SECURITIES AND EXCHANGE COMMISSION
                                         
                             Washington, D.C.  20549
                                         
                                    FORM 10-Q
                                         
    QUARTERLY REPORT UNDER SECTION 13 OR 15 (d) OF THE SECURITIES EXCHANGE ACT
                                         
                                     OF 1934
                                         
                                         
                     For the Quarter Ended September 30, 1998
                                         
                                         
                                   No. 0-15786             
                             (Commission File Number)
                                         
                                         
                              COMMUNITY BANKS, INC.                       
              (Exact Name of Registrant as Specified in its Charter)
                                         
   
          PENNSYLVANIA                                       23-2251762       
    (State of Incorporation)                          (IRS Employer ID Number)
   
          
          150 Market Street, Millersburg, PA                 17061         
      (Address of Principal Executive Offices)              (Zip Code)
                                         
                                         
                                  (717) 692-4781           
                         (Registrant's Telephone Number)
                                         
                                         
   
   
   Indicate by check mark whether the registrant (1) has filed all reports 
   required to be filed by Sections 12, 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     
   
              Number of Shares Outstanding as of September 30, 1998.
                                         
      CAPITAL STOCK-COMMON                                    6,528,507      
       (Title of Class)                                 (Outstanding Shares)
   
   
   
   
   
   
     
                     COMMUNITY BANKS, INC. and SUBSIDIARIES
                                        
                                   Index 10-Q
                                        
     
     Part I
     
     Financial Information.............................................1
     
     Consolidated Balance Sheets.......................................2
     
     Consolidated Statements of Income.................................3
     
     Consolidated Statements of Changes in Stockholders' Equity........4
     
     Consolidated Statements of Cash Flows.............................5
     
     Notes to Consolidated Financial Statements........................6-9
     
     Management's Discussion and Analysis of Financial
        Condition and Results of Operation............................10-15
     
     
     
     Part II
     
     Other information and Signatures..................................16
     
     
     
     
     
     
     
     
     
     
     
                         PART I - FINANCIAL INFORMATION
                                        
                     COMMUNITY BANKS, INC. and SUBSIDIARIES
                                        
                                        
     The following financial information sets forth the operations of
     Community Banks, Inc. and Subsidiaries for the three month and nine
     month periods ending September 30, 1998 and 1997.
     
     
     In the opinion of management, the following Consolidated Balance
     Sheets and related Consolidated Statements of Income and Cash Flows
     reflect all adjustments (consisting of normal recurring accrual
     adjustments) necessary to present fairly the financial position and
     results of operations for such periods.
     
     
     
     
     
     
     
     
     
     
     
     
     
     
     
     
     
     
     
     
                                             
     
     
     
     
     
     
     
     
     
     
     
     
     
     
     
     
     
     
     
     
     
                                       -1-
     
     




   Community Banks, Inc. and Subsidiaries
   CONSOLIDATED BALANCE SHEETS
   (unaudited)
   (dollars in thousands except per share data)
   
                                              
                                              September 30,       December 31,
                                                  1998                1997    
                                               
                                   
   ASSETS                     
   
   Cash and due from banks...................     $ 21,499         $ 28,015
   Interest-bearing time deposits in other 
      banks..................................        1,119            2,406
   Investment securities, available for sale
      (market value).........................      266,289          219,284
   Fed funds sold............................        5,025            2,100
   Loans.....................................      492,709          456,460
   Less:  Unearned income....................      (11,267)         (12,429)
          Allowance for loan losses..........       (6,779)          (6,270)
          Net loans..........................      474,663          437,761 
   Premises and equipment, net...............       14,416           13,963
   Goodwill..................................          725              906
   Other real estate owned...................          672              866
   Loans held for sale.......................          746            2,641
   Accrued interest receivable and other         
      assets.................................       14,943           11,520
    
      Total assets...........................     $800,097         $719,462 
                                                  ========         ========
   
   LIABILITIES
   
   Deposits:
      Demand.................................     $ 46,381         $ 44,181
      Savings................................      252,039          226,377
      Time...................................      254,730          248,998
      Time in denominations of $100,000 or
       more..................................       31,499           30,199  
      Total deposits.........................      584,649          549,755
   Short-term borrowings.....................        2,271           10,540 
   Long-term debt............................      126,000           77,280
   Accrued interest payable and other 
      liabilities............................        8,662            7,874
      
      Total liabilities......................      721,582          645,449
   
   
   STOCKHOLDERS' EQUITY
   
   Preferred stock, no par value; 500,000
      shares authorized; no shares issued
      and outstanding........................        ---              ---
   Common stock-$5.00 par value; 20,000,000
      shares authorized; 6,631,000 and
      4,405,000 shares issued in 1998 and
      1997, respectively.....................       33,156           22,026
   Surplus...................................       17,986           28,647
   Retained earnings.........................       25,434           21,219
   Other accumulated comprehensive income,
    net of tax of $2,038 and $1,668,
     respectively............................        3,956            3,237  
   Less:  Treasury stock of 103,000 and 
      44,000 shares at cost..................       (2,017)          (1,116) 
      Total stockholders' equity.............       78,515           74,013 
      Total liabilities and stockholders'
       equity................................     $800,097         $719,462
                                                  ========         ========
   
   
   
   The accompanying notes are an integral part of the consolidated financial
   statements.
                                    
   All periods reflect the combined data of Community Banks, Inc. and the
   Peoples State Bank.
                                     -2-
<TABLE>   


   Community Banks, Inc. and Subsidiaries
   CONSOLIDATED STATEMENTS OF INCOME
   (unaudited)
   (dollars in thousands except per share data)
   
<CAPTION>   
                                                        Three Months Ended       Nine Months Ended
                                                          September 30,             September 30,   
                                                          1998       1997         1998        1997 
<S>                                                   <C>         <C>           <C>         <C>
   Interest income:
   Interest and fees on loans.................         $10,453     $ 9,641      $30,482     $28,207
   Interest and dividends on investment 
    securities:
       Taxable................................           2,900       3,015        8,086       8,435
       Exempt from federal income tax.........           1,014         689        2,665       1,708
   Fed funds interest.........................             161         103          402         251
   Other interest income......................              14          19           65          60
        Total interest income.................          14,542      13,467       41,700      38,661
   
   Interest expense:
   Interest on deposits:  
        Savings...............................           1,417       1,394        4,121       4,171
        Time..................................           3,388       3,401        9,938      10,037
        Time in denominations of $100,000 or
         more.................................             356         384        1,210       1,161
   Interest on short-term borrowings and
    long-term debt............................           1,427         681        3,202       1,794
   Fed funds purchased and repo interest......             329         408        1,011         847
        Total interest expense................           6,917       6,268       19,482      18,010
        Net interest income...................           7,625       7,199       22,218      20,651
   Provision for loan losses..................             487         340          911       1,020
        Net interest income after provision 
         for loan losses......................           7,138       6,859       21,307      19,631 
   Other income:
        Trust department income...............              79         107          237         251
        Service charges on deposit accounts...             416         352        1,145         975
        Other service charges, commissions
         and fees.............................             196         153          561         449
        Investment security gains ............             224          86          567         563
        Income on insurance premiums..........             172         150          449         436
        Gains on mortgage sales...............             131          31          415         133
        Other income..........................             108         114          337         292
             Total other income...............           1,326         993        3,711       3,099
   
   Other expenses:
        Salaries and employee benefits........           2,610       2,403        7,651       6,965
        Net occupancy expense.................             821         730        2,383       2,177
   Operating expense of insurance
          subsidiary..........................              87         104          343         325
        Other operating expense...............           1,502       1,441        4,460       4,194
             Total other expense..............           5,020       4,678       14,837      13,661
             Income before income taxes.......           3,444       3,174       10,181       9,069
   Provision for income taxes.................             868         931        2,764       2,671
   
             Net income.......................         $ 2,576     $ 2,243      $ 7,417     $ 6,398
                                                       =======     =======      =======     =======
   Earnings per share: 
      Basic...................................         $   .39     $   .34      $  1.13     $   .98
      Diluted.................................         $   .39     $   .34      $  1.11     $   .96
   Dividends paid per share...................         $   .16     $   .12      $   .46     $   .35
   
   Per share data has been adjusted to reflect stock dividends and splits.
   A three for two stock split was paid May 8, 1998.
   
   
   The accompanying notes are an integral part of the consolidated financial 
   statements.
                                      
   All periods reflect the combined data of Community Banks, Inc. and The 
   Peoples State Bank.
   
                                         -3-      

</TABLE>


<TABLE>   
   Community Banks, Inc. and Subsidiaries
   Consolidated Statements of Changes in Stockholders' Equity
   (Dollars in thousands except per share data)
   
   
<CAPTION>    
                                                    Nine Month Periods Ended September 30
                                                                                
                                                                                 Accumulated
                                                                                    Other
                                            Common                   Retained    Comprehensive   Treasury    Total
                                            Stock      Surplus       Earnings       Income        Stock      Equity
   
<S>                                       <C>         <C>            <C>          <C>          <C>         <C>         
   Balance, January 1, 1997..............  $20,954     $21,624        $21,756      $   166      $  (421)    $64,079  
   Comprehensive income:
         Net income......................                               6,398                                 6,398
         Change in unrealized gain (loss)
          on securities, net of tax of
           $697,000......................                                            1,353                    1,353
          Total comprehensive income.....                                                                     7,751
   Cash dividends........................                              (2,300)                               (2,300)
   5% stock dividend.....................      723       3,905         (4,628)
   Purchase of treasury stock............                                                          (695)       (695)
   Issuance of additional shares.........      248       2,343           (112)                                2,479
   
   Balance, September 30, 1997...........  $21,925     $27,872        $21,114      $ 1,519     $ (1,116)    $71,314
                                           =======     =======        =======      =======      =======     =======  
   
   Balance, January 1, 1998..............  $22,026     $28,647        $21,219      $ 3,237      $(1,116)    $74,013  
      Comprehensive income:
         Net income......................                               7,417                                 7,417
         Change in unrealized gain (loss)
          on securities, net of tax of
            $370,000 ....................                                              719                      719
          Total comprehensive income.....                                                                     8,136  
   Cash dividends........................                              (3,059)                               (3,059)
   3 for 2 stock split...................   11,024     (11,024)                                           
   Purchase of treasury stock............                                                          (901)       (901)
   Issuance of additional shares.........      106         363           (143)                                  326
   
   Balance, September 30, 1998...........  $33,156     $17,986        $25,434      $ 3,956      $(2,017)    $78,515
                                           =======     =======        =======      =======      =======     =======  
   
   
   
   
   Per share data for all periods has been restated to reflect stock dividends and splits.
   
   
   The accompanying notes are an integral part of the consolidated financial statements.
   
   
   All periods reflect the combined data of Community Banks, Inc. and The Peoples State Bank.
   
   
   
   
   
   
   
   
   
   
                                                      -4-
   
   
</TABLE>   
   
   
   
   
   
   
   
   
   
   
   
   
   
   Community Banks, Inc. and Subsidiaries
   CONSOLIDATED STATEMENTS OF CASH FLOWS
   (unaudited)
   (dollars in thousands)
                                                          Nine Months Ended
                                                            September 30,   
                                                            1998       1997   
   
   
   Operating Activities:
      Net income......................................   $ 7,417      $ 6,398
      Adjustments to reconcile net income to net
       cash provided by operating activities:
         Provision for loan losses....................       911        1,020
         Provision for depreciation and amortization..     1,211        1,111
         Amortization of goodwill.....................       181          180
         Investment security gains....................      (567)        (563)
         Loans originated for sale....................   (21,390)      (4,896) 
         Proceeds from sale of loans..................    23,700        6,319
         Gains on mortgage sales......................      (415)        (133)
         Increase in other assets.....................    (2,577)        (996)
         Increase in accrued interest payable 
          and other liabilities.......................       418          452 
           Net cash provided by operating activities..     8,889        8,892
   
   Investing Activities:
      Net decrease in interest-bearing time                    
       deposits in other banks........................     1,287          149
      Proceeds from sales of investment           
       securities.....................................    11,565       32,936
      Proceeds from maturities of investment 
       securities.....................................    71,974       19,153
      Purchases of investment securities..............  (128,888)     (87,712) 
      Net increase in total loans.....................   (38,465)     (20,343)
      Purchases of premises and equipment.............    (1,664)      (2,319)
           Net cash used by investing activities......   (84,191)     (58,136)
   
   Financing Activities:
      Net increase in total deposits..................    34,894       22,994  
      Net decrease in short-term borrowings...........    (8,269)      (9,026)
      Proceeds from issuance of long-term debt........    51,731       35,413
      Repayment of long-term debt.....................    (3,011)      (5,005)
      Cash dividends..................................    (3,059)      (2,300)
      Purchases of treasury stock.....................      (901)        (695)
      Proceeds from issuance of common stock..........       326        2,479 
           Net cash provided by financing 
            activities................................    71,711       43,860
       
           Decrease in cash and cash equivalents......    (3,591)      (5,384)
                     
            
   Cash and cash equivalents at beginning of period...    30,115       23,699
   Cash and cash equivalents at end of period.........   $26,524      $18,315 
                                                         =======      =======
   
   
   
   The accompanying notes are an integral part of the consolidated financial
   statements.
   
   
   All periods reflect the combined data of Community Banks, Inc. and The
   Peoples State Bank.  
                                      -5-      
   
   
   
   
   
   
                                           
   Community Banks, Inc. and Subsidiaries
   NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
   (unaudited)
   (dollars in thousands)
                                          
   
   1.  Accounting Policies
             The information contained in this report is unaudited and is
   subject to future adjustments. However, in the opinion of management, the
   information reflects all adjustments necessary for a fair statement of
   results for the three month and nine month periods ended September 30, 1998
   and 1997.
   
             The accounting policies of Community Banks, Inc. and subsidiaries,
   as applied in the consolidated interim financial statements presented herein,
   are substantially the same as those followed on an annual basis as presented
   on page 9 of the 1997 Annual Report to shareholders.  
   
             Statement of Financial Accounting Standards (SFAS) 133, "Accounting
   for Derivative Instruments and Hedging Activities" establishes standards for
   recording derivative financial instruments on the balance sheet at their fair
   value. This Statement requires changes in the fair value of derivatives be
   recorded each period in current earnings or other comprehensive income,
   depending on whether a derivative is designated as part of a hedge
   transaction and, if it is, the type of hedge transaction. Management
   anticipates that the adoption of SFAS 133 will not have a significant effect
   on the Corporation's financial condition or results of operations.
   
   
   
   
   
   
   
   
   
   
   
   
   
   
   
   
   
   
   
   
   
   
   
   
   
   
   
   
   
   
   
   
   
   
                                   -6-
   
   
   
   
   
   
   2.  Investment Securities
            The amortized cost and estimated market values of investment
   securities at September 30, 1998 and December 31, 1997, were as follows:
   
                                                       September 30,
                                                           1998   
   
                                                                        
                                                                  Estimated
                                                Amortized           Fair
                                                  Cost              Value  
   
   U.S. Treasury securities and obligations
    of U.S. government corporations and
     agencies...............................    $ 69,090          $ 70,070
   Mortgage-backed U.S. government 
    agencies................................      80,954            82,055
   Obligations of states and political
    subdivisions............................      81,026            83,690
   Corporate securities.....................      20,499            20,451  
   Equity securities........................       8,726            10,023 
         Total..............................    $260,295          $266,289 
                                                ========          ======== 
   
                                                       December 31,
                                                           1997    
                                                                          
   U.S. Treasury securities and obligations 
    of U.S. government corporations and
     agencies...............................    $ 66,940          $ 67,389
   Mortgage-backed U.S. government 
    agencies................................      84,568            85,137
   Obligations of states and political
    subdivisions............................      55,248            56,633
   Corporate securities.....................       1,244             1,278   
   Equity securities........................       6,379             8,847
         Total..............................    $214,379          $219,284
                                                ========          ======== 
                                        
   
   
   
   
   
   
   
   
   
   
   
   
   
   
   
   
   
                                       -7-           
   
                                       





                                      

   
<TABLE>   
   
   
   3.  Allowance for loan losses
            Changes in the allowance for loan losses are as follows:
 <CAPTION>  
                                         Nine months ended      Year Ended   Nine Months ended
                                            September 30,       December 31,   September 30,
                                                1998               1997             1997      
    
 <S>                                         <C>                  <C>            <C>   
   Balance, January 1..................       $6,270               $5,561         $5,561
   Provision for loan losses...........          911                1,317          1,020
   Loan charge-offs....................         (793)              (1,466)        (1,077)
   Recoveries..........................          391                  858            700
   
   Balance, September 30, 1998, December 
    31, 1997, and September 30, 1997...       $6,779               $6,270         $6,204
                                              ======               ======         ======
   
                           NONPERFORMING LOANS (a) AND OTHER REAL ESTATE
   
                                            September 30,        December 31,   September 30,
                                                1998                 1997            1997    
   
   Loans past due 90 days or more
    and still accruing interest:
      Commercial, financial and 
       agricultural...................            ---               $   53           ---
      Mortgages.......................           $497                  405          $588
      Personal installment............            271                   72           388
      Other...........................             20                   21            16
                                                  788                  551           992
   
   Loans renogotiated with borrowers..            247                NONE            527  
   Loans on which accrual of interest
    has been discontinued:
      Commercial, financial and
       agricultural....................           916                  926         1,048 
      Mortgages........................         2,763                3,388         3,142
      Other............................           335                  300           277
                                                4,014                4,614         4,467
    
   Other real estate...................           672                  866         1,194
      Total............................        $5,721               $6,031        $7,180
                                               ======               ======        ======
   
   (a)  The determination to discontinue the accrual of interest on nonperforming loans is made
   on the individual case basis. Such factors as the character and size of the loan, quality of
   the collateral and the historical creditworthiness of the borrower and/or guarantors are
   considered by management in assessing the collectibility of such amounts.  
   
   Impaired Loans
        At September 30, 1998 and December 31, 1997 the Corporation recorded no investment in
   impaired loans or related valuation allowance. For the nine month periods ended September
   30, 1998 and 1997 the average balance of impaired loans was negligible. In addition, the
   Corporation recognized no interest on impaired loans on the cash basis for the nine month
   periods ended September 30, 1998 and 1997.
   
   
   
   
   
   
                                           -8-
   
 </TABLE>  
   
   
   
   
   
   
   
   
   
   4.  Statement of Cash Flows
            Cash and cash equivalents include cash and due from banks and
   federal funds sold. The company made cash payments of $3,485,000 and
   $1,990,000 and $19,608,000 and $16,976,000 for income taxes and interest,
   respectively, for each of the nine month periods ended September 30, 1998
   and 1997.
   
            Excluded from the consolidated statements of cash flows for the
   periods ended September 30, 1998 and 1997 was the effect of certain non-cash
   activities. The company acquired real estate through foreclosure totalling
   $652,000 and $749,000, respectively. The company also recorded an increase
   in deferred tax liabilities of $370,000 in 1998. An increase in deferred tax
   liabilities of $2,050,000 was recognized in 1997. These variations related
   to the effects of changes in the net unrealized gain (loss) on investment
   securities available for sale.
 <TABLE>  
   
   5.  Earnings Per Share:
   
            The following tables set forth the calculation of Basic and Diluted
   Earnings Per Share for the periods indicated:
 <CAPTION>  
                                                                 Three Months Ended September 30,         
                                                               1998                         1997          
                                                                   Per-Share                    Per-Share
                                                     Income  Shares  Amount   Income   Shares     Amount  
                                                               (in thousands except per share data)
 <S>                                                <C>      <C>     <C>        <C>       <C>      <C>     
   Basic EPS:
   Income available to common stockholders...        $2,576   6,552   $.39       $2,243    6,511    $.34  
   Effect of Dilutive Securities:                                     ====                          ====     
   Incentive stock options outstanding.......                   138                          172
   Diluted EPS:
   Income available to common stockholders
      & assumed conversion...................        $2,576   6,690   $.39       $2,243    6,683    $.34
                                                     ======   =====   ====       ======    =====    ====
   
   
   
                                                                   Nine Months Ended September 30,        
                                                               1998                         1997          
                                                                   Per-Share                    Per-Share
                                                     Income  Shares  Amount   Income   Shares     Amount  
                                                               (in thousands except per share data)
   
   Basic EPS:
   Income available to common stockholders...        $7,417   6,547  $1.13       $6,398    6,515    $.98  
   Effect of Dilutive Securities:                                    =====                          ====     
   Incentive stock options outstanding.......                   154                          162
   Diluted EPS:
   Income available to common stockholders
      & assumed conversion...................        $7,417   6,701  $1.11       $6,398    6,677    $.96
                                                     ======   =====  =====       ======    =====    ====
   
   
   Per share data has been adjusted to reflect a three for two stock split payable May 8,1998.
   
   All periods reflect the combined data of Community Banks, Inc. and The Peoples State Bank.
   
        
   
    
                                                   -9-
   
 </TABLE>  
   
   
   
   
   
   
   
   
                                      
                                      
                                      
                                      
                                      
                                      
                                      
                                      
                                      
                                      
                                      
                                      
                                      
                                      
                                      
                                      



                                       



   
   
   
                    Community Banks, Inc. and Subsidiaries
                     Management's Discussion and Analysis
               of Financial Condition and Results of Operations
                                       
   Results of Operations
                                       
        Net interest income after provision for loan losses for the first
   nine months of 1998 was $1,676,000 or 8.5% greater than 1997. Total
   interest income for the first nine months increased $3,039,000 or 7.9%
   while total interest expense increased $1,472,000 or 8.2% over the
   comparable period of 1997. The amount of net interest income and total
   interest income are dependent upon many factors including the volume of
   earning assets and interest bearing liabilities, the level of and
   changes in interest rates and levels of non-performing assets. The cost
   of interest bearing liabilities changes with the amount of funds
   necessary to support earning assets, the rates paid to attract and
   maintain deposits, rates paid on borrowed funds and the level of
   non-interest bearing demand deposits and equity capital. The increases
   in net interest income and total interest income were impacted by an
   increase in average earning assets of approximately $66,467,000 or 10.5%
   while average interest bearing liabilities increased  $52,491,000 or
   9.3% for the first nine months of 1998 over the comparable period of
   1997. Impacting the increase in average earning assets were increases in
   average loan balances of 9.0%. The average yields realized on earning
   assets for the first nine months approximated 8.0% and 8.2% in 1998 and
   1997, respectively. The average costs of interest-bearing liabilities
   approximated 4.2% and 4.3%, respectively. Net interest margins, on a tax
   equivalent basis for the first nine months approximated 4.5% and 4.7% in
   1998 and 1997, respectively. The provision for loan losses charged to
   income decreased 10.7% in 1998. Total loans past due 90 days and still
   accruing interest, non-performing loans, and other real estate
   approximated $5,721,000 and $7,180,000, respectively, as of September
   30, 1998 and September 30, 1997. The balance of the allowance for loan
   losses increased from $6,204,000 at September 30, 1997 to $6,779,000 at
   September 30, 1998.   
   
        Total other income for the first nine months of 1998 was $612,000
   or 19.7% more than total other income for the first nine months of 1997.
   Affecting this change were increases in service charges on deposit
   accounts and other service charges, commissions, and fees of $282,000.
   In addition, security gains of $567,000 and $563,000 were recognized in
   1998 and 1997, respectively. Gains recognized on mortgage sales totalled
   $415,000 and $133,000 in 1998 and 1997, respectively. Loans held for
   sale are comprised for the most part of fixed-rate real estate and
   education loans extended specifically for resale. Demand for these
   products has been greater in 1998 than 1997. Loans held for sale as of
   September 30, 1998 totalled $746,000. The market value of these loans
   approximated book value at that time.
   
        Total other expenses for the first nine months of 1998 increased
   $1,176,000 or 8.6%. Contributing factors were increases of $686,000 or
   9.8% in salaries and employee benefits, $206,000 or 9.5% in net
   occupancy expense, and $266,000 or 6.3% in other operating expense.
   These increases were affected by the opening of new banking offices and
   the recognition of certain retirement plan obligations.
   
        The provision for income taxes increased $93,000  or 3.5% for the
   first nine months of 1998 in comparison to the first nine months of
   1997. Affecting this change was an increase in the relative amount of
   tax-free income in 1998. The effective tax rates approximated 27.1% and
   29.5% for the respective periods.  
   
        The previously described factors contributed to a net increase of
   $1,019,000 or 15.9% in net income for the nine month period ended
   September 30, 1998.
   
        The significant changes and related causes which occurred during
   the three month period ending September 30, 1998 were generally
   consistent with those described for the nine month period ending
   September 30, 1998. The provision for loan losses increased $147,000 and
   investment security gains increased $138,000 in 1998. Gains on mortgage
   sales were $131,000 and $31,000, respectively, for the three month
   periods ending September, 1998 and 1997. 
                                 
                                    -10-
   
   
   
   Management's Discussion, Continued
   
   
   
   
   Financial Condition
   
        The Corporation's financial condition can be examined in terms of
   developing trends in its sources and uses of funds. These trends are the
   result of both external environmental factors, such as changing economic
   conditions, regulatory changes and competition, and internal
   environmental factors such as Management's evaluation as to the best use
   of funds under these changing conditions.
                                     
                                                         Increase (Decrease)
                                        Balance                 since
                                  September 30, 1998        December 31, 1997 
                                              (dollars in thousands)
                                         
   
                                                            Amount         %
   Funding Sources:
   
   Deposits and borrowed funds:
   
    Non-interest bearing............    $ 46,381           $ 2,200       5.0%
    Interest bearing................     538,268            32,694       6.5  
       Total deposits...............     584,649            34,894       6.3
   
    Borrowed funds..................     128,271            40,451      46.1
   Other liabilities................       8,662               788      10.0
   Shareholders' equity.............      78,515             4,502       6.1  
   
      Total sources.................    $800,097           $80,635      11.2% 
                                        ========           =======      ==== 
   
   Funding uses:
   
   Interest earning assets:
   
    Short-term investments..........    $  6,144           $ 1,638      36.4%
    Investment securities...........     266,289            47,005      21.4
    Loans, net of unearned income...     481,442            37,411       8.4
                                    
      Total interest earning assets.     753,875            86,054      12.9 
   
   Cash and due from banks..........      21,499            (6,516)    (23.3)
   Other assets.....................      24,723             1,097       4.6
   
      Total uses....................    $800,097           $80,635      11.2%
                                        ========           =======     =====  
   
   
    
      
   
   
   
               
   
   
                                     -11-       
   
   
   
   
   
   Management's Discussion, Continued
   
   
   
   
        As of September 30, 1998 cash and due from banks was $6,516,000 or
   23.3% less than it was at December 31, 1997. Interest-bearing time
   deposits in other banks and investment securities increased $45,718,000
   or 20.6% while fed funds sold increased $2,925,000. The approximate
   market value of debt securities was $4,697,000 greater than amortized
   cost at September 30, 1998. The approximate market value of debt
   securities was $2,437,000 greater than amortized cost at December 31,
   1997. Securities to be held for indefinite periods of time and not
   intended to be held to maturity or on a long-term basis are classified
   as available for sale and carried at market value. Securities held for
   indefinite periods of time include securities that management intends to
   use as part of its asset/liability management strategy and that may be
   sold in response to changes in interest rates, resultant prepayment risk
   and other factors related to interest rate and resultant prepayment risk
   changes. At September 30, 1998 and December 31, 1997, management
   classified investment securities with amortized costs and market values
   of $260,295,000 and $266,289,000, and $214,379,000 and $219,284,000,
   respectively, as available for sale. Net loans increased $36,902,000 or
   8.4% from December 31, 1997 to September 30, 1998. Affecting this change
   were increases in real estate loans of $24,565,000 and consumer loans of
   $3,265,000. Commercial loans increased $4,835,000 during the period. The
   allowance for loan losses approximated 1.41% of net loans at September
   30, 1998 and December 31, 1997. Much of the increase in net premises and
   equipment of $453,000 related to new banking offices. Goodwill continues
   to be amortized at an annualized rate of $240,000. As previously noted,
   Community Banks, Inc. sells only fixed-rate real estate and education
   loans specifically designated for resale on the secondary market and at
   September 30, 1998 and December 31, 1997 these loans totalled $746,000
   and $2,641,000, respectively. Affecting the increase of $3,423,000 in
   accrued interest receivable and other assets was an increase in prepaid
   expenses and deferred taxes. These factors contributed to an increase of
   $80,635,000 or 11.2% in total assets from December 31, 1997 to September
   30, 1998. 
     
        Total deposits increased $34,894,000 or 6.3% from December 31, 1997
   to September 30, 1998. Most of this increase can be attributed to
   increases in savings deposits. It is management's philosophy to
   generally maintain competitive but not overly-aggressive interest rates
   relative to interest-bearing liabilities. 
        
        Management decreased short-term borrowings and increased long-term
   debt in 1998 in an attempt to better balance rate sensitive assets and
   liabilities and enhance earnings through more effective use of equity.
   At September 30, 1998 long-term debt totalling $126,000,000 included
   borrowings from the Federal Home Loan Bank of Pittsburgh of $106,000,000
   and repurchase agreements totalling $20,000,000 at a weighted average
   interest rate of 5.56%.  
                
        Based on a one year interval, rate sensitive assets to rate
   sensitive liabilities approximated 110% as of September 30, 1998.
   
   
   
   
   
   
    
                                     -12-
   
   
   
   Management's Discussion, Continued 
   
        As of September 30, 1998 the Corporation had risk-based capital in
   excess of the fully implemented regulatory requirements, and tier 1 plus
   tier 2 capital approximating 15% of risk-weighted assets.  
   
   Liquidity 
        
        Liquidity is the ratio of net liquid assets to net liabilities. The
   primary functions of asset/liability management are the assurance of
   adequate liquidity and maintenance of an appropriate balance between
   interest-sensitive earning assets and interest-bearing liabilities.
   Liquidity management refers to the ability to meet the cash flow
   requirements of depositors and borrowers.
        
        A continuous review of net liquid assets is conducted to assure
   appropriate cash flow to meet needs and obligations in a timely manner.
   There was an adequate relationship of liquid assets to short-term
   liabilities at September 30, 1998
   
   Forward Outlook
        
        Management is unaware of any regulatory recommendations which, if
   implemented, would have a material effect on the liquidity, capital
   resources, or operations of CBI. Adequate loan demand is anticipated for
   the remainder of 1998 and management will continue to carefully evaluate
   this demand based on the creditworthiness of the borrower and the
   relative strength of the economy in the Corporation's market.     
   
        The Corporation is anticipating the maintenance of a favorable net
   interest margin throughout the remainder of 1998.
   
   Other Events
   
        On March 31, 1998, Community Banks, Inc. (Community) completed its
   merger of The Peoples State Bank (Peoples). Peoples has six banking
   offices which are located in York and Adams Counties, Pennsylvania.
   Community issued 1,325,330 shares of common stock for all of the
   outstanding common stock of Peoples. This transaction was accounted for
   as a pooling of interests and combined unaudited financial information
   is included in this report.
   
                              
                                For Three Months Ended September 30, 1997
                               (dollars in thousands except per share data)
   
                                Community         Peoples         Combined
   
   Interest income............   $8,754           $4,713          $13,467
   Interest expense...........    3,784            2,484            6,268 
   Net interest income........    4,970            2,229            7,199
   Loan loss provision........      140              200              340
   Other income...............      667              326              993
   Other expense..............    3,273            1,405            4,678
   Income before taxes........    2,224              950            3,174
   Taxes......................      630              301              931
                                                                          
   Net income.................   $1,594           $  649           $2,243  
                                 ========================================
   
   Earnings per common share:
   
      Basic                      $  .35           $  .29           $  .34 
      Diluted                    $  .35           $  .29           $  .34 
     
   
                                        -13-
   
   
   
   Management's Discussion, Continued
   
   
   
   
   
                               For the Nine Months Ended September 30, 1997
                               (dollars in thousands except per share data)
   
                                Community         Peoples         Combined
   
   Interest income............   $25,156         $13,505          $38,661
   Interest expense...........    10,713           7,297           18,010
   Net interest income........    14,443           6,208           20,651
   Loan loss provision........       520             500            1,020
   Other income...............     2,379             720            3,099
   Other expense..............     9,644           4,017           13,661
   Income before taxes........     6,658           2,411            9,069 
   Taxes......................     1,902             769            2,671
                                                                          
   Net income.................   $ 4,756         $ 1,642           $6,398
                                 ========================================
   
   Earnings per common share:    
   
      Basic                      $  1.05          $  .75           $  .98
      Diluted                    $  1.03          $  .75           $  .96
   
   
   Per share data has been adjusted to reflect a three for two stock split
   payable May 8, 1998.
                                       
   
   
   
   
   
   
   
   
   
   
   
   
   
   
   
   
   
   
   
   
   
   
   
   
   
   
                                     -14-
   
   
   
   
   Management's Discussion, Continued
   
   
   Impact of The Year 2000 Issue
   
        The "Year 2000 Issue" is the result of the possibility that
   computer programs may be unable to properly recognize the year 2000.
   This could result in a system failure or miscalculations causing
   disruptions of operations, including among other things, a temporary
   inability to process transactions, send invoices, or engage in similar
   business activities.
   
        Based on an ongoing assessment, the Corporation has determined that
   it will need to modify or replace portions of its software and hardware
   so that its computer systems will properly utilize dates beyond December
   31, 1999. If such modifications and conversions are not made, or are not
   completed on a timely basis, the Year 2000 Issue could have an adverse
   impact on the operations of the Corporation. However, management
   presently believes that as a result of modifications to existing
   software and hardware and conversions to new software and hardware, the
   Year 2000 Issue will be mitigated.
   
        The Corporation's Year 2000 Action Plan has been categorized into
   five phases: Awareness, Assessment, Testing, Validation, and
   Implementation. The initial focus within those phases has been on
   vendors and systems that are related to mission critical business
   processes. Mission critical processes are defined as those areas of the
   business whose continued operations are required in order to provide
   basic banking services. Management is currently testing these mission
   critical processes and plans to complete implementation by March 31,
   1999. In addition, all other business processes subject to Y2K
   remediation are expected to be completed prior to December 31, 1999.
   
        Community Banks, Inc. has initiated formal communications with all
   of its significant vendors and large commercial customers to determine
   the extent to which it is vulnerable to those third parties' failure to
   remediate their own Year 2000 Issue. To date, no material impact is
   anticipated based upon responses to these communications. The
   Corporation's estimated Year 2000 project costs include the costs and
   time associated with the impact of a third party's Year 2000 Issue, and
   are based on presently available information. For significant vendors,
   management will validate that they are Year 2000 compliant by December
   31, 1998, or make plans to switch to a new vendor or system that is
   compliant. For large commercial loan customers, management will take
   appropriate action based upon the customer's response.
   
         The Corporation will utilize both internal and external resources
   to reprogram or replace, and test software for Year 2000 modifications.
   Cost incurred to date as well as for the 1998 fiscal year for the Year
   2000 project are generally considered normal operating costs by the
   Corporation. All Year 2000 conversion software and modifications are
   being delivered and executed by the Corporation's various software
   vendors with which the Corporation deals for its many different computer
   processing and transaction functions. The Corporation does not
   anticipate significant expenses incurred or charged to the Year 2000
   Issue due to its many software, maintenance, and licensing agreements
   with its software vendors. The cost to complete the internal process is
   currently estimated to be less than $100,000.
   
        Management believes that the Corporation's existing alternative
   processing procedures will be available as a contingency alternative in
   the unanticipated event that the Year 2000 Issue results in significant
   disruption of normal business activities.    
   
   
                                  -15-    
   
   
   
   
   
   
   
   
   
   
   
   
   
   
   
   
   
   
   
   
                                    
    
   
   
   
   
   
            

    
    
    
    
    
    
    
    
                      COMMUNITY BANKS, INC. and SUBSIDIARIES
                                          
                     PART II - OTHER INFORMATION AND SIGNATURES
    
    
            
    
    
    Item 6.  Exhibits and Reports on Form 8-K/A1
    
             (a)  Exhibits - none
    
             (b)  Registrant filed the following reports
                  on  Form 8-K during the quarter ending September 30, 1998.
    
                    
             Reports Dated July 8, 1998
    
             Community Banks, Inc. announced a stock repurchase program
             effective July 8 through October 1 of 1998. Up to two percent of
             outstanding shares could be purchased in open market transactions
             as treasury shares to be used for general corporate purposes,
             including grants under the Employee Stock Option Plan.   
    
          
    
    
                                          
                                          
                                     SIGNATURES
    
    Pursuant to the requirements of the Securities Exchange Act of 1934, the
    Registrant has duly caused this report to be signed on its behalf by the
    undersigned thereunto duly authorized.
    
                                                COMMUNITY BANKS, INC.
                                                (Registrant)
    
    
    Date  November  11, 1998                   /S/ Eddie L. Dunklebarger   
                                                    Eddie L. Dunklebarger
                                                          President       
                                                  (Chief Executive Officer)
                                              
    
    
    Date  November 11, 1998                   /S/  Terry L. Burrows        
                                                    Terry L. Burrows
                                                 Executive Vice-President
                                                 (Chief Financial Officer)
    
    
    
    
    
    
                                       -16-