $    42,924

PER SHARE DATA:
Earnings per Share              $      2.62  $      2.21  $      2.17  $      1.99  $      2.20
Dividends per Share             $      1.25  $      1.15  $      1.10  $      1.05  $      1.05
Book Value per Share            $     25.44  $     23.31  $     21.30  $     20.93  $     19.98
Common Shares Outstanding         2,148,000    2,148,000    2,148,000    2,148,000    2,148,000

FINANCIAL RATIOS:
Net Interest Margin                   4.30%        4.08%        4.22%        4.12%        4.51%
Return on Average Assets              1.18%        1.06%        1.08%         .99%        1.14%
Return on Average Equity             10.57%        9.96%       10.12%        9.54%       11.22%
Average Equity to Average Assets     11.19%       10.60%       10.70%       10.38%       10.16%
Dividend Payout Ratio                47.71%       52.04%       50.69%       52.76%       47.73%
</TABLE>

10 Penseco Financial Services Corporation / 2001 Annual Report

<PAGE>

ITEM 7  Management Discussion and Analysis of Financial Condition and Results of
          Operations

The following  discussion is intended to provide  information  to facilitate the
understanding  and assessment of  significant  changes and trends related to the
financial  condition  of the  Company and the  results of its  operations.  This
discussion and analysis should be read in conjunction with the Company's audited
consolidated   financial  statements  and  notes  thereto.  All  information  is
presented in thousands of dollars, except as indicated.

SUMMARY

Net  earnings  for 2001  totalled  $5,622,  an increase of 18.5% from the $4,743
earned in 2000,  which in turn was an increase of 1.5% from the $4,671 earned in
1999.  Net earnings per share were $ 2.62 in 2001,  compared  with $2.21 in 2000
and $2.17 in 1999.  Net earnings for 2001  increased from 2000 results due to an
increase in the net interest margin and fee income, offset by an increase in the
provision for loan losses and operating  costs.  Net earnings for 2000 increased
from 1999  results due to an  increase in the net  interest  margin.  Also,  fee
income increased, offset by increases in operating costs.


NET INCOME (in millions)               YEAR
-------------------------------------------
          $  5,622                     2001
             4,743                     2000
             4,671                     1999
             4,281                     1998
             4,725                     1997


The  Company's  return on average  assets was 1.18% in 2001 compared to 1.06% in
2000 and 1.08% in 1999. Return on average equity was 10.57%, 9.96% and 10.12% in
2001, 2000 and 1999, respectively.


RETURN ON AVERAGE ASSETS               YEAR
-------------------------------------------
             1.18%                     2001
             1.06%                     2000
             1.08%                     1999
              .99%                     1998
             1.14%                     1997


RETURN ON AVERAGE EQUITY               YEAR
-------------------------------------------
            10.57%                     2001
             9.96%                     2000
            10.12%                     1999
             9.54%                     1998
            11.22%                     1997


                  Penseco Financial Services Corporation / 2001 Annual Report 11

<PAGE>

RESULTS OF OPERATIONS


Net Interest Income

The principal component of the Company's earnings is net interest income,  which
is the difference  between interest and fees earned on  interest-earning  assets
and interest paid on deposits and other borrowings.
     Net interest income was $19.3 million in 2001,  compared with $17.3 million
in 2000,  an increase of 11.6%.  The  increase  in net  interest  income in 2001
resulted from increases in loan income,  increases in securities  income,  along
with lower funding costs mainly due to the Federal  Reserve Bank reducing  short
term interest rates eleven times during the year.
     Net interest income was $17.3 million in 2000,  compared with $17.1 million
in 1999,  an  increase of 1.2%.  The  increase  in net  interest  income in 2000
resulted  from  increases in loan  income,  along with  increases in  securities
income,  offset by higher money market,  time deposit and  short-term  borrowing
costs.
     Net  interest   income,   when   expressed  as  a  percentage   of  average
interest-earning  assets,  is referred to as net interest margin.  The Company's
net interest  margin for the year ended December 31, 2001 was 4.3% compared with
4.1% for the year ended  December 31, 2000, and 4.2% for the year ended December
31, 1999.
     Interest  income in 2001 totalled $31.9 million,  compared to $31.0 million
in  2000,   increasing   2.9%  from  the  prior  year.   The  yield  on  average
interest-earning  assets  was 7.1% in 2001,  compared  to 7.3% in 2000.  Average
interest-earning  assets increased in 2001 to $450.0 million from $424.9 million
in 2000. Average loans, which are the Company's highest yielding earning assets,
increased  $28.5  million in 2001,  while  investment  securities  increased  on
average  by $7.7  million.  Average  loans  represented  72.4%  of 2001  average
interest-earning assets, compared to 70.0% in 2000.
     Interest expense also decreased in 2001 to $12.5 million from $13.7 million
in 2000, a decrease of $1.2 million or 8.8%.  This  decrease  resulted  from the
Federal  Reserve  cutting short term interest rates due to the economy  slipping
into a recession.  The average rate paid on interest-bearing  liabilities during
2001 was 3.5%, compared to 4.0% a decrease of 12.5% from 2000.
     Interest  income in 2000 totalled $31.0 million,  compared to $28.3 million
in 1999, increasing 9.5% from the prior year.
     The yield on average  interest-earning assets was 7.3% in 2000, compared to
7.0% in  1999.  Average  interest-earning  assets  increased  in 2000 to  $424.9
million from $405.0  million in 1999.  Average  loans,  which are the  Company's
highest  yielding  earning  assets,  increased  $14.3  million  in  2000,  while
investment  securities  and other  earning  assets  increased on average by $5.7
million.  Average  loans  represented  70.0%  of 2000  average  interest-earning
assets, compared to 69.9% in 1999.
     Interest expense also increased in 2000 to $13.7 million from $11.2 million
in 1999,  an increase of $2.5  million or 22.3%.  This  increase  resulted  from
higher money market,  time deposit and short-term  borrowing  costs. The average
rate paid on  interest-bearing  liabilities  during  2000 was 4.0%,  compared to
3.4%, an increase of 17.6% from 1999.
     The most  significant  impact on net  interest  income  between  periods is
derived  from the  interaction  of changes in the volume of and rates  earned or
paid on interest-earning assets and interest-bearing  liabilities. The volume of
earning   dollars  in  loans  and   investments,   compared  to  the  volume  of
interest-bearing  liabilities  represented by deposits and borrowings,  combined
with the spread, produces the changes in net interest income between periods.


NET INTEREST INCOME (in millions)        YEAR
---------------------------------------------
       $ 19,336                          2001
         17,345                          2000
         17,107                          1999
         16,796                          1998
         17,714                          1997


12 Penseco Financial Services Corporation / 2001 Annual Report

<PAGE>

Distribution of Assets, Liabilities and Stockholders'  Equity/Interest Rates and
Interest Differential

The table below presents  average  balances,  interest income on a fully taxable
equivalent basis and interest expense,  as well as average rates earned and paid
on the Company's  major asset and liability  items for the years 2001,  2000 and
1999.

<TABLE>
<CAPTION>

                                                    2001                            2000                            1999
------------------------------------------------------------------------------------------------------------------------------------
                                        Average   Revenue/   Yield/     Average   Revenue/   Yield/     Average   Revenue/   Yield/
                                        Balance   Expense     Rate      Balance   Expense    Rate       Balance   Expense     Rate
------------------------------------------------------------------------------------------------------------------------------------
<S>                                    <C>        <C>         <C>      <C>        <C>         <C>      <C>        <C>         <C>
ASSETS
Investment securities:
  Available-for-sale:
    U.S. Treasury securities           $  40,596  $  2,262     5.57%   $  60,684  $  3,465     5.71%   $  75,346  $  4,329     5.75%
    U.S. Agency obligations               47,802     3,130     6.55       20,011     1,338     6.69        5,000       286     5.72
    States & political subdivisions        6,725       245     5.52       15,522       572     5.58       23,434       836     5.41
    Federal Home Loan Bank stock           1,881       122     6.49        1,798       127     7.06        1,796       119     6.63
    Other                                    211         6     2.84           20         1     5.00           20         1     5.00
  Held-to-maturity:
    U.S. Agency obligations                3,192       185     5.80        4,407       259     5.88        4,647       279     6.00
    States & political subdivisions       22,852     1,189     7.88       13,122       735     8.49          640        34     8.05
Loans, net of unearned income:
  Real estate mortgages                  250,000    19,148     7.66      227,819    18,249     8.01      221,001    17,236     7.80
  Commercial                              27,885     2,117     7.59       19,613     1,845     9.41       21,164     1,818     8.59
  Consumer and other                      47,961     3,418     7.13       49,930     3,717     7.44       40,923     2,819     6.89
Federal funds sold                           181         6     3.31        6,729       414     6.15        7,035       369     5.25
Interest on balances with banks              651        32     4.92        5,253       321     6.11        3,977       194     4.88
------------------------------------------------------------------------------------------------------------------------------------
Total Earning Assets/
  Total Interest Income                  449,937  $ 31,860     7.08%     424,908  $ 31,043     7.31%     404,983  $ 28,320     6.99%
------------------------------------------------------------------------------------------------------------------------------------
Cash and due from banks                    8,310                                    11,514                          11,188
Bank premises and equipment               11,218                                    12,104                          12,588
Accrued interest receivable                3,831                                     2,628                           2,992
Other assets                               5,063                                     1,125                           2,186
Less: Allowance for loan losses            3,185                                     3,004                           2,894
------------------------------------------------------------------------------------------------------------------------------------
Total Assets                           $ 475,174                       $ 449,275                       $ 431,043
====================================================================================================================================

LIABILITIES AND STOCKHOLDERS' EQUITY
Deposits:
  Demand-Interest bearing              $  25,033  $    240      .96%   $  23,380  $    250     1.07%   $  23,643  $    252     1.07%
  Savings                                 64,513       965     1.50       65,927       983     1.49       71,084     1,061     1.49
  Money markets                           86,154     2,616     3.04       75,959     2,927     3.85       59,066     1,585     2.68
  Time - Over $100                        32,998     1,779     5.39       38,407     2,262     5.89       43,397     2,172     5.00
  Time - Other                           114,943     5,784     5.03      115,345     6,236     5.41      115,764     5,633     4.87
Federal funds purchased                        3         -        -           22         1     4.55           78         4     5.13
Repurchase agreements                     17,366       570     3.28       15,101       786     5.20       12,169       482     3.96
Short-term borrowings                     15,520       570     3.67        4,522       253     5.59          481        24     4.99
------------------------------------------------------------------------------------------------------------------------------------
Total Interest Bearing Liabilities/
  Total Interest Expense                 356,530  $ 12,524     3.51%     338,663  $ 13,698     4.04%     325,682  $ 11,213     3.44%
------------------------------------------------------------------------------------------------------------------------------------
Demand - Non-interest bearing             61,823                          61,162                          57,339
All other liabilities                      3,656                           1,813                                     1,888
Stockholders' equity                      53,165                          47,637                                    46,134
------------------------------------------------------------------------------------------------------------------------------------
Total Liabilities and
  Stockholders' Equity                 $ 475,174                       $ 449,275                       $ 431,043
====================================================================================================================================
Interest Spread                                                3.57%                           3.27%                           3.55%
------------------------------------------------------------------------------------------------------------------------------------
Net Interest Income                               $ 19,336                        $ 17,345                        $ 17,107
====================================================================================================================================

Financial Ratios
  Net interest margin                                          4.30%                           4.08%                           4.22%
  Return on average assets                                     1.18%                           1.06%                           1.08%
  Return on average equity                                    10.57%                           9.96%                          10.12%
  Average equity to average assets                            11.19%                          10.60%                          10.70%
  Dividend payout ratio                                       47.71%                          52.04%                          50.69%
</TABLE>

                  Penseco Financial Services Corporation / 2001 Annual Report 13

<PAGE>

DOLLAR AMOUNT OF CHANGE IN INTEREST INCOME AND INTEREST EXPENSE

<TABLE>
<CAPTION>
                                                     Dollar                             Change
                                                     Amount   Change in   Change in    in Rate-
             2001 compared to 2000                 of Change   Volume        Rate       Volume
             ----------------------------------------------------------------------------------
<S>                                                <C>        <C>         <C>          <C>
EARNING      Investment securities:
ASSETS         Available-for-sale:
                 U.S. Treasury securities          $ (1,203)  $ (1,147)   $    (84)    $    28
                 U.S. Agency obligations              1,792      1,859         (28)        (39)
                 States & political subdivisions       (327)      (324)         (6)          3
                 Equity securities                        -         19         (17)         (2)
               Held-to-maturity:
                 U.S. Agency obligations                (74)       (71)         (4)          1
                 States & political subdivisions        454        545         (52)         39)
             Loans, net of unearned income:
               Real estate mortgages                    899      1,775        (798)        (78)
               Commercial                               272        778        (356)       (150)
               Consumer and other                      (299)      (146)       (154)          1
             Federal funds sold                        (408)      (403)       (191)        186
             Interest bearing balances with banks      (289)      (281)        (63)         55
             ----------------------------------------------------------------------------------
               Total Interest Income                    817      2,604      (1,753)        (34)
             ----------------------------------------------------------------------------------
INTEREST     Deposits:
BEARING        Demand - Interest bearing                (10)        18         (26)         (2)
LIABILITIES    Savings                                  (18)       (21)          3           -
               Money markets                           (311)       393        (615)        (89)
               Time - Over $100                        (483)      (318)       (192)         27
               Time - Other                            (452)       (22)       (438)          8
             Federal funds purchased                     (1)        (1)          -           -
             Repurchase agreements                     (216)       118        (290)        (44)
             Short-term borrowings                      317        615         (87)       (211)
             ----------------------------------------------------------------------------------
               Total Interest Expense                (1,174)       782      (1,645)       (311)
             ----------------------------------------------------------------------------------
               Net Interest Income                 $  1,991   $  1,822    $   (108)    $   277
             ==================================================================================
</TABLE>


<TABLE>
<CAPTION>

             2000 compared to 1999
             ----------------------------------------------------------------------------------
<S>                                                <C>        <C>         <C>          <C>
EARNING      Investment securities:
ASSETS         Available-for-sale:
                 U.S. Treasury securities          $   (864)  $   (843)   $    (30)    $     9
                 U.S. Agency obligations              1,052        859          48         145
                 States & political subdivisions       (264)      (282)         26          (8)
                 Equity securities                        8          -           8           -
               Held-to-maturity:
                 U.S. Agency obligations                (20)       (14)         (6)          -
                 States & political subdivisions        701        663           2          36
             Loans, net of unearned income:
                 Real estate mortgages                1,013        532         464          17
                 Commercial                              27       (133)        174         (14)
                 Consumer and other                     898        621         225          52
             Federal funds sold                          45        (16)         63          (2)
             Interest bearing balances with banks       127         62          49          16
             ----------------------------------------------------------------------------------
               Total Interest Income                  2,723      1,449       1,023         251
             ----------------------------------------------------------------------------------
INTEREST     Deposits:
BEARING        Demand - Interest bearing                 (2)        (2)          -           -
LIABILITIES    Savings                                  (78)       (78)          -           -
               Money markets                          1,342        453         691         198
               Time - Over $100                          90       (249)        386         (47)
               Time - Other                             603        (20)        625          (2)
             Federal funds purchased                     (3)        (3)          -           -
             Repurchase agreements                      304        116         151          37
             Short-term borrowings                      229        202           3          24
             ----------------------------------------------------------------------------------
               Total Interest Expense                 2,485        419       1,856         210
             ----------------------------------------------------------------------------------
               Net Interest Income                 $    238   $  1,030    $   (833)    $    41
             ==================================================================================
</TABLE>

14 Penseco Financial Services Corporation / 2001 Annual Report

<PAGE>

PROVISION FOR LOAN LOSSES

The  provision  for loan losses  represents  management's  determination  of the
amount  necessary  to bring  the  allowance  for  loan  losses  to a level  that
management  considers  adequate to reflect the risk of future losses inherent in
the Company's loan  portfolio.  The process of  determining  the adequacy of the
allowance  is  necessarily   judgmental  and  subject  to  changes  in  external
conditions.  Accordingly,  there can be no assurance that existing levels of the
allowance will ultimately prove adequate to cover actual loan losses.

OTHER INCOME

The following  table sets forth  information by category of other income for the
Company for the past three years:

Years Ended December 31,            2001        2000       1999
---------------------------------------------------------------
Trust department income         $  1,233    $  1,329   $  1,047
Service charges on
  deposit accounts                 1,126         718        695
Merchant transaction income        5,331       5,354      5,166
Other fee income                   1,291         975        704
Other operating income               231         211        134
Realized losses on
  securities, net                    (26)       (354)         -
---------------------------------------------------------------
  Total Other Income            $  9,186    $  8,233   $  7,746
===============================================================

Total other income increased $953 or 11.6% during 2001 to $9,186 from $8,233 for
2000. Components of this increase include service charges on deposit accounts of
$408 or 56.8% mainly due to the ongoing implementation of the recommendations of
a cost/revenue study held in the first quarter of 2001, an increase in other fee
income of $316 or 32.4% from the same period last year, of which $199 was due to
our  brokerage  division.  The  loss on the sale of  securities  in 2001 was $26
compared to a $354 loss in 2000.
     Total other income increased $487 or 6.3% during 2000 to $8,233 from $7,746
for 1999. Contributing increases came from trust fee income of $282 or 26.9%, of
which $107 is  attributable  to a one-time  change from a quarterly  charging of
fees to a monthly  charging of fees for many of our trust  customers  during the
third  quarter.  Also,  merchant  transaction  income  increased $188 or 3.6% to
$5,354 from $5,166,  along with  increases in other fee income of $271 or 38.5%,
of  which  $173 was due to our  brokerage  division.  The  loss on the  sales of
securities  occurred mainly in the second quarter of 2000, which included a $333
loss on the sale of ten  million  dollars of  short-term  municipal  securities,
which was  re-invested in longer term,  higher  yielding  municipal  securities.

OTHER EXPENSES

The following table sets forth information by category of other expenses for the
Company for the past three years:

Years Ended December 31,            2001        2000       1999
---------------------------------------------------------------
Salaries and employee  benefits $  8,180    $  7,951   $  7,528
Occupancy expenses, net            1,416       1,387      1,334
Furniture and equipment expenses   1,245       1,189      1,227
Merchant transaction expenses      4,636       4,784      4,471
Other operating expenses           4,600       3,995      3,752
---------------------------------------------------------------
  Total Other Expenses          $ 20,077    $ 19,306   $ 18,312
===============================================================

Other expenses increased $771 or 4.0% for 2001 to $20,077 from $19,306 for 2000.
Salaries and benefits  increased $229 or 2.9% to $8,180 for 2001 from $7,951 for
2000.  Also,  other  operating  expenses  increased $605 or 15.1% to $4,600 from
$3,995 due to increases in advertising costs associated with our loan growth and
non-recurring  insurance costs of $117 and $180 in outside consulting  services.
     Other expenses  increased $994 or 5.4% for 2000 to $19,306 from $18,312 for
1999.  Salaries and  benefits  increased  $423 or 5.6% to $7,951 for 2000,  from
$7,528  for 1999 due to higher  health  care costs and staff  additions  for our
brokerage division. Merchant transaction expenses increased $313 or 7.0%, due to
authorization   interchange   expenses   passed  on  by   MasterCard   and  Visa
International.  Also, other operating  expenses increased $243 or 6.5% to $3,995
from $3,752 due to increases in  advertising,  insurance and  consulting  costs.

INCOME TAXES

Federal income tax expense increased $573 or 44.2% to $1,869 in 2001 compared to
$1,296 in 2000.  This is largely the result of increased  net income from normal
business  operations.
     The  Company's  effective  income tax rate for 2001 was 25.0%  compared  to
21.5% for 2000. In 2000,  income tax expense decreased $485 from $1,781 in 1999.
Largely this decrease resulted from increases in tax free income recorded during
2000.  The  effective  income tax rate for 2000 was 21.5%  compared to 27.6% for
1999.
     For further  discussion  pertaining to Federal income taxes, see Note 12 to
the Consolidated Financial Statements.

FINANCIAL CONDITION

Total assets  increased  $15.4 million or 3.3% during 2001 to $482.6  million at
December 31, 2001 compared to $467.2  million at December 31, 2000. For the year
ended December 31, 2000 total assets  increased  $38.6 million to $467.2 million
or a 9.0% increase over $428.6 million at December 31, 1999.


ASSETS (in millions)             YEAR
-------------------------------------
       $ 482,551                 2001
         467,230                 2000
         428,614                 1999
         436,099                 1998
         427,577                 1997


INVESTMENT PORTFOLIO

The Company maintains a portfolio of investment securities to provide income and
serve as a source of liquidity for its ongoing  operations.
     The following  table presents the carrying value, by security type, for the
Company's investment portfolio.

December 31,                         2001        2000       1999
----------------------------------------------------------------
U.S.Treasury securities         $  36,069   $  54,662  $  66,459
U.S. Agency obligations            60,520      39,654      9,643
States & political subdivisions    29,741      29,624     28,591
Equity securities                   2,293       1,868      1,818
----------------------------------------------------------------
  Total Investment Securities   $ 128,623   $ 125,808  $ 106,511
================================================================

                  Penseco Financial Services Corporation / 2001 Annual Report 15

<PAGE>

LOAN PORTFOLIO

Details regarding the Company's loan portfolio for the past five years are as
follows:

<TABLE>
<CAPTION>

December 31,                           2001        2000        1999         1998        1997
--------------------------------------------------------------------------------------------
<S>                               <C>         <C>         <C>          <C>         <C>
Real estate - construction
  and land development            $   9,124   $   9,321   $   3,241    $   4,152   $   3,731
Real estate mortgages               246,486     234,212     216,574      221,879     213,128
Commercial                           30,001      21,566      18,995       18,169      17,173
Credit card and related plans         2,377       2,267       2,203        2,286       2,293
Installment                          30,142      30,290      28,693       28,538      26,811
Obligations of states &
  political subdivisions              5,678      10,085      11,821        8,195       8,910
--------------------------------------------------------------------------------------------
  Loans, net of unearned income     323,808     307,741     281,527      283,219     272,046
Less: Allowance for loan losses       3,600       3,100       2,950        2,830       2,600
--------------------------------------------------------------------------------------------
  Loans, net                      $ 320,208   $ 304,641   $ 278,577    $ 280,389   $ 269,446
============================================================================================
</TABLE>

LOANS

Total net loans increased $15.6 million to $320.2 million at December 31, 2001
from $304.6 million at December 31, 2000, an increase of 5.1%. The increase is
due to growth in the Company's real estate and commercial loan portfolios.
     Total net loans  increased  $26.0 million to $304.6 million at December 31,
2000 from $278.6 million at December 31, 1999, an increase of 9.3%. The increase
is due to growth in the Company's real estate,  commercial and installment  loan
portfolios.


NET LOANS (in millions)                YEAR
-------------------------------------------
       $ 320,208                       2001
         304,641                       2000
         278,577                       1999
         280,389                       1998
         269,446                       1997


LOAN QUALITY

The lending  activities  of the Company are guided by the basic  lending  policy
established  by the Board of Directors.  Loans must meet criteria  which include
consideration of the character, capacity and capital of the borrower, collateral
provided for the loan, and prevailing economic conditions.
     Regardless  of credit  standards,  there is risk of loss  inherent in every
loan  portfolio.  The  allowance  for loan losses is an amount  that  management
believes will be adequate to absorb  possible  losses on existing loans that may
become  uncollectible,  based on evaluations of the collectibility of the loans.
The evaluations take into consideration such factors as change in the nature and
volume of the loan  portfolio,  overall  portfolio  quality,  review of specific
problem  loans,  industry  experience,  collateral  value and  current  economic
conditions that may affect the borrower's  ability to pay.  Management  believes
that the allowance for loan losses is adequate.  While management uses available
information to recognize losses on loans,  future additions to the allowance may
be  necessary  based on changes in economic  conditions.  In  addition,  various
regulatory  agencies,   as  an  integral  part  of  their  examination  process,
periodically  review the Company's  allowance for loan losses. Such agencies may
require the  Company to  recognize  additions  to the  allowance  based on their
judgment of information available to them at the time of their examination.
     The  allowance  for loan losses is  increased by periodic  charges  against
earnings  as  a  provision  for  loan  losses,  and  decreased  periodically  by
charge-offs  of loans  (or  parts of  loans)  management  has  determined  to be
uncollectible,  net of actual  recoveries on loans  previously  charged-off.Such
agencies may require the Company to recognize  additions to the allowance  based
on  their  judgment  of  information  available  to  them at the  time of  their
examination.  The  allowance  for loan losses is increased  by periodic  charges
against earnings as a provision for loan losses,  and decreased  periodically by
charge-offs  of loans  (or  parts of  loans)  management  has  determined  to be
uncollectible, net of actual recoveries on loans previously charged-off.

16 Penseco Financial Services Corporation / 2001 Annual Report

<PAGE>

NON-PERFORMING ASSETS

Non-performing  assets consist of non-accrual  loans,  loans past due 90 days or
more and still  accruing  interest and other real estate  owned.  The  following
table sets forth  information  regarding  non-performing  assets as of the dates
indicated:

<TABLE>
<CAPTION>

December 31,                                     2001      2000      1999      1998      1997
---------------------------------------------------------------------------------------------
<S>                                           <C>       <C>       <C>       <C>       <C>
Non-accrual loans                             $ 1,917   $ 1,210   $   836   $   929   $ 1,031
Loans past due 90 days or more and accruing:
  Guaranteed student loans                        304       313       476       348       343
  Credit card and home equity loans                22        23         -        27        98
---------------------------------------------------------------------------------------------
  Total non-performing loans                    2,243     1,546     1,312     1,304     1,472
Other real estate owned                           143       201        33       111       339
---------------------------------------------------------------------------------------------
  Total non-performing assets                 $ 2,386   $ 1,747   $ 1,345   $ 1,415   $ 1,811
=============================================================================================
</TABLE>

Loans are generally placed on a non-accrual status when principal or interest is
past  due 90 days or when  payment  in full is not  anticipated.  When a loan is
placed on non-accrual  status, all interest previously accrued but not collected
is charged  against  current  income.  Loans are returned to accrual status when
past due interest is collected and the collection of principal is probable.
     Loans on which the accrual of  interest  has been  discontinued  or reduced
amounted  to  $1,917,  $1,210  and $836 at  December  31,  2001,  2000 and 1999,
respectively.  If interest on those loans had been  accrued,  such income  would
have been $152,  $138 and $140 for 2001, 2000 and 1999,  respectively.  Interest
income on those loans,  which is recorded only when  received,  amounted to $86,
$86 and $22 for 2001, 2000 and 1999,  respectively.  There are no commitments to
lend additional funds to individuals whose loans are on non-accrual status.
     The  management  process for  evaluating  the adequacy of the allowance for
loan losses  includes  reviewing each month's loan committee  reports which list
all  loans  that  do  not  meet  certain  internally  developed  criteria  as to
collateral adequacy, payment performance, economic conditions and overall credit
risk.  These  reports also address the current  status and actions in process on
each listed loan. From this  information,  adjustments are made to the allowance
for loan losses.  Such adjustments include both specific loss allocation amounts
and general  provisions  by loan category  based on present and past  collection
experience,  nature and volume of the loan portfolio, overall portfolio quality,
and current economic  conditions that may affect the borrower's  ability to pay.
As of December 31, 2001,  there are no significant  loans as to which management
has serious  doubt about their  collectibility.
     At December  31,  2001,  2000 and 1999,  the Company did not have any loans
specifically  classified as impaired.
     Most of the Company's  lending  activity is with  customers  located in the
Company's  geographic  market area and repayment thereof is affected by economic
conditions in this market area.

LOAN LOSS EXPERIENCE

The following  tables  present the  Company's  loan loss  experience  during the
periods indicated:

<TABLE>
<CAPTION>

Years Ended December 31,                   2001      2000      1999      1998      1997
---------------------------------------------------------------------------------------
<S>                                     <C>       <C>       <C>       <C>       <C>
Balance at beginning of year            $ 3,100   $ 2,950   $ 2,830   $ 2,600   $ 2,300
Charge-offs:
  Real estate mortgages                      38        37        82        69        38
  Commercial and all others                 389        51        13       252         -
  Credit card and related plans              37        27        65        37        52
  Installment loans                          19        24        26        25        32
---------------------------------------------------------------------------------------
Total charge-offs                           483       139       186       383       122
---------------------------------------------------------------------------------------
Recoveries:
  Real estate mortgages                      20        30         -         1        79
  Commercial and all others                   -         -       195         -         1
  Credit card and related plans               1         9        10         9        17
  Installment loans                           8        17        12         8         9
---------------------------------------------------------------------------------------
Total recoveries                             29        56       217        18       106
---------------------------------------------------------------------------------------
Net charge-offs (recoveries)                454        83       (31)      365        16
---------------------------------------------------------------------------------------
Provision charged to operations             954       233        89       595       316
---------------------------------------------------------------------------------------
  Balance at End of Year                $ 3,600   $ 3,100   $ 2,950   $ 2,830   $ 2,600
=======================================================================================
Ratio of net charge-offs (recoveries)
to average loans outstanding              0.14%     0.03%   (0.01)%     0.13%     0.01%
=======================================================================================
</TABLE>

                  Penseco Financial Services Corporation / 2001 Annual Report 17

<PAGE>

The allowance for loan losses is allocated as follows:

<TABLE>
<CAPTION>

December 31,                    2001             2000             1999             1998             1997
---------------------------------------------------------------------------------------------------------------
                              Amount     %1    Amount     %1    Amount     %1    Amount     %1    Amount     %1
---------------------------------------------------------------------------------------------------------------
<S>                          <C>      <C>     <C>      <C>     <C>      <C>     <C>      <C>     <C>      <C>
Real estate mortgages        $ 1,700   79%    $ 1,500   79%    $ 1,500   78%    $ 1,550   80%    $ 1,350   71%
Commercial
  and all others               1,375   11       1,100   10         950   10         830    9         850   19
Credit card and
  related plans                  175    1         150    1         150    1         150    1         150    1
Personal installment loans       350    9         350   10         350   11         300   10         250    9
---------------------------------------------------------------------------------------------------------------
  Total                      $ 3,600  100%    $ 3,100  100%    $ 2,950  100%    $ 2,830  100%    $ 2,600  100%
===============================================================================================================
</TABLE>

Note: 1 - Percent of loans in each category to total loans

DEPOSITS

The primary  source of funds to support the Company's  operations is its deposit
base. Company deposits increased $19.1 million to $406.5 million at December 31,
2001 from  $387.4  million at  December  31,  2000,  an  increase of 4.9% due to
increases in DDA, savings and time deposits.  Company  deposits  increased $20.1
million to $387.4  million at December 31, 2000 from $367.3  million at December
31, 1999,  an increase of 5.5%.  The increase in deposits in 2000 was the result
of the  Company  introducing  new deposit  products  along with  increasing  its
non-interest bearing deposits.

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

  Three months or less                  $  11,288
  Over three months through six months      8,570
  Over six months through twelve months     7,604
  Over twelve months                       10,144
                                        ---------
  Total                                 $  37,606
                                        =========


DEPOSITS (in millions)            YEAR
--------------------------------------
       $ 406,531                  2001
         387,439                  2000
         367,332                  1999
         377,526                  1998
         374,488                  1997


ASSET/LIABILITY MANAGEMENT

The  Company's  policy  is to match  its  level  of  rate-sensitive  assets  and
rate-sensitive liabilities within a limited range, thereby reducing its exposure
to interest rate fluctuations.  While no single measure can completely  identify
the impact of changes in interest  rates on net  interest  income,  one gauge of
interest  rate-sensitivity  is to measure,  over a variety of time periods,  the
differences  in  the  amounts  of  the  Company's   rate-sensitive   assets  and
rate-sensitive liabilities.  These differences, or "gaps", provide an indication
of the extent to which net interest  income may be affected by future changes in
interest  rates.  A  positive  gap  exists  when  rate-sensitive  assets  exceed
rate-sensitive  liabilities  and indicates  that a greater volume of assets than
liabilities  will  reprice  during a given  period.  This  mismatch  may enhance
earnings in a rising  interest rate  environment  and may inhibit  earnings when
interest rates  decline.  Conversely,  when  rate-sensitive  liabilities  exceed
rate-sensitive  assets,  referred  to as a negative  gap,  it  indicates  that a
greater volume of liabilities than assets may reprice during the period. In this
case, a rising  interest  rate  environment  may inhibit  earnings and declining
interest  rates  may  enhance  earnings.  However,  because  interest  rates for
different asset and liability products offered by financial institutions respond
differently, the gap is only a general indicator of interest rate sensitivity.

LIQUIDITY

The objective of liquidity  management is to maintain a balance  between sources
and uses of funds in such a way that  the cash  requirements  of  customers  for
loans and deposit withdrawals are met in the most economical manner.  Management
monitors its liquidity position  continuously in relation to trends of loans and
deposits for  short-term  as well as long-term  requirements.  Liquid assets are
monitored  on a daily  basis to  assure  maximum  utilization.  Management  also
manages its liquidity  requirements  by maintaining an adequate level of readily
marketable assets and access to short-term funding sources.

18 Penseco Financial Services Corporation / 2001 Annual Report

<PAGE>


LIQUIDITY (continued)

     The Company remains in a highly liquid condition both in the short and long
term. Sources of liquidity include the Company's  substantial U.S. Treasury bond
portfolio,  additional  deposits,  earnings,  overnight  loans to and from other
companies  (Federal  Funds) and lines of credit at the Federal  Reserve Bank and
the  Federal  Home Loan Bank.  The  Company  is not a party to any  commitments,
guarantees or obligations that could materially affect its liquidity.
     In the normal course of business,  there are  outstanding  commitments  and
contingent   liabilities,   created  under   prevailing   terms  and  collateral
requirements  such as  commitments to extend  credit,  financial  guarantees and
letters  of  credit,  which  are not  reflected  in the  accompanying  Financial
Statements.  The  Company  does not  anticipate  any losses as a result of these
transactions.  These instruments involve, to varying degrees, elements of credit
and interest rate risk in excess of the amount recognized in the Balance Sheets.
     The contract or notional amounts of those instruments reflect the extent of
involvement  the Company has in  particular  classes of  financial  instruments.
     Financial  instruments  whose  contract  amounts  represent  credit risk at
December 31, 2001 and 2000 are as follows:

                                    2001       2000
---------------------------------------------------
Commitments to extend credit:
  Fixed rate                    $ 17,490   $ 19,100
  Variable rate                 $ 45,033   $ 37,075
Standby letters of credit       $  3,311   $  2,077

RELATED PARTIES

The Company does not have any material transactions involving related persons or
entities, other than traditional banking transactions which are made on the same
terms and conditions as those prevailing at the time for comparable transactions
with unrelated parties.

CAPITAL RESOURCES

A strong  capital  position is important to the continued  profitability  of the
Company and promotes  depositor and investor  confidence.  The Company's capital
provides a basis for future growth and  expansion  and also provides  additional
protection against unexpected losses.
     Additional  sources of capital would come from  retained  earnings from the
operations  of the  Company  and  from  the  sale of  additional  common  stock.
Management has no plans to offer additional common stock at this time.
     The  Company's  total  risk-based  capital ratio was 18.22% at December 31,
2001. The Company's  risk-based capital ratio is more than the 10.00% ratio that
Federal regulators use as the "well capitalized" threshold.  This is the current
criteria  which the FDIC  uses in  determining  the  lowest  insurance  rate for
deposit  insurance.  The Company's  risk-based capital ratio is more than double
the 8.00% limit which determines whether a company is "adequately  capitalized".
Under these rules, the Company could significantly increase its assets and still
comply with these capital  requirements  without the necessity of increasing its
equity capital.

DIVIDEND POLICY

Payment of future  dividends  will be subject to the  discretion of the Board of
Directors  and will  depend  upon the  earnings of the  Company,  its  financial
condition, its capital requirements, its need for funds and other matters as the
Board deems appropriate.
     Dividends  on the  Company  common  stock,  if  approved  by the  Board  of
Directors,  are customarily paid on or about March 15, June 15, September 15 and
December 15.


STOCKHOLDERS' EQUITY (in millions)        YEAR
----------------------------------------------
        $ 54,648                          2001
          50,067                          2000
          45,743                          1999
          44,961                          1998
          42,924                          1997


                  Penseco Financial Services Corporation / 2001 Annual Report 19

<PAGE>

ITEM 7A Quantitative and Qualitative Disclosures About Market Risk

The Company  currently  does not enter into  derivative  financial  instruments,
which include futures, forwards, interest rate swaps, option contracts and other
financial  instruments  with similar  characteristics.  However,  the Company is
party to financial  instruments with off-balance sheet risk in the normal course
of  business  to meet the  financing  needs of its  customers.  These  financial
instruments  include  commitments  to extend  credit,  financial  guarantees and
letters of credit.  These  instruments  involve to varying degrees,  elements of
credit  and  interest  rate  risk in  excess  of the  amount  recognized  in the
Consolidated Balance Sheets. Commitments to extend credit are agreements to lend
to a customer as long as there is no violation of any condition  established  in
the  contract.  Commitments  generally  have  fixed  expiration  dates  or other
termination  clauses and may require payment of a fee. Standby letters of credit
are conditional commitments issued to guarantee the performance of a customer to
a third party up to a stipulated amount and with specified terms and conditions.
     Commitments to extend credit and standby letters of credit are not recorded
as an asset or liability by the Company until the instrument is exercised.
     The Company's exposure to market risk is reviewed on a regular basis by the
Asset/Liability  Committee.  Interest  rate risk is the  potential  of  economic
losses  due to future  interest  rate  changes.  These  economic  losses  can be
reflected as a loss of future net interest  income and/or a loss of current fair
market values. The objective is to measure the effect on net interest income and
to adjust the balance sheet to minimize the inherent risk while at the same time
maximizing income.  Management  realizes certain risks are inherent and that the
goal is to identify and minimize the risks. Tools used by management include the
standard GAP report and an interest rate shock  simulation  report.  The Company
has no market risk sensitive  instruments held for trading purposes.  It appears
the Company's market risk is reasonable at this time.
     The following table provides  information  about the Company's  market rate
sensitive instruments used for purposes other than trading that are sensitive to
changes  in  interest  rates.  For  loans,  securities,   and  liabilities  with
contractual  maturities,  the table  presents  principal  cash flows and related
weighted-average  interest  rates  by  contractual  maturities  as  well  as the
Company's  historical  experience of the impact of interest rate fluctuations on
the  prepayment  of  residential  and  home  equity  loans  and  mortgage-backed
securities.  For core deposits (e.g., DDA, interest checking,  savings and money
market deposits) that have no contractual maturity, the table presents principal
cash flows and, as applicable,  related weighted-average interest rates based on
the Company's  historical  experience,  management's  judgment,  and statistical
analysis, as applicable, concerning their most likely withdrawal behaviors.

20 Penseco Financial Services Corporation / 2001 Annual Report

<PAGE>

MATURITIES AND SENSITIVITY OF MARKET RISK AS OF DECEMBER 31, 2001

<TABLE>
<CAPTION>
                                                                                                     Non-Rate
                                          2002        2003      2004      2005      2006  Thereafter Sensitive     Total  Fair Value
------------------------------------------------------------------------------------------------------------------------------------
<S>                                  <C>        <C>         <C>       <C>       <C>       <C>        <C>        <C>        <C>
ASSETS
Fixed interest rate securities:
  U.S. Treasury securities           $  10,095  $   15,232  $  5,306  $  5,436  $      -  $       -  $       -  $  36,069  $  36,069
    Yield                                6.59%       3.64%     6.01%     6.79%         -          -          -      5.29%
  U.S. Agency obligations                    -      10,522    18,342    21,435     7,844          -          -     58,143     58,143
    Yield                                    -       6.98%     5.78%     6.34%     5.61%          -          -      6.18%
  States & political subdivisions            -           -         -         -         -     29,741          -     29,741     30,285
    Yield                                    -           -         -         -         -      7.74%          -      7.74%
Variable interest rate securities:
  U.S. Agency obligations                1,500         877         -         -         -          -          -      2,377      2,332
    Yield                                5.80%       5.80%         -         -         -          -          -      5.80%
  Federal Home Loan Bank stock               -           -         -         -         -      1,911          -      1,911      1,911
    Yield                                    -           -         -         -         -      6.39%          -      6.39%
  Other                                      -           -         -         -         -        382          -        382        382
    Yield                                    -           -         -         -         -      2.84%          -      2.84%
Fixed interest rate loans:
  Real estate mortgages                  9,282       9,020    11,765     8,940     9,414      86,859         -    135,280    136,713
    Yield                                7.49%       7.62%     7.78%     7.63%     7.55%      7.58%          -      7.60%
  Consumer and other                     1,684       1,499     1,356     1,244     1,168      1,322          -      8,273      8,108
    Yield                                7.94%       7.81%     7.67%     7.49%     7.33%      8.29%          -      7.77%
Variable interest rate loans:
  Real estate mortgages                 20,214       9,605     9,485    10,066     8,794     62,166          -    120,330    122,151
    Yield                                5.35%       5.84%     5.86%     6.10%     5.91%      6.41%          -      6.08%
  Commercial                            30,001           -         -         -         -          -          -     30,001     30,001
    Yield                                7.59%           -         -         -         -          -          -      7.59%
  Consumer and other                    11,405       4,799     4,569     4,331     4,553        267          -     29,924     30,443
    Yield                                6.44%       7.80%     7.40%     6.87%     6.88%      5.79%          -      6.93%
Less: Allowance for loan losses            807         277       302       273       266      1,675          -      3,600
Interest bearing deposits with banks     4,270           -         -         -         -          -          -      4,270      4,270
    Yield                                1.20%           -         -         -         -          -          -      1.20%
Federal funds sold                           -           -         -         -         -          -          -          -
    Yield                                    -           -         -         -         -          -          -          -
Cash and due from banks                      -           -         -         -         -          -     13,026     13,026     13,026
Other assets                                 -           -         -         -         -          -     16,424     16,424
------------------------------------------------------------------------------------------------------------------------------------
Total Assets                         $  87,644  $   51,277  $ 50,521  $ 51,179  $ 31,507  $ 180,973  $  29,450  $ 482,551  $ 473,834
====================================================================================================================================
LIABILITIES AND STOCKHOLDERS' EQUITY
Variable interest rate deposits:
  Demand - Interest bearing          $       -  $   27,498  $      -  $      -  $      -  $       -  $       -  $  27,498  $  27,498
    Yield                                    -        .50%         -         -         -          -          -       .50%
  Savings                                    -      67,613         -         -         -          -          -     67,613     67,613
    Yield                                    -       1.48%         -         -         -          -          -      1.48%
  Money markets                         88,342           -         -         -         -          -          -     88,342     88,342
    Yield                                1.57%           -         -         -         -          -          -      1.57%
  Time - Other                          13,746           -         -         -         -          -          -     13,746     13,746
    Yield                                3.06%           -         -         -         -          -          -      3.06%
Fixed interest rate deposits:
  Time - Over $100,000                  27,462       4,583     2,606       205     2,350        400          -     37,606     38,711
    Yield                                3.71%       5.04%     5.00%     7.15%     5.78%       7.25%         -      4.15%
  Time - Other                          70,767      15,433     7,029     1,510     4,633       1,542         -    100,914    102,713
    Yield                                4.13%       4.67%     4.92%     6.34%     5.01%       6.40%         -      4.38%
Demand - Non-interest bearing                -           -         -         -         -          -     70,812     70,812     70,812
Repurchase agreements                   18,140           -         -         -         -          -          -     18,140     18,140
    Yield                                1.74%           -         -         -         -          -          -      1.74%
Short-term borrowings                       17           -         -         -         -          -          -         17         17
    Yield                                2.03%           -         -         -         -          -          -      2.03%
Other liabilities                            -           -         -         -         -          -      3,215      3,215
Stockholders' equity                         -           -         -         -         -          -     54,648     54,648
------------------------------------------------------------------------------------------------------------------------------------
Total Liabilities and
Stockholders' Equity                 $ 218,474  $  115,127  $  9,635  $  1,715  $  6,983  $   1,942  $ 128,675  $ 482,551  $ 427,592
====================================================================================================================================
Excess of (liabilities) assets
subject to interest rate change      $(130,830) $  (63,850) $ 40,886  $ 49,464  $ 24,524  $ 179,031  $ (99,225) $       -
====================================================================================================================================
</TABLE>

                  Penseco Financial Services Corporation / 2001 Annual Report 21

<PAGE>

ITEM 8 Financial Statements and Supplementary Data

                          Consolidated Balance Sheets

(in thousands, except per share data)

                 December 31,                                    2001       2000
                 ---------------------------------------------------------------
ASSETS           Cash and due from banks                    $  13,026  $  18,775
                 Interest bearing balances with banks           4,270        358
                 Federal funds sold                                 -          -
                 ---------------------------------------------------------------
                   Cash and Cash Equivalents                   17,296     19,133

                 Investment securities:
                   Available-for-sale, at fair value           96,505    105,572
                   Held-to-maturity (fair value of $32,617
                      and $20,840, respectively)               32,118     20,236
                 ---------------------------------------------------------------
                   Total Investment Securities                128,623    125,808

                 Loans, net of unearned income                323,808    307,741
                   Less: Allowance for loan losses              3,600      3,100
                 ---------------------------------------------------------------
                   Loans, Net                                 320,208    304,641
                 Bank premises and equipment                   10,783     11,707
                 Other real estate owned                          143        201
                 Accrued interest receivable                    3,599      3,990
                 Other assets                                   1,899      1,750
                 ---------------------------------------------------------------
                   Total Assets                             $ 482,551  $ 467,230
                 ===============================================================

LIABILITIES      Deposits:
                   Non-interest bearing                     $  70,812  $  64,184
                   Interest bearing                           335,719    323,255
                 ---------------------------------------------------------------
                   Total Deposits                             406,531    387,439
                 Other borrowed funds:
                   Repurchase agreements                       18,140     15,086
                   Short-term borrowings                           17     11,503
                 Accrued interest payable                       1,577      2,268
                 Other liabilities                              1,638        867
                 ---------------------------------------------------------------
                   Total Liabilities                          427,903    417,163

STOCKHOLDERS'    Common stock, $.01 par value, 15,000,000
EQUITY             shares authorized, 2,148,000
                   shares issued and outstanding                   21         21
                 Surplus                                       10,819     10,819
                 Retained earnings                             41,206     38,269
                 Accumulated other comprehensive income         2,602        958
                 ---------------------------------------------------------------
                   Total Stockholders' Equity                  54,648     50,067
                 ---------------------------------------------------------------
                   Total Liabilities and
                   Stockholders' Equity                     $ 482,551  $ 467,230
                 ===============================================================

The  accompanying  Notes are an integral  part of these  Consolidated  Financial
Statements.

22 Penseco Financial Services Corporation / 2001 Annual Report

<PAGE>

                       Consolidated Statements of Income

(in thousands, except per share data)

<TABLE>
<CAPTION>

              Years Ended December 31,                      2001       2000       1999
              ------------------------------------------------------------------------
              <S>                                       <C>        <C>        <C>
INTEREST      Interest and fees on loans                $ 24,683   $ 23,811   $ 21,873
INCOME        Interest and dividends on investments:
                U.S. Treasury securities and U.S.
                  Agency obligations                       5,577      5,062      4,894
                States & political subdivisions            1,434      1,307        870
                Other securities                             128        128        120
              Interest on Federal funds sold                   6        414        369
              Interest on balances with banks                 32        321        194
              ------------------------------------------------------------------------
                Total Interest Income                     31,860     31,043     28,320
              ------------------------------------------------------------------------
INTEREST      Interest on time deposits
EXPENSE         of $100,000 or more                        1,779      2,262      2,172
              Interest on other deposits                   9,605     10,396      8,531
              Interest on other borrowed funds             1,140      1,040        510
              ------------------------------------------------------------------------
                Total Interest Expense                    12,524     13,698     11,213
              ------------------------------------------------------------------------
                Net Interest Income                       19,336     17,345     17,107
              Provision for loan losses                      954        233         89
              ------------------------------------------------------------------------
                Net Interest Income After Provision
                  for Loan Losses                         18,382     17,112     17,018
              ------------------------------------------------------------------------
OTHER         Trust department income                      1,233      1,329      1,047
INCOME        Service charges on deposit accounts          1,126        718        695
              Merchant transaction income                  5,331      5,354      5,166
              Other fee income                             1,291        975        704
              Other operating income                         231        211        134
              Realized losses on securities, net             (26)      (354)         -
              ------------------------------------------------------------------------
                Total Other Income                         9,186      8,233      7,746
              ------------------------------------------------------------------------
OTHER         Salaries and employee benefits               8,180      7,951      7,528
EXPENSES      Occupancy expenses, net                      1,416      1,387      1,334
              Furniture and equipment expenses             1,245      1,189      1,227
              Merchant transaction expenses                4,636      4,784      4,471
              Other operating expenses                     4,600      3,995      3,752
              ------------------------------------------------------------------------
                Total Other Expenses                      20,077     19,306     18,312
              ------------------------------------------------------------------------
              Income before income taxes                   7,491      6,039      6,452
              Applicable income taxes                      1,869      1,296      1,781
              ------------------------------------------------------------------------
NET INCOME      Net Income                              $  5,622   $  4,743   $  4,671
              ========================================================================
PER SHARE       Earnings Per Share                      $   2.62   $   2.21   $   2.17
              ========================================================================
</TABLE>

The  accompanying  Notes are an integral  part of these  Consolidated  Financial
Statements.

                  Penseco Financial Services Corporation / 2001 Annual Report 23

<PAGE>

                Consolidated Statements of Stockholders' Equity

Years Ended December 31, 2001, 2000 and 1999
--------------------------------------------

<TABLE>
<CAPTION>
                                                                              Accumulated
                                                                                 Other          Total
                                             Common               Retained   Comprehensive   Stockholders'
(in thousands except per share data)         Stock      Surplus   Earnings      Income          Equity
----------------------------------------------------------------------------------------------------------
<S>                                         <C>        <C>        <C>          <C>             <C>
Balance, December 31, 1998                  $ 21       $ 10,819   $ 33,688     $    433        $ 44,961

Comprehensive income:
  Net income, 1999                             -              -      4,671            -           4,671
  Unrealized losses on securities,
    net of taxes of $786                       -              -          -       (1,526)         (1,526)
                                                                                                 -------
Comprehensive income                                                                              3,145

Cash dividends declared ($1.10 per share)      -              -     (2,363)           -          (2,363)
----------------------------------------------------------------------------------------------------------

Balance, December 31, 1999                    21         10,819     35,996       (1,093)         45,743

Comprehensive income:
  Net income, 2000                             -              -      4,743            -           4,743
  Unrealized gains on securities,
    net of reclassification adjustment
    and taxes                                  -              -          -        2,051           2,051
                                                                                                 -------
Comprehensive income                                                                              6,794

Cash dividends declared ($1.15 per share)      -              -     (2,470)           -          (2,470)
----------------------------------------------------------------------------------------------------------

Balance, December 31, 2000                    21         10,819     38,269          958          50,067

Comprehensive income:
  Net income, 2001                             -              -      5,622            -           5,622
  Unrealized gains on securities,
    net of reclassification adjustment
    and taxes                                  -              -          -        1,644           1,644
                                                                                                 -------
Comprehensive income                                                                              7,266

Cash dividends declared ($1.25 per share)      -              -     (2,685)           -          (2,685)
----------------------------------------------------------------------------------------------------------
Balance, December 31, 2001                  $ 21       $ 10,819   $ 41,206     $  2,602        $ 54,648
==========================================================================================================
</TABLE>

The  accompanying  Notes are an integral  part of these  Consolidated  Financial
Statements.

24 Penseco Financial Services Corporation / 2001 Annual Report

<PAGE>

                     Consolidated Statements of Cash Flows
<TABLE>
<CAPTION>

(in thousands)   Years Ended December 31,                                 2001          2000          1999
                 ------------------------------------------------------------------------------------------
                 <S>                                                 <C>           <C>           <C>
OPERATING        Net Income                                          $   5,622     $   4,743     $   4,671
ACTIVITIES       Adjustments to reconcile net income to net
                   cash provided by operating activities:
                     Depreciation                                        1,288         1,243         1,176
                     Provision for loan losses                             954           233            89
                     Deferred income tax benefit                          (213)         (109)         (165)
                     Amortization of securities
                       (net of accretion)                                   38            55           336
                     Net realized losses on securities                      26           354             -
                     (Gain) loss on other real estate                      (14)          (22)           28
                     Loss on disposition of fixed assets                     -             8             -
                     Decrease (increase) in interest receivable            391        (1,063)          307
                     (Increase) decrease in other assets                  (299)          463            37
                     Increase in income taxes payable                      208            26           253
                     (Decrease) increase in interest payable              (691)          408          (179)
                     Increase (decrease) in other liabilities               78            30           (56)
                 ------------------------------------------------------------------------------------------
                     Net cash provided by
                       operating activities                              7,388         6,369         6,497
                 ------------------------------------------------------------------------------------------
INVESTING        Purchase of investment securities
ACTIVITIES         available-for-sale                                  (41,035)      (44,610)      (48,307)
                 Proceeds from sales and maturities of investment
                   securities available-for-sale                        52,568        37,801        62,015
                 Purchase of investment securities to be
                   held-to-maturity                                    (13,407)      (10,689)       (5,639)
                 Proceeds from repayments of investment
                   securities to be held-to-maturity                     1,487           898         1,535
                 Net loans (originated) repaid                         (16,786)      (26,569)        1,612
                 Proceeds from other real estate                           337           126           161
                 Proceeds from sale of fixed assets                          -             4             -
                 Investment in premises and equipment                     (364)         (666)         (841)
                 ------------------------------------------------------------------------------------------
                     Net cash (used) provided by
                       investing activities                            (17,200)      (43,705)       10,536
                 ------------------------------------------------------------------------------------------
FINANCING        Net increase in demand and savings deposits            14,784        28,375           851
ACTIVITIES       Net proceeds (payments) on time deposits                4,308        (8,268)      (11,045)
                 Increase in repurchase agreements                       3,054         3,105         1,022
                 Net (decrease) increase in short-term borrowings      (11,486)       10,616           887
                 Cash dividends paid                                    (2,685)       (2,470)       (2,363)
                 ------------------------------------------------------------------------------------------
                     Net cash provided (used) by
                       financing activities                              7,975        31,358       (10,648)
                 ------------------------------------------------------------------------------------------
                     Net (decrease) increase in cash
                       and cash equivalents                             (1,837)       (5,978)        6,385

                 Cash and cash equivalents at January 1                 19,133        25,111        18,726
                 ------------------------------------------------------------------------------------------
                 Cash and cash equivalents at December 31            $  17,296     $  19,133     $  25,111
                 ==========================================================================================
</TABLE>

The  accompanying  Notes are an integral  part of these  Consolidated  Financial
Statements.

                  Penseco Financial Services Corporation / 2001 Annual Report 25

<PAGE>

                     General Notes To Financial Statements

1  NATURE OF OPERATIONS AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES

Penseco Financial Services Corporation (Company) is a financial holding company,
incorporated in 1997 under the laws of Pennsylvania. It is the parent company of
Penn Security Bank and Trust Company (Bank), a state chartered bank.
     The Company  operates from nine banking  offices under a state bank charter
and provides full banking services,  including trust services, to individual and
corporate  customers  primarily  in  Northeastern  Pennsylvania.  The  Company's
primary   deposit   products  are  savings  and  demand  deposit   accounts  and
certificates  of  deposit.   Its  primary  lending  products  are  real  estate,
commercial and consumer  loans.
     The Company's  revenues are  attributable to a single  reportable  segment,
therefore segment  information is not presented.
     The accounting  policies of the Company conform with accounting  principles
generally  accepted in the United  States of America and with general  practices
within the banking industry.

BASIS OF PRESENTATION

The Financial Statements of the Company have been consolidated with those of its
wholly-owned subsidiary,  Penn Security Bank and Trust Company,  eliminating all
intercompany items and transactions.
     The  Statements  are  presented  on the accrual  basis of  accounting.
     All  information  is presented  in  thousands of dollars,  except per share
data.

USE OF ESTIMATES

The preparation of financial  statements in conformity  with generally  accepted
accounting principles requires management to make estimates and assumptions that
affect  the  reported  amounts  of assets  and  liabilities  and  disclosure  of
contingent  assets and  liabilities at the date of the financial  statements and
the  reported  amounts of revenues  and expenses  during the  reporting  period.
Actual results could differ from those  estimates.
     Material estimates that are particularly  susceptible to significant change
relate  to the  determination  of the  allowance  for  losses  on loans  and the
valuation  of  real  estate  acquired  in  connection  with  foreclosures  or in
satisfaction of loans. In connection  with the  determination  of the allowances
for losses on loans and foreclosed real estate,  management obtains  independent
appraisals for significant properties.

EMERGING ACCOUNTING STANDARDS

The  Financial  Accounting  Standards  Board has issued  various new  accounting
standards as of December  31,  2001,  which are  applicable  in future  periods.
     Management  does  not  anticipate  that  the  adoption  of any  of the  new
standards will have a significant  effect on the Company's earnings or financial
position.

INVESTMENT SECURITIES

Investments in securities are classified in two categories and accounted for as
follows:
     Securities  Held-to-Maturity.  Bonds, notes, debentures and mortgage-backed
securities for which the Company has the positive  intent and ability to hold to
maturity  are  reported at cost,  adjusted  for  amortization  of  premiums  and
accretion of discounts  computed on the straight-line  basis, which approximates
the  interest  method,  over  the  remaining  period  to  maturity.
     Securities Available-for-Sale.  Bonds, notes, debentures and certain equity
securities  not  classified  as securities to be held to maturity are carried at
fair value with unrealized  holding gains and losses,  net of tax, reported as a
net amount in a separate component of stockholders' equity until realized.
     Gains  and  losses  on  the  sale  of  securities   available-for-sale  are
determined  using the  specific  identification  method  and are  reported  as a
separate component of other income in the Statements of Income.

LOANS AND PROVISION (ALLOWANCE) FOR POSSIBLE LOAN LOSSES

Loans are  stated  at the  principal  amount  outstanding,  net of any  unearned
income,  deferred  loan fees and the  allowance  for loan  losses.  Interest  is
accrued daily on the outstanding balances.
     Loans are  generally  placed on a  non-accrual  status  when  principal  or
interest is past due 90 days or when payment in full is not anticipated.  When a
loan is placed on non-accrual  status,  all interest  previously accrued but not
collected  is charged  against  current  income.  Loans are  returned to accrual
status when past due interest is collected  and the  collection  of principal is
probable.
     The  provision  for loan  losses  is based on past  loan  loss  experience,
management's  evaluation  of the  potential  loss in the current loan  portfolio
under current  economic  conditions  and such other factors as, in  management's
best  judgement,  deserve  current  recognition in estimating  loan losses.  The
annual  provision  for loan losses  charged to operating  expense is that amount
which is  sufficient  to bring the balance of the  allowance  for possible  loan
losses to an adequate level to absorb anticipated losses.

PREMISES AND EQUIPMENT

Premises  and  equipment  are  stated  at cost  less  accumulated  depreciation.
Provision  for  depreciation  and  amortization,  computed  principally  on  the
straight-line method, is charged to operating expenses over the estimated useful
lives of the assets.  Maintenance  and repairs are charged to current expense as
incurred.

LONG-LIVED ASSETS

The Company  reviews the  carrying  value of  long-lived  assets for  impairment
whenever events or changes in  circumstances  indicate that carrying  amounts of
the assets might not be  recoverable,  as  prescribed  in Statement of Financial
Accounting  Standards  No. 121,  "Accounting  for the  Impairment  of Long-Lived
Assets and for Long-Lived Assets to be Disposed Of" (SFAS 121).

PENSION EXPENSE

Pension  expense has been  determined in accordance  with Statement of Financial
Accounting Standards No. 87, "Employers Accounting for Pensions" (SFAS 87).

POSTRETIREMENT BENEFITS EXPENSE

Postretirement benefits expense has been determined in accordance with Statement
of  Financial   Accounting   Standards  No.  106,   "Employers   Accounting  for
Postretirement Benefits Other Than Pensions" (SFAS 106).

26 Penseco Financial Services Corporation / 2001 Annual Report

<PAGE>

1  NATURE  OF  OPERATIONS  AND  SUMMARY  OF  SIGNIFICANT   ACCOUNTING   POLICIES
   (continued)

ADVERTISING EXPENSES

Advertising costs are expensed as incurred.  Advertising  expenses for the years
ended  December  31,  2001,  2000 and  1999,  amounted  to $497,  $466 and $387,
respectively.

INCOME TAXES

Provisions  for income taxes are based on taxes  payable or  refundable  for the
current year (after  exclusion of  non-taxable  income such as interest on state
and municipal  securities) as well as deferred  taxes on temporary  differences,
between the amount of taxable  income and pre-tax  financial  income and between
the tax bases of  assets  and  liabilities  and their  reported  amounts  in the
Financial  Statements.  Deferred tax assets and  liabilities are included in the
Financial  Statements at currently  enacted  income tax rates  applicable to the
period in which the  deferred  tax assets and  liabilities  are  expected  to be
realized or settled as prescribed in Statement of Financial Accounting Standards
No. 109,  "Accounting  for Income  Taxes" (SFAS 109).  As changes in tax laws or
rates are enacted,  deferred tax assets and liabilities are adjusted through the
provision for income taxes.

CASH FLOWS

For purposes of the Statements of Cash Flows, cash and cash equivalents  include
cash on hand, due from banks,  interest  bearing balances with banks and Federal
funds sold for a one-day period.

The Company paid  interest and income taxes during the years ended  December 31,
2001, 2000 and 1999 as follows:

                           2001         2000         1999
---------------------------------------------------------
Income taxes paid      $  1,909     $  1,379     $  1,694
Interest paid          $ 13,215     $ 13,290     $ 11,392

Non-cash  transactions  during the years ended December 31, 2001, 2000 and 1999,
comprised  entirely of the net  acquisition  of real estate in the settlement of
loans, amounted to $265, $272 and $111, respectively.

TRUST ASSETS AND INCOME

Assets held by the Company in a fiduciary or agency  capacity for its  customers
are not included in the Financial  Statements since such items are not assets of
the Company. Trust income is reported on the accrual basis of accounting.

EARNINGS PER SHARE

Basic  earnings per share is computed on the weighted  average  number of common
shares  outstanding  during each year  (2,148,000) as prescribed in Statement of
Financial  Accounting  Standards  No. 128,  "Earnings  Per Share"  (SFAS 128). A
calculation of diluted earnings per share is not applicable to the Company.

RECLASSIFICATIONS

Certain  prior  year  amounts  have been  reclassified  to  conform  to the 2001
presentation.

2  CASH AND DUE FROM BANKS

Cash and due from banks are summarized as follows:

December 31,                                    2001         2000
-----------------------------------------------------------------
Cash items in process of collection         $    293     $     37
Non-interest bearing balances                  9,672       13,263
Cash on hand                                   3,061        5,475
-----------------------------------------------------------------
  Total                                     $ 13,026     $ 18,775
=================================================================

     The Company  may,  from time to time,  maintain  bank  balances  with other
financial  institutions  in excess of $100,000 each.  Management is not aware of
any evidence that would indicate that such deposits are at risk.

3  INVESTMENT SECURITIES

The amortized cost and fair value of investment  securities at December 31, 2001
and 2000 are as follows:

                               AVAILABLE-FOR-SALE

                                          Gross       Gross
                           Amortized   Unrealized   Unrealized      Fair
2001                          Cost       Gains        Losses       Value
--------------------------------------------------------------------------
U.S. Treasury securities   $  35,014   $    1,086   $       31    $ 36,069
U.S. Agency securities        55,368        2,775            -      58,143
States & political
  subdivisions                     -            -            -           -
--------------------------------------------------------------------------
  Total Debt Securities       90,382        3,861           31      94,212
Equity securities              2,180          113            -       2,293
--------------------------------------------------------------------------
  Total Available-
    for-Sale               $  92,562   $    3,974   $       31    $ 96,505
==========================================================================

                                          Gross       Gross
                           Amortized   Unrealized   Unrealized      Fair
2000                          Cost       Gains        Losses       Value
--------------------------------------------------------------------------
U.S. Treasury securities   $  54,133   $      614   $       85    $ 54,662
U.S. Agency securities        34,666        1,120           37      35,749
States & political
  subdivisions                13,455            -          162      13,293
--------------------------------------------------------------------------
  Total Debt Securities      102,254        1,734          284     103,704
Equity securities              1,868            -            -       1,868
--------------------------------------------------------------------------
  Total Available-
    for-Sale               $ 104,122   $    1,734   $      284    $105,572
==========================================================================

Equity securities at December 31, 2001 and 2000,  consisted primarily of Federal
Home Loan Bank stock, which is a required  investment in order to participate in
an available line of credit  program.  The stock is stated at par value as there
is no readily determinable fair value.

                  Penseco Financial Services Corporation / 2001 Annual Report 27

<PAGE>

3  INVESTMENT SECURITIES (continued)

A summary of transactions involving  available-for-sale debt securities in 2001,
2000 and 1999 are as follows:

December 31,                    2001        2000    1999
--------------------------------------------------------
Proceeds from sales         $ 28,594    $ 18,952    $  -
Gross realized gains              53           2       -
Gross realized losses             79         356       -


                                Held-to-Maturity

                                          Gross       Gross
                           Amortized   Unrealized   Unrealized      Fair
2001                          Cost       Gains        Losses       Value
--------------------------------------------------------------------------
U.S. Agency Obligations:
  Mortgage-backed
    securities             $   2,377   $        -   $       45    $  2,332
States & political
  subdivisions                29,741          799          255      30,285
--------------------------------------------------------------------------
  Total Held-to-Maturity   $  32,118   $      799   $      300    $ 32,617
==========================================================================

                                          Gross       Gross
                           Amortized   Unrealized   Unrealized      Fair
2000                          Cost       Gains        Losses       Value
--------------------------------------------------------------------------
U.S. Agency Obligations:
  Mortgage-backed
    securities             $   3,905   $        -   $      125    $  3,780
States & political
  subdivisions                16,331          729            -      17,060
--------------------------------------------------------------------------
  Total Held-to-Maturity   $  20,236   $      729   $      125    $ 20,840
==========================================================================

Investment  securities  with  amortized  costs and fair  values of  $76,419  and
$79,091 at December 31, 2001 and $74,820 and $77,872 at December 31, 2000,  were
pledged  to secure  trust  funds,  public  deposits  and for other  purposes  as
required by law.
     The amortized  cost and fair value of debt  securities at December 31, 2001
by contractual  maturity,  are shown in the following table. Expected maturities
will differ from contractual  maturities because borrowers may have the right to
call or prepay obligations with or without call or prepayment penalties.

                                  Available-for-Sale        Held-to-Maturity
-------------------------------------------------------------------------------
                                Amortized      Fair      Amortized      Fair
                                   Cost        Value        Cost        Value
-------------------------------------------------------------------------------
Due in one year or less:
  U.S. Treasury securities      $   9,998    $ 10,095    $       -    $      -
After one year through
  five years:
  U.S. Treasury securities         25,016      25,974            -           -
  U.S. Agency securities           55,368      58,143            -           -
After ten years:
  States & political
    subdivisions                        -           -       29,741      30,285
-------------------------------------------------------------------------------
  Subtotal                         90,382      94,212       29,741      30,285
Mortgage-backed securities              -           -        2,377       2,332
-------------------------------------------------------------------------------
Total Debt Securities           $  90,382    $ 94,212    $  32,118    $ 32,617
===============================================================================

4  LOANS

Major classifications of loans are as follows:

December 31,                                      2001        2000
------------------------------------------------------------------
Loans secured by real estate:
  Construction and land development          $   9,124   $   9,321
  Secured by farmland                              395         508
  Secured by 1-4 family residential
    properties:
    Revolving, open-end loans                    8,410       6,146
    Secured by first liens                     159,748     146,422
    Secured by junior liens                     29,269      33,791
  Secured by multi-family properties               808         843
  Secured by non-farm, non-residential
    properties                                  47,856      46,502
Commercial and industrial loans
    to U.S. addressees                          30,001      21,566
Loans to individuals for household, family
  and other personal expenditures:
  Credit card and related plans                  2,377       2,267
  Other (installment and
    student loans, etc.)                        29,169      29,725
Obligations of states &
  political subdivisions                         5,678      10,085
All other loans                                    973         565
------------------------------------------------------------------
  Gross Loans                                  323,808     307,741
Less: Unearned income on loans                       -           -
------------------------------------------------------------------
  Loans, Net of Unearned Income              $ 323,808   $ 307,741
==================================================================

Loans on which the accrual of interest has been discontinued or reduced amounted
to $1,917, $1,210 and $836 at December 31, 2001, 2000 and 1999, respectively. If
interest on those loans had been accrued, such income would have been $152, $138
and $140 for 2001, 2000 and 1999, respectively.  Interest income on those loans,
which is recorded  only when  received,  amounted to $86,  $86 and $22 for 2001,
2000 and 1999,  respectively.  Also, at December 31, 2001 and 2000, the Bank had
loans totalling $326 and $336, respectively, which were past due 90 days or more
and still accruing  interest  (credit card,  home equity and guaranteed  student
loans).

5  ALLOWANCE FOR LOAN LOSSES

Changes in the allowance for loan losses are as follows:

Years Ended December 31,                   2001       2000       1999
----------------------------------------------------------------------
Balance at beginning of year            $ 3,100    $ 2,950    $ 2,830
Provision charged to operations             954        233        89
Recoveries credited to allowance             29         56        217
----------------------------------------------------------------------
                                          4,083      3,239      3,136
Losses charged to allowance                (483)      (139)      (186)
----------------------------------------------------------------------
  Balance at End of Year                $ 3,600    $ 3,100    $ 2,950
======================================================================

A comparison of the provision for loan losses for Financial  Statement  purposes
with the allowable bad debt deduction for tax purposes is as follows:

Years Ended December 31,        Book Provision           Tax Deduction
------------------------        --------------           -------------
        2001                        $  954                   $  454
        2000                        $  233                   $   52
        1999                        $   89                   $    0

The  balance of the Reserve  for Bad Debts as  reported  for Federal  income tax
purposes  was  $948,  $948  and  $979 at  December  31,  2001,  2000  and  1999,
respectively.

28 Penseco Financial Services Corporation / 2001 Annual Report

<PAGE>

6  BANK PREMISES AND EQUIPMENT

December 31,                                2001       2000
-----------------------------------------------------------
Land                                    $  2,919   $  2,919
Buildings and improvements                14,473     14,379
Furniture and equipment                   11,208     10,938
-----------------------------------------------------------
                                          28,600     28,236
Less: Accumulated depreciation            17,817     16,529
-----------------------------------------------------------
  Net Bank Premises and Equipment       $ 10,783   $ 11,707
===========================================================

Buildings and improvements are being  depreciated over 10 to 50 year periods and
equipment over 3 to 10 year periods.  Depreciation expense amounted to $1,288 in
2001, $1,243 in 2000 and $1,176 in 1999.
     Occupancy  expenses were reduced by rental income received in the amount of
$61,  $60  and  $59 in the  years  ended  December  31,  2001,  2000  and  1999,
respectively.

7  OTHER REAL ESTATE OWNED

Real estate  acquired  through  foreclosure  is recorded at the lower of cost or
market  at the time of  acquisition.  Any  subsequent  write-downs  are  charged
against operating expenses.  The other real estate owned as of December 31, 2001
and 2000 was $143 and $201,  respectively,  supported by  appraisals of the real
estate involved.

8  INVESTMENT  IN AND LOAN TO, INCOME FROM  DIVIDENDS  AND EQUITY IN EARNINGS OR
   LOSSES OF SUBSIDIARY

Penseco Realty, Inc. is a wholly-owned subsidiary of the Bank which owns certain
banking premises. Selected financial information is presented below:


                                    Equity in
                                    underlying                   Bank's
           Percent         Total    net assets    Amount    proportionate
          of voting     investment  at balance      of      part of loss
Year     stock owned     and loan   sheet date   dividends  for the period
--------------------------------------------------------------------------

2001         100%        $ 3,650     $ 3,635       None        $     -
2000         100%        $ 3,750     $ 3,735       None        $     -
1999         100%        $ 3,850     $ 3,835       None        $     -


9  DEPOSITS

December 31,                                 2001        2000
-------------------------------------------------------------
Demand - Non-interest bearing           $  70,812   $  64,184
Demand - Interest bearing                  27,498      24,075
Savings                                    67,613      63,552
Money markets                              88,342      87,670
Time - Over $100,000                       37,606      33,328
Time - Other                              114,660     114,630
-------------------------------------------------------------
  Total                                 $ 406,531   $ 387,439
=============================================================

9  DEPOSITS (continued)

Scheduled maturities of time deposits are as follows:

        2002                  $ 111,975
        2003                     20,016
        2004                      9,635
        2005                      1,715
        2006                      6,983
        2007 and thereafter       1,942
        -------------------------------
          Total               $ 152,266
        ===============================

10 OTHER BORROWED FUNDS

At December 31, 2001 and 2000, other borrowed funds consisted of demand notes to
the U.S. Treasury, Repurchase agreements and Federal funds purchased.
     Short-term borrowings generally have original maturity dates of thirty days
or less.
     Investment  securities  with amortized costs and fair values of $22,056 and
$23,367 at December 31, 2001 and $22,038 and $22,498 at December 31, 2000,  were
pledged to secure repurchase agreements.

Years Ended December 31,                    2001            2000
----------------------------------------------------------------
Amount outstanding at year end          $ 18,157        $ 26,589
Average interest rate at year end          1.81%           6.03%
Maximum amount outstanding at
  any month end                         $ 49,313        $ 30,280
Average amount outstanding              $ 32,364        $ 19,490
Weighted average interest rate
  during the year:
    Federal funds purchased                2.55%           4.55%
    Repurchase agreements                  3.28%           5.20%
Demand notes to U.S. Treasury              3.67%           5.59%

The Company has an available  credit  facility with the Federal  Reserve Bank in
the amount of $10,000,  secured by pledged  securities  with amortized costs and
fair values of $9,998 and  $10,095 at December  31, 2001 and $10,092 and $10,039
at December  31, 2000,  with an interest  rate of 1.25% and 6.0% at December 31,
2001 and December 31, 2000, respectively. There is no stated expiration date for
the credit facility as long as the Company  maintains the pledged  securities at
the Federal  Reserve Bank.  There was no outstanding  balance as of December 31,
2001 and 2000, respectively.
     The Company has the availability of a $5,000  overnight  Federal funds line
of credit with First Union Bank. There was no balance outstanding as of December
31, 2001 and 2000, respectively.
     The  Company  maintains  a  collateralized  maximum  borrowing  capacity of
$200,654  with the Federal  Home Loan Bank of  Pittsburgh  (FHLB).  There was no
balance outstanding or assets pledged as of December 31, 2001.

                  Penseco Financial Services Corporation / 2001 Annual Report 29

<PAGE>

11 EMPLOYEE BENEFIT PLANS

The Company  provides an Employee  Stock  Ownership  Plan  (ESOP),  a Retirement
Profit  Sharing  Plan,  an  Employees'  Pension Plan and a  Postretirement  Life
Insurance Plan, all non-contributory, covering all eligible employees.
     The Company also maintains an unfunded supplemental executive pension plan,
that provides  certain officers with additional  retirement  benefits to replace
benefits lost due to limits imposed on qualified plans by Federal tax law.
     Under the Employee Stock Ownership Plan (ESOP),  amounts voted by the Board
of Directors  are paid into the ESOP and each  employee is credited with a share
in proportion to their annual  compensation.  All  contributions to the ESOP are
invested in or will be invested  primarily in Company stock.  Distribution  of a
participant's  ESOP account  occurs upon  retirement,  death or  termination  in
accordance with the plan provisions.
     At  December  31, 2001 and 2000,  the ESOP held  85,337 and 87,369  shares,
respectively  of the  Company's  stock,  all of which were acquired as described
above and allocated to specific participant  accounts.  These shares are treated
the same for dividend  purposes and earnings per share  calculations  as are any
other outstanding  shares of the Company's stock. The Company  contributed $140,
$110 and $90 to the plan  during the years ended  December  31,  2001,  2000 and
1999, respectively.
     Under the  Retirement  Profit  Sharing Plan,  amounts voted by the Board of
Directors  are paid into a fund and each  employee is  credited  with a share in
proportion to their annual compensation.  Upon retirement, death or termination,
each  employee is paid the total amount of their credits in the fund in one of a
number of optional ways in accordance with the plan provisions.  The Company did
not  contribute to the plan during the years ended  December 31, 2001,  2000 and
1999, respectively.
     Under the Pension Plan,  amounts computed on an actuarial basis are paid by
the Company into a trust fund.  Provision is made for fixed benefits payable for
life  upon  retirement  at  the  age of 65,  based  on  length  of  service  and
compensation  levels as defined in the plan.  Plan  assets of the trust fund are
invested and  administered  by the Trust  Department  of Penn  Security Bank and
Trust Company.
     The postretirement life insurance plan is an unfunded,  non-vesting defined
benefit plan. The plan is non-contributory  and provides for a reducing level of
term life insurance coverage following retirement.

In determining the benefit obligation the following assumptions were made:

                            Pension Benefits      Other Benefits
                           ------------------    -----------------
December 31,                  2001     2000        2001    2000
------------------------------------------------------------------
Weighted - average
  assumptions:
    Discount rate             6.50%   7.00%       6.50%   7.00%
    Expected return on
      plan assets             9.00%   9.00%           -       -
    Rate of compensation
      increase                4.50%   4.50%       4.50%   4.50%

A reconciliation of the funded status of the plans with amounts reported on the
Consolidated Balance Sheets is as follows:

                            Pension Benefits      Other Benefits
                           ------------------    -----------------
December 31,                  2001     2000        2001     2000
------------------------------------------------------------------
Change in benefit
  obligation:
    Benefit obligation,
      beginning             $ 7,940  $ 7,387    $    167   $  140
    Service cost                310      295           5        5
    Interest cost               540      509          11       11
    Actuarial gain (loss)       563       28          10       16
    Benefits paid              (294)    (279)         (7)      (5)
------------------------------------------------------------------
  Benefit obligation,
    ending                    9,059    7,940         186      167
------------------------------------------------------------------
Change in plan assets:
    Fair value of plan
      assets, beginning       8,247    7,956           -        -
    Actual return on plan
      assets                     86      570           -        -
    Employer contribution        61        -           -        -
    Benefits paid              (294)    (279)          -        -
------------------------------------------------------------------
  Fair value of plan
    assets, ending            8,100    8,247           -        -
------------------------------------------------------------------
Funded status                  (959)     307        (186)    (167)
Unrecognized net transition
    asset                         -      (66)          -        -
Unrecognized net actuarial
    loss (gain)               1,853      614         (88)    (103)
Unrecognized prior service
    cost                        (55)     (46)         72       79
------------------------------------------------------------------
  Prepaid (accrued) benefit
    cost                    $   839  $   809    $   (202)  $ (191)
==================================================================

A reconciliation of net periodic pension and other benefit costs is as follows:

                                            Pension Benefits
                                           ------------------
Years Ended December 31,               2001       2000       1999
------------------------------------------------------------------
Components of net periodic
  pension cost:
    Service cost                     $  310     $  295     $  310
    Interest cost                       540        509        475
    Expected return on plan assets     (732)      (705)      (676)
    Amortization of transition
      asset                             (66)       (66)       (66)
    Amortization of unrecognized
      net (gain) loss                     -        (12)        12
------------------------------------------------------------------
      Net periodic pension cost      $   52     $   21     $   55
==================================================================

                                                Other Benefits
                                              ------------------
Years Ended December 31,                  2001       2000       1999
---------------------------------------------------------------------
Components of net periodic
  other benefit cost:
    Service cost                        $    5     $    5     $    5
    Interest cost                           11         11          9
    Amortization of prior service
      cost                                   7          8          7
    Amortization of unrecognized
      net loss                              (5)        (7)        (7)
---------------------------------------------------------------------
      Net periodic other benefit cost   $   18     $   17     $   14
=====================================================================

The projected benefit obligation,  accumulated benefit obligation and fair value
of plan assets for the pension  plan with  accumulated  benefit  obligations  in
excess of plan assets were $185, $174 and $0,  respectively at December 31, 2001
and $160, $130 and $0, respectively at December 31, 2000.

30 Penseco Financial Services Corporation / 2001 Annual Report

<PAGE>

12 INCOME TAXES

The total income taxes in the Statements of Income are as follows:

Years Ended December 31,       2001       2000       1999
---------------------------------------------------------
Currently payable           $ 2,082    $ 1,405    $ 1,946
Deferred benefit               (213)      (109)      (165)
---------------------------------------------------------
  Total                     $ 1,869    $ 1,296    $ 1,781
=========================================================

A reconciliation  of income taxes at statutory rates to applicable  income taxes
reported in the Statements of Income is as follows:

Years Ended December 31,       2001       2000       1999
---------------------------------------------------------
Tax at statutory rate       $ 2,547    $ 2,053    $ 2,194
Reduction for non-taxable
  interest                     (746)      (748)      (471)
Other (reductions)
  additions                      68         (9)        58
---------------------------------------------------------
  Applicable Income Taxes   $ 1,869    $ 1,296    $ 1,781
=========================================================

The components of the deferred  income tax benefit,  which result from temporary
differences, are as follows:

Years Ended December 31,          2001       2000      1999
------------------------------------------------------------
Accretion of discount on bonds   $   53    $   34    $  (57)
Accelerated depreciation            (96)      (85)      (59)
Supplemental benefit plan            (9)       (4)       (7)
Allowance for loan losses          (180)      (51)      (30)
Prepaid pension cost                 19        (3)      (12)
------------------------------------------------------------
  Total                          $ (213)   $ (109)   $ (165)
============================================================

The  significant  components  of  deferred  tax  assets and  liabilities  are as
follows:

December 31,                                 2001       2000
------------------------------------------------------------
Deferred tax assets:
  Allowance for loan losses               $   901    $   721
  Depreciation                                370        274
  Supplemental Benefit Plan                    35         26
------------------------------------------------------------
    Total Deferred Tax Assets               1,306      1,021
============================================================
Deferred tax liabilities:
  Unrealized securities gains               1,340        493
  Prepaid pension costs                       355        336
  Accretion                                    95         42
------------------------------------------------------------
    Total Deferred Tax Liabilities          1,790        871
------------------------------------------------------------
    Net Deferred Tax (Liabilities) Assets $  (484)   $   150
============================================================

In  management's  opinion,  the deferred tax assets are realizable in as much as
there is a history of strong earnings and a carryback potential greater than the
deferred tax assets. Management is not aware of any evidence that would preclude
the  realization  of the  benefit  in  the  future  and,  accordingly,  has  not
established a valuation allowance against the deferred tax assets.

13 ACCUMULATED OTHER COMPREHENSIVE INCOME

Accumulated other comprehensive  income of $2,602, $958 and $(1,093) at December
31, 2001, 2000 and 1999,  respectively consisted entirely of unrealized gains or
losses on available-for-sale securities, net of tax.
     A reconciliation of other comprehensive income for the years ended December
31, 2001 and 2000 is as follows:

                                                        Tax
                                         Before-Tax   (Expense)    Net-of-Tax
2001                                       Amount      Benefit       Amount
------------------------------------------------------------------------------
Unrealized gains on
  available-for-sale securities:
    Unrealized gains arising during
      the year                            $ 2,465     $   (838)      $ 1,627
    Less:  Reclassification adjustment
      for losses realized in income           (26)           9           (17)
------------------------------------------------------------------------------
    Net unrealized gains                  $ 2,491     $   (847)      $ 1,644
==============================================================================

2000
------------------------------------------------------------------------------
Unrealized gains on
  available-for-sale securities:
    Unrealized gains arising during
      the year                            $ 2,753     $   (936)      $ 1,817
    Less:  Reclassification adjustment
      for losses realized in income          (354)         120          (234)
------------------------------------------------------------------------------
    Net unrealized gains                  $ 3,107     $ (1,056)      $ 2,051
==============================================================================

14 COMMITMENTS AND CONTINGENT LIABILITIES

In the  normal  course  of  business,  there  are  outstanding  commitments  and
contingent   liabilities,   created  under   prevailing   Terms  and  collateral
requirements  such as  commitments to extend  credit,  financial  guarantees and
letters  of  credit,  which  are not  reflected  in the  accompanying  Financial
Statements.  The Company  does not  anticipate  any losses as a result o f these
transactions.  These instruments involve, to varying degrees, elements of credit
and interest rate risk in excess of the amount recognized in the Balance Sheets.
     The contract or notional amounts of those instruments reflect the extent of
involvement the Company has in particular classes of financial instruments.
     Financial  instruments  whose  contract  amounts  represent  credit risk at
December 31, 2001 and 2000 are as follows:

                                       2001          2000
---------------------------------------------------------
Commitments to extend credit:
  Fixed rate                       $ 17,490      $ 19,100
  Variable rate                    $ 45,033      $ 37,075

Standby letters of credit          $  3,311      $  2,077

     Commitments  to extend credit are  agreements to lend to a customer as long
as  there  is no  violation  of  any  condition  established  in  the  contract.
Commitments  generally  have  expiration  dates  of one  year or  less or  other
termination  clauses  and  may  require  payment  of a fee.  Since  many  of the
commitments  are  expected  to  expire  without  being  drawn  upon,  the  total
commitment amounts do not necessarily represent future cash requirements.
     Standby letters of credit are conditional  commitments  issued to guarantee
the  performance  of a customer to a third  party.  The credit risk  involved in
issuing  letters of credit is essentially the same as that involved in extending
loan facilities to customers.
     Various actions and proceedings are presently  pending to which the Company
is a party. Management is of the opinion that the aggregate liabilities, if any,
arising  from such  actions  would  not have a  material  adverse  effect on the
financial position of the Company.

                  Penseco Financial Services Corporation / 2001 Annual Report 31

<PAGE>

15 FAIR VALUE DISCLOSURE

GENERAL

Statement of Financial  Accounting  Standards  No.107,  "Disclosures  about Fair
Value of  Financial  Instruments"  (SFAS 107),  requires the  disclosure  of the
estimated fair value of on and off - balance sheet financial instruments.

VALUATION METHODS AND ASSUMPTIONS

Estimated fair values have been  determined  using the best  available  data, an
estimation methodology suitable for each category of financial instruments.  For
those loans and  deposits  with  floating  interest  rates it is  presumed  that
estimated fair values generally approximate the carrying amount balances.
     Financial  instruments  actively  traded in a  secondary  market  have been
valued using quoted available market prices.  Those with stated  maturities have
been valued  using a present  value  discounted  cash flow with a discount  rate
approximating   current  market  for  similar  assets  and  liabilities.   Those
liabilities with no stated maturities have an estimated fair value equal to both
the amount  payable  on demand and the  carrying  amount  balance.  The net loan
portfolio  has been  valued  using a present  value  discounted  cash flow.  The
discount rate used in these  calculations  is the current loan rate adjusted for
non-interest  operating  costs,  credit loss and assumed  prepayment  risk.  Off
balance sheet carrying amounts and fair value of letters of credit represent the
deferred  income fees arising  from those  unrecognized  financial  instruments.
     Changes in  assumptions  or  estimation  methodologies  may have a material
effect on these estimated fair values.
     All assets and liabilities which are not considered  financial  instruments
have not been valued  differently  than has been customary with  historical cost
accounting.

<TABLE>
<CAPTION>

                                             December 31, 2001          December 31, 2000
--------------------------------------------------------------------------------------------
                                           Carrying       Fair        Carrying      Fair
                                            Amount        Value        Amount       Value
--------------------------------------------------------------------------------------------
<S>                                       <C>           <C>          <C>          <C>
Financial Assets:
  Cash and due from banks                 $  13,026     $  13,026    $  18,775    $  18,775
  Interest bearing balances with banks        4,270         4,270          358          358
  Federal funds sold                              -             -            -            -
--------------------------------------------------------------------------------------------
    Cash and cash equivalents                17,296        17,296       19,133       19,133
  Investment Securities:
    Available-for-sale:
      U.S. Treasury securities               36,069        36,069       54,662       54,662
      U.S. Agency obligations                58,143        58,143       35,749       35,749
      States & political subdivisions             -             -       13,293       13,293
      Federal Home Loan Bank stock            1,911         1,911        1,798        1,798
      Other securities                          382           382           70           70
    Held-to-maturity:
      U.S. Agency obligations                 2,377         2,332        3,905        3,780
      States & political subdivisions        29,741        30,285       16,331       17,060
--------------------------------------------------------------------------------------------
        Total investment securities         128,623       129,122      125,808      126,412
  Loans, net of unearned income:
    Real estate mortgages                   255,610       258,864      243,533      237,664
    Commercial                               30,001        30,001       21,566       21,566
    Consumer and other                       38,197        38,551       42,642       42,291
    Less:  Allowance for loan losses          3,600                      3,100
--------------------------------------------------------------------------------------------
      Loans, net                            320,208       327,416      304,641      301,521
--------------------------------------------------------------------------------------------
      Total Financial Assets                466,127     $ 473,834      449,582    $ 447,066
Other assets                                 16,424                     17,648
--------------------------------------------------------------------------------------------
      Total Assets                        $ 482,551                  $ 467,230
============================================================================================
Financial Liabilities:
  Demand - Non-interest bearing           $  70,812     $  70,812    $  64,184    $  64,184
  Demand - Interest bearing                  27,498        27,498       24,075       24,075
  Savings                                    67,613        67,613       63,552       63,552
  Money markets                              88,342        88,342       87,670       87,670
  Time                                      152,266       155,170      147,958      148,518
-------------------------------------------------------------------------------------------
      Total Deposits                        406,531       409,435      387,439      387,999
  Repurchase agreements                      18,140        18,140       15,086       15,086
  Short-term borrowings                          17            17       11,503       11,503
--------------------------------------------------------------------------------------------
      Total Financial Liabilities           424,688     $ 427,592      414,028    $ 414,588
Other Liabilities                             3,215                      3,135
Stockholders' Equity                         54,648                     50,067
--------------------------------------------------------------------------------------------
      Total Liabilities and
      Stockholders' Equity                $ 482,551                  $ 467,230
============================================================================================
Standby Letters of Credit                 $     (33)    $     (33)   $     (21)   $     (21)
</TABLE>

32 Penseco Financial Services Corporation / 2001 Annual Report

<PAGE>

16 OPERATING LEASES

The Company leases the land upon which the Mount Pocono Office was built and the
land upon which a drive-up ATM was built on Meadow Avenue, Scranton. The Company
also leases space at several  locations  which are being used as remote  banking
facilities.  Rental  expense was $81 in 2001,  $81 in 2000 and $80 in 1999.  All
leases contain  renewal  options.  The Mount Pocono and the Meadow Avenue leases
contain  the right of first  refusal  for the  purchase  of the  properties  and
provisions for annual rent adjustments based upon the Consumer Price Index.
     Future minimum rental  commitments  under these leases at December 31, 2001
are as follows:

                            Mount   Meadow    ATM
                           Pocono   Avenue   Sites    Total
-----------------------------------------------------------
2002                        $  47   $  19    $  15    $  81
2003                           47      19        6       72
2004                           47      19        -       66
2005                           47      19        -       66
2006                           47      12        -       59
2007 to 2011                  204       -        -      204
-----------------------------------------------------------
  Total minimum
    payments required       $ 439   $  88    $  21    $ 548
===========================================================

17 LOANS TO DIRECTORS, PRINCIPAL OFFICERS AND RELATED PARTIES

The  Company  has  had,  and may be  expected  to have  in the  future,  banking
transactions  in the  ordinary  course of  business  with  directors,  principal
officers,  their immediate  families and affiliated  companies in which they are
principal  stockholders  (commonly referred to as related parties),  on the same
terms, including interest rates and collateral,  as those prevailing at the time
for  comparable  transactions  with  others.  A summary  of loans to  directors,
principal officers and related parties is as follows:

Years Ended December 31,       2001         2000
-------------------------------------------------
Beginning Balance          $  5,959     $  4,921
Additions                     2,997        2,914
Collections                  (2,292)      (1,876)
-------------------------------------------------
  Ending Balance           $  6,664     $  5,959
=================================================

18 REGULATORY MATTERS

The Company and the Bank are subject to various regulatory capital  requirements
administered  by the Federal banking  agencies.  Failure to meet minimum capital
requirements   can   initiate   certain   mandatory--and   possibly   additional
discretionary--actions  by regulators  that, if undertaken,  could have a direct
material effect on the Company and the Bank's Consolidated Financial Statements.
Under  capital  adequacy  guidelines  and the  regulatory  framework  for prompt
corrective  action,  the  Company  and  the  Bank  must  meet  specific  capital
guidelines that involve quantitative measures of their assets, liabilities,  and
certain  off-balance  sheet  items as  calculated  under  regulatory  accounting
practices.  The Company and the Bank's capital amounts and  classifications  are
also subject to qualitative judgements by the regulators about components,  risk
weightings and other factors.
     Quantitative  measures established by regulation to ensure capital adequacy
require the Company  and the Bank to  maintain  minimum  amounts and ratios (set
forth in the Capital  Adequacy table on the following  page) of Tier I and Total
Capital  to  risk-weighted  assets  and of  Tier I  Capital  to  average  assets
(Leverage  ratio).  The table also presents the Company's actual capital amounts
and ratios.  The Bank's  actual  capital  amounts  and ratios are  substantially
identical to the Company's.  Management believes,  as of December 31, 2001, that
the Company and the Bank meet all capital  adequacy  requirements  to which they
are subject.
     As of December  31,  2001,  the most recent  notification  from the Federal
Deposit  Insurance   Corporation   (FDIC)   categorized  the  Company  as  "well
capitalized" under the regulatory  framework for prompt corrective action. To be
categorized  as "well  capitalized",  the Company must  maintain  minimum Tier I
Capital,  Total Capital and Leverage ratios as set forth in the Capital Adequacy
table. There are no conditions or events since that notification that management
believes have changed the Company's categorization by the FDIC.
     The Company and Bank are also subject to minimum capital levels which could
limit the payment of  dividends,  although the Company and Bank  currently  have
capital levels which are in excess of minimum capital level ratios required.
     The Pennsylvania Banking Code restricts capital funds available for payment
of dividends to the Retained Earnings of the Bank. Accordingly,  at December 31,
2001, the balances in the Capital Stock and Surplus accounts  totalling  $10,840
are unavailable for dividends.
     In addition,  the Bank is subject to restrictions imposed by Federal law on
certain transactions with the Company's  affiliates.  These transactions include
extensions  of  credit,  purchases  of or  investments  in stock  issued  by the
affiliate,  purchases of assets  subject to certain  exceptions,  acceptance  of
securities  issued by an affiliate as collateral for loans,  and the issuance of
guarantees,  acceptances,  and letters of credit on behalf of affiliates.  These
restrictions  prevent the  Company's  affiliates  from  borrowing  from the Bank
unless the loans are secured by obligations of designated amounts.  Further, the
aggregate of such transactions by the Bank with a single affiliate is limited in
amount to 10 percent of the Bank's Capital Stock and Surplus,  and the aggregate
of such  transactions with all affiliates is limited to 20 percent of the Bank's
Capital Stock and Surplus.  The Federal Reserve System has interpreted  "Capital
Stock and Surplus" to include undivided profits.

                  Penseco Financial Services Corporation / 2001 Annual Report 33

<PAGE>

18 REGULATORY MATTERS (continued)

<TABLE>
<CAPTION>
               Actual                                       Regulatory Requirements
----------------------------------------------    --------------------------------------------
                                                       For Capital                To Be
                                                    Adequacy Purposes       "Well Capitalized"

December 31, 2001              Amount   Ratio        Amount    Ratio          Amount    Ratio
----------------------------------------------------------------------------------------------
<S>                           <C>       <C>       <C>         <C>         <C>         <C>
Total Capital
  (to Risk Weighted Assets)   $ 55,646  18.22%    > $ 24,428  > 8.0%      > $ 30,535  > 10.0%
                                                  -           -           -           -
Tier I Capital
  (to Risk Weighted Assets)   $ 52,046  17.04%    > $ 12,214  > 4.0%      > $ 18,321  >  6.0%
                                                  -           -           -           -
Tier I Capital
  (to Average Assets)         $ 52,046  10.95%    >        *  >   *       > $ 23,759  >  5.0%
                                                  -           -           -           -
</TABLE>

* 3.0%  ($14,255),  4.0%  ($19,007)  or 5.0%  ($23,759)  depending on the bank's
CAMELS Rating and other regulatory risk factors.

<TABLE>
<CAPTION>

December 31, 2000
----------------------------------------------------------------------------------------------
<S>                           <C>       <C>       <C>         <C>         <C>         <C>
Total Capital
  (to Risk Weighted Assets)   $ 52,209  18.32%    > $ 22,796  > 8.0%      > $ 28,494  > 10.0%
                                                  -           -           -           -
Tier I Capital
  (to Risk Weighted Assets)   $ 49,109  17.23%    > $ 11,398  > 4.0%      > $ 17,096  >  6.0%
                                                  -           -           -           -
Tier I Capital
  (to Average Assets)         $ 49,109  10.93%    >        *  >   *       > $ 22,464  >  5.0%
                                                  -           -           -           -
</TABLE>

* 3.0%  ($13,478),  4.0%  ($17,971)  or 5.0%  ($22,464)  depending on the bank's
CAMELS Rating and other regulatory risk factors.

19 PENSECO FINANCIAL SERVICES CORPORATION (PARENT CORPORATION)

The condensed Company-only information follows:

BALANCE SHEETS

December 31,                          2001        2000
------------------------------------------------------
Cash                              $      6    $      -
Investment in bank subsidiary       54,319      50,017
Equity Investments                     362          50
------------------------------------------------------
  Total Assets                    $ 54,687    $ 50,067
------------------------------------------------------
  Total Stockholders' Equity      $ 54,687    $ 50,067
======================================================

STATEMENTS OF INCOME

Years Ended December 31,                    2001         2000        1999
-------------------------------------------------------------------------
Dividends from bank subsidiary           $ 2,892      $ 2,520     $ 2,363
Dividends on investment securities             5            -           -
-------------------------------------------------------------------------
  Total Income                             2,897        2,520       2,363
Other non-interest expense                     7            -           -
-------------------------------------------------------------------------
Net income before undistributed
  earnings of bank subsidiary              2,890        2,520       2,363
Undistributed earnings of bank
  subsidiary                               2,732        2,223       2,308
-------------------------------------------------------------------------
  Net Income                             $ 5,622      $ 4,743     $ 4,671
=========================================================================

STATEMENTS OF CASH FLOWS

Years Ended December 31,                         2001       2000       1999
----------------------------------------------------------------------------
Operating Activities:
Net Income                                   $  5,622   $  4,743   $  4,671
Adjustments to reconcile net income
  to net cash provided by
    operating activities:
      Equity in undistributed net
        income of bank subsidiary              (2,732)    (2,223)    (2,308)
----------------------------------------------------------------------------
      Net cash provided by
        operating activities                    2,890      2,520      2,363
----------------------------------------------------------------------------
Investing Activities:
Purchase of equity investment                    (199)       (50)         -
----------------------------------------------------------------------------
      Net cash (used) provided by
        investing activities                     (199)       (50)         -
----------------------------------------------------------------------------
Financing Activities:
Cash dividends paid                            (2,685)    (2,470)    (2,363)
----------------------------------------------------------------------------
      Net cash used by
        financing activities                   (2,685)    (2,470)    (2,363)
----------------------------------------------------------------------------
      Net increase in cash and
        cash equivalents                            6          -          -
Cash and cash equivalents at January 1              -          -          -
----------------------------------------------------------------------------
Cash and cash equivalents at December 31     $      6   $      -   $      -
============================================================================

34 Penseco Financial Services Corporation / 2001 Annual Report

<PAGE>

McGrail Merkel Quinn & Associates
Certified Public Accountants & Consultants

                                                                February 7, 2002


To the Board of Directors and Stockholders
Penseco Financial Services Corporation
Scranton, Pennsylvania

                          Independent Auditor's Report
                          ----------------------------

     We have audited the  accompanying  consolidated  balance  sheets of Penseco
Financial  Services  Corporation and its wholly-owned subsidiary,  Penn Security
Bank and  Trust  Company  as of  December  31,  2001 and 2000,  and the  related
consolidated statements of income,  stockholders' equity and cash flows for each
of the years in the three year period ended December 31, 2001.  These  financial
statements  are  the  responsibility  of  the  Corporation's   management.   Our
responsibility  is to express an opinion on these financial  statements based on
our audits.

     We conducted our audits in accordance  with  auditing  standards  generally
accepted in the United States of America.  Those standards  require that we plan
and perform the audit to obtain reasonable assurance about whether the financial
statements are free of material misstatement.  An audit includes examining, on a
test basis,  evidence  supporting  the amounts and  disclosures in the financial
statements.  An audit also includes assessing the accounting principles used and
significant  estimates  made by  management,  as well as evaluating  the overall
financial  statement  presentation.   We  believe  that  our  audits  provide  a
reasonable basis for our opinion.

     In our opinion,  the financial statements referred to above present fairly,
in all  material  respects,  the  consolidated  financial  position  of  Penseco
Financial Services  Corporation and subsidiary as of December 31, 2001 and 2000,
and the  consolidated  results of their operations and their cash flows for each
of the years in the three year period ended  December 31,  2001,  in  conformity
with accounting principles generally accepted in the United States of America.


                                         /s/ McGrail, Merkel, Quinn & Associates


               Penseco Financial Services Corporation  /  2001 Annual Report  35

<PAGE>

ITEM 9  Changes  in  and  Disagreements  with  Accountants  on  Accounting   and
        Financial Disclosure

There  were no  changes  in or  disagreements  with  accountants  on  matters of
accounting principles or practices or financial statement disclosures in 2001.


                                    PART III


ITEM 10 Directors and Executive Officers of the Registrant

The  information  on  Directors  of  the  Company  on  pages  4,  5 and 6 in the
definitive  proxy  statement   relating  to  the  Company's  Annual  Meeting  of
stockholders,  to be held May 7,  2002,  is  incorporated  herein  by  reference
thereto.

The information on Executive  Officers on pages 6 and 7 in the definitive  proxy
statement  relating to the Company's Annual Meeting of stockholders,  to be held
May 7, 2002, is incorporated herein by reference thereto.


ITEM 11 Executive Compensation

The information  contained under the heading "Executive  Compensation" on page 6
in the definitive  proxy statement  relating to the Company's  Annual Meeting of
stockholders,  to be held May 7,  2002,  is  incorporated  herein  by  reference
thereto.


ITEM 12 Security Ownership of Certain Beneficial Owners and Management

The  information  contained  under the heading  "Voting  Securities  & Principal
Holders Thereof" on pages 2 and 3 in the definitive proxy statement  relating to
the  Company's  Annual  Meeting  of  stockholders,  to be held May 7,  2002,  is
incorporated herein by reference thereto.


ITEM 13 Certain Relationships and Related Transactions

The  information  contained in Note 17 under Item 8 on page 33 under the heading
"General  Notes to Financial  Statements" in the Company's 2001 Annual Report to
Shareholders is incorporated herein by reference thereto.

36 Penseco Financial Services Corporation / 2001 Annual Report

<PAGE>

                                    PART IV


ITEM 14 Exhibits, Financial Statement Schedules and Reports on Form 8-K

(a)  (1)  Financial   Statements  -  The  following  financial   statements  are
          incorporated by reference in Part II, Item 8 hereof:

          Balance Sheets
          Consolidated Statements of Income
          Consolidated Statements of Stockholders' Equity
          Consolidated Statements of Cash Flows
          General Notes to Financial Statements
          Independent Auditor's Report

     (2)  Financial Statement  Schedules - The Financial Statement Schedules are
          incorporated by reference in Part II, Item 8 hereof.

     (3)  Exhibits

          The following exhibits are filed herewith or incorporated by reference
          as part of this Annual Report.

          3(i) Registrant's  Articles of Incorporation  (Incorporated  herein by
               reference  to Exhibit  3(i) of  Registrant's  report on Form 10-K
               filed with the SEC on March 30, 1998.)

          3(ii)Registrant's   By-Laws   (Incorporated  herein  by  reference  to
               Exhibit 3(ii) of Registrant's  report on Form 10-K filed with the
               SEC on March 30, 1998.)

          10   Material   contracts  -   Supplemental   Benefit  Plan  Agreement
               (Incorporated  herein by reference to Exhibit 10 of  Registrant's
               report on Form 10-Q filed with the SEC on May 10, 1999.)

          13   Annual report to security  holders  (Included herein by reference
               on pages 1-40, including the cover.)

          21   Subsidiaries of the registrant  (Incorporated herein by reference
               to Exhibit 21 of Registrant's  report on Form 10-K filed with the
               SEC on March 30, 1998.)

(b)       No current report on Form 8-K was filed for the fourth quarter of 2001
          of the fiscal year ended December 31, 2001.

(c)       The exhibits  required to be filed by this Item are listed  under Item
          14. (a) 3, above.

(d)       There are no financial  statement schedules required to be filed under
          this item.

                  Penseco Financial Services Corporation / 2001 Annual Report 37

<PAGE>

                                   SIGNATURES

Pursuant to the requirements of Section 13 or 15(d) of the Securities  Exchan ge
Act of 1934,  the Bank has duly caused this report to be signed on its behalf by
the undersigned, thereunto duly authorized on February 19, 2002.


By:  /s/ Otto P. Robinson, Jr.
         -------------------------
         Otto P. Robinson, Jr.
         President


By:  /s/ Richard E. Grimm
         -------------------------
         Richard E. Grimm
         Executive Vice-President


By:  /s/ Patrick Scanlon
         -------------------------
         Patrick Scanlon
         Controller

Pursuant to the requirements of the Securities Exchange Act of 1934, this report
has been signed below by the following  persons on behalf of the  registrant and
in the capacities indicated on February 19, 2002.


By:  /s/ Edwin J. Butler                  By:   /s/ Robert W. Naismith, Ph.D.
         -------------------------                  -------------------------
         Edwin J. Butler                            Robert W. Naismith, Ph.D.
         Director                                   Director


By:  /s/ Richard E. Grimm                 By:   /s/ James B. Nicholas
         -------------------------                  -------------------------
         Richard E. Grimm                           James B. Nicholas
         Director                                   Director


By:  /s/ Russell C. Hazelton              By:   /s/ Emily S. Perry
         -------------------------                  -------------------------
         Russell C. Hazelton                        Emily S. Perry
         Director                                   Director


By:  /s/ D. William Hume                  By:   /s/ Sandra C. Phillips
         -------------------------                  -------------------------
         D. William Hume                            Sandra C. Phillips
         Director                                   Director


By:  /s/ James G. Keisling                By:   /s/ Otto P. Robinson, Jr.
         -------------------------                  -------------------------
         James G. Keisling                          Otto P. Robinson, Jr.
         Director                                   Director


By:  /s/ P. Frank Kozik                   By:   /s/ Steven L. Weinberger
         -------------------------                  -------------------------
         P. Frank Kozik                             Steven L. Weinberger
         Director                                   Director

38 Penseco Financial Services Corporation / 2001 Annual Report

<PAGE>
                               INDEX TO EXHIBITS
<TABLE>
<CAPTION>

Exhibit Number
Referred to
Item 601 of                                                            Prior Filing or Exhibit
Regulation S-K    DESCRIPTION OF EXHIBIT                               Page Number Herein
----------------------------------------------------------------------------------------------------------------------------
  <S>             <C>                                                  <C>
   2              Plan of acquisition, reorganization, arrangement,    None
                  liquidation or succession

   3              (i)  Articles of Incorporation                       Incorporated herein by reference to Exhibit 3 (i) of
                                                                       Registrant's report on Form 10-K filed with the
                                                                       SEC on March 30, 1998.

                  (ii) By-Laws                                         Incorporated herein by reference to Exhibit 3 (ii) of
                                                                       Registrant's report on Form 10-K filed with the
                                                                       SEC on March 30, 1998.

   4              Instruments defining the rights of security holders, None
                  including indentures

   9              Voting trust agreement                               None

  10              Material contracts - Supplemental Benefit Plan       Incorporated herein by reference to Exhibit 10 of
                  Agreement                                            Registrant's report on Form 10-Q filed with the
                                                                       SEC on May 10, 1999.

  11              Statement re:  Computation of per share earnings     None

  12              Statements re:  Computation of ratios                None

  13              Annual report to security holders, Form 10-Q or      Included herein by reference on pages 1-40,
                  quarterly report to security holders                 including the cover.

  16              Letter re:  Change in certifying accountant          None

  18              Letter re:  Change in accounting principles          None

  21              Subsidiaries of the registrant                       Incorporated herein by reference to Exhibit 21 of
                                                                       Registrant's report on Form 10-K filed with the
                                                                       SEC on March 30, 1998.

  22              Published report regarding matters submitted to      None
                  vote of security holders

  23              Consents of experts and counsel                      None

  24              Power of attorney                                    None

  99              Additional Exhibits                                  None
</TABLE>

                  Penseco Financial Services Corporation / 2001 Annual Report 39

<PAGE>

                                Company Officers
                                ----------------

PENSECO FINANCIAL SERVICES CORPORATION AND PENN SECURITY BANK AND TRUST COMPANY

OFFICERS

Otto P. Robinson, Jr.
President and General Counsel

Richard E. Grimm
Executive Vice-President and Treasurer

Peter F. Moylan
Executive Vice-President Non-Deposit Services and Trust Officer

William J. Calpin, Jr.
Senior Vice-President, Trust Services

Andrew A. Kettel, Jr.
Senior Vice-President

Christe A. Casciano
Vice-President, Director of Marketing

Audrey F. Markowski
Vice-President

Michael G. Ostermayer
Vice-President, Chief Investment Officer, Trust Services

Richard P. Rossi
Vice-President, Director of Human Resources

Lynn M. Peters Thiel
Vice-President and Compliance Officer

James Tobin
Vice-President, Charge Card Manager

John H. Warnken
Vice-President, Operations

Robert P. Heim
Director of Internal Audit

Patrick Scanlon
Controller

Susan M. Bray
Assistant Controller and Assistant Treasurer

Gerard P. Vasil
Manager, Data Processing

P. Frank Kozik
Secretary

Mark M. Bennett
Credit Review Officer and Assistant Secretary

PENN SECURITY BANK AND TRUST COMPANY OFFICERS

ASSISTANT VICE-PRESIDENTS

Carl M. Baruffaldi
Denise M. Cebular
Carol Curtis McMullen
  Assistant Trust Officer and Assistant Secretary
Paula M. DePeters
  and Assistant Treasurer
J. Patrick Dietz
Karyn Gaus Vashlishan
Lisa A. Kearney
Eleanor Kruk
Caroline Mickelson
Aleta Sebastianelli
  and Assistant Secretary
Jeffrey Solimine
Jennifer S. Wohlgemuth
Linda Wolf
  and Training Officer
Beth S. Wolff
Deborah A. Wright

ASSISTANT CASHIERS
Susan Cottle
Lori A. Dzwieleski
Pamela Edwards
Frank Gardner
Barbara Garofoli
Susan T. Holweg
Susan A. Kopp
Jacqueline Lucke
Kristen A. McGoff
  and Branch Operations Officer
Candace F. Quick
Nereida Santiago
Sharon Thauer

ACCOUNTING OFFICER
Luree M. Waltz

ASSISTANT BRANCH OPERATIONS OFFICERS
Carolyn E. Brown
Jennifer A. Lucchese

ASSISTANT CHARGE CARD MANAGER
Eileen Yanchak

ASSISTANT DIRECTOR OF INTERNAL AUDIT
Paula A. Ralston Nenish

ASSISTANT STUDENT LOAN OFFICER
Jo Ann M. Bevilaqua

ASSISTANT TRUST OFFICER
Dominick P. Gianuzzi

BRANCH OPERATIONS OFFICERS
Patricia A. Bruno
Stephen A. Hoffman

BUSINESS DEVELOPMENT OFFICER
Mary Carol Cicco

COMPUTER OPERATIONS OFFICER
Charles Penn

DIRECTOR OF CAMPUS BANKING
Douglas R. Duguay

DIRECTOR OF P.C. SYSTEMS
Robert J. Saslo

FINANCIAL REPORTING OFFICER
John R. Anderson III

LOAN ADMINISTRATION OFFICER
Susan D. Blascak

LOAN OFFICER
Denise Belton

MERCHANT OFFICER
Jill Ross

OPERATIONS OFFICER
Patricia Pliske

TAX OFFICER
Robert W. McDonald

TRUST OPERATIONS OFFICER
Carol Trezzi

TRUST PORTFOLIO MANAGER
Katherine M. Oven

40 Penseco Financial Services Corporation / 2001 Annual Report

<PAGE>

                              (INSIDE BACK COVER)

                              Company Board Members
                              ---------------------

PENSECO FINANCIAL SERVICES CORPORATION AND
PENN SECURITY BANK AND TRUST COMPANY

BOARD OF DIRECTORS

Edwin J. Butler
Retired Bank Officer

Richard E. Grimm
Executive Vice-President and Treasurer

Russell C. Hazelton
Retired Captain, Trans World Airlines

D. William Hume
Retired Bank Officer

James G. Keisling
Partner & Treasurer, Compression Polymers Group,
  Manufacturer of Plastic Sheet Products

P. Frank Kozik
President, Scranton Craftsmen, Inc., Manufacturer of
  Ornamental Iron and Precast Concrete Products

Robert W. Naismith, Ph.D.
Chairman & CEO, eMedsecurities, Inc.

James B. Nicholas
President, D. G. Nicholas Co., Wholesale Auto Parts Company

Emily S. Perry
Retired Insurance Account Executive & Community Volunteer

Sandra C. Phillips
Penn State Master Gardener
  Community Volunteer

Otto P. Robinson, Jr.
Attorney-at-Law, President

Steven L. Weinberger
Vice-President of G. Weinberger Company, Mechanical
  Contractor Specializing in Commercial & Industrial
  Construction

PENN SECURITY BANK AND TRUST COMPANY

ADVISORY BOARDS

ABINGTON OFFICE
Carl M. Baruffaldi
James L. Burne, DDS
Keith Eckel
Richard C. Florey
C. Lee Havey, Jr.
Attorney Patrick J. Lavelle
Sandra C. Phillips

EAST SCRANTON OFFICE
Marie W. Allen
J. Conrad Bosley
Judge Carmen Minora
Mark R. Sarno
Beth S. Wolff

EAST STROUDSBURG OFFICE
Denise M. Cebular
Mary Citro
Robert J. Dillman, Ph.D.
Attorney Kirby Upright
Jeffrey Weichel

GREEN RIDGE OFFICE
Joseph N. Connor
Everett Jones
Attorney Patrick J. Mellody
Caroline Mickelson
George Noone
Howard J. Snowdon
Jeffrey Solimine

MOUNT POCONO OFFICE
Bruce Berry
Francis Cappelloni
Attorney Brian Golden
Robert C. Hay
David Lansdowne
Karyn Gaus Vashlishan

NORTH POCONO OFFICE
Jacqueline A. Carling
Anthony J. Descipio
George F. Edwards
James A. Forti
Attorney David Z. Smith
Deborah A. Wright

SOUTH SIDE OFFICE
Attorney Zygmunt R. Bialkowski, Jr.
Michael P. Brown
J. Patrick Dietz
Lois Ferrari
Jeffrey J. Leventhal
Ted M. Stampien, DDS

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