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

                                   FORM 10-K

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

                  FOR THE FISCAL YEAR ENDED DECEMBER 31, 2006

                        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 if the  registrant is a well-known  seasoned  issuer,  as
defined in Rule 405 of the Securities Act. Yes ( ) No (X)

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

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 (ss 229.405 of this chapter) 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. [  ]

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

Large accelerated filer ( )    Accelerated filer (X)   Non-accelerated filer ( )

Indicate by check mark whether the  registrant is a shell company (as defined in
Rule 12b-2 of the Act). Yes ( ) No (X)

The aggregate market value of the Company's voting stock held by  non-affiliates
of the registrant on June 30, 2006,  based on the closing price of such stock on
that date, equals approximately $79,136,087.

The number of shares of common stock  outstanding  as of February 9, 2007 equals
2,148,000.

DOCUMENTS INCORPORATED BY REFERENCE

Portions of the  Corporation's  definitive proxy statement  relating to the 2007
Annual Meeting of Stockholders are incorporated by reference in Part III.

                  Penseco Financial Services Corporation / 2006 Annual Report  9

<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,  regulation and examination 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,  central loan
processing and central bookkeeping offices. There are eight additional offices.

     Through its banking subsidiary,  the Company generates interest income from
its outstanding loans receivable and its 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  borrowings  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 Company also offers  collateralized
repurchase  agreements,  that have a one day maturity, as an alternative deposit
option for its customers.

     The Bank has a third party  marketing  agreement  with  National  Financial
Services (formerly Fiserv Investor Services, Inc.) that allows the bank to offer
a full range of securities,  brokerage and annuity sales to its  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 its
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.

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 risks 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 1A Risk Factors

RISKS RELATED TO OUR BUSINESS

Credit Risk

Changes in the credit  quality of our loan portfolio may impact the level of our
allowance for loan losses.

We make various judgments about the  collectibility of our loans,  including the
creditworthiness  of our  borrowers  and the value of the real  estate and other
assets  serving as collateral for our loans.  In  determining  the amount of the
allowance for loan losses, we review our loans and our loan loss and delinquency
experience, and we evaluate economic conditions. If our judgments are incorrect,
our  allowance  for loan losses may not be  sufficient  to cover future  losses,
which will result in additions to our allowance through increased provisions for
loan losses. In addition,  bank regulators periodically review our allowance for
loan  losses and may  require us to increase  our  provision  for loan losses or
recognize further loan charge-offs.  Increased  provisions for loan losses would
increase our expenses and reduce our profits.

10 Penseco Financial Services Corporation / 2006 Annual Report

<PAGE>

     Nonetheless,  to the  best of  management's  knowledge,  there  are also no
particular  risk  elements in the local  economy that put a group or category of
loans  at  increased  risk.  Also 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 its  operations.  The operations and earnings of the
Corporation are also not materially affected by seasonal changes

Market Risk

Changes in interest  rates could affect our  investment  values and net interest
income.

At  December  31,  2006,  the  Company  owned  approximately  $91.7  million  of
marketable  securities  available for sale. These securities are carried at fair
value on the  consolidated  balance sheet.  Unrealized  gains or losses on these
securities,  that is, the  difference  between the fair value and the  amortized
cost of these securities,  is reflected in stockholders' equity, net of deferred
taxes.  As of December 31, 2006,  the Company's  available  for sale  marketable
securities  portfolio had a net unrealized  gain, net of taxes,  of $1,011.  The
fair value of the Company's available for sale marketable  securities is subject
to interest rate change,  which would not affect  recorded  earnings,  but would
increase or decrease comprehensive income and stockholders' equity.

     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.  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.

     The Company  continually  monitors the  relationship  of its interest  rate
sensitive assets and liabilities through its Asset/Liability Committee.

Strong competition within our market could affect our profits and growth.

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 its region. The competition  includes
commercial banks,  savings and loan associations,  credit unions,  other lending
institutions and mortgage originators.

     The principal  competitive  factors among the Company's  competitors can be
grouped into two  categories:  pricing and services.  In the  Company'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.

Compliance

We operate in a highly  regulated  environment and may be affected by changes in
laws and regulations.

The Company is registered as a financial  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 ("FRB").  The
Company is required to file quarterly reports of its operations with the FRB.

     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.

     Our  banking  subsidiary,  Penn  Security  Bank  and  Trust  Company,  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.

Operational Risk

The Company needs to continually  attract and retain qualified personnel for its
operations.  High quality customer service,  as well as efficient and profitable
operations,  are  dependent  on the  Company's  ability  to  attract  and retain
qualified individuals for key positions within the organization.  As of December
31, 2006, the Company employed 171 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.

                  Penseco Financial Services Corporation / 2006 Annual Report 11

<PAGE>


Our operations could be affected if we do not have access to modern and reliable
technology.

The  Company  operates in a  highly-automated  environment,  wherein  almost all
transactions are processed by computer  software to produce  results.  To remain
competitive,  the Company  must  continually  evaluate  the adequacy of its data
processing  capabilities and make revisions as needed.  The Company has recently
upgraded its computer technology at a total cost of $1.5 million.

     The Company regularly tests its ability to restore data capabilities in the
event of a natural  disaster,  sustained  power  failure or other  inability  to
utilize its primary systems.

Liquidity Risk

Increased  needs for  disbursement of funds on loans and deposits can affect our
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.  Management does not
foresee any adverse trends in liquidity.

Our future pension plan costs and contributions could be unfavorably impacted by
the factors that are used in the actuarial calculations.

Our  costs of  providing  non-contributory  defined  benefit  pension  plans are
dependent upon a number of factors,  such as the rates of return on plan assets,
discount rates, the level of interest rates used to measure the required minimum
funding levels of the plans,  future  government  regulation and our required or
voluntary  contributions  made to the  plans.  Without  sustained  growth in the
pension  investments  over time to  increase  the value of our plan  assets  and
depending upon the other factors  impacting our costs as listed above,  we could
be required to fund our plans with higher  amounts of cash than are  anticipated
by our  actuaries.  Such  increased  funding  obligations  could have a material
impact on our liquidity by reducing our cash flows.

ITEM 1B Unresolved Staff Comments

Not applicable

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 Company also owns property
in the  Borough  of  Dalton,  Lackawanna  County,  to use for  potential  future
expansion.

     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.

12 Penseco Financial Services Corporation / 2006 Annual Report

<PAGE>

                                    Part II
                                    -------

ITEM 5  Market for Registrant's Common Equity, Related Stockholder Matters and
        Issuer Purchases of Equity Securities

This Form 10-K is the Company's  annual  disclosure  statement as required under
Section 13 or 15(d) of the  Securities  Exhchange 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:

Boenning & Scattergood, Inc.                          Jefferies & Company, Inc.
Ferris, Baker, Watts, Inc.                            Knight Equity Markets, LP
Hill Thompson Magid & Company, Inc.                   Monroe Securities, Inc.
Hudson Securities, Inc..                              Ryan, Beck & Company, 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
2006              High     Low   Per Share
---------------------------------------------
First Quarter     $ 46    $ 41   $  .35
Second Quarter      45      42      .35
Third Quarter       43      41      .35
Fourth Quarter      44      41      .45
                                 ------
                                 $ 1.50
                                 ======


                               Dividends Paid
2005              High     Low   Per Share
---------------------------------------------
First Quarter     $ 48    $ 39   $  .33
Second Quarter      47      42      .33
Third Quarter       44      41      .33
Fourth Quarter      43      41      .45
                                 ------
                                 $ 1.44
                                 ======



A graph depicts Dividends Paid (in millions)       Year
-------------------------------------------------------
               $ 3,222                             2006
                 3,094                             2005
                 2,900                             2004
                 2,900                             2003
                 2,899                             2002


As of February 9, 2007 there were  approximately 895 stockholders of the Company
based on the number of holders of record.

Reference should be made to the information about the Company's  dividend policy
and regulatory guidelines on pages 23 and 46.

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 AMOUNTS (unaudited)
                    (in thousands, except per share amounts)

                            First    Second     Third    Fourth
2006                       Quarter   Quarter   Quarter   Quarter
----------------------------------------------------------------
Net Interest Income        $ 5,171   $ 5,212   $ 5,214   $ 5,271
Provision for Loan Losses      127        27       143       136
Other Income                 2,038     1,655     2,452     2,060
Other Expenses and Taxes     5,508     5,279     5,650     6,195
Net Income                   1,574     1,561     1,873     1,000
Earnings Per Share         $   .73   $   .73   $   .87   $   .47


                            First    Second     Third    Fourth
2005                       Quarter   Quarter   Quarter   Quarter
----------------------------------------------------------------
Net Interest Income        $ 4,697   $ 4,888   $ 4,960   $ 5,045
Provision for Loan Losses      122         -         -       141
Other Income                 2,346     2,126     2,564     1,838
Other Expenses and Taxes     5,675     5,494     5,827     5,336
Net Income                   1,246     1,520     1,697     1,406
Earnings Per Share         $   .58   $   .71   $   .79   $   .65

                  Penseco Financial Services Corporation / 2006 Annual Report 13

<PAGE>

                     PENSECO FINANCIAL SERVICES CORPORATION

     The following line graph sets forth comparative  information  regarding the
Company's  cumulative  shareholder return on its Common Stock over the last five
fiscal years.  Total shareholder  return is measured by dividing total dividends
(assuming  dividend  reinvestment)  plus share price  change for a period by the
share price at the beginning of the investment period. The Company's  cumulative
shareholder  return  based  on an  investment  of $100 at the  beginning  of the
five-year period begining  December 31, 2001 is compared to the cumulative total
return  of the  Russell  2000  Index  ("Russell  2000")  and the SNL  Securities
Northeast  Quadrant  Pink Sheet Banks Index ("Pink  Banks"),  which more closely
reflects the Company's  peer group.  The yearly points marked on the  horizontal
axis of the graph correspond to December 31st of that year.


                         Total Return Performance Graph

<TABLE>
<CAPTION>
                                                               Period Ending
                                       ---------------------------------------------------------------
Index                                  12/31/01   12/31/02   12/31/03   12/31/04   12/31/05   12/31/06
------------------------------------------------------------------------------------------------------
<S>                                     <C>        <C>        <C>        <C>        <C>        <C>
Penseco Financial Services Corporation  100.00     123.66     150.02     159.18     164.69     173.59
Russell 2000                            100.00      79.52     117.09     138.55     144.86     171.47
SNL Northeast OTC-BB and Pink Banks     100.00     121.20     176.77     205.94     205.31     212.18
</TABLE>

14 Penseco Financial Services Corporation / 2006 Annual Report

<PAGE>


ITEM 6  Selected Financial Data

(in thousands, except per share amounts)

RESULTS OF OPERATIONS:

<TABLE>
<CAPTION>
                                     2006         2005         2004         2003         2002
---------------------------------------------------------------------------------------------
<S>                             <C>          <C>          <C>          <C>          <C>
Interest Income                 $  31,922    $  28,170    $  25,385    $  26,014    $  27,899
Interest Expense                   11,054        8,580        7,579        8,228        8,011
---------------------------------------------------------------------------------------------
Net Interest Income                20,868       19,590       17,806       17,786       19,888
Provision for Loan Losses             433          263          144          476          813
---------------------------------------------------------------------------------------------
Net Interest Income after
   Provision for Loan Losses       20,435       19,327       17,662       17,310       19,075
Other Income                        8,205        8,874        9,594       10,743       11,032
Other Expenses                     21,037       20,719       20,584       20,454       21,098
Income Taxes                        1,595        1,613        1,071        1,628        2,256
---------------------------------------------------------------------------------------------
Net Income                      $   6,008    $   5,869    $   5,601    $   5,971    $   6,753
=============================================================================================

BALANCE SHEET AMOUNTS:
Assets                          $ 569,821    $ 575,688    $ 563,708    $ 584,590    $ 496,956
Investment Securities           $ 166,080    $ 229,957    $ 262,678    $ 293,125    $ 139,132
Net Loans                       $ 365,722    $ 317,562    $ 276,576    $ 236,882    $ 285,509
Deposits                        $ 413,800    $ 397,867    $ 395,301    $ 407,944    $ 414,664
Long-Term Borrowings            $  65,853    $  75,401    $  84,620    $  93,523    $       -
Stockholders' Equity            $  66,571    $  63,799    $  62,376    $  60,807    $  58,975

PER SHARE AMOUNTS:
Earnings per Share              $    2.80    $    2.73    $    2.61    $    2.78    $    3.14
Dividends per Share             $    1.50    $    1.44    $    1.35    $    1.35    $    1.35
Book Value per Share            $   30.99    $   29.70    $   29.04    $   28.31    $   27.46
Common Shares Outstanding       2,148,000    2,148,000    2,148,000    2,148,000    2,148,000

FINANCIAL RATIOS:
Net Interest Margin                 3.89%        3.57%        3.18%        3.24%        4.21%
Return on Average Assets            1.07%        1.03%         .96%        1.05%        1.37%
Return on Average Equity            9.15%        9.23%        9.11%        9.87%       11.79%
Average Equity to Average Assets   11.68%       11.19%       10.57%       10.59%       11.58%
Dividend Payout Ratio              53.57%       52.75%       51.72%       48.56%       42.99%
</TABLE>

                  Penseco Financial Services Corporation / 2006 Annual Report 15

<PAGE>

ITEM 7  Management's 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.

CRITICAL ACCOUNTING POLICIES

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.
     Provision  (allowance)  for possible  loan losses - 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.
     Actuarial  assumptions  associated with pension,  post-retirement and other
employee benefit plans - These assumptions include discount rate, rate of future
compensation increases and expected return on plan assets.
     Provision for income taxes - Management  believes that the  assumptions and
judgements  used  to  record  tax  related  assets  or  liabilities   have  been
appropriate.
     Fair  value of certain  investment  securities  - Fair value of  investment
securities are based on quoted market prices.
     Loan  servicing  rights -  Mortgage  servicing  rights  are  evaluated  for
impairment  based on the fair value of those  rights.  Fair values are estimated
using  discounted  cash flows  based on current  market  rates of  interest  and
current expected future prepayment rates. For purposes of measuring  impairment,
the rights must be stratified by one or more predominant risk characteristics of
the underlying loans. The Company stratifies its capitalized  mortgage servicing
rights  based on the  product  type,  interest  rate and term of the  underlying
loans. The amount of impairment  recognized is the amount,  if any, by which the
amortized cost of the rights for each stratum exceed the fair value.
     Premium  amortization  - The  amortization  of premiums on  mortgage-backed
securities  is  done  based  on  management's  estimate  of  the  lives  of  the
securities,  adjusted,  when  necessary,  for advanced  prepayments in excess of
those estimates.

SUMMARY

Net  earnings  for 2006  totalled  $6,008,  an increase of $139 or 2.4% from the
$5,869  earned in 2005,  which was an  increase  of $268 or 4.8% from the $5,601
earned in 2004.  Net earnings per share were $2.80 in 2006,  compared with $2.73
in 2005 and  $2.61 in 2004.  Core  after tax  earnings  for  2006,  excluding  a
Voluntary Early Retirement  Initiative  (VERI) and security gains,  increased by
$658 or 11.2% compared with 2005.  The Company  recorded an expense of $1,119 in
the 4th quarter of 2006 in  connection  with the VERI.  The Company  anticipates
after tax cost savings of  approximately  $1,571 over the next three years.  Net
earnings for 2006  increased from 2005 mainly from higher  interest  income from
strong  loan  demand  experienced  during  2006.  This  was  offset  by a higher
provision for loan losses and lower  non-interest  income, as well as, increased
operating expenses.  Income taxes were slightly lower than year ago levels. Core
after tax  earnings  for 2005,  excluding  one time  securities  gains or losses
increased by $513 or 9.6%  compared with 2004.  Net earnings for 2005  increased
from  2004  mainly  due to  higher  interest  income  from  strong  loan  demand
experienced  during 2005. This was offset by a higher  provision for loan losses
and lower non-interest  income.  Income taxes were higher largely from increased
operating income and lower tax-free income.
     The Company's  return on average assets was 1.07% in 2006 compared to 1.03%
in 2005 and .96% in 2004. Return on average equity was 9.15%, 9.23% and 9.11% in
2006, 2005 and 2004, respectively.

A graph depicts Net Income (in millions)    Year
------------------------------------------------
            $ 6,008                         2006
              5,869                         2005
              5,601                         2004
              5,971                         2003
              6,753                         2002


A graph depicts Return on Average Assets    Year
------------------------------------------------
            1.07%                           2006
            1.03%                           2005
             .96%                           2004
            1.05%                           2003
            1.37%                           2002

16 Penseco Financial Services Corporation / 2006 Annual Report
<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  increased  $1.3 million or 6.6% to $20.9  million for
2006 compared to $19.6 million for 2005. Loan interest income was higher overall
for 2006 due to  increases  in the  volume  of new  loans  and  interest  rates.
Investment  income  decreased  due in part to the  return  of  principal  on the
Mortgage-Backed  Securities  portfolio and maturities of U.S. Agency Securities.
The proceeds were used to fund loan demand.  Interest expense for 2006 increased
$2.5  million or 29.1% to $11.1  million for 2006  compared  to $8.6  million in
2005. The increase is primarily due to increases in interest rates through 2005.
     Net interest  income  increased  $1.8 million or 10.1% to $19.6 million for
2005 compared to $17.8 million for 2004. Loan interest income was higher overall
for 2005 due to increases in volume of new loans and interest rates.  Investment
income  decreased due in part to the return of principal on the  Mortgage-Backed
Securities  portfolio and the sale of $10 million long term fixed rate municipal
securities during the first quarter of 2005. Interest expense for 2005 increased
$1.0 million or 13.2% to $8.6 million for 2005 compared to $7.6 million in 2004.
The  increase in primarily  due to  increases  in interest  rates as the Federal
Reserve continued to raise interest rates through 2005.
     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, 2006 was 3.9% compared with
3.6% for the year ended  December 31, 2005 and 3.2% for the year ended  December
31, 2004.
     Interest  income in 2006 totalled $31.9 million,  compared to $28.2 million
in  2005,  an  increase  of  $3.7  million  or  13.1%.   The  yield  on  average
interest-earning  assets  increased  to 6.0% in 2006,  compared to 5.1% in 2005.
Average  interest-earning assets decreased in 2006 to $536.9 million from $548.2
million in 2005.  Average  loans,  which are  typically  the  Company's  highest
yielding earning assets, increased $42.0 million or 14.1% in 2006. Average loans
represented 63.3% of 2006 average  interest-earning assets, compared to 54.3% in
2005.  Income on loans  increased $4.8 million or 25.8% in 2006,  compared to an
increase  in loan  income  of $5.0  million  or 36.8%  during  2005.  Investment
securities  decreased  on  average by $43.0  million or 18.1% to $194.1  million
compared to $237.1 million in 2005.  Income on investments  declined $.8 million
or 8.7% to $8.4 million in 2006, from $9.2 million in 2005.
     The average rate paid on interest-bearing liabilities during 2006 was 2.6%,
compared to 2.1% in 2005.
     Interest  income in 2005 totalled $28.2 million,  compared to $25.4 million
in  2004,  an  increase  of  $2.8  million  or  11.0%.   The  yield  on  average
interest-earning  assets  was 5.1% in 2005,  compared  to 4.5% in 2004.  Average
interest-earning  assets decreased in 2005 to $548.2 million from $560.3 million
in 2004.  Average  loans,  which are typically the  Company's  highest  yielding
earning  assets,  increased  $41.8  million  or  16.3% in  2005.  Average  loans
represented 54.3% of 2005 average  interest-earning assets, compared to 45.7% in
2004.  Interest  expense  also  increased  $1.0 million or 13.1% in 2005 to $8.6
million from $7.6 million in 2004.
     The average rate paid on interest-bearing liabilities during 2005 was 2.1%,
compared to 1.7% in 2004.
     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.


A graph depicts Net Interest Income (in millions)      Year
-----------------------------------------------------------
                  $  20,868                            2006
                     19,590                            2005
                     17,806                            2004
                     17,786                            2003
                     19,888                            2002


                  Penseco Financial Services Corporation / 2006 Annual Report 17

<PAGE>

DISTRIBUTION OF ASSETS, LIABILITIES AND STOCKHOLDERS'  EQUITY/INTEREST RATES AND
INTEREST DIFFERENTIAL

The table below presents  average weekly  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 2006,
2005 and 2004.


<TABLE>
<CAPTION>
                                                    2006                            2005                            2004
------------------------------------------------------------------------------------------------------------------------------------
                                        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           $       -  $      -       -%    $   1,849  $      7    6.87%    $   6,206  $    370    5.96%
    U.S. Agency obligations               83,355     3,186    3.82       116,429     3,650    3.13       133,231     4,340    3.26
    States & political subdivisions       24,851     1,114    6.79        23,873     1,006    6.38        41,142     1,931    7.11
    Federal Home Loan Bank stock           4,738       232    4.90         4,907       143    2.91         5,704        94    1.65
    Other                                  3,119       108    3.46         1,765        47    2.66           549        13    2.37
  Held-to-maturity:
    U.S. Agency obligations               48,801     2,174    4.45        59,036     2,631    4.46        74,291     3,334    4.49
    States & political subdivisions       29,221     1,574    8.16        29,250     1,610    8.34        31,103     1,545    7.53
Loans, net of unearned income:
  Real estate mortgages                  270,445    18,459    6.83       217,942    13,396    6.15       185,440    10,044    5.42
  Commercial                              31,690     2,131    6.72        42,820     2,782    6.50        36,312     1,814    5.00
  Consumer and other                      37,679     2,784    7.39        37,037     2,391    6.46        34,287     1,774    5.17
Federal funds sold                             -         -       -         6,011       176    2.93         5,434        58    1.07
Interest on balances with banks            3,047       160    5.25         7,302       211    2.89         6,589        68    1.03
------------------------------------------------------------------------------------------------------------------------------------
Total Earning Assets/
  Total Interest Income                  536,946  $ 31,922    5.95%      548,221  $ 28,170    5.14%      560,288  $ 25,385    4.53%
------------------------------------------------------------------------------------------------------------------------------------
Cash and due from banks                   10,534                           8,961                           8,732
Bank premises and equipment                9,427                           9,184                           9,593
Accrued interest receivable                3,035                           2,967                           3,225
Other assets                               6,243                           2,663                           3,040
Less: Allowance for loan losses            3,895                           3,686                           3,523
------------------------------------------------------------------------------------------------------------------------------------
Total Assets                           $ 562,290                       $ 568,310                       $ 581,355

LIABILITIES AND STOCKHOLDERS' EQUITY
Deposits:
  Demand-Interest bearing              $  49,753  $    347     .70%    $  32,821  $    190     .58%    $  31,425  $    115     .37%
  Savings                                 71,624       248     .35        79,262       275     .35        81,812       346     .42
  Money markets                           83,349     2,225    2.67        84,115     1,246    1.48        89,161       707     .79
  Time - Over $100                        32,692     1,408    4.31        26,088       808    3.10        28,067       806    2.87
  Time - Other                            88,614     3,384    3.82        86,995     2,501    2.87        92,752     1,985    2.14
Repurchase agreements                     19,457       455    2.34        27,546       415    1.51        22,817       167     .73
Short-term borrowings                      3,466       189    5.45           378        19    5.03           595        10    1.68
Long-term borrowings                      70,592     2,798    3.96        79,919     3,126    3.91        88,955     3,443    3.87
------------------------------------------------------------------------------------------------------------------------------------
Total Interest Bearing Liabilities/
  Total Interest Expense                 419,547  $ 11,054    2.63%      417,124  $  8,580    2.06%      435,584  $  7,579    1.74%
------------------------------------------------------------------------------------------------------------------------------------
Demand - Non-interest bearing             72,950                          86,302                          82,757
All other liabilities                      4,141                           1,270                           1,545
Stockholders' equity                      65,652                          63,614                          61,469
------------------------------------------------------------------------------------------------------------------------------------
Total Liabilities and
  Stockholders' Equity                 $ 562,290                       $ 568,310                       $ 581,355
Interest Spread                                               3.32%                           3.08%                           2.79%
------------------------------------------------------------------------------------------------------------------------------------
Net Interest Income                               $ 20,868                        $ 19,590                        $ 17,806

FINANCIAL RATIOS
Net interest margin                                           3.89%                           3.57%                           3.18%
Return on average assets                                      1.07%                           1.03%                            .96%
Return on average equity                                      9.15%                           9.23%                           9.11%
Average equity to average assets                             11.68%                          11.19%                          10.57%
Dividend payout ratio                                        53.57%                          52.75%                          51.72%
</TABLE>

18 Penseco Financial Services Corporation / 2006 Annual Report

<PAGE>

DOLLAR AMOUNT OF CHANGE IN INTEREST INCOME AND INTEREST EXPENSE


<TABLE>
<CAPTION>
                                                     Dollar                             Change
                                                     Amount   Change in   Change in    in Rate-
             2006 compared to 2005                 of Change   Volume        Rate       Volume
             ----------------------------------------------------------------------------------
<S>                                                <C>        <C>         <C>          <C>
EARNING      Investment securities:
ASSETS         Available-for-sale:
                 U.S. Treasury securities          $   (127)  $   (127)   $   (127)    $   127
                 U.S. Agency obligations               (464)    (1,035)        803        (232)
                 States & political subdivisions        108         33          64          11
                 Equity securities                      150         34          99          17
               Held-to-maturity:
                 U.S. Agency obligations               (457)      (456)         (6)          5
                 States & political subdivisions        (36)        (2)        (34)          -
             Loans, net of unearned income:
               Real estate mortgages                  5,063      3,229       1,482         352
               Commercial                              (651)      (723)         94         (22)
               Consumer and other                       393         41         344           8
             Federal funds sold                        (176)      (176)       (176)        176
             Interest bearing balances with banks       (51)      (123)        172        (100)
             ----------------------------------------------------------------------------------
               Total Interest Income                  3,752        695       2,715         342
             ----------------------------------------------------------------------------------
INTEREST     Deposits:
BEARING        Demand - Interest bearing                157         98          39          20
LIABILITIES    Savings                                  (27)       (27)          -           -
               Money markets                            979        (11)      1,001         (11)
               Time - Over $100                         600        205         316          79
               Time - Other                             883         46         822          15
             Repurchase agreements                       40       (122)        229         (67)
             Short-term borrowings                      170        155           2          13
             Long-term borrowings                      (328)      (365)         40          (3)
             ----------------------------------------------------------------------------------
               Total Interest Expense                 2,474        (21)      2,449          46
             ----------------------------------------------------------------------------------
               Net Interest Income                 $  1,278   $    716    $    266     $   296
             ==================================================================================
</TABLE>

<TABLE>
<CAPTION>
                                                     Dollar                             Change
                                                     Amount   Change in   Change in    in Rate-
             2005 compared to 2004                 of Change   Volume        Rate       Volume
             ----------------------------------------------------------------------------------
<S>                                                <C>        <C>         <C>          <C>
EARNING      Investment securities:
ASSETS         Available-for-sale:
                 U.S. Treasury securities          $   (243)  $   (260)   $     56     $   (39)
                 U.S. Agency obligations               (690)      (548)       (173)         31
                 States & political subdivisions       (925)      (810)       (197)         82
                 Equity securities                       83          7          71           5
               Held-to-maturity:
                 U.S. Agency obligations               (703)      (685)        (22)          4
                 States & political subdivisions         65        (92)        165          (8)
             Loans, net of unearned income:
               Real estate mortgages                  3,352      1,762       1,354         236
               Commercial                               968        325         545          98
               Consumer and other                       617        142         442          33
             Federal funds sold                         118          6         101          11
             Interest bearing balances with banks       143          7         123          13
             ----------------------------------------------------------------------------------
               Total Interest Income                  2,785       (146)      2,465         466
             ----------------------------------------------------------------------------------
INTEREST     Deposits:
BEARING        Demand - Interest bearing                 75          5          66           4
LIABILITIES    Savings                                  (71)       (11)        (57)         (3)
               Money markets                            539        (40)        615         (36)
               Time - Over $100                           2        (57)         65          (6)
               Time - Other                             516       (123)        677         (38)
             Repurchase agreements                      248         35         178          35
             Short-term borrowings                        9         (4)         20          (7)
             Long-term borrowings                      (317)      (350)         36          (3)
             ----------------------------------------------------------------------------------
               Total Interest Expense                 1,001       (545)      1,600         (54)
             ----------------------------------------------------------------------------------
               Net Interest Income                 $  1,784   $    399    $    865     $   520
             ==================================================================================
</TABLE>

                  Penseco Financial Services Corporation / 2006 Annual Report 19

<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  provision  for loan  losses  was $433 in 2006,  an  increase  of 64.6%
compared  to  $263  for  2005.  The  increase  in the  provision  was due to the
Company's increased loan portfolio.
     The Company  believes that the judgments used in establishing the Allowance
for Loan Losses are based on reliable information.  In assessing the sufficiency
of the Allowance for Loan Losses, management considers, how well prior estimates
have related to actual  experience.  The Company  continually  monitors the risk
elements,  historical rates and other data used in establishing the allowance on
a periodic basis. The Company has not found it necessary to change the allowance
by material  amounts,  which would call into  question  the  reliability  of the
judgments used in its calculation.
     There are also no particular  risk elements in the local economy that put a
group or category of loans at increased risk,  however the Company has increased
its portfolio of commercial  loans,  which  typically bear a higher risk.  These
loans are typically secured by real estate to minimize this risk.
     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,                        2006          2005          2004
--------------------------------------------------------------------------------
Trust department income                     $  1,483      $  1,479      $  1,353
Service charges on
  deposit accounts                               860           940         1,056
Merchant transaction income                    3,947         4,521         5,001
Other fee income                               1,423         1,575         1,650
Other operating income                           173           372           177
Realized gains (losses) on
  securities, net                                319           (13)          357
--------------------------------------------------------------------------------
  Total Other Income                        $  8,205      $  8,874      $  9,594
--------------------------------------------------------------------------------

Other income  declined $669 or 7.5% to $8,205  during 2006,  from $8,874 for the
same period of 2005.  Service charges on deposit accounts decreased $80 or 8.5%,
largely  due to  the  implementation  of the  free  checking  program.  Merchant
transaction  income  decreased  $574 or 12.7%,  mainly due to lower  transaction
volume.  Other fee income  declined $152 or 9.7%,  including  reduced  brokerage
income of $98 or 26.6%. Other operating income decreased $199, mainly from lower
Sunny Day income of $143 from  2005.  The Sunny Day income  rebate  program  was
discontinued  in 2005. The Company  realized a gain on the sale of securities of
$319 which was used to partly offset the cost associated with the VERI discussed
earlier.
     Other income  decreased  $720 or 7.5% during 2005 to $8,874 from $9,594 for
2004. Service charge income decreased $116 or 11.0%. Merchant transaction income
declined $480 or 9.6%, mainly from lower volumes.  Other fee income declined $75
or 4.5%,  including  reduced  brokerage  income  of $140 or 27.5%.  The  Company
experienced a loss on securities of $13 in 2005 compared to a gain on securities
of $357 in 2004.  Offsetting  these declines were increases in trust  department
income of $126 or 9.3% and other operating income of $195 or 110.2%.

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,                        2006          2005          2004
--------------------------------------------------------------------------------
Salaries and employee
  benefits                                  $ 10,315      $  9,261      $  9,165
Expense of premises and
  equipment, net                               2,397         2,455         2,391
Merchant transaction
  expenses                                     3,141         3,646         4,058
Other operating expenses                       5,184         5,357         4,970
--------------------------------------------------------------------------------
  Total Other Expenses                      $ 21,037      $ 20,719      $ 20,584
--------------------------------------------------------------------------------

Total other expenses increased $318 or 1.5% to $21,037 during 2006 compared with
$20,719 the same period of 2005. Salaries and employee benefits increased $1,054
or 11.4%,  primarily due to the $1,119 expense recorded in the fourth quarter of
2006 in connection with the VERI. The Company anticipates after tax cost savings
of approximately $1,571 over the next three years. Merchant transaction expenses
decreased  $505 or  13.9%,  due to lower  transaction  volume.  Other  operating
expenses decreased $173 or 3.2%, mostly from lower professional fees and general
operating expenses.
     Other expenses  increased $135 or 1.0% for 2005 to $20,719 from $20,584 for
2004.  Occupancy  expense  increased  $122 or  9.7%.  Other  operating  expenses
increased $387 or 7.8%, mainly due to increased professional services.  Merchant
transaction expenses declined $412 or 10.2% due to lower volumes.

INCOME TAXES

Federal  income tax expense  decreased $18 or 1.1% to $1,595 in 2006 compared to
$1,613 in 2005,  due to increased  operating  income  offset by higher  tax-free
income.
     Federal  income  tax  expense  increased  $542 or 50.6% to  $1,613  in 2005
compared to $1,071 in 2004,  due to  increased  operating  income and  decreased
taxfree income.
     The Company's  effective income tax rate for 2006, 2005 and 2004 was 21.0%,
21.6% and 16.1%, respectively.
     The Company uses the asset and liability  method of accounting for deferred
income  taxes.  If  current  available   information  raises  doubt  as  to  the
realization of deferred tax assets,  a valuation  allowance is established.  The
Company evaluates the recoverability of deferred tax assets based on its ability
to generate future profits. The Company employs budgeting and periodic reporting
processes to continually monitor its progress. Historically, the Company has had
sufficient profits for recovery of deferred tax benefits.
     For further  discussion  pertaining to Federal income taxes, see Note 15 to
the Consolidated Financial Statements.

FINANCIAL CONDITION

Total assets  decreased  $5.9  million or 1.0% during 2006 to $569.8  million at
December 31, 2006 compared to $575.7  million at December 31, 2005. For the year
ended December 31, 2005,  total assets increased $12.0 million or 2.1% to $575.7
million compared to $563.7 million at December 31, 2004.

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,                                  2006          2005          2004
--------------------------------------------------------------------------------
U.S.Treasury securities                  $       -     $       -     $   5,077
U.S. Agency obligations                     99,247       171,308       190,547
States & political subdivisions             59,471        50,887        60,789
Equity securities                            7,362         7,762         6,265
--------------------------------------------------------------------------------
  Total Investment Securities            $ 166,080     $ 229,957     $ 262,678
--------------------------------------------------------------------------------

20 Penseco Financial Services Corporation / 2006 Annual Report

<PAGE>

LOAN PORTFOLIO

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

<TABLE>
<CAPTION>
December 31,                           2006        2005        2004        2003        2002
-------------------------------------------------------------------------------------------
<S>                               <C>         <C>         <C>         <C>         <C>
Real estate - construction
  and land development            $  23,714   $  13,132   $   6,805   $   3,078   $   5,031
Real estate mortgages               284,323     227,853     196,149     172,964     217,883
Commercial                           26,265      42,894      41,560      30,056      30,077
Credit card and related plans         3,282       3,152       2,872       2,403       2,320
Installment                          25,532      26,293      25,679      25,855      27,306
Obligations of states &
  political subdivisions              6,806       8,038       7,111       6,026       6,239
-------------------------------------------------------------------------------------------
  Loans, net of unearned income     369,922     321,362     280,176     240,382     288,856
-------------------------------------------------------------------------------------------
Less: Allowance for loan losses       4,200       3,800       3,600       3,500       3,347
-------------------------------------------------------------------------------------------
  Loans, net                      $ 365,722   $ 317,562   $ 276,576   $ 236,882   $ 285,509
===========================================================================================
</TABLE>

LOANS

Total net loans  increased  $48.1 million or 15.1% to $365.7 million at December
31, 2006 from $317.6  million at December 31, 2005.  This increase is mainly due
to strong loan demand with a mix of fixed and variable rate loans backed by real
estate.
     Total net loans  increased  $41.0 million to $317.6 million at December 31,
2005 from  $276.6  million at December  31,  2004,  an  increase of 14.8%.  This
increase is mainly due to strong  loan  demand with a mix of fixed and  variable
rate loans.

A graph depicts Net Loans (in millions)      Year
--------------------------------------------------
              $ 365,722                      2006
                317,562                      2005
                276,576                      2004
                236,882                      2003
                285,509                      2002

LOAN QUALITY

The lending  activities of the Company are guided by the  comprehensive  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.

                  Penseco Financial Services Corporation / 2006 Annual Report 21

<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,                                     2006      2005      2004      2003      2002
---------------------------------------------------------------------------------------------
<S>                                           <C>       <C>       <C>       <C>       <C>
Non-accrual loans                             $ 3,180   $ 1,627   $ 1,991   $ 1,533   $ 2,245
Loans past due 90 days or more and accruing:
  Guaranteed student loans                        251       152       253       169       394
  Secured by real estate                          177         -         -         -         -
  Credit card loans                                 6        21        13         3         -
---------------------------------------------------------------------------------------------
  Total non-performing loans                    3,614     1,800     2,257     1,705     2,639
Other real estate owned                             -        91       176       121        59
---------------------------------------------------------------------------------------------
  Total non-performing assets                 $ 3,614   $ 1,891   $ 2,433   $ 1,826   $ 2,698
---------------------------------------------------------------------------------------------
</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 $3,180,  $1,627 and $1,991 at  December  31,  2006,  2005 and 2004,
respectively.  The increase in 2006 was due to a single  borrowing  relationship
for which  managment  feels the company is well  secured and projects no loss of
principal.  If interest on those loans had been accrued,  such income would have
been $209, $264 and $199 for 2006, 2005 and 2004, respectively.  Interest income
on those loans,  which is recorded only when received,  amounted to $10, $27 and
$16 for 2006,  2005 and 2004,  respectively.  There are no  commitments  to lend
additional funds to borrowers 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, 2006,  there are no significant  loans as to which management
has serious doubt about their collectibility.
     At December  31,  2006,  2005 and 2004,  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,                   2006      2005      2004      2003      2002
---------------------------------------------------------------------------------------
<S>                                     <C>       <C>       <C>       <C>       <C>
Balance at beginning of year            $ 3,800   $ 3,600   $ 3,500   $ 3,347   $ 3,600
---------------------------------------------------------------------------------------
Charge-offs:
  Real estate mortgages                      74        31         -        11        91
  Commercial and all others                  18         -        12       289       944
  Credit card and related plans              49        68        34        51        44
  Installment loans                          26        14         7         4        22
---------------------------------------------------------------------------------------
Total charge-offs                           167       113        53       355     1,101
---------------------------------------------------------------------------------------
Recoveries:
  Real estate mortgages                       -        46         3        24        31
  Commercial and all others                 131         -         -         6         -
  Credit card and related plans               3         3         2         2         1
  Installment loans                           -         1         4         -         3
---------------------------------------------------------------------------------------
Total recoveries                            134        50         9        32        35
---------------------------------------------------------------------------------------
Net charge-offs                              33        63        44       323     1,066
---------------------------------------------------------------------------------------
Provision charged to operations             433       263       144       476       813
---------------------------------------------------------------------------------------
  Balance at End of Year                $ 4,200   $ 3,800   $ 3,600   $ 3,500   $ 3,347
=======================================================================================
Ratio of net charge-offs
to average loans outstanding              0.01%     0.02%     0.02%     0.12%     0.34%
=======================================================================================
</TABLE>

22 Penseco Financial Services Corporation / 2006 Annual Report

<PAGE>

The allowance for loan losses is allocated as follows:

<TABLE>
<CAPTION>
December 31,                    2006             2005             2004             2003             2002
---------------------------------------------------------------------------------------------------------------
                              Amount     %1    Amount     %1    Amount     %1    Amount     %1    Amount     %1
---------------------------------------------------------------------------------------------------------------
<S>                          <C>      <C>     <C>      <C>     <C>      <C>     <C>      <C>     <C>      <C>
Real estate mortgages        $ 1,200   83%    $ 1,200   75%    $ 1,100   72%    $ 1,100   73%    $ 1,600   77%
Commercial
  and all others               2,500    9       2,190   16       2,070   18       1,970   15       1,222   13
Credit card and
  related plans                  250    1         185    1         180    1         180    1         175    1
Personal installment loans       250    7         225    8         250    9         250   11         350    9
---------------------------------------------------------------------------------------------------------------
  Total                      $ 4,200  100%    $ 3,800  100%    $ 3,600  100%    $ 3,500  100%    $ 3,347  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 $15.9 million to $413.8 million at December 31,
2006 from $397.9 million at December 31, 2005. Largely,  the Company experienced
growth in Money  Market  Accounts  as well as Time  Deposits.  Company  deposits
increased  $2.6  million to $397.9  million at  December  31,  2005 from  $395.3
million at December 31, 2004.

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

Three months or less                          $  4,166
Over three months through six months            12,617
Over six months through twelve months            8,547
Over twelve months                              14,148
                                              --------
Total                                         $ 39,478
                                              ========


A graph depicts Deposits (in millions)     Year
-----------------------------------------------
                 $ 413,800                 2006
                   397,867                 2005
                   395,301                 2004
                   407,944                 2003
                   414,664                 2002


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.

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.  Management does not
foresee any adverse trends in liquidity.

                  Penseco Financial Services Corporation / 2006 Annual Report 23

<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 U.S. Agency bond  portfolios,
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.
     The Company offers collateralized  repurchase  agreements,  that have a one
day maturity,  as an alternative  deposit option for its customers.  The Company
also has long-term debt  outstanding  to the FHLB,  which was used to purchase a
Freddie Mac pool of residential mortgages,  as described earlier in this report.
The Company continues to have $178,176 of available  borrowing capacity with the
FHLB.

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 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, 2006 and 2005 are as follows:

                                        2006              2005
--------------------------------------------------------------
Commitments to extend credit:
  Fixed rate                        $ 37,692          $ 41,229
  Variable rate                     $ 74,577          $ 75,100
Standby letters of credit           $ 15,061          $ 15,268

     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.

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.  The Bank has issued  standby  letters of
credit for the accounts of related parties in the amount of $6,248.


A graph depicts Assets   (in millions)     Year
-----------------------------------------------
                 $ 569,821                 2006
                   575,688                 2005
                   563,708                 2004
                   584,590                 2003
                   496,956                 2002


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 19.65% at December 31,
2006. 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.

     The following  table presents  Stockholders'  Equity of the Company for the
past two years:

Years Ended December 31,                         2006              2005
-----------------------------------------------------------------------
Balance at beginning of year                 $ 63,799          $ 62,376
Net Income                                      6,008             5,869
Other comprehensive
  income                                        1,659            (1,352)
Cash dividends declared                        (3,222)           (3,094)
Adjustment to initially apply
  FASB Statement No. 158,
  net of tax                                   (1,673)                -
-----------------------------------------------------------------------
Total Stockholders' Equity                   $ 66,571          $ 63,799
=======================================================================

24 Penseco Financial Services Corporation / 2006 Annual Report

<PAGE>


A graph depicts Stockholders' Equity (in millions)     Year
-----------------------------------------------------------
                $  66,571                              2006
                   63,799                              2005
                   62,376                              2004
                   60,807                              2003
                   58,975                              2002


A graph depicts Return on Average Equity               Year
-----------------------------------------------------------
                 9.15%                                 2006
                 9.23%                                 2005
                 9.11%                                 2004
                 9.87%                                 2003
                11.79%                                 2002


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 traditional  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 traditional 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.

                  Penseco Financial Services Corporation / 2006 Annual Report 25

<PAGE>

MATURITIES AND SENSITIVITY OF MARKET RISK AS OF DECEMBER 31, 2006

The table below presents States and political subdivisions securities on a fully
taxable equivalent basis.

<TABLE>
<CAPTION>
                                                                                                      Non-Rate
                                          2007        2008      2009      2010      2011 Thereafter  Sensitive    Total   Fair Value
------------------------------------------------------------------------------------------------------------------------------------
<S>                                  <C>        <C>         <C>       <C>       <C>       <C>        <C>        <C>        <C>
ASSETS
Fixed interest rate securities:
  U.S. Agency obligations            $  19,674  $   17,891  $ 10,814  $  4,432  $  3,428  $  13,472          -  $  69,711  $  68,623
    Yield                                4.79%       4.99%     4.45%     4.89%     4.89%      4.89%          -      4.82%
  States & political subdivisions            -           -     7,635     8,885    13,005     29,946          -     59,471     61,286
    Yield                                    -           -     8.80%     8.50%     7.57%      6.97%          -      7.55%
Variable interest rate securities:
  U.S. Agency obligations               23,743       5,793         -         -         -          -          -     29,536     29,554
    Yield                                5.63%       5.26%         -         -         -          -          -      5.56%
  Federal Home Loan Bank stock           5,093           -         -         -         -          -          -      5,093      5,093
    Yield                                5.25%           -         -         -         -          -          -      5.25%
  Other                                      -           -         -         -         -      2,269          -      2,269      2,269
    Yield                                    -           -         -         -         -      2.92%          -      2.92%
Fixed interest rate loans:
  Real estate mortgages                 28,009      21,681    18,515    15,334    12,675     57,940          -    154,154    153,889
    Yield                                6.30%       6.23%     6.22%     6.25%     6.25%      6.28%          -      6.26%
  Commercial                             5,908       2,352     3,822     1,102       818      4,634          -     18,636     18,422
    Yield                                6.73%       6.58%     5.88%     7.04%     7.15%      7.36%          -      6.73%
  Consumer and other                     8,077       1,174       990       729       492      4,407          -     15,869     15,813
    Yield                                5.49%       7.26%     7.18%     7.27%     7.36%      6.50%          -      6.15%
Variable interest rate loans:
  Real estate mortgages                119,537      14,583    12,631     4,286     1,708      1,138          -    153,883    153,619
    Yield                                7.73%       5.70%     6.33%     6.47%     7.53%      6.74%          -      7.38%
  Commercial                             7,629           -         -         -         -          -          -      7,629      7,541
    Yield                                7.75%           -         -         -         -          -          -      7.75%
  Consumer and other                    19,751           -         -         -         -          -          -     19,751     19,679
    Yield                                8.91%           -         -         -         -          -          -      8.91%
Less: Allowance for loan losses              -           -         -         -         -          -      4,200          -      4,200
Interest bearing deposits with banks     1,779           -         -         -         -          -          -      1,779      1,779
    Yield                                4.78%           -         -         -         -          -          -      4.78%
Cash surrender life insurance            7,054           -         -         -         -          -          -      7,054      7,054
    Yield                                4.98%           -         -         -         -          -          -      4.98%
Cash and due from banks                 12,999           -         -         -         -          -          -     12,999     12,999
    Yield                                4.92%           -         -         -         -          -          -      4.92%
Other assets                                 -           -         -         -         -          -          -     16,187     16,187
------------------------------------------------------------------------------------------------------------------------------------
Total Assets                         $ 259,253  $   63,474  $ 54,407  $ 34,768  $ 32,126  $ 109,606  $  16,187  $ 569,821  $ 557,620
====================================================================================================================================
LIABILITIES AND STOCKHOLDERS' EQUITY
Variable interest rate deposits:
  Demand - Interest bearing          $       -  $        -  $      -  $      -  $      -  $  57,309  $       -  $  57,309  $  57,309
    Yield                                    -           -         -         -         -      0.24%          -      0.24%
  Savings                               12,633           -         -         -         -     67,695          -     80,328     80,328
    Yield                                4.82%           -         -         -         -      0.36%          -      1.05%
  Money markets                         85,720           -         -         -         -          -          -     85,720     85,720
    Yield                                3.18%           -         -         -         -          -          -      3.18%
Fixed interest rate deposits:
  Time - Over $100,000                  25,330       3,988     4,026     5,447       287        400          -     39,478     39,255
    Yield                                4.63%       4.44%     5.13%     5.13%     4.63%      5.16%          -      4.74%
  Time - Other                          61,170       8,094     3,261     3,678     2,118      1,059          -     79,380     78,946
    Yield                                4.11%       4.01%     3.63%     4.24%     4.63%      4.95%          -      4.32%
Demand - Non-interest bearing                -           -         -         -         -          -     71,585     71,585     71,585
Repurchase agreements                   13,441           -         -         -         -          -          -     13,441     13,441
    Yield                                2.48%           -         -         -         -          -          -      2.48%
Short-term borrowings                    5,486           -         -         -         -          -          -      5,486      5,486
    Yield                                5.40%           -         -         -         -          -          -      5.40%
Long-term borrowings                     9,887       8,781     8,612     6,634     6,116     25,823          -     65,853     63,306
    Yield                                3.59%       3.66%     3.75%     3.85%     3.99%      4.44%          -      4.00%
Other liabilities                            -           -         -         -         -          -          -      4,670      4,670
Stockholders' equity                         -           -         -         -         -          -          -     66,571     66,571
------------------------------------------------------------------------------------------------------------------------------------
Total Liabilities and
Stockholders' Equity                 $ 213,667  $   20,863  $ 15,899  $ 15,759  $  8,521  $ 152,286  $ 142,826  $ 569,821  $ 495,376
====================================================================================================================================
Excess of assets (liabilities)
subject to interest rate change      $  45,586  $   42,611  $ 38,508  $ 19,009  $ 23,605  $ (42,680) $(126,639) $       -
====================================================================================================================================
</TABLE>

26 Penseco Financial Services Corporation / 2006 Annual Report

<PAGE>

        MANAGEMENT'S REPORT ON INTERNAL CONTROL OVER FINANCIAL REPORTING

The management of Penseco  Financial  Services  Corporation  is responsible  for
establishing and maintaining adequate internal control over financial reporting.
Penseco Financial Services Corporation's internal control system was designed to
provide reasonable  assurance to the Company's management and Board of Directors
regarding  the  preparation  and  fair   presentation  of  published   financial
statements in accordance with U.S. generally accepted accounting principles. All
internal   control  systems,   no  matter  how  well  designed,   have  inherent
limitations.  Therefore,  even those  systems  determined  to be  effective  can
provide  only   reasonable   assurance  with  respect  to  financial   statement
preparation and presentation.
     Management  maintains a comprehensive system of controls intended to ensure
that  transactions are executed in accordance with  management's  authorization,
assets are  safeguarded,  and financial  records are reliable.  Management  also
takes steps to see that information and communication flows are effective and to
monitor performance, including performance of internal control procedures.
     Penseco   Financial   Services   Corporation    management   assessed   the
effectiveness of the Company's  internal control over financial  reporting as of
December 31, 2006 based on the criteria set forth by the Committee of Sponsoring
Organizations of the Treadway  Commission (COSO) in Internal  Control-Integrated
Framework.  Based on this assessment,  management  believes that, as of December
31, 2006, the Company's internal control over financial reporting is effective.
     Management's  assessment of the  effectiveness  of the  Company's  internal
control  over  financial  reporting  as of December 31, 2006 has been audited by
McGrail, Merkel, Quinn & Associates, the Company's independent registered public
accounting firm, as stated in their report appearing on page 28, which expresses
unqualified opinions on management's  assessment and on the effectiveness of the
Company's internal control over financial reporting as of December 31, 2006.

                  Penseco Financial Services Corporation / 2006 Annual Report 27

<PAGE>

MMQ                                                Francis J. Merkel, CPA
                                                   Joseph J. Quinn, CPA/ABV, CVA
                                                   Daniel J. Gerrity, CPA
                                                   Mary Ann E. Novak, CPA

McGrail Merkel Quinn & Associates
CERTIFIED PUBLIC ACCOUNTANTS & CONSULTANTS

            Report of Independent Registered Public Accounting Firm

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

We  have  audited   management's   assessment,   included  in  the  accompanying
Management's Report on Internal Control Over Financial  Reporting,  that Penseco
Financial  Services  Corporation and subsidiary  maintained  effective  internal
control over  financial  reporting  as of December  31, 2006,  based on criteria
established in Internal Control-Integrated  Framework issued by the Committee of
Sponsoring  Organizations of the Treadway  Commission (COSO).  Penseco Financial
Services Corporation and subsidiary's  management is responsible for maintaining
effective  internal  control over financial  reporting and for its assessment of
the   effectiveness   of  internal   control  over  financial   reporting.   Our
responsibility  is to  express  an opinion  on  management's  assessment  and an
opinion on the  effectiveness  of the company's  internal control over financial
reporting based on our audit.

We conducted  our audit in accordance  with the standards of the Public  Company
Accounting Oversight Board (United States). Those standards require that we plan
and perform the audit to obtain  reasonable  assurance  about whether  effective
internal  control  over  financial  reporting  was  maintained  in all  material
respects. Our audit included obtaining an understanding of internal control over
financial reporting,  evaluating management's assessment, testing and evaluating
the design and operating  effectiveness of internal control, and performing such
other  procedures as we considered  necessary in the  circumstances.  We believe
that our audit provides a reasonable basis for our opinion.

A company's  internal control over financial  reporting is a process designed to
provide reasonable  assurance  regarding the reliability of financial  reporting
and the preparation of financial  statements for external purposes in accordance
with generally accepted accounting principles. A company's internal control over
financial  reporting  includes those policies and procedures that (1) pertain to
the  maintenance  of records that, in reasonable  detail,  accurately and fairly
reflect the  transactions  and  dispositions  of the assets of the company;  (2)
provide  reasonable  assurance  that  transactions  are recorded as necessary to
permit preparation of financial statements in accordance with generally accepted
accounting  principles,  and that receipts and  expenditures  of the company are
being made only in accordance with authorizations of management and directors of
the company; and (3) provide reasonable assurance regarding prevention or timely
detection of  unauthorized  acquisition,  use, or  disposition  of the company's
assets that could have a material effect on the financial statements.



                             RSM McGladrey Network
                         An Independently Owned Member

      Clay Avenue Professional Plaza, 1173 Clay Avenue, Scranton, PA 18510
                         570 961-0345 Fax: 570 961-8650
                                  www.mmq.com

28 Penseco Financial Services Corporation / 2006 Annual Report

<PAGE>

To the Board of Directors and Stockholders
Penseco Financial Services Corporation


Because of its inherent  limitations,  internal control over financial reporting
may  misstatements.  Also,  projections  of any evaluation of  effectiveness  to
future periods the risk that controls may become  inadequate  because of changes
in conditions, or compliance with the policies or procedures may deteriorate.

In  our  opinion,   management's  assessment  that  Penseco  Financial  Services
Corporation  subsidiary  maintained  effective  internal  control over financial
reporting  as of December  fairly  stated,  in all material  respects,  based on
criteria established in Internal Framework issued by the Committee of Sponsoring
Organizations of the Treadway  Commission (COSO).  Also in our opinion,  Penseco
Financial Services  Corporation and subsidiary all material respects,  effective
internal control over financial reporting as of based on criteria established in
Internal Control-Integrated  Framework issued by Sponsoring Organizations of the
Treadway Commission (COSO).

We have also  audited,  in accordance  with the standards of the Public  Company
Accounting  Board (United  States),  the  consolidated  financial  statements of
Penseco  Financial  Corporation and subsidiary and our report dated February 26,
2006 expressed an unqualified opinion.

/s/ McGrail Merkel Quinn & Associates

Scranton, Pennsylvania
February 26, 2006


                  Penseco Financial Services Corporation / 2006 Annual Report 29

<PAGE>

MMQ                                                Francis J. Merkel, CPA
                                                   Joseph J. Quinn, CPA/ABV, CVA
                                                   Daniel J. Gerrity, CPA
                                                   Mary Ann E. Novak, CPA

McGrail Merkel Quinn & Associates
CERTIFIED PUBLIC ACCOUNTANTS & CONSULTANTS


            Report of Independent Registered Public Accounting Firm

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

We  have  audited  the  accompanying  consolidated  balance  sheets  of  Penseco
Financial Services  Corporation and subsidiary as of December 31, 2006 and 2005,
and the related consolidated statements of income, stockholders' equity and cash
flows for each of the three years in the period ended  December 31, 2006.  These
financial  statements are the  responsibility of the Company's  management.  Our
responsibility  is to express an opinion on these financial  statements based on
our audits.

We conducted our audits in accordance  with the standards of the Public  Company
Accounting Oversight Board (United States). Those standards require that we plan
and perform the 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  provided  a
reasonable basis for our opinion.

In our opinion, the consolidated  financial statements referred to above present
fairly, in all material  respects,  the financial  position of Penseco Financial
Services  Corporation  and  subsidiary as of December 31, 2006 and 2005, and the
results of their  operations and their cash flows for each of the three years in
the period ended December 31, 2006, in conformity with U.S.  generally  accepted
accounting principles.

We also have  audited,  in accordance  with the standards of the Public  Company
Accounting  Oversight  Board  (United  States),  the  effectiveness  of  Penseco
Financial Services Corporation and subsidiary's  internal control over financial
reporting  as of December 31, 2006,  based on criteria  established  in Internal
Control-Integrated Framework issued by the Committee of Sponsoring Organizations
of the  Treadway  Commission  (COSO)  and our report  dated  February  26,  2007
expressed an unqualified opinion on management's assessment of the effectiveness
of Penseco Financial Services Corporation and subsidiary's internal control over
financial  reporting and an unqualified  opinion on the effectiveness of Penseco
Financial Services Corporation and subsidiary's  internal control over financial
reporting.

/s/ McGrail Merkel Quinn & Associates

Scranton, Pennsylvania
February 26, 2006

                             RSM McGladrey Network
                         An Independently Owned Member

      Clay Avenue Professional Plaza, 1173 Clay Avenue, Scranton, PA 18510
                         570 961-0345 Fax: 570 961-8650
                                  www.mmq.com

30 Penseco Financial Services Corporation / 2006 Annual Report

<PAGE>

ITEM 8  Financial Statements and Supplementary Data

                           Consolidated Balance Sheets

(in thousands, except per share amounts)
<TABLE>
<CAPTION>
                 December 31,                                    2006       2005
                 ---------------------------------------------------------------
<S>              <C>                                        <C>        <C>
ASSETS           Cash and due from banks                    $  12,999  $  11,310
                 Interest bearing balances with banks           1,779        263
                 ---------------------------------------------------------------
                   Cash and Cash Equivalents                   14,778     11,573
                 Investment securities:
                   Available-for-sale, at fair value           91,705    147,942
                   Held-to-maturity (fair value of $75,120
                     and $83,130, respectively)                74,375     82,015
                   Total Investment Securities                166,080    229,957

                 Loans, net of unearned income                369,922    321,362
                   Less: Allowance for loan losses              4,200      3,800
                 ---------------------------------------------------------------
                   Loans, Net                                 365,722    317,562

                 Bank premises and equipment                    9,471      9,453
                 Other real estate owned                            -         91
                 Accrued interest receivable                    3,632      3,473
                 Cash surrender value of life insurance         7,054          -
                 Other assets                                   3,084      3,579
                 ---------------------------------------------------------------
                   Total Assets                             $ 569,821  $ 575,688
                 ===============================================================

LIABILITIES      Deposits:
                   Non-interest bearing                     $  71,585  $  91,713
                   Interest bearing                           342,215    306,154
                 ---------------------------------------------------------------
                   Total Deposits                             413,800    397,867

                 Other borrowed funds:
                   Repurchase agreements                       13,441     30,414
                   Short-term borrowings                        5,486      4,626
                   Long-term borrowings                        65,853     75,401
                 Accrued interest payable                       1,472      1,261
                 Other liabilities                              3,198      2,320
                 ---------------------------------------------------------------
                   Total Liabilities                          503,250    511,889
                 ===============================================================
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                             56,393     53,607
                 Accumulated other comprehensive income          (662)      (648)
                 ---------------------------------------------------------------
                   Total Stockholders' Equity                  66,571     63,799
                 ---------------------------------------------------------------
                   Total Liabilities and
                     Stockholders' Equity                   $ 569,821  $ 575,688
                 ===============================================================
</TABLE>


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

                  Penseco Financial Services Corporation / 2006 Annual Report 31

<PAGE>

                        Consolidated Statements of Income


(in thousands, except per share amounts)

<TABLE>
<CAPTION>
              Years Ended December 31,                      2006       2005       2004
              ------------------------------------------------------------------------
              <S>                                       <C>        <C>        <C>
INTEREST      Interest and fees on loans                $ 23,374   $ 18,569   $ 13,632
INCOME        Interest and dividends on investments:
                U.S. Treasury securities and U.S.
                  Agency obligations                       5,360      6,408      8,044
                States & political subdivisions            2,688      2,616      3,476
                Other securities                             340        190        107
              Interest on Federal funds sold                   -        176         58
              Interest on balances with banks                160        211         68
              ------------------------------------------------------------------------
                Total Interest Income                     31,922     28,170     25,385
              ------------------------------------------------------------------------
INTEREST      Interest on time deposits
EXPENSE         of $100,000 or more                        1,408        808        806
              Interest on other deposits                   6,204      4,212      3,153
              Interest on other borrowed funds             3,442      3,560      3,620
                Total Interest Expense                    11,054      8,580      7,579
              ------------------------------------------------------------------------
                Net Interest Income                       20,868     19,590     17,806
              Provision for loan losses                      433        263        144
              ------------------------------------------------------------------------
                Net Interest Income After Provision
                  for Loan Losses                         20,435     19,327     17,662
              ------------------------------------------------------------------------
OTHER         Trust department income                      1,483      1,479      1,353
INCOME        Service charges on deposit accounts            860        940      1,056
              Merchant transaction income                  3,947      4,521      5,001
              Other fee income                             1,423      1,575      1,650
              Other operating income                         173        372        177
              Realized gains (losses) on securities, net     319        (13)       357
              ------------------------------------------------------------------------
                Total Other Income                         8,205      8,874      9,594
              ------------------------------------------------------------------------
OTHER         Salaries and employee benefits              10,315      9,261      9,165
EXPENSES      Expense of premises and equipment, net       2,397      2,455      2,391
              Merchant transaction expenses                3,141      3,646      4,058
              Other operating expenses                     5,184      5,357      4,970
              ------------------------------------------------------------------------
                Total Other Expenses                      21,037     20,719     20,584
              ------------------------------------------------------------------------
              Income before income taxes                   7,603      7,482      6,672
              Applicable income taxes                      1,595      1,613      1,071
              ------------------------------------------------------------------------
NET INCOME    Net Income                                $  6,008   $  5,869   $  5,601
              ========================================================================
PER SHARE     Earnings Per Share                        $   2.80   $   2.73   $   2.61
              ========================================================================
</TABLE>

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

32 Penseco Financial Services Corporation / 2006 Annual Report

<PAGE>
                 Consolidated Statements of Stockholders' Equity

Years Ended December 31, 2006, 2005 and 2004
--------------------------------------------
<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, 2003                  $ 21       $ 10,819   $ 48,131     $  1,836        $ 60,807

Comprehensive income:
  Net income, 2004                             -              -      5,601            -           5,601
  Unrealized losses on securities,
    net of reclassification adjustment
    and taxes                                  -              -          -       (1,132)         (1,132)
                                                                                                -------
Comprehensive income                                                                              4,469

Cash dividends declared ($1.35 per share)      -              -     (2,900)           -          (2,900)
----------------------------------------------------------------------------------------------------------

Balance, December 31, 2004                    21         10,819     50,832          704          62,376

Comprehensive income:
  Net income, 2005                             -              -      5,869           -            5,869
  Other comprehensive income, net of tax
    Unrealized losses on securities,
      net of reclassification adjustment       -              -          -         (341)           (341)
    Minimum pension liability adjustment       -              -          -       (1,011)         (1,011)
                                                                                -------          -------
  Other comprehensive income                                                     (1,352)         (1,352)
Comprehensive income                                                                              4,517

Cash dividends declared ($1.44 per share)      -              -     (3,094)           -          (3,094)
----------------------------------------------------------------------------------------------------------

Balance, December 31, 2005                  $ 21       $ 10,819   $ 53,607     $   (648)       $ 63,799

Comprehensive income:
  Net income, 2006                             -              -      6,008            -           6,008
  Other comprehensive income, net of tax
    Unrealized gains on securities
      net of reclassification adjustment       -              -          -          648             648
    Minimum pension liability adjustment       -              -          -        1,011           1,011
                                                                                -------          -------
  Other comprehensive income                                                      1,659           1,659
Comprehensive income                                                                              7,667

Cash dividends declared ($1.50 per share)      -              -     (3,222)           -          (3,222)
Adjustment to initially apply FASB Statement
    No. 158, net of tax.                       -              -          -       (1,673)         (1,673)
----------------------------------------------------------------------------------------------------------
Balance, December 31, 2006                  $ 21       $ 10,819   $ 56,393     $   (662)       $ 66,571
==========================================================================================================
</TABLE>

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

                  Penseco Financial Services Corporation / 2006 Annual Report 33

<PAGE>

                      Consolidated Statements of Cash Flows

<TABLE>
<CAPTION>

(in thousands)   Years Ended December 31,                                    2006          2005          2004
                 --------------------------------------------------------------------------------------------
                 <S>                                                    <C>           <C>           <C>
OPERATING        Net Income                                             $   6,008     $   5,869     $   5,601
ACTIVITIES       Adjustments to reconcile net income to net
                   cash provided by operating activities:
                     Depreciation                                             723           704           813
                     Provision for loan losses                                433           263           144
                     Deferred income tax (benefit) provision                 (254)          166          (119)
                     Amortization of securities
                       (net of accretion)                                     419         1,379         1,573
                     Increase cash surrender value of life insurance          (54)            -             -
                     Net realized (gains) losses on securities               (319)           13          (357)
                     Loss (gain) on other real estate                          10           (46)           (2)
                     Gain on disposition of fixed asset                         -            (5)            -
                     Increase in interest receivable                         (159)          (67)         (108)
                     (Increase) decrease in other assets                     (304)          313           366
                     (Decrease) increase in income taxes payable               (4)         (442)          117
                     Increase (decrease) in interest payable                  211           375          (272)
                     Increase (decrease) in other liabilities                 940           (29)          110
                 --------------------------------------------------------------------------------------------
                     Net cash provided by
                       operating activities                                 7,650         8,493         7,866
                 --------------------------------------------------------------------------------------------
INVESTING        Purchase of investment securities
ACTIVITIES         available-for-sale                                     (25,770)      (47,526)      (49,975)
                 Proceeds from sales and maturities of investment
                   securities available-for-sale                           68,287        46,451        41,938
                 Proceeds from repayments of investment
                   securities available-for-sale                           15,028        19,140        17,893
                 Proceeds from repayments of investment
                   securities to be held-to-maturity                        7,213        12,746        17,661
                 Net loans originated                                     (48,676)      (41,550)      (40,015)
                 Proceeds from other real estate                              164           432           124
                 Proceeds from sale of fixed assets                             -            10             -
                 Investment in premises and equipment                        (741)         (929)         (111)
                 Purchase of life insurance policies                       (7,000)            -             -
                 --------------------------------------------------------------------------------------------
                     Net cash provided (used) by
                       investing activities                                 8,505       (11,226)      (12,485)
                 --------------------------------------------------------------------------------------------
FINANCING        Net (decrease) increase in demand and savings deposits    (1,374)       (3,984)        5,977
ACTIVITIES       Net proceeds (payments) on time deposits                  17,307         6,550       (18,620)
                 (Decrease) increase in repurchase agreements             (16,973)       12,016        (1,056)
                 Net increase (decrease) in short-term borrowings             860         3,740            63
                 Payments on long-term borrowings                          (9,548)       (9,219)       (8,903)
                 Cash dividends paid                                       (3,222)       (3,094)       (2,900)
                 --------------------------------------------------------------------------------------------
                     Net cash (used) provided by
                       financing activities                               (12,950)        6,009       (25,439)
                 --------------------------------------------------------------------------------------------
                     Net increase (decrease) in cash
                       and cash equivalents                                 3,205         3,276       (30,058)

                 Cash and cash equivalents at January 1                    11,573         8,297        38,355
                 --------------------------------------------------------------------------------------------
                 Cash and cash equivalents at December 31               $  14,778     $  11,573     $   8,297
                 ============================================================================================
</TABLE>

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

34 Penseco Financial Services Corporation / 2006 Annual Report

<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
amounts.

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

In December  2004,  the  Financial  Accounting  Standards  Board  (FASB)  issued
Statement  No.  123  (Revised  2004),  Share-Based  Payment.  Statement  No. 123
(Revised 2004) is a revision of FASB Statement 123,  Accounting for  Stock-Based
Compensation  and supersedes APB Opinion No. 25,  Accounting for Stock Issued to
Employees,  and its  related  implementation  guidance.  The  Statement  focuses
primarily on accounting for  transactions  in which an entity  obtains  employee
services in share-based payment  transactions.  Statement No. 123 (Revised 2004)
requires a public  entity to measure the cost of employee  services  received in
exchange for an award of equity  instruments  based on the grant-date fair value
of the award, except in certain circumstances. That cost will be recognized over
the period  during which an employee is required to provide  service in exchange
for the award. The Company adopted this Statement on January 1, 2006.
     The adoption of this  Statement had no effect on the  Company's  results of
operations or financial position.
      In December 2004, FASB issued  Statement No. 153, Exchanges of Nonmonetary
Assets  - An  Amendment  of APB  Opinion  No.  29,  Accounting  for  Nonmonetary
Transactions.  Statement  No.  153  eliminates  the  exception  from fair  value
measurement for nonmonetary  exchanges of similar productive assets in paragraph
21(b) of APB Opinion No. 29 and replaces it with an exception for exchanges that
do not have commercial substance. Statement No. 153 specifies that a nonmonetary
exchange  has  commercial  substance  if the future cash flows of the entity are
expected to change significantly as a result of the exchange.  The Statement was
effective for fiscal periods beginning after June 15, 2005.
     The adoption of this  Statement had no effect on the  Company's  results of
operations or financial position.
     In May 2005, FASB issued  Statement No. 154,  Accounting  Changes and Error
Corrections - a replacement of APB Opinion No. 20, Accounting Changes,  and FASB
Statement No. 3, Reporting  Accounting Changes in Interim Financial Statements -
An Amendment of APB Opinion No, 28.  Statement No. 154 provides  guidance on the
accounting  for and reporting of accounting  changes and error  corrections.  It
establishes  retrospective  application,  or earliest date  practicable,  as the
required method for reporting a change in accounting  principle or correction of
an error.  The Statement was effective for accounting  changes or corrections of
errors made in fiscal periods beginning after December 15, 2005.
     The adoption of this  Statement had no effect on the  Company's  results of
operations or financial position.
     In November  2005, the FASB issued FASB Staff Position (FSP) FAS 115- 1 and
FAS 124-1, The Meaning of Other-Than-Temporary Impairment and Its Application to
Certain  Investments.  The FSP addresses the determination of when an investment
is considered impaired and whether that impairment is other than temporary,  and
provides  guidance on measuring an  impairment  loss.  The FSP requires  certain
disclosures  about  unrealized  losses not  recognized  as  other-than-temporary
impairments.  The guidance in the FSP amends FASB Statements No. 115, Accounting
for Certain  Investments in Debt and Equity Securities,  and No. 124, Accounting
for Certain  Investments Held by Not-For-Profit  Organizations,  and APB Opinion
No. 18, The Equity Method of Accounting  for  Investments  in Common Stock.  The
Company has  considered  the  requirements  of this FSP in its assessment of the
investment portfolio.
     In February  2006,  FASB issued  Statement No. 155,  Accounting for Certain
Hybrid Financial  Instruments - An Amendment of FASB Statements No. 133 and 140.
Statement  No. 155  eliminates  the  exception  from  applying  Statement 133 to
interests  in  securitized  financial  assets so that  similar  instruments  are
accounted for similarly regardless of the form of the instruments. The Statement
is  effective  for all  financial  instruments  acquired  or  issued  after  the
beginning of the first fiscal year that begins after September 15, 2006.
     The Company  believes that the adoption of this  Statement  will not have a
significant impact on its results of operations or financial position.
     In March 2006, FASB issued  Statement No. 156,  Accounting for Servicing of
Financial  Instruments - An Amendment of FASB  Statement No. 140.  Statement No.
156 requires the recognition of the fair value of a servicing asset or servicing
liability each time an obligation to service a financial  asset by entering into
a servicing contract is undertaken, if practicable.

                  Penseco Financial Services Corporation / 2006 Annual Report 35

<PAGE>

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

It also allows the entity to  subsequently  measure the asset or liability under
an  amortization  or fair value  method.  The  Statement  is  effective  for all
financial instruments acquired or issued after the beginning of the first fiscal
year that begins after September 15, 2006.
     The Company  believes that the adoption of this  Statement  will not have a
significant impact on its results of operations or financial position.
     In July 2006,  FASB  issued  FASB  Interpretation  No. 48,  Accounting  for
Uncertainty  in Income  Taxes - an  Interpretation  of FASB  Statement  No. 109.
Interpretation  No.  48  clarifies  the  application  of  Statement  No.  109 by
establishing a threshold condition that a tax position must meet for any part of
that  position to be  recognized  in the  financial  statements.  In addition to
recognition,   the   Interpretation   provides   guidance  on  the  measurement,
derecognition,   classification   and   disclosure   of   tax   positions.   The
Interpretation is effective for fiscal years beginning after December 15, 2006.
     The Company  believes that the adoption of this  Statement  will not have a
significant impact on its results of operations or financial position.
     In September 2006, FASB issued Statement No. 157, Fair Value  Measurements.
Statement No. 157 defines fair value, establishes a framework for measuring fair
value  in  generally   accepted   accounting   principles  (GAAP),  and  expands
disclosures  about fair value  measurements.  The  Statement  is  effective  for
financial  statements issued for fiscal years beginning after November 15, 2007,
and interim periods within those fiscal years.
     The Company  believes that the adoption of this  Statement  will not have a
significant impact on its results of operations or financial position.
     In September 2006, FASB issued Statement No. 158, Employers' Accounting for
Defined  Benefit Pension and Other  Postretirement  Plans - an amendment of FASB
Statements  No. 87, 88, 106, and 132(R).  Statement No. 158 requires an employer
to  recognize  the  overfunded  or  underfunded  status  of  a  defined  benefit
postretirement  plan (other than a multiemployer  plan) as an asset or liability
in its statement of financial  position and to recognize  changes in that funded
status in the year in which the changes occur through  comprehensive income. The
Statement was effective for financial  statements issued for fiscal years ending
after December 31, 2006.
     The effects of the  adoption of this  Statement  are included in Note 14 to
these Consolidated  Financial  Statements and relate to the Company's  financial
position.  The adoption of the Statement had no effect on the Company's  results
of operations.
     In the September  2006 EITF meeting,  a consensus was reached on EITF 06-4,
Accounting  for Deferred  Compensation  and  Postretirement  Benefit  Aspects of
Endorsement  Split-Dollar  Life Insurance  Arrangements.  EITF 06-4 requires the
recognition of a liability related to the postretirement  benefits covered by an
endorsement  split-dollar  life insurance  arrangement  based on the substantive
agreement with the employee.  The issue is effective for fiscal years  beginning
after December 15, 2007, with early adoption permitted.
     The Company is  evaluating  the potential  impact of this  statement on its
results of operations and financial position.
     In the September  2006 EITF meeting,  a consensus was reached on EITF 06-5,
Accounting for Purchases of Life  Insurance - Determining  the Amount That Could
be Realized in accordance with FASB Technical Bulletin No. 85-4, "Accounting for
Purchases of Life  Insurance".  EITF 06-5 requires that the amount that could be
realized  under  the  insurance  contract  as of the  date of the  statement  of
financial position should be reported as an asset net of any potential surrender
charges.  The issue is effective for fiscal years  beginning  after December 15,
2006.
     The  Company  believes  the  adoption  of this  Statement  will  not have a
significant impact on its results of operations and financial position.
     In September 2006, the SEC staff issued SEC Staff  Accounting  Bulletin No.
108 (SAB No. 108) Topic 1N,  Financial  Statements - Considering  the Effects of
Prior  Year  Misstatements  When  Quantifying   Misstatements  in  Current  Year
Financial Statements. SAB No. 108 addresses how a registrant should quantify the
effect of an error on the financial statements.  The SEC staff concluded in that
a dual  approach  should  be used  to  compute  the  amount  of a  misstatement.
Specifically,  the amount should be computed using both the "rollover"  (current
year income statement  perspective) and "iron curtain"  (year-end  balance sheet
perspective)  methods.  This SAB was effective for annual  financial  statements
covering the first fiscal year ending after November 15, 2006.
     The  adoption  of this  SAB  had no  effect  on the  Company's  results  of
operations 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, mortgage-backed
securities 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.
     The amortization of premiums on mortgage-backed securities is done based on
management's estimate of the lives of the securities,  adjusted, when necessary,
for advanced prepayments in excess of those estimates.
     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.

36 Penseco Financial Services Corporation / 2006 Annual Report

<PAGE>

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

     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.

LOAN SERVICING

The  Company  generally  retains  the right to  service  mortgage  loans sold to
others.  The cost allocated to the mortgage  servicing  rights retained has been
recognized as a separate asset and is being  amortized in proportion to and over
the period of estimated net servicing income.
     Mortgage  servicing  rights are evaluated for impairment  based on the fair
value of those rights.  Fair values are estimated  using  discounted  cash flows
based on current market rates of interest and current expected future prepayment
rates.  For purposes of measuring  impairment,  the rights must be stratified by
one or more  predominant  risk  characteristics  of the  underlying  loans.  The
Company  stratifies  its  capitalized  mortgage  servicing  rights  based on the
product type,  interest  rate and term of the  underlying  loans.  The amount of
impairment  recognized is the amount, if any, by which the amortized cost of the
rights for each stratum exceed the fair value.

ADVERTISING EXPENSES

Advertising costs are expensed as incurred.  Advertising  expenses for the years
ended  December  31,  2006,  2005 and  2004,  amounted  to $379,  $472 and $476,
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.

PENSION EXPENSE

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

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. 144,  Accounting  for the  Impairment  or Disposal of
Long-Lived Assets (SFAS 144).

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).

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,
2006, 2005 and 2004 as follows:

                                   2006         2005         2004
-----------------------------------------------------------------
Income taxes paid              $  1,752     $  1,886     $    802
Interest paid                  $ 10,843     $  8,205     $  7,851

Non-cash  transactions  during the years ended December 31, 2006, 2005 and 2004,
comprised  entirely of the net  acquisition  of real estate in the settlement of
loans, amounted to $83, $301 and $177, 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 2006
presentation.

                  Penseco Financial Services Corporation / 2006 Annual Report 37

<PAGE>

2  CASH AND DUE FROM BANKS

Cash and due from banks are summarized as follows:

December 31,                                     2006       2005
----------------------------------------------------------------
Cash items in process of collection          $     31   $  6,568
Non-interest bearing balances                   9,102      1,544
Cash on hand                                    3,866      3,198
----------------------------------------------------------------
  Total                                      $ 12,999   $ 11,310
================================================================

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, 2006
and 2005 are as follows:

                             AVAILABLE-FOR-SALE

                                            Gross        Gross
                           Amortized   Unrealized   Unrealized         Fair
2006                            Cost        Gains       Losses        Value
---------------------------------------------------------------------------
U.S. Agency securities     $  24,897   $        9   $       23    $  24,883
Mortgage-backed securities    29,231           91           82       29,240
States & political
  subdivisions                29,281          939            -       30,220
---------------------------------------------------------------------------
  Total Debt Securities       83,409        1,039          105       84,343
Equity securities              6,764          628           30        7,362
---------------------------------------------------------------------------
  Total Available-
    for-Sale               $  90,173   $    1,667   $      135    $  91,705
===========================================================================


                                            Gross        Gross
                           Amortized   Unrealized   Unrealized         Fair
2005                            Cost        Gains       Losses        Value
---------------------------------------------------------------------------
U.S. Agency securities     $  74,852   $        -   $      308    $  74,544
Mortgage-backed securities    44,408            -          407       44,001
States & political
  subdivisions                20,698          937            -       21,635
---------------------------------------------------------------------------
  Total Debt Securities      139,958          937          715      140,180
Equity securities              7,433          402           73        7,762
---------------------------------------------------------------------------
  Total Available-
    for-Sale               $ 147,391   $    1,339   $      788    $ 147,942
===========================================================================


Equity  securities at December 31, 2006 and 2005,  consisted  primarily of other
financial institutions stock and Federal Home Loan Bank (FHLB) stock, which is a
required  investment  in order to  participate  in an  available  line of credit
program.  The  FHLB  stock  is  stated  at par  value  as  there  is no  readily
determinable fair value.

A summary of transactions involving  available-for-sale debt securities in 2006,
2005 and 2004 are as follows:

December 31,                                 2006         2005         2004
---------------------------------------------------------------------------
Proceeds from sales                    $        -   $   10,250    $  18,380
Gross realized gains                            -           51          385
Gross realized losses                           -           64           28

                                Held-to-Maturity

                                            Gross        Gross
                           Amortized   Unrealized   Unrealized         Fair
2006                            Cost        Gains       Losses        Value
---------------------------------------------------------------------------
Mortgage-backed
  securities               $  45,124   $        4   $    1,074    $  44,054
States & political
  subdivisions                29,251        1,815            -       31,066
---------------------------------------------------------------------------
  Total Held-to-
    Maturity               $  74,375   $    1,819   $    1,074    $  75,120
===========================================================================

                                            Gross        Gross
                           Amortized   Unrealized   Unrealized         Fair
2005                            Cost        Gains       Losses        Value
---------------------------------------------------------------------------
Mortgage-backed
  securities               $  52,763   $        3   $    1,274    $  51,492
States & political
  subdivisions                29,252        2,386            -       31,638
---------------------------------------------------------------------------
  Total Held-to-
    Maturity               $  82,015   $    2,389   $    1,274    $  83,130
===========================================================================

Investment  securities  with  amortized  costs and fair  values of  $98,949  and
$99,898 at December  31, 2006 and  $106,280  and  $107,914 at December 31, 2005,
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, 2006
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. Agency securities        $   9,999    $   9,985    $       -    $       -
After one year through
  five years:
  U.S. Agency
    securities                     14,898       14,898            -            -
After five years through
  ten years:
  States & political
    subdivisions                        -            -        1,041        1,114
After ten years:
  States & political
    subdivisions                   29,281       30,220       28,210       29,952
--------------------------------------------------------------------------------
  Subtotal                         54,178       55,103       29,251       31,066
Mortgage-backed
  securities                       29,231       29,240       45,124       44,054
--------------------------------------------------------------------------------
Total Debt Securities           $  83,409    $  84,343    $  74,375    $  75,120
================================================================================

38 Penseco Financial Services Corporation / 2006 Annual Report

<PAGE>

3  INVESTMENT SECURITIES (CONTINUED)

The  gross  fair  value and  unrealized  losses  of the  Company's  investments,
aggregated by investment category and length of time that individual  securities
have been in a continuous  unrealized  loss  position,  at December 31, 2006 and
2005 are as follows:


<TABLE>
<CAPTION>

                                  Less than twelve months    Twelve months or more            Totals
------------------------------------------------------------------------------------------------------------
                                         Fair Unrealized          Fair  Unrealized          Fair  Unrealized
December 31, 2006                       Value     Losses         Value      Losses         Value      Losses
------------------------------------------------------------------------------------------------------------
<S>                                <C>        <C>            <C>        <C>            <C>        <C>
U.S. Agency securities             $   9,868  $        9     $   9,985  $       14     $  19,853  $       23
Mortgage-backed securities                 -           -        50,379       1,156        50,379       1,156
Equities                                 160           1           541          29           701          30
------------------------------------------------------------------------------------------------------------
  Total                            $  10,028  $       10     $  60,905  $    1,199     $  70,933  $    1,209
============================================================================================================
</TABLE>

<TABLE>
<CAPTION>

                                  Less than twelve months    Twelve months or more            Totals
------------------------------------------------------------------------------------------------------------
                                         Fair Unrealized          Fair  Unrealized          Fair  Unrealized
December 31, 2005                       Value     Losses         Value      Losses         Value      Losses
------------------------------------------------------------------------------------------------------------
<S>                                <C>        <C>            <C>        <C>            <C>        <C>
U.S. Agency securities             $  39,870  $      227     $  34,674  $       81     $  74,544  $      308
Mortgage-backed securities             8,598         104        86,501       1,577        95,099       1,681
Equities                               1,298          73             -           -         1,298          73
------------------------------------------------------------------------------------------------------------
  Total                            $  49,766  $      404     $ 121,175  $    1,658     $ 170,941  $    2,062
============================================================================================================
</TABLE>

The table above at December 31, 2006,  includes  five (5)  securities  that have
unrealized  losses for less than twelve months and ten (10) securities that have
been in an unrealized loss position for twelve or more months.

U.S. Agency Securities
The unrealized  losses on the Company's  investments in these  obligations  were
caused  by  recent  interest  rate  increases.  The  contractual  terms of these
investments  do not permit the issuer to settle the  securities  at a price less
than the par value of the  investment.  Because  the  Company has the ability to
hold these  investments  until a recovery of fair value,  which may be maturity,
the Company does not consider  these  investments  to be  other-than-temporarily
impaired at December 31, 2006.

Mortgage-Backed Securities
The unrealized losses on the Company's investment in mortgage-backed  securities
were caused by recent  interest rate increases.  The  contractual  cash flows of
these  investments  are  guaranteed  by  an  agency  of  the  U.S.   government.
Accordingly,  it is  expected  that these  securities  would not be settled at a
price less than the  amortized  cost of the  Company's  investment.  Because the
decline in market  value is  attributable  to changes in interest  rates and not
credit quality and because the Company has the ability to hold these investments
until a recovery  of fair value,  which may be  maturity,  the Company  does not
consider these investments to be other-than-temporarily impaired at December 31,
2006.

Marketable Equity Securities
The  unrealized  losses  on  the  Company's   investment  in  marketable  equity
securities  were caused  primarily by recent  interest rate  increases and other
market  conditions.  The Company's  investments in marketable  equity securities
consist  primarily of  investments in common stock of companies in the financial
services industry.  Because the Company has the ability and intent to hold these
investments for a reasonable period of time sufficient for a forecasted recovery
of  fair  value,  the  Company  does  not  consider  these   investments  to  be
other-than-temporarily impaired at December 31, 2006.

                  Penseco Financial Services Corporation / 2006 Annual Report 39

<PAGE>

4  LOANS

Major classifications of loans are as follows:

December 31,                                               2006           2005
------------------------------------------------------------------------------
Loans secured by real estate:
  Construction and land development                   $  23,714      $  13,132
Secured by 1-4 family residential
  properties:
  Revolving, open-end loans                              17,691         15,070
  Secured by first liens                                156,944        125,950
  Secured by junior liens                                30,108         22,649
Secured by multi-family properties                        2,870            355
Secured by non-farm, non-residential
  properties                                             76,710         63,829
Commercial and industrial loans
  to U.S. addressees                                     26,265         42,894
Loans to individuals for household, family
  and other personal expenditures:
  Credit card and related plans                           3,282          3,152
  Other (installment and
    student loans, etc.)                                 24,647         24,773
Obligations of states &
  political subdivisions                                  6,806          8,038
All other loans                                             885          1,520
------------------------------------------------------------------------------
  Gross Loans                                           369,922        321,362
Less: Unearned income on loans                                -              -
------------------------------------------------------------------------------
  Loans, Net of Unearned Income                       $ 369,922      $ 321,362
==============================================================================

Loans on which the accrual of interest has been discontinued or reduced amounted
to $3,180, $1,627 and $1,991 at December 31, 2006, 2005 and 2004,  respectively.
If interest on those loans had been  accrued,  such income would have been $209,
$264 and $199 for 2006,  2005 and 2004,  respectively.  Interest income on those
loans,  which is recorded only when  received,  amounted to $10, $27 and $16 for
2006, 2005 and 2004, respectively. Also, at December 31, 2006 and 2005, the Bank
had loans totalling $434 and $173, respectively,  which were past due 90 days or
more and still accruing interest.

--------------------------------------------------------------------------------

5  ALLOWANCE FOR LOAN LOSSES

Changes in the allowance for loan losses are as follows:

Years Ended December 31,              2006       2005       2004
----------------------------------------------------------------
Balance at beginning of year       $ 3,800    $ 3,600    $ 3,500
Provision charged to operations        433        263        144
Recoveries credited to allowance       134         50          9
----------------------------------------------------------------
                                     4,367      3,913      3,653
Losses charged to allowance           (167)      (113)       (53)
----------------------------------------------------------------
  Balance at End of Year           $ 4,200    $ 3,800    $ 3,600
================================================================

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
------------------------   --------------     -------------
             2006              $ 433              $ 33
             2005              $ 263              $ 63
             2004              $ 144              $ 44

The  balance of the Reserve  for Bad Debts as  reported  for Federal  income tax
purposes  was  $0,  $380  and  $664  at  December  31,  2006,   2005  and  2004,
respectively.

--------------------------------------------------------------------------------

6  LOAN SERVICING

The Company  services  $49,116 in  mortgage  loans for Freddie Mac which are not
included in the accompanying Consolidated Balance Sheets.
     Custodial escrow balances  maintained in connection with the foregoing loan
servicing,  and  included in  deposits,  were  approximately  $595 and $562,  at
December 31, 2006 and 2005,  respectively.  The balance of the servicing  rights
was  $197  and  $314  at  December  31,  2006  and  2005,  respectively,  net of
amortization.
     The Company has not recorded any new mortgage  servicing rights during 2006
or 2005.  Amortization expense of $116 and $136 was recorded for the years ended
December 31, 2006 and 2005, respectively.
     There was no  allowance  for  impairment  recorded at December  31, 2006 or
2005.

--------------------------------------------------------------------------------

7  BANK PREMISES AND EQUIPMENT

December 31,                                   2006           2005
------------------------------------------------------------------
Land                                      $   3,117      $   3,117
Buildings and improvements                   14,752         14,623
Furniture and equipment                      14,018         13,406
------------------------------------------------------------------
                                             31,887         31,146
Less: Accumulated depreciation               22,416         21,693
------------------------------------------------------------------
  Net Bank Premises
    and Equipment                         $   9,471      $   9,453
==================================================================

Buildings and  improvements  are being  depreciated over 10 to 39.5 year periods
and equipment over 3 to 10 year periods.  Depreciation  expense amounted to $723
in 2006, $704 in 2005 and $813 in 2004.
     Occupancy  expenses were reduced by rental income received in the amount of
$64,  $61  and  $63 in the  years  ended  December  31,  2006,  2005  and  2004,
respectively.

--------------------------------------------------------------------------------

8  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, 2006
and 2005 was $0 and  $91,  respectively,  supported  by  appraisals  of the real
estate involved.

--------------------------------------------------------------------------------
9  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
--------------------------------------------------------------------------

2006         100%        $ 3,250     $ 3,235       None        $     -
2005         100%        $ 3,250     $ 3,235       None        $     -
2004         100%        $ 3,350     $ 3,335       None        $     -

--------------------------------------------------------------------------------

10 CASH SURRENDER VALUE OF LIFE INSURANCE

The Company has purchased Bank Owned Life Insurance  (BOLI)  policies on certain
officers.
     The policies are split-dollar life insurance policies which provide for the
Company  to  receive  the cash  value of the  policy  and to split the  residual
proceeds  with  the  officer's  designated  beneficiary  upon  the  death of the
insured.  The majority of the residual  proceeds are retained by the Company per
the individual agreements with the insured officers.

40 Penseco Financial Services Corporation / 2006 Annual Report

<PAGE>

11 DEPOSITS

December 31,                                     2006              2005
-----------------------------------------------------------------------
Demand - Non-interest bearing               $  71,585         $  91,713
Demand - Interest bearing                      57,309            33,094
Savings                                        80,328            86,013
Money markets                                  85,720            80,463
Time - Over $100,000                           39,478            28,124
Time - Other                                   79,380            78,460
-----------------------------------------------------------------------
  Total                                     $ 413,800         $ 397,867
=======================================================================

Scheduled maturities of time deposits are as follows:
                       2007        $  86,500
                       2008           12,082
                       2009            7,287
                       2010            9,125
                       2011            2,405
        2012 and thereafter            1,459
-----------------------------------------------------
          Total                    $ 118,858
=====================================================

--------------------------------------------------------------------------------

12 OTHER BORROWED FUNDS

At December 31, 2006 and 2005, other borrowed funds consisted of demand notes to
the U.S. Treasury and Repurchase agreements.
     Short-term borrowings generally have original maturity dates of thirty days
or less.
     Investment  securities  with amortized costs and fair values of $31,109 and
$31,062 at December 31, 2006 and $35,209 and $35,026 at December 31, 2005,  were
pledged to secure repurchase agreements.


Years Ended December 31,                                  2006              2005
--------------------------------------------------------------------------------
Amount outstanding at year end                        $ 18,927          $ 35,040
Average interest rate at year end                        2.91%             2.01%
Maximum amount outstanding at
  any month end                                       $ 29,285          $ 35,040
Average amount outstanding                            $ 22,775          $ 27,638
Weighted average interest rate
  during the year:
    Federal funds purchased                              5.28%             3.96%
    Repurchase agreements                                2.34%             1.46%
    Demand notes to U.S. Treasury                        4.96%             2.99%

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 $10,202  and $9,958 at December  31, 2006 and $10,257 and $10,008
at December  31, 2005 and with an interest  rate of 5.25% at both  December  31,
2006 and December 31, 2005.  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, 2006 and 2005,
respectively.
     The Company has the availability of a $5,000  overnight  Federal funds line
of credit with Wachovia Bank,  N.A.  Also,  the Company has a $16,000  overnight
Federal  Funds  line  with PNC  Bank.  There was no  balance  outstanding  as of
December 31, 2006 and 2005, respectively.
     The  Company  maintains  a  collateralized  maximum  borrowing  capacity of
$178,176 with the Federal Home Loan Bank of Pittsburgh.

--------------------------------------------------------------------------------

13 LONG-TERM DEBT

The loans from the  Federal  Home Loan Bank,  which were  borrowed to purchase a
mortgage-backed  security,  are  secured by a general  collateral  pledge of the
Company's assets.
     A summary of long-term debt,  including  amortizing  principal and interest
payments, at December 31, 2006 is as follows:

Monthly           Fixed       Maturity
Installment        Rate         Date        Balance
---------------------------------------------------
$ 161             2.73%       03/13/08     $  2,366
  253             3.22%       03/13/10        9,354
  430             3.74%       03/13/13       28,722
  186             4.69%       03/13/23       25,411
---------------------------------------------------
  Total                                    $ 65,853
===================================================

The Company has agreed to maintain  sufficient  qualifying  collateral  to fully
secure the above borrowings.

     Aggregate maturities of long-term debt at December 31, 2006 are as follows:
2007, $9,887,  2008 $8,781, 2008 $8,612, 2010 $6,634, 2011 $6,116 and thereafter
$25,823 for a total of $65,853.

--------------------------------------------------------------------------------

14 EMPLOYEE BENEFIT PLANS

The Company  provides an Employee  Stock  Ownership  Plan  (ESOP),  a Retirement
Profit  Sharing  Plan,  an  Employees'  Pension  Plan,  as well  as an  unfunded
supplemental  executive  pension plan and a Postretirement  Life Insurance Plan,
all non-contributory, covering all eligible employees.
     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, 2006 and 2005,  the ESOP held  73,591 and 87,840  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 $70,
$70 and $0 to the plan during the years ended December 31, 2006,  2005 and 2004,
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
contributed  $70,  $70 and $60 to the plan during the years ended  December  31,
2006, 2005 and 2004, 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 unfunded supplemental  executive pension plan provides certain officers
with  additional  retirement  benefits  to replace  benefits  lost due to limits
imposed on qualified plans by Federal tax law.
     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.
     For the unfunded plans above,  amounts calculated on an actuarial basis are
recorded as a liability.

                  Penseco Financial Services Corporation / 2006 Annual Report 41

<PAGE>

14 EMPLOYEE BENEFIT PLANS (CONTINUED)

Obligations and funded status of the plans:

                                          Pension Benefits       Other Benefits
                                          ----------------       ---------------
December 31,                                 2006       2005      2006     2005
--------------------------------------------------------------------------------
Change in benefit obligation:
  Benefit obligation, beginning          $ 13,267   $ 11,800    $  287   $  285
  Service cost                                436        415         6        6
  Interest cost                               673        678        17       16
  Change in assumptions                    (1,167)       947         1      (10)
  Actuarial (gain) loss                       (55)      (223)        -        -
  Benefits paid                              (554)      (350)      (12)     (10)
--------------------------------------------------------------------------------
  Benefit obligation, ending             $ 12,600     13,267       299      287
--------------------------------------------------------------------------------
Change in plan assets:
  Fair value of plan
    assets, beginning                       9,709      9,469         -        -
  Actual return on plan assets                954        213         -        -
  Employer contribution                     1,439        377         -        -
  Benefits paid                              (554)      (350)        -        -
--------------------------------------------------------------------------------
  Fair value of plan
    assets, ending                         11,548      9,709         -        -
--------------------------------------------------------------------------------
Funded status                            $ (1,052)    (3,558)   $ (299)    (287)
                                         =========              =======
Unrecognized net actuarial
  loss (gain)                                          3,933                (33)
Unrecognized prior service
  cost                                                    53                 41
--------------------------------------------------------------------------------
  Net amount recognized                             $    428             $ (279)
--------------------------------------------------------------------------------

Amounts recognized in the balance sheets consist of:

                                          Pension Benefits       Other Benefits
                                          ----------------       ---------------
December 31,                                 2006       2005      2006     2005
--------------------------------------------------------------------------------
Prepaid benefit cost                                $    580             $    -
Accrued benefit cost                                  (1,683)              (279)
Intangible assets                                        520                  -
Accumulated other
  comprehensive income                                 1,011                  -
--------------------------------------------------------------------------------
  Net amount recognized                             $    428             $ (279)
--------------------------------------------------------------------------------

Non Current Assets                       $    358               $    -
Non Current Liabilities                  $  1,052               $  299

Amounts recognized in the accumulated other comprehensive income consist of:

                                          Pension Benefits       Other Benefits
                                          ----------------       ---------------
December 31,                                 2006       2005      2006     2005
--------------------------------------------------------------------------------
Prior service costs                      $     52               $   34
Net actuarial loss (gain)                   2,482                  (34)
Deferred taxes                               (861)                   -
--------------------------------------------------------------------------------
Net amount recognized                    $  1,673               $    -
--------------------------------------------------------------------------------

The  accumulated  benefit  obligation for all defined  benefit pension plans was
$10,915 and $10,866 at December 31, 2006 and 2005 respectively.

Information for pension plans with an accumulated  benefit  obligation in excess
of plan assets is as follows:


                                                 Pension Benefits
                                                 ----------------
                                                 2006          2005
-------------------------------------------------------------------
Projected benefit obligation                 $      -      $ 13,267
Accumulated benefit obligation                      -        10,866
Fair value of plan assets                           -         9,709

Components of net periodic  pension cost and other  amounts  recognized in other
comprehensive income:

                                                  Pension Benefits
                                                  ----------------
Years Ended December 31,                     2006       2005       2004
------------------------------------------------------------------------
Components of net periodic
  pension cost:
    Service cost                           $  436     $  415     $  385
    Interest cost                             673        678        664
    Expected return on plan assets           (890)      (755)      (700)
    Amortization of prior service cost          -          -          -
    Amortization of unrecognized
      net loss                                166        114        114
------------------------------------------------------------------------
      Net periodic pension cost            $  385     $  452     $  463
------------------------------------------------------------------------

Other  changes  in plan  assets  and  benefit  obligations  recognized  in other
comprehensive income:

FASB 158 recognition of deferred cost, net $1,673
Reverse effect of additional minimum
  liability                                (1,011)
------------------------------------------------------------------------
  Total recognized in other comprehensive
    income                                 $  662
------------------------------------------------------------------------
  Total recognized in net period pension
    cost and other comprehensive income    $1,047
------------------------------------------------------------------------

                                                   Other Benefits
                                                  ----------------
Years Ended December 31,                     2006       2005       2004
------------------------------------------------------------------------
Components of net periodic
  other benefit cost:
    Service cost                           $    6     $    6     $    6
    Interest cost                              17         16         16
    Amortization of prior service cost          7          7          7
    Amortization of unrecognized
      net gain                                  -          -          -
------------------------------------------------------------------------
      Net periodic other benefit cost      $   30     $   29     $   29
------------------------------------------------------------------------

Other  changes  in plan  assets  and  benefit  obligations  recognized  in other
comprehensive income:

FASB 158 recognition of deferred cost, net $    -
------------------------------------------------------------------------
  Total recognized in other comprehensive
    income                                 $    -
------------------------------------------------------------------------
  Total recognized in net periodic pension
    cost and other comprehensive income    $   30
------------------------------------------------------------------------

The estimated net loss and prior  service cost for the defined  benefit  pension
plan(s) that will be amortized from accumulated other comprehensive  income into
net  periodic  benefit  cost  over  the  next  fiscal  year  are  $102  and  $0,
respectively.  The estimated  prior  service cost for the other defined  benefit
postretirement  plan will be  amortized  from  accumulated  other  comprehensive
income into net periodic benefit cost over the next fiscal year is $7.

42 Penseco Financial Services Corporation / 2006 Annual Report

<PAGE>

14 EMPLOYEE BENEFIT PLANS (CONTINUED)

Weighted-average  assumptions  used to  determine  benefit  obligations  were as
follows:


                                          Pension Benefits       Other Benefits
                                          ----------------       ---------------
December 31,                                 2006       2005      2006     2005
--------------------------------------------------------------------------------
Discount rate                           5.75%-6.00% 5.5%-6.00%    6.00%   6.00%
Rate of compensation
  increase                                  3.00%      4.00%      4.50%   4.50%


                                          Pension Benefits       Other Benefits
                                          ----------------       ---------------
December 31,                                 2006       2005      2006     2005
--------------------------------------------------------------------------------
Discount rate                            5.75%-6.00% 5.5%-6.00%   6.00%   6.00%
Expected long-term
  return on plan assets                     8.50%      8.00%          -       -
Rate of compensation
  increase                                  3.00%      4.00%      4.50%   4.50%

The  expected  long-term  return on plan  assets was  determined  using  average
historical returns of the Company's plan assets.
     The Company's pension plan  weighted-average  asset allocations at December
31, 2006 and 2005 by asset category are as follows:


                                   Plan Assets at December 31,
                                   ---------------------------
                                      2006             2005
--------------------------------------------------------------
Asset Category
--------------
Equity securities                      55.9%           55.7%
Corporate bonds                        20.1%           24.6%
U.S. Government securities             23.2%           19.4%
Cash and cash equivalents                .8%             .3%
--------------------------------------------------------------
                                      100.0%          100.0%

The Company investment policies and strategies include:

1.) The Trust and Investment Division's equity philosophy is Large-Cap Core with
a value bias. We invest in individual high-grade common stocks that are selected
from our approved list.
2.)  Diversification  is  maintained  by having no more than 20% in any industry
sector and no individual equity representing more than 10% of the portfolio.
3.) The fixed income style is  conservative  but also  responsive to the various
needs of our individual clients. For our "Fixed Income" securities,  we buy U.S.
Government bonds and Agencies or high-grade  Corporate rated "A" or better.  The
Company targets the following  allocation  percentages:  cash  equivalents  10%,
fixed income 40% and equities 50%.
     There is no Company  stock  included in equity  securities  at December 31,
2006 or 2005.

Contributions
-------------
The Company expects to contribute $250, to its pension plan and $13 to its other
postretirement plan in 2007.

Estimated Future Benefit Payments
---------------------------------
The following  benefit  payments,  which reflect  expected  future  service,  as
appropriate, are expected to be paid in the next five years and in the aggregate
for the five years thereafter:


                 Pension Benefits      Other Benefits
                 ----------------      --------------
2007                 $    499               $ 13
2008                      497                 13
2009                      507                 13
2010                      540                 14
2011                      599                 15
2012-2016               4,041                 93

--------------------------------------------------------------------------------

15 INCOME TAXES

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

Years Ended December 31,                2006             2005             2004
-------------------------------------------------------------------------------
Currently payable                   $  1,849         $  1,447         $  1,190
Deferred (benefit) provision            (254)             166             (119)
-------------------------------------------------------------------------------
  Total                             $  1,595         $  1,613         $  1,071
-------------------------------------------------------------------------------

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,                2006             2005             2004
-------------------------------------------------------------------------------
Tax at statutory rate               $  2,585         $  2,544         $  2,268
Reduction for non-taxable
   interest                           (1,052)          (1,012)          (1,262)
Other additions                           62               81               65
-------------------------------------------------------------------------------
  Applicable Income Taxes           $  1,595         $  1,613         $  1,071
-------------------------------------------------------------------------------

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

Years Ended December 31,                2006             2005             2004
-------------------------------------------------------------------------------
Accretion of discount on bonds      $    (29)        $     18         $     24
Accelerated depreciation                  13               (4)              21
Supplemental benefit plan                 51               (3)              (1)
Allowance for loan losses               (243)            (165)            (130)
Prepaid pension cost                     (46)             320              (33)
-------------------------------------------------------------------------------
  Total                             $   (254)        $    166         $   (119)
-------------------------------------------------------------------------------

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

December 31,                                   2006          2005
-----------------------------------------------------------------
Deferred tax assets:
  Allowance for loan losses                 $ 1,406       $ 1,163
  Minimum pension liability                       -           520
  Accrued pension costs                         358             -
  Accumulated depreciation                      309           322
  Accrued supplemental benefit plan               -            51
-----------------------------------------------------------------
    Total Deferred Tax Assets                 2,073         2,056
-----------------------------------------------------------------
Deferred tax liabilities:
  Prepaid pension costs                           -           571
  Unrealized securities gains                   522           187
  Accumulated accretion                          40            69
-----------------------------------------------------------------
    Total Deferred Tax Liabilities              562           827
-----------------------------------------------------------------
    Net Deferred Tax Assets                 $ 1,511       $ 1,229
-----------------------------------------------------------------

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.

                  Penseco Financial Services Corporation / 2006 Annual Report 43

<PAGE>

16 ACCUMULATED OTHER COMPREHENSIVE INCOME

Accumulated other comprehensive  income was ($662),  ($648) and $704 at December
31, 2006, 2005 and 2004, respectively.

Other Comprehensive Income

Other  comprehensive  income  (comprehensive  income,   excluding  net  income),
beginning  with  the  2005  period,  includes  two  components,  the  change  in
unrealized  holding  gains and losses on available for sale  securities  and the
change in the unfunded pension liability.  The components of other comprehensive
income are reported net of related tax effects in the Consolidated Statements of
Changes in  Stockholders'  Equity.  Prior to 2005,  other  comprehensive  income
included only one component,  the change in unrealized  holding gains and losses
on available for sale securities, net of related tax effects.
     In 2006,  accumulated  other  comprehensive  income  includes  the  initial
application  of FASB  No.  158 to  record  the  unrecognized  components  of net
periodic pension cost. In future years changes in these components will be shown
in other comprehensive income.

     A reconciliation of other comprehensive income for the years ended December
31, 2006, 2005 and 2004 is as follows:

<TABLE>
<CAPTION>
                                                                                    Tax
                                                                     Before-Tax  (Expense)  Net-of-Tax
2006                                                                   Amount     Benefit     Amount
------------------------------------------------------------------------------------------------------
<S>                                                                  <C>          <C>        <C>
Unrealized losses on available-for-sale securities:
  Unrealized gains arising during the year                           $  1,302     $  (443)   $    859
  Less:  Reclassification adjustment for gains realized in income         319        (108)        211
                                                                     ---------------------------------
  Net unrealized losses                                                   983        (335)        648

Change in minimum pension liability                                     1,531        (520)      1,011
------------------------------------------------------------------------------------------------------
  Other Comprehensive Income                                         $  2,514     $  (855)   $  1,659
======================================================================================================
</TABLE>


<TABLE>
<CAPTION>
                                                                                    Tax
                                                                     Before-Tax  (Expense)  Net-of-Tax
2005                                                                   Amount     Benefit     Amount
------------------------------------------------------------------------------------------------------
<S>                                                                  <C>          <C>        <C>
Unrealized losses on available-for-sale securities:
  Unrealized losses arising during the year                          $   (531)    $   181    $   (350)
  Less:  Reclassification adjustment for losses realized in income        (13)          4          (9)
                                                                     ---------------------------------
  Net unrealized losses                                                  (518)        177        (341)

Change in minimum pension liability                                    (1,531)        520      (1,011)
------------------------------------------------------------------------------------------------------
  Other Comprehensive Income                                         $ (2,049)    $   697    $ (1,352)
======================================================================================================
</TABLE>


<TABLE>
<CAPTION>
                                                                                    Tax
                                                                     Before-Tax  (Expense)  Net-of-Tax
2004                                                                   Amount     Benefit     Amount
------------------------------------------------------------------------------------------------------
<S>                                                                  <C>          <C>        <C>
Unrealized losses on available-for-sale securities:
  Unrealized losses arising during the year                          $ (1,357)    $   461    $   (896)
  Less:  Reclassification adjustment for gains realized in income         357        (121)        236
------------------------------------------------------------------------------------------------------
  Net unrealized losses                                              $ (1,714)    $   582    $ (1,132)
======================================================================================================
</TABLE>


17 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 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, 2006 and 2005 are as follows:


                                        2006              2005
--------------------------------------------------------------
Commitments to extend credit:
  Fixed rate                        $ 37,692          $ 41,229
  Variable rate                     $ 74,577          $ 75,100

Standby letters of credit           $ 15,061          $ 15,268

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.

44 Penseco Financial Services Corporation / 2006 Annual Report

<PAGE>

18 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, 2006                 December 31, 2005
------------------------------------------------------------------------------------------------------------------
                                                      Carrying          Fair             Carrying         Fair
                                                       Amount           Value             Amount          Value
------------------------------------------------------------------------------------------------------------------
<S>                                                  <C>              <C>               <C>             <C>
Financial Assets:
  Cash and due from banks                            $  12,999        $  12,999        $  11,310        $  11,310
  Interest bearing balances with banks                   1,779            1,779              263              263
------------------------------------------------------------------------------------------------------------------
        Cash and cash equivalents                       14,778           14,778           11,573           11,573
  Investment Securities:
    Available-for-sale:
      U.S. Agency obligations                           54,123           54,123          118,545          118,545
      States & political subdivisions                   30,220           30,220           21,635           21,635
      Federal Home Loan Bank stock                       5,093            5,093            4,699            4,699
      Other securities                                   2,269            2,269            3,063            3,063
    Held-to-maturity:
      U.S. Agency obligations                           45,124           44,054           52,763           51,492
      States & political subdivisions                   29,251           31,066           29,252           31,638
------------------------------------------------------------------------------------------------------------------
        Total investment securities                    166,080          166,825          229,957          231,072

  Loans, net of unearned income:
    Real estate mortgages                              308,037          307,508          240,985          235,427
    Commercial                                          26,265           25,963           42,894           42,894
    Consumer and other                                  35,620           35,492           37,483           37,899
    Less: Allowance for loan losses                      4,200                -            3,800
------------------------------------------------------------------------------------------------------------------
      Loans, net                                       365,722          368,963          317,562          316,220
  Cash surrender value of life insurance                 7,054            7,054                -                -
------------------------------------------------------------------------------------------------------------------
      Total Financial Assets                           553,634        $ 557,620          559,092        $ 558,865
                                                                      =========                         =========
Other assets                                            16,187                            16,596
------------------------------------------------------------------------------------------------------------------
      Total Assets                                   $ 569,821                         $ 575,688
------------------------------------------------------------------------------------------------------------------
Financial Liabilities:
  Demand - Non-interest bearing                      $  71,585        $  71,585        $  91,713        $  91,713
  Demand - Interest bearing                             57,309           57,309           33,094           33,094
  Savings                                               80,328           80,328           86,013           86,013
  Money markets                                         85,720           85,720           80,463           80,463
  Time                                                 118,858          118,201          106,584          107,794
-----------------------------------------------------------------------------------------------------------------
    Total Deposits                                     413,800          413,143          397,867          399,077
  Repurchase agreements                                 13,441           13,441           30,414           30,414
  Short-term borrowings                                  5,486            5,486            4,626            4,626
  Long-term borrowings                                  65,853           63,306           75,401           75,710
------------------------------------------------------------------------------------------------------------------
    Total Financial Liabilities                        498,580        $ 495,376          508,308        $ 509,827
Other Liabilities                                        4,670                             3,581
Stockholders' Equity                                    66,571                            63,799
------------------------------------------------------------------------------------------------------------------
    Total Liabilities and
      Stockholders' Equity                           $ 569,821                         $ 575,688
------------------------------------------------------------------------------------------------------------------
Standby Letters of Credit                            $   (151)        $   (151)        $   (153)        $   (153)

</TABLE>

                  Penseco Financial Services Corporation / 2006 Annual Report 45

<PAGE>

19 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 $90 in 2006,  $94 in 2005 and $90 in 2004.  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, 2006
are as follows:

                                     Mount    Meadow      ATM
                                    Pocono    Avenue     Sites    Total
-----------------------------------------------------------------------
2007                                $   55    $   22    $    6    $  83
2008                                    55        22         4       81
2009                                    55        22         -       77
2010                                    55        22         -       77
2011                                    21         9         -       30
-----------------------------------------------------------------------
  Total minimum
    payments required               $  241    $   97    $   10    $ 348
-----------------------------------------------------------------------

--------------------------------------------------------------------------------

20 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,               2006             2005
-------------------------------------------------------------
Beginning Balance                  $ 10,490         $  9,632
Additions                             1,042            5,387
Reclassifications                         8             (217)
Collections                          (1,115)          (4,312)
-------------------------------------------------------------
Ending Balance                     $ 10,425         $ 10,490
-------------------------------------------------------------

In addition to the loan amounts shown above, the Bank has issued standby letters
of credit for the accounts of related parties in the amount of $6,248.

21 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, 2006, that
the Company and the Bank meet all capital  adequacy  requirements  to which they
are subject.
     As of December  31,  2006,  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,
2006, 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.

46 Penseco Financial Services Corporation / 2006 Annual Report

<PAGE>

21 REGULATORY MATTERS (CONTINUED)

<TABLE>
<CAPTION>
                          Actual                                       Regulatory Requirements
---------------------------------------------------------    --------------------------------------------
                                                                  For Capital                To Be
                                                               Adequacy Purposes       "Well Capitalized"
                                                               -----------------       ------------------
As of December 31, 2006                   Amount   Ratio        Amount    Ratio          Amount    Ratio
---------------------------------------------------------------------------------------------------------
<S>                                      <C>       <C>       <C>         <C>         <C>         <C>
Total Capital (to Risk Weighted Assets)
          PFSC (Company)                 $ 71,235  19.65%    > $ 28,998  > 8.0%      > $ 36,248  > 10.0%
                                                             -           -           -           -
          PSB (Bank)                     $ 68,029  18.84%    > $ 28,882  > 8.0%      > $ 36,103  > 10.0%
                                                             -           -           -           -
Tier I Capital (to Risk Weighted Assets)
          PFSC                           $ 67,035  18.49%    > $ 14,499  > 4.0%      > $ 21,749  >  6.0%
                                                             -           -           -           -
          PSB                            $ 63,829  17.68%    > $ 14,441  > 4.0%      > $ 21,662  >  6.0%
                                                             -           -           -           -
Tier I Capital (to Average Assets)
          PFSC                           $ 67,035  11.93%    > $      *  >    *      > $ 28,105  >  5.0%
                                                             -                       -           -
          PSB                            $ 63,829  11.36%    > $      *  >    *      > $ 28,083  >  5.0%
                                                             -           -           -           -
</TABLE>

PFSC - * 3.0%  ($16,863),  4.0%  ($22,484)  or 5.0%  ($28,105)  depending on the
bank's CAMELS Rating and other regulatory risk factors.

PSB - * 3.0% ($16,850), 4.0% ($22,466) or 5.0% ($28,083) depending on the bank's
CAMELS Rating and other regulatory risk factors.


<TABLE>
<CAPTION>
                          Actual                                       Regulatory Requirements
---------------------------------------------------------    --------------------------------------------
                                                                  For Capital                To Be
                                                               Adequacy Purposes       "Well Capitalized"
                                                               -----------------       ------------------
As of December 31, 2005                   Amount   Ratio        Amount    Ratio          Amount    Ratio
---------------------------------------------------------------------------------------------------------
<S>                                      <C>       <C>       <C>         <C>         <C>         <C>
Total Capital (to Risk Weighted Assets)
          PFSC (Company)                 $ 66,923  19.78%    > $ 27,073  > 8.0%      > $ 33,841  > 10.0%
                                                             -           -           -           -
          PSB                            $ 64,127  19.10%    > $ 26,865  > 8.0%      > $ 33,581  > 10.0%
                                                             -           -           -           -
Tier 1 Capital (to Risk Weighted Assets)
          PFSC                           $ 63,123  18.65%    > $ 13,536  > 4.0%      > $ 20,304  >  6.0%
                                                             -           -           -           -
          PSB                            $ 60,327  17.97%    > $ 13,432  > 4.0%      > $ 20,148  >  6.0%
                                                             -           -           -           -
Tier 1 Capital (to Average Assets)
          PFSC                           $ 63,123  11.11%    > $      *  >    *      > $ 28,400  >  5.0%
                                                             -                       -           -
          PSB                            $ 60,327  10.66%    > $      *  >    *      > $ 28,297  >  5.0%
                                                             -           -           -           -
</TABLE>

PFSC - * 3.0%  ($17,040),  4.0%  ($22,720)  or 5.0%  ($28,400)  depending on the
bank's CAMELS Rating and other regulatory risk factors.

PSB - * 3.0% ($16,978), 4.0% ($22,638) or 5.0% ($28,297) depending on the bank's
CAMELS Rating and other regulatory risk factors.

--------------------------------------------------------------------------------

22 PENSECO FINANCIAL SERVICES CORPORATION (PARENT CORPORATION)

The condensed Company-only information follows:

BALANCE SHEETS

December 31,                                      2006        2005
------------------------------------------------------------------
Cash                                          $      1    $      5
Interest bearing balances with banks             1,554          76
------------------------------------------------------------------
  Cash and Cash Equivalents                      1,555          81
Investment in bank subsidiary                   62,970      60,787
------------------------------------------------------------------
Equity Investments                               2,249       3,043
------------------------------------------------------------------
Total Assets                                  $ 66,774    $ 63,911
------------------------------------------------------------------
Total Liabilities                             $    203    $    112
Total Stockholders' Equity                      66,571      63,799
------------------------------------------------------------------
Total Liabilities and Stockholders' Equity    $ 66,774    $ 63,911
------------------------------------------------------------------

STATEMENTS OF INCOME

Years Ended December 31,                                  2006     2005     2004
--------------------------------------------------------------------------------
Dividends from bank subsidiary                         $ 3,222  $ 5,594  $ 2,900
Dividends on investment securities                         106       45       11
Interest on balances with banks                              5        3        -
Gain on sale of equities                                   319        -        -
--------------------------------------------------------------------------------
  Total Income                                           3,652    5,642    2,911
Other non-interest expense                                  21       10       10
--------------------------------------------------------------------------------
Net income before undistributed
  earnings of bank subsidiary                            3,631    5,632    2,901
Undistributed earnings of bank
  subsidiary                                             2,377      237    2,700
--------------------------------------------------------------------------------
Net Income                                             $ 6,008  $ 5,869  $ 5,601
--------------------------------------------------------------------------------

STATEMENTS OF CASH FLOWS


Years Ended December 31,                            2006       2005        2004
--------------------------------------------------------------------------------
Operating Activities:
Net Income                                      $  6,008   $  5,869   $   5,601
Adjustments to reconcile net income
  to net cash provided by
  operating activities:
    Gain on sale of equities                        (319)         -           -
    Equity in undistributed net
      income of bank subsidiary                   (2,377)      (237)     (2,700)
--------------------------------------------------------------------------------
    Net cash provided by
      operating activities                         3,312      5,632       2,901
--------------------------------------------------------------------------------
Investing Activities:
Purchase of equity investments                      (160)    (2,465)          -
Proceeds from sales of equity securities           1,544          -           -
--------------------------------------------------------------------------------
    Net cash provided (used) by
      investing activities                         1,384     (2,465)          -
--------------------------------------------------------------------------------
Financing Activities:
Cash dividends paid                               (3,222)    (3,094)     (2,900)
--------------------------------------------------------------------------------
    Net cash used by
      financing activities                        (3,222)    (3,094)     (2,900)
--------------------------------------------------------------------------------
    Net increase in cash and
      cash equivalents                             1,474         73           1
Cash and cash equivalents at January 1                81          8           7
--------------------------------------------------------------------------------
Cash and cash equivalents at December 31        $  1,555   $     81   $       8
--------------------------------------------------------------------------------

                  Penseco Financial Services Corporation / 2006 Annual Report 47

<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 2006.

ITEM 9A Controls and Procedures

Under the supervision and with the  participation  of our management,  including
our Chief Executive  Officer and  Controller,  we conducted an evaluation of our
disclosure controls and procedures, as such term is defined under Rule 13a-15(e)
under the Securities Exchange Act of 1934. Based upon this evaluation, our Chief
Executive Officer and our Controller  concluded that our disclosure controls and
procedures  were  effective  as of the end of the period  covered by this annual
report.  Management's annual report on internal control over financial reporting
is  included  under the  heading  "Report on  Internal  Control  Over  Financial
Reporting" at Item 8 of this Annual Report on Form 10-K. The attestation  report
of the registered  public  accounting firm is included under the heading "Report
of the Independent  Registered  Public Accounting Firm" at Item 8 of this Annual
Report on Form 10-K.
     The Company continually  assesses the adequacy of its internal control over
financial  reporting  and enhances its controls in response to internal  control
assessments, and internal and external audit and regulatory recommendations.  No
change in internal  control over  financial  reporting  during the quarter ended
December  31, 2006 or through  the date of this Annual  Report on Form 10-K have
materially  affected,  or  are  reasonably  likely  to  materially  affect,  the
Company's internal control over financial reporting.
     Because  of its  inherent  limitations,  internal  control  over  financial
reporting  may not prevent or detect  misstatements.  Also,  projections  of any
evaluation  of  effectiveness  to future  periods  are  subject to the risk that
controls may become inadequate due to changes in conditions,  or that the degree
of compliance with the policies or procedures may deteriorate.

ITEM 9B Other Information

There are no items required to be reported

                                    PART III

ITEM 10 Directors, Executive Officers and Corporate
          Governance

                                 CODE OF ETHICS
                                 --------------
The Company has had for many years a Code of Ethics  applicable to all employees
including  the Company's  principal  Executive  Officer and principal  Financial
Officer  (Controller).  The purpose of the Code is to promote honest and ethical
conduct,  full and fair  disclosures of financial  information,  compliance with
laws and regulations and accountability for actions.
     A copy of the Code of Ethics may be obtained,  without  charge,  on the web
site or by contacting:
                          Patrick Scanlon, Controller
                     Penseco Financial Services Corporation
                          150 North Washington Avenue
                            Scranton, PA 18503-1848
                                 1-800-327-0394

                        AUDIT COMMITTEE FINANCIAL EXPERT
                        --------------------------------
The  Sarbanes-Oxley  Act of 2002 requires the Company to disclose whether or not
its Audit Committee has, as one of its members,  an "Audit  Committee  Financial
Expert", as that term is defined by the U. S. Securities and Exchange Commission
(SEC).
     The Board of Directors has  determined  that the Audit  Committee  does not
have an  "audit  committee  financial  expert"  as that term is  defined  in the
Securities and Exchange  Commission's rules and regulations.  However, the Board
believes that each of the members of the Audit Committee has  demonstrated  that
he is capable of analyzing and evaluating the Company's financial statements and
understanding internal controls and procedures for financial reporting.  Because
the Board believes that the current members of the Audit Committee are qualified
to carry out all of the  duties  and  responsibilities  of the  Company's  Audit
Committee,  the Board  does not  believe  that it is  necessary  at this time to
actively search for an outside person to serve on the Board who would qualify as
an audit committee financial expert.
     Other  information  required  by this Item as to  Directors  of the Company
contained under the headings "Voting  Securities & Principal  Holders  Thereof",
"Election  of   Directors",   "Board  and   Committee   Meetings"  and  "Certain
Relationships  and Related  Transactions"  within the definitive proxy statement
relating to the  Company's  Annual  Meeting of  Shareholders,  to be held May 1,
2007, is incorporated herein by reference thereto.

48 Penseco Financial Services Corporation / 2006 Annual Report

<PAGE>

ITEM 11 Executive Compensation

The  information   contained  under  the  headings   "Executive   Compensation",
"Directors   Compensation",   "Compensation   Committee   Report  on   Executive
Compensation" and "Compensation  Committee Interlocks and Insider Participation"
in the definitive  proxy statement  relating to the Company's  Annual Meeting of
stockholders,  to be held May 1,  2007,  is  incorporated  herein  by  reference
thereto.

ITEM 12 Security Ownership of Certain Beneficial Owners and
          Management and Related Stockholder Matters

The  information  contained  under the heading  "Voting  Securities  & Principal
Holders  Thereof" in the definitive  proxy  statement  relating to the Company's
Annual Meeting of stockholders,  to be held May 1, 2007, is incorporated  herein
by reference thereto.

ITEM 13 Certain Relationships and Related Transactions
          and Director Independence

The information  contained  under the heading  "Certain  Relationships,  Related
Transactions"  and "Transactions  with Directors and Principal  Officers" in the
definitive  proxy  statement   relating  to  the  Company's  Annual  Meeting  of
stockholders,  to be  held  May 1,  2007 is  incorporated  herein  by  reference
thereto.

ITEM 14 Principal Accounting Fees and Services

The information contained under the heading "Our Relationship with Our Auditors"
in the definitive  proxy statement  relating to the Company's  Annual Meeting of
stockholders,  to be  held  May 1,  2007 is  incorporated  herein  by  reference
thereto.

                                    PART IV

ITEM 15 Exhibits and Financial Statement Schedules

(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
        Report of Independent Registered Public Accounting Firm
    (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 16, 2006.)
        10    Material contracts
        13    Annual report to security holders (Included herein by reference
              on pages 1- 56.)
        14    Code of Ethics (Incorporated herein by reference to Exhibit 10 of
              Registrant's report on Form 10-K filed with the SEC on March 16,
              2006.)
        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.)
        31    Certifications required under Section 302 of the Sarbanes-Oxley
              Act of 2002
        32    Certifications required under Section 906 of the Sarbanes-Oxley
              Act of 2002
(b)     A Form 8-K was filed during the fourth quarter of the fiscal year ended
          December 31, 2006.
(c)     The exhibits required to be filed by this Item are listed under Item
          15(a)(3), above.
(d)     There are no financial statement schedules required to be filed under
          this item.

                  Penseco Financial Services Corporation / 2006 Annual Report 49

<PAGE>

SIGNATURES

Pursuant to the  requirements of Section 13 or 15(d) of the Securities  Exchange
Act of 1934,  the Bank has duly caused this report to be signed on its behalf by
the undersigned, thereunto duly authorized on February 27, 2007.


By:  /s/ CRAIG W. BEST
     ------------------------------
     Craig W. Best
     President and CEO


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 27, 2007.


By:  /s/ CRAIG W. BEST                       By:  /s/ ROBERT W. NAISMITH, PH.D.
     ------------------------------               ------------------------------
     Craig W. Best                                Robert W. Naismith, Ph.D.
     President and CEO                            Director


By: /s/ EDWIN J. BUTLER                       By: /s/ JAMES B. NICHOLAS
     ------------------------------               ------------------------------
     Edwin J. Butler                              James B. Nicholas
     Director                                     Director


By: /s/ RICHARD E. GRIMM                     By:  /s/ EMILY S. PERRY
     ------------------------------               ------------------------------
     Richard E. Grimm                             Emily S. Perry
     Director                                     Director


By: /s/ RUSSELL C. HAZELTON                  By:  /s/ SANDRA C.PHILLIPS
     ------------------------------               ------------------------------
     Russell C. Hazelton                          Sandra C. Phillips
     Director                                     Director


By: /s/ D. WILLIAM HUME                      By:  /s/ OTTO P. ROBINSON,JR.
     ------------------------------               ------------------------------
     D. William Hume                              Otto P. Robinson, Jr.
     Director, Chairman of the Board              Director


By: /s/ JAMES G. KEISLING                    By:  /s/ STEVEN L.WEINBERGER
     ------------------------------               ------------------------------
     James G. Keisling                            Steven L. Weinberger
     Director                                     Director


By: /s/ P. FRANK KOZIK
     ------------------------------
     P. Frank Kozik
     Director

50 Penseco Financial Services Corporation / 2006 Annual Report

<PAGE>

                                 CERTIFICATIONS

I, Craig W. Best, certify that:

1. I have reviewed this annual report on Form 10-K of Penseco Financial Services
Corporation;

2. Based on my knowledge, this report does not contain any untrue statement of a
material fact or omit to state a material fact  necessary to make the statements
made, in light of the  circumstances  under which such statements were made, not
misleading with respect to the period covered by this report;

3. Based  on  my  knowledge,  the  financial  statements,  and  other  financial
information included in this report, fairly present in all material respects the
financial  condition,  results of operations and cash flows of the registrant as
of, and for, the periods presented in this report;

4. The  registrant's  other   certifying  officer  and  I  are  responsible  for
establishing and maintaining  disclosure  controls and procedures (as defined in
Exchange Act Rules 13a-15(e) and 15d-15(e)) for the registrant and have:

a) Designed such disclosure  controls and procedures,  or caused such disclosure
controls and  procedures to be designed  under our  supervision,  to ensure that
material  information  relating to the  registrant,  including its  consolidated
subsidiaries, is made known to us by others within those entities,  particularly
during the period in which this report is being prepared;

b) Designed  such  internal  control over  financial  reporting,  or caused such
internal control over financial  reporting to be designed under our supervision,
to provide reasonable assurance regarding the reliability of financial reporting
and the preparation of financial  statements for external purposes in accordance
with generally accepted accounting principles;

c) Evaluated  the  effectiveness  of the  registrant's  disclosure  controls and
procedures and presented in this report our conclusions  about the effectiveness
of the disclosure  controls and procedures,  as of the end of the period covered
by this report based on such evaluation; and

d) Disclosed in this report any change in the registrant's internal control over
financial  reporting that occurred  during the  registrant's  most recent fiscal
quarter (the registrant's fourth fiscal quarter in the case of an annual report)
that has materially affected,  or is reasonably likely to materially affect, the
registrant's internal control over financial reporting; and

5. The registrant's other certifying officer and I have disclosed,  based on our
most recent  evaluation of internal  control over  financial  reporting,  to the
registrant's  auditors  and the audit  committee  of the  registrant's  board of
directors:

a) All  significant  deficiencies  and  material  weaknesses  in the  design  or
operation of internal  control over  financial  reporting  which are  reasonably
likely  to  adversely  affect  the  registrant's  ability  to  record,  process,
summarize and report financial information; and

b) Any  fraud,  whether  or not  material,  that  involves  management  or other
employees who have a significant role in the registrant's  internal control over
financial reporting.

Date: February 26, 2007

/s/ Craig W. Best
-------------------
Craig W. Best
President and CEO


I, Patrick Scanlon, certify that:

1. I have reviewed this annual report on Form 10-K of Penseco Financial Services
Corporation;

2. Based on my knowledge, this report does not contain any untrue statement of a
material fact or omit to state a material fact  necessary to make the statements
made, in light of the  circumstances  under which such statements were made, not
misleading with respect to the period covered by this report;

3. Based  on  my  knowledge,  the  financial  statements,  and  other  financial
information included in this report, fairly present in all material respects the
financial  condition,  results of operations and cash flows of the registrant as
of, and for, the periods presented in this report;

4. The  registrant's  other   certifying  officer  and  I  are  responsible  for
establishing and maintaining  disclosure  controls and procedures (as defined in
Exchange Act Rules 13a-15(e) and 15d-15(e)) for the registrant and have:

a) Designed such disclosure  controls and procedures,  or caused such disclosure
controls and  procedures to be designed  under our  supervision,  to ensure that
material  information  relating to the  registrant,  including its  consolidated
subsidiaries, is made known to us by others within those entities,  particularly
during the period in which this report is being prepared;

b) Designed  such  internal  control over  financial  reporting,  or caused such
internal control over financial  reporting to be designed under our supervision,
to provide reasonable assurance regarding the reliability of financial reporting
and the preparation of financial  statements for external purposes in accordance
with generally accepted accounting principles;

c) Evaluated  the  effectiveness  of the  registrant's  disclosure  controls and
procedures and presented in this report our conclusions  about the effectiveness
of the disclosure  controls and procedures,  as of the end of the period covered
by this report based on such evaluation; and

d) Disclosed in this report any change in the registrant's internal control over
financial  reporting that occurred  during the  registrant's  most recent fiscal
quarter (the registrant's fourth fiscal quarter in the case of an annual report)
that has materially affected,  or is reasonably likely to materially affect, the
registrant's internal control over financial reporting; and

5. The registrant's other certifying officer and I have disclosed,  based on our
most recent  evaluation of internal  control over  financial  reporting,  to the
registrant's  auditors  and the audit  committee  of the  registrant's  board of
directors:

a) All  significant  deficiencies  and  material  weaknesses  in the  design  or
operation of internal  control over  financial  reporting  which are  reasonably
likely  to  adversely  affect  the  registrant's  ability  to  record,  process,
summarize and report financial information; and

b) Any  fraud,  whether  or not  material,  that  involves  management  or other
employees who have a significant role in the registrant's  internal control over
financial reporting.

Date: February 26, 2007

/s/ Patrick Scanlon
-------------------
Patrick Scanlon
Controller


                  Penseco Financial Services Corporation / 2006 Annual Report 51

<PAGE>

CERTIFICATION  OF  PERIODIC  FINANCIAL  REPORT  PURSUANT  TO SECTION  906 OF THE
                           SARBANES-OXLEY ACT OF 2002

Pursuant to Section 906 of the  Sarbanes-Oxley  Act of 2002  (subsection (a) and
(b)  of  Section  1350,  Chapter  63 of  Title  18,  United  States  Code),  the
undersigned  officer of Penseco Financial  Services  Corporation (the "Company")
certifies to his knowledge that:

     (1) The  Annual  Report  on Form  10-K of the  Company  for the year  ended
     December 31, 2006 (the "Form 10-K") fully complies with the requirements of
     Section 13(a) or 15(d) of the Securities  Exchange Act of 1934 (the "Act");
     and

     (2) The  information  contained  in the Form 10-K fairly  presents,  in all
     material  respects,  the financial  conditions and results of operations of
     the  Company as for the dates and for the  periods  referred to in the Form
     10-K.

                               /s/ Craig W. Best
                               -------------------
                               Craig W. Best
                               President and CEO
                               February 26, 2007

--------------------------------------------------------------------------------

CERTIFICATION  OF  PERIODIC  FINANCIAL  REPORT  PURSUANT  TO SECTION  906 OF THE
                           SARBANES-OXLEY ACT OF 2002

Pursuant to Section 906 of the  Sarbanes-Oxley  Act of 2002  (subsection (a) and
(b)  of  Section  1350,  Chapter  63 of  Title  18,  United  States  Code),  the
undersigned  officer of Penseco Financial  Services  Corporation (the "Company")
certifies to his knowledge that:

     (1) The  Annual  Report  on Form  10-K of the  Company  for the year  ended
     December 31, 2006 (the "Form 10-K") fully complies with the requirements of
     Section 13(a) or 15(d) of the Securities  Exchange Act of 1934 (the "Act");
     and

     (2) The  information  contained  in the Form 10-K fairly  presents,  in all
     material  respects,  the financial  conditions and results of operations of
     the  Company as for the dates and for the  periods  referred to in the Form
     10-K.
                               /s/ Patrick Scanlon
                               -------------------
                               Patrick Scanlon
                               Controller
                               February 26, 2007

52 Penseco Financial Services Corporation / 2006 Annual Report

<PAGE>


                              INDEX TO EXHIBITS
<TABLE>
<CAPTION>

Exhibit Number
Referred to
Item 601 of
Regulation S-K    DESCRIPTION OF EXHIBIT                                 Prior Filing or 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 16, 2006.

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

   9              Voting trust agreement                                 None

  10              Material contracts                                     Incorporated herein by reference to Exhibit 10 of
                                                                         Registrant's report on Form 10-K filed with the SEC
                                                                         on March 16, 2006

  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 1-56.
                  quarterly report to security holders

  14              Code of Ethics                                         Incorporated herein by reference to Exhibit 10 of
                                                                         Registrant's report on Form 10-K filed with the SEC
                                                                         on March 16, 2006.

  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

  31              (i) Rule 13a-14(a)/15d-14(a) Certifications            Included herein by reference on page 51.
                  (ii) Rule 13a-14(a)/15d-14(a) Certifications           Included herein by reference on page 51.

  32              Section 1350 Certifications                            Included herein by reference on page 52.

  33              Report on assessment of compliance with                None
                  servicing for asset-backed securities

  34              Attestation report on assessment of compliance         None
                  with servicing criteria for asset-backed securities

  35              Servicer compliance statement                          None

  99              Additional Exhibits                                    None
</TABLE>

                  Penseco Financial Services Corporation / 2006 Annual Report 53