**UNITEDSTATES**

**SECURITIESAND EXCHANGE COMMISSION**

**WASHINGTON, D.C. 20549**

**FORM 10-Q**
| **x**      | ** ** | **Quarterly Report pursuant to Section 13 or 15  (d) of the Securities Exchange Act of 1934 for the Quarterly Period Ended  September 30, 2006,**                                                                                                                                                                                                                                                                             |
|------------|------------|-------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
| ** ** | ** ** | ** **                                                                                                                                                                                                                                                                                                                                                                                                                    |
| **o**      | ** ** | **Transition report pursuant to Section 13 or 15  (d) of the Exchange Act for the Transition Period from                            to                          .** |

 

**No.0-17077**

(Commission FileNumber)

**PENNSWOODS BANCORP, INC.**

(Exact name ofRegistrant as specified in its charter)

| **PENNSYLVANIA**                                   | ** ** | **23-2226454**       |
|----------------------------------------------------|------------|----------------------|
| (State or other  jurisdiction of                   |       | (I.R.S. Employer     |
| incorporation or  organization)                    |       | Identification  No.) |
|                                               |       |                 |
| **300  Market Street, Williamsport, Pennsylvania** | ** ** | **17701-0967**       |
| (Address of principal  executive offices)          |       | (Zip Code)           |

 

**(570) 322-1111**

Registrant’stelephone number, including area code

Indicate by check mark whether the registrant (1) has filed all reportsrequired to be filed by Section 13 or 15(d) of the Securities Exchange Act of1934 during the preceding 12 months (or for such shorter period that Registrantwas required to file such reports), and (2) has been subject to such filingrequirements for the past 90 days.

YES  x              NO  o

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

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

Indicate by check mark whether the registrant is a shell company (asdefined in Rule 12b-2 of the Exchange Act).

YES  o              NO  x

On November 1, 2006 there were 3,916,413 shares of the Registrant’scommon stock outstanding.

 

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**PENNS WOODS BANCORP, INC.**

**INDEX TOQUARTERLY REPORT ON FORM 10-Q**
|                                                                                                                                     | ** ** | ** **                                                                                      | ** ** | ** ** |
|-------------------------------------------------------------------------------------------------------------------------------------|------------|-------------------------------------------------------------------------------------------------|------------|------------|
| ** **                                                                                                                          |       |                                                                                            |       |       |
| **Part I**                                                                                                                          | ** ** | **Financial Information**                                                                       |       |       |
| ** **                                                                                                                          | ** ** | ** **                                                                                      |       |       |
| **Item 1.**                                                                                                                         | ** ** | **Financial Statements**                                                                        |       |       |
|                                                                                                                                |       |                                                                                            |
| Consolidated Balance Sheet (unaudited) as of September  30, 2006 and December 31, 2005                                              |       |                                                                                            |
|                                                                                                                                |       |                                                                                            |       |       |
| Consolidated  Statement of Income (unaudited) for the Three and Nine Months ended September  30, 2006  and 2005                     |       |                                                                                            |
|                                                                                                                                |       |                                                                                            |       |       |
| Consolidated  Statement of Changes in Shareholders’ Equity (unaudited) for the Nine Months  ended  September 30, 2006 and 2005 |       |                                                                                            |
|                                                                                                                                |       |                                                                                            |       |       |
| Consolidated  Statement of Comprehensive Income (unaudited) for the Three and Nine Months  ended  September 30, 2006 and 2005       |       |                                                                                            |
|                                                                                                                                |       |                                                                                            |       |       |
| Consolidated Statement of Cash Flows (unaudited) for  the Nine Months ended September 30, 2006 and 2005                             |       |                                                                                            |
|                                                                                                                                |       |                                                                                            |       |       |
| Notes to Consolidated Financial Statements (unaudited)                                                                              |       |                                                                                            |
|                                                                                                                                |       |                                                                                            |
| **Item 2.**                                                                                                                         | ** ** | **Management’s Discussion and Analysis of Financial  Condition and Results of Operations** | ** ** |       |
| **Item 3.**                                                                                                                         | ** ** | **Quantitative and Qualitative Disclosures About Market  Risk**                                 | ** ** |       |
| **Item 4.**                                                                                                                         | ** ** | **Controls and Procedures**                                                                     | ** ** |       |
| ** **                                                                                                                          | ** ** | ** **                                                                                      |       |       |
| **Part  II**                                                                                                                        | ** ** | **Other  Information**                                                                          |       |       |
| ** **                                                                                                                          | ** ** | ** **                                                                                      |       |       |
| **Item  1.**                                                                                                                        | ** ** | **Legal  Proceedings**                                                                          |       |       |
| **Item  1A.**                                                                                                                       | ** ** | **Risk  Factors**                                                                               |       |       |
| **Item 2.**                                                                                                                         | ** ** | **Unregistered Sales of Equity Securities and Use of  Proceeds**                                |       |       |
| **Item 3.**                                                                                                                         | ** ** | **Defaults Upon Senior Securities**                                                             |       |       |
| **Item 4.**                                                                                                                         | ** ** | **Submission of Matters to a Vote of Security Holders**                                         |       |       |
| **Item  5.**                                                                                                                        | ** ** | **Other  Information**                                                                          |       |       |
| **Item 6.**                                                                                                                         | ** ** | **Exhibits**                                                                                    |       |       |
| **Signatures**                                                                                                                      | ** ** |                                                                                            |
| **Exhibit Index and Exhibits**                                                                                                      |       |                                                                                            |
|                                                                                                                                     |            |                                                                                                 |            |            |  |

 

2

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**Part I.  FINANCIAL INFORMATION**

**Item 1.  Financial Statements**

PENNS WOODS BANCORP, INC.

CONSOLIDATED BALANCE SHEET

(UNAUDITED)
| **(In Thousands, Except Share Data)**                                           | ** ** | **September 30,  2006** | ** ** | **December 31,  2005** | ** ** |
|-----------------------------------------------------------------------------------------------------|------------|------------------------------|------------|-----------------------------|------------|
|                                                                                                |       |                         |       |                        |       |
| ASSETS                                                                                              |       |                         |       |                        |       |
| Noninterest-bearing  balances                                                                       |       | $                            | 13,371     |                        | $          | 14,065 |   |
| Interest-bearing  deposits in other financial institutions                                          |       | 97                           |       | 25                          |       |
| Total cash and  cash equivalents                                                                    |       | 13,468                       |       | 14,090                      |       |
|                                                                                                |       |                         |       |                        |       |
| Investment securities,  available for sale, at fair value                                           |       | 184,484                      |       | 187,018                     |       |
| Investment securities  held to maturity (fair value of $285 and $238)                               |       | 282                          |       | 265                         |       |
| Loans held for sale                                                                                 |       | 4,746                        |       | 3,545                       |       |
| Loans                                                                                               |       | 356,556                      |       | 338,438                     |       |
| Less: Allowance for  loan losses                                                                    |       | 4,045                        |       | 3,679                       |       |
| Loans, net                                                                                          |       | 352,511                      |       | 334,759                     |       |
| Premises and equipment,  net                                                                        |       | 6,627                        |       | 6,409                       |       |
| Accrued interest  receivable                                                                        |       | 2,720                        |       | 2,828                       |       |
| Bank-owned life  insurance                                                                          |       | 11,202                       |       | 10,718                      |       |
| Investment in limited  partnerships                                                                 |       | 4,927                        |       | 3,549                       |       |
| Goodwill                                                                                            |       | 3,032                        |       | 3,032                       |       |
| Other assets                                                                                        |       | 2,753                        |       | 2,455                       |       |
| TOTAL ASSETS                                                                                        |       | $                            | 586,752    |                        | $          | 568,668 |   |
|                                                                                                |       |                         |       |                        |       |
| LIABILITIES                                                                                         |       |                         |       |                        |       |
| Interest-bearing  deposits                                                                          |       | $                            | 332,310    |                        | $          | 281,150 |   |
| Noninterest-bearing  deposits                                                                       |       | 69,412                       |       | 71,142                      |       |
| Total deposits                                                                                      |       | 401,722                      |       | 352,292                     |       |
|                                                                                                |       |                         |       |                        |       |
| Short-term borrowings                                                                               |       | 18,026                       |       | 54,003                      |       |
| Long-term borrowings,  Federal Home Loan Bank (FHLB)                                                |       | 82,878                       |       | 84,478                      |       |
| Accrued interest  payable                                                                           |       | 1,510                        |       | 1,108                       |       |
| Other liabilities                                                                                   |       | 7,891                        |       | 2,868                       |       |
| TOTAL LIABILITIES                                                                                   |       | 512,027                      |       | 494,749                     |       |
|                                                                                                |       |                         |       |                        |       |
| SHAREHOLDERS’ EQUITY                                                                           |       |                         |       |                        |       |
| Common stock, par value  $8.33, 10,000,000 shares authorized; 4,002,580 and 4,002,159 shares issued |       | 33,354                       |       | 33,351                      |       |
| Additional paid-in  capital                                                                         |       | 17,784                       |       | 17,772                      |       |
| Retained earnings                                                                                   |       | 25,208                       |       | 22,938                      |       |
| Accumulated other  comprehensive income                                                             |       | 1,674                        |       | 850                         |       |
| Less: Treasury stock at  cost, 86,372 and 26,372 shares                                             |       | (3,295                       | )          | (992                        | )          |
| TOTAL SHAREHOLDERS’  EQUITY                                                                    |       | 74,725                       |       | 73,919                      |       |
| TOTAL LIABILITIES AND SHAREHOLDERS’ EQUITY                                                     |       | $                            | 586,752    |                        | $          | 568,668 |   |

 

See accompanying notes tothe unaudited consolidated financial statements.

3

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PENNSWOODS BANCORP, INC.

CONSOLIDATED STATEMENT OFINCOME

(UNAUDITED)
| ** **                                                         | ** ** | **Three Months Ended  September 30,** | ** ** | **Nine Months Ended  September 30,** | ** ** |
|--------------------------------------------------------------------|------------|------------------------------------------------------|------------|-----------------------------------------------------|------------|
| **(In Thousands, Except Per Share Data)** | ** ** | **2006**                                             | ** ** | **2005**                                            | ** ** | **2006** | ** ** | **2005** | ** ** |
|                                                               |       |                                                 |       |                                                |       |   |   |   |   |
| INTEREST AND DIVIDEND  INCOME                                      |       |                                                 |       |                                                |       |   |   |   |   |
| Loans including fees                                               |       | $                                                    | 6,355      |                                                | $          | 5,602 |   | $ | 18,250 |   | $ | 16,341 |   |
| Investment Securities:                                             |       |                                                 |       |                                                |       |   |   |   |   |
| Taxable                                                            |       | 874                                                  |       | 966                                                 |       | 2,691 |   | 3,420 |   |
| Tax-exempt                                                         |       | 1,004                                                |       | 969                                                 |       | 2,993 |   | 2,246 |   |
| Dividend and  other interest income                                |       | 314                                                  |       | 279                                                 |       | 982 |   | 898 |   |
| TOTAL INTEREST AND  DIVIDEND INCOME                                |       | 8,547                                                |       | 7,816                                               |       | 24,916 |   | 22,905 |   |
|                                                               |       |                                                 |       |                                                |       |   |   |   |   |
| INTEREST EXPENSE                                                   |       |                                                 |       |                                                |       |   |   |   |   |
| Deposits                                                           |       | 2,447                                                |       | 1,537                                               |       | 6,252 |   | 4,151 |   |
| Short-term borrowings                                              |       | 306                                                  |       | 199                                                 |       | 1,221 |   | 545 |   |
| Long-term borrowings,  FHLB                                        |       | 954                                                  |       | 965                                                 |       | 2,844 |   | 2,711 |   |
| TOTAL INTEREST EXPENSE                                             |       | 3,707                                                |       | 2,701                                               |       | 10,317 |   | 7,407 |   |
|                                                               |       |                                                 |       |                                                |       |   |   |   |   |
| NET INTEREST INCOME                                                |       | 4,840                                                |       | 5,115                                               |       | 14,599 |   | 15,498 |   |
|                                                               |       |                                                 |       |                                                |       |   |   |   |   |
| PROVISION FOR LOAN  LOSSES                                         |       | 89                                                   |       | 180                                                 |       | 485 |   | 540 |   |
|                                                               |       |                                                 |       |                                                |       |   |   |   |   |
| NET INTEREST INCOME  AFTER PROVISION FOR LOAN LOSSES               |       | 4,751                                                |       | 4,935                                               |       | 14,114 |   | 14,958 |   |
|                                                               |       |                                                 |       |                                                |       |   |   |   |   |
| NON-INTEREST INCOME                                                |       |                                                 |       |                                                |       |   |   |   |   |
| Deposit service charges                                            |       | 596                                                  |       | 612                                                 |       | 1,773 |   | 1,603 |   |
| Securities gains, net                                              |       | 561                                                  |       | 556                                                 |       | 1,385 |   | 1,854 |   |
| Bank-owned life  insurance                                         |       | 94                                                   |       | 288                                                 |       | 272 |   | 475 |   |
| Gain on sale of loans                                              |       | 264                                                  |       | 263                                                 |       | 624 |   | 631 |   |
| Insurance commissions                                              |       | 502                                                  |       | 507                                                 |       | 1,732 |   | 1,802 |   |
| Other                                                              |       | 370                                                  |       | 321                                                 |       | 1,154 |   | 964 |   |
| TOTAL NON-INTEREST  INCOME                                         |       | 2,387                                                |       | 2,547                                               |       | 6,940 |   | 7,329 |   |
|                                                               |       |                                                 |       |                                                |       |   |   |   |   |
| NON-INTEREST EXPENSE                                               |       |                                                 |       |                                                |       |   |   |   |   |
| Salaries and employee  benefits                                    |       | 2,174                                                |       | 2,096                                               |       | 6,620 |   | 6,225 |   |
| Occupancy, net                                                     |       | 308                                                  |       | 261                                                 |       | 826 |   | 838 |   |
| Furniture and equipment                                            |       | 309                                                  |       | 262                                                 |       | 894 |   | 717 |   |
| Pennsylvania shares tax                                            |       | 151                                                  |       | 138                                                 |       | 447 |   | 417 |   |
| Other                                                              |       | 1,172                                                |       | 1,031                                               |       | 3,356 |   | 3,035 |   |
| TOTAL NON-INTEREST  EXPENSE                                        |       | 4,114                                                |       | 3,788                                               |       | 12,143 |   | 11,232 |   |
|                                                               |       |                                                 |       |                                                |       |   |   |   |   |
| INCOME BEFORE INCOME  TAX PROVISION                                |       | 3,024                                                |       | 3,694                                               |       | 8,911 |   | 11,055 |   |
| INCOME TAX PROVISION                                               |       | 560                                                  |       | 746                                                 |       | 1,558 |   | 2,632 |   |
| NET INCOME                                                         |       | $                                                    | 2,464      |                                                | $          | 2,948 |   | $ | 7,353 |   | $ | 8,423 |   |
|                                                               |       |                                                 |       |                                                |       |   |   |   |   |
| EARNINGS PER SHARE -  BASIC                                        |       | $                                                    | 0.63       |                                                | $          | 0.74 |   | $ | 1.87 |   | $ | 2.12 |   |
| EARNINGS PER SHARE -  DILUTED                                      |       | $                                                    | 0.63       |                                                | $          | 0.74 |   | $ | 1.87 |   | $ | 2.12 |   |
| WEIGHTED AVERAGE SHARES  OUTSTANDING - BASIC                       |       | 3,927,261                                            |       | 3,972,862                                           |       | 3,942,533 |   | 3,973,455 |   |
| WEIGHTED AVERAGE SHARES  OUTSTANDING - DILUTED                     |       | 3,927,740                                            |       | 3,974,956                                           |       | 3,943,016 |   | 3,975,769 |   |
| DIVIDENDS PER SHARE                                                |       | $                                                    | 0.44       |                                                | $          | 0.39 |   | $ | 1.29 |   | $ | 1.15 |   |

 

See accompanying notes to theunaudited consolidated financial statements.

4

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PENNSWOODS BANCORP, INC.

CONSOLIDATED STATEMENT OFCHANGES IN SHAREHOLDERS’ EQUITY

(UNAUDITED)
| ** **                                                                                                                       | ** ** | **COMMON  STOCK** | ** ** | **ADDITIONAL  PAID-IN** | ** ** | **RETAINED** | ** ** | **ACCUMULATED  OTHER  COMPREHENSIVE** | ** ** | **TREASURY** | ** ** | **TOTAL  SHAREHOLDERS’** | ** ** |
|----------------------------------------------------------------------------------------------------------------------------------|------------|-------------------|------------|-------------------------|------------|--------------|------------|---------------------------------------|------------|--------------|------------|-------------------------------|------------|
| **(In Thousands Except  Per Share Data)**                                                                    | ** ** | **SHARES**        | ** ** | **AMOUNT**              | ** ** | **CAPITAL**  | ** ** | **EARNINGS**                          | ** ** | **INCOME**   | ** ** | **STOCK**                     | ** ** | **EQUITY** | ** ** |
| Balance, December 31,  2005                                                                                                      |       | 4,002,159         |       | $                       | 33,351     |         | $          | 17,772                                |       | $            | 22,938     |                          | $          | 850 |   | $ | (992 | ) | $ | 73,919 |   |
|                                                                                                                             |       |              |       |                    |       |         |       |                                  |       |         |       |                          |       |   |   |
| Comprehensive Income:                                                                                                            |       |              |       |                    |       |         |       |                                  |       |         |       |                          |       |   |   |
| Net income                                                                                                                       |       |              |       |                    |       |         |       | 7,353                                 |       |         |       |                          |       | 7,353 |   |
| Net change in unrealized  gain on investments available for sale, net of reclassification adjustment,  net of income tax of $424 |       |              |       |                    |       |         |       |                                  |       | 824          |       |                          |       | 824 |   |
| Total comprehensive income                                                                                                       |       |              |       |                    |       |         |       |                                  |       |         |       |                          |       | 8,177 |   |
| Dividends declared,  ($1.29 per share)                                                                                           |       |              |       |                    |       |         |       | (5,083                                | )          |         |       |                          |       | (5,083 | ) |
| Purchase of treasury  stock (60,000 shares)                                                                                      |       |              |       |                    |       |         |       |                                  |       |         |       | (2,303                        | )          | (2,303 | ) |
| Common shares issued for  employee stock purchase plan                                                                           |       | 421               |       | 3                       |       | 12           |       |                                  |       |         |       |                          |       | 15 |   |
| Balance, September 30, 2006                                                                                                      |       | 4,002,580         |       | $                       | 33,354     |         | $          | 17,784                                |       | $            | 25,208     |                          | $          | 1,674 |   | $ | (3,295 | ) | $ | 74,725 |   |

 
| ** **                                                                                                                                 | ** ** | **COMMON  STOCK** | ** ** | **ADDITIONAL  PAID-IN** | ** ** | **RETAINED** | ** ** | **ACCUMULATED  OTHER  COMPREHENSIVE** | ** ** | **TREASURY** | ** ** | **TOTAL  SHAREHOLDERS’** | ** ** |
|--------------------------------------------------------------------------------------------------------------------------------------------|------------|-------------------|------------|-------------------------|------------|--------------|------------|---------------------------------------|------------|--------------|------------|-------------------------------|------------|
| ** **                                                                                                                                 | ** ** | **SHARES**        | ** ** | **AMOUNT**              | ** ** | **CAPITAL**  | ** ** | **EARNINGS**                          | ** ** | **INCOME**   | ** ** | **STOCK**                     | ** ** | **EQUITY** | ** ** |
| Balance, December 31,  2004                                                                                                                |       | 3,998,204         |       | $                       | 33,318     |         | $          | 17,700                                |       | $            | 18,262     |                          | $          | 4,331 |   | $ | (446 | ) | $ | 73,165 |   |
|                                                                                                                                       |       |              |       |                    |       |         |       |                                  |       |         |       |                          |       |   |   |
| Comprehensive Income:                                                                                                                      |       |              |       |                    |       |         |       |                                  |       |         |       |                          |       |   |   |
| Net income                                                                                                                                 |       |              |       |                    |       |         |       | 8,423                                 |       |         |       |                          |       | 8,423 |   |
| Net change in unrealized  loss on investments available for sale, net of reclassification adjustment,  net of income tax benefit of $1,245 |       |              |       |                    |       |         |       |                                  |       | (2,417       | )          |                          |       | (2,417 | ) |
| Total comprehensive  income                                                                                                                |       |              |       |                    |       |         |       |                                  |       |         |       |                          |       | 6,006 |   |
| Dividends declared,  ($1.15 per share)                                                                                                     |       |              |       |                    |       |         |       | (4,583                                | )          |         |       |                          |       | (4,583 | ) |
| Purchase of treasury  stock (3,000 shares)                                                                                                 |       |              |       |                    |       |         |       |                                  |       |         |       | (115                          | )          | (115 | ) |
| Stock options exercised                                                                                                                    |       | 675               |       | 6                       |       | 11           |       |                                  |       |         |       |                          |       | 17 |   |
| Balance, September 30, 2005                                                                                                                |       | 3,998,879         |       | $                       | 33,324     |         | $          | 17,711                                |       | $            | 22,102     |                          | $          | 1,914 |   | $ | (561 | ) | $ | 74,490 |   |

 

Seeaccompanying notes to the unaudited consolidated financial statements.

PENNSWOODS BANCORP, INC.

CONSOLIDATEDSTATEMENT OF COMPREHENSIVE INCOME

(UNAUDITED)
| ** **                                                                 | ** ** | **Three Months Ended September 30,** | ** ** | **Nine Months Ended September 30,** | ** ** |
|----------------------------------------------------------------------------|------------|----------------------------------------------------------|------------|---------------------------------------------------------|------------|
| **(In Thousands)**                                                    | ** ** | **2006**                                                 | ** ** | **2005**                                                | ** ** | **2006** | ** ** | **2005** | ** ** |
|                                                                       |       |                                                     |       |                                                    |       |   |   |   |   |
| Net Income                                                                 |       | $                                                        | 2,464      |                                                    | $          | 2,948 |   | $ | 7,353 |   | $ | 8,423 |   |
| Other comprehensive  income (loss):                                        |       |                                                     |       |                                                    |       |   |   |   |   |
| Net unrealized gains  (losses) on available for sale securities            |       | 5,026                                                    |       | (3,350                                                  | )          | 2,633 |   | (1,808 | ) |
| Less: Reclassification  adjustment for net gains included in net income    |       | 561                                                      |       | 556                                                     |       | 1,385 |   | 1,854 |   |
| Other comprehensive  income (loss) before tax                              |       | 4,465                                                    |       | (3,906                                                  | )          | 1,248 |   | (3,662 | ) |
| Income tax expense  (benefit) related to other comprehensive income (loss) |       | 1,518                                                    |       | (1,328                                                  | )          | 424 |   | (1,245 | ) |
| Other comprehensive  income (loss), net of tax                             |       | 2,947                                                    |       | (2,578                                                  | )          | 824 |   | (2,417 | ) |
| Comprehensive income                                                       |       | $                                                        | 5,411      |                                                    | $          | 370 |   | $ | 8,177 |   | $ | 6,006 |   |

 

See accompanying notes to theunaudited consolidated financial statements.

5

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PENNSWOODS BANCORP, INC.

CONSOLIDATED STATEMENT OF CASH FLOWS

(UNAUDITED)
| ** **                                                                         | ** ** | **Nine Months Ended  September 30,** | ** ** |
|------------------------------------------------------------------------------------|------------|-----------------------------------------------------|------------|
| **(In Thousands)**                                                            | ** ** | **2006**                                            | ** ** | **2005** | ** ** |
|                                                                               |       |                                                |       |   |   |
| OPERATING ACTIVITIES                                                               |       |                                                |       |   |   |
| Net Income                                                                         |       | $                                                   | 7,353      |   | $ | 8,423 |   |
| Adjustments to  reconcile net income to net cash provided by operating activities: |       |                                                |       |   |   |
| Depreciation                                                                       |       | 549                                                 |       | 377 |   |
| Provision for  loan losses                                                         |       | 485                                                 |       | 540 |   |
| Accretion and  amortization of investment security discounts and premiums          |       | (575                                                | )          | (319 | ) |
| Securities  gains, net                                                             |       | (1,385                                              | )          | (1,854 | ) |
| Originations of  loans held for sale                                               |       | (28,031                                             | )          | (21,562 | ) |
| Proceeds of  loans held for sale                                                   |       | 27,454                                              |       | 22,909 |   |
| Gain on sale of loans                                                              |       | (624                                                | )          | (631 | ) |
| Earnings on  bank-owned life insurance                                             |       | (272                                                | )          | (475 | ) |
| Other, net                                                                         |       | (80                                                 | )          | 200 |   |
| Net cash  provided by operating activities                                         |       | 4,874                                               |       | 7,608 |   |
| INVESTING ACTIVITIES                                                               |       |                                                |       |   |   |
| Investment  securities available for sale:                                         |       |                                                |       |   |   |
| Proceeds from  sales                                                               |       | 39,056                                              |       | 113,007 |   |
| Proceeds from  calls and maturities                                                |       | 5,445                                               |       | 10,697 |   |
| Purchases                                                                          |       | (33,972                                             | )          | (133,687 | ) |
| Investment  securities held to maturity:                                           |       |                                                |       |   |   |
| Proceeds from  calls and maturities                                                |       | 25                                                  |       | 327 |   |
| Purchases                                                                          |       | (25                                                 | )          | (35 | ) |
| Net increase in  loans                                                             |       | (18,288                                             | )          | (6,918 | ) |
| Acquisition of  bank premises and equipment                                        |       | (767                                                | )          | (1,636 | ) |
| Proceeds from  the sale of foreclosed assets                                       |       | 83                                                  |       | 67 |   |
| Investment in  limited partnership                                                 |       | (1,535                                              | )          | (3,124 | ) |
| Net cash used  for investing activities                                            |       | (9,978                                              | )          | (21,302 | ) |
| FINANCING ACTIVITIES                                                               |       |                                                |       |   |   |
| Net increase in  interest-bearing deposits                                         |       | 51,160                                              |       | 8,351 |   |
| Net decrease in  noninterest-bearing deposits                                      |       | (1,730                                              | )          | (1,997 | ) |
| Proceeds of  long-term borrowings                                                  |       | —                                              |       | 10,000 |   |
| Repayment of  long-term borrowings                                                 |       | (1,600                                              | )          | (1,400 | ) |
| Net (decrease)  increase in short-term borrowings                                  |       | (35,977                                             | )          | 3,935 |   |
| Dividends paid                                                                     |       | (5,083                                              | )          | (4,583 | ) |
| Issuance of  common stock                                                          |       | 15                                                  |       | — |   |
| Stock options  exercised                                                           |       | —                                              |       | 17 |   |
| Purchase of  treasury stock                                                        |       | (2,303                                              | )          | (115 | ) |
| Net cash  provided by financing activities                                         |       | 4,482                                               |       | 14,208 |   |
| NET (DECREASE) INCREASE  IN CASH AND CASH EQUIVALENTS                              |       | (622                                                | )          | 514 |   |
| CASH AND CASH  EQUIVALENTS, BEGINNING                                              |       | 14,090                                              |       | 12,626 |   |
| CASH AND CASH  EQUIVALENTS, ENDING                                                 |       | $                                                   | 13,468     |   | $ | 13,140 |   |
|                                                                               |       |                                                |       |   |   |
| SUPPLEMENTAL  DISCLOSURES OF CASH FLOW INFORMATION                                 |       |                                                |       |   |   |
|                                                                               |       |                                                |       |   |   |
| Interest paid                                                                      |       | $                                                   | 9,915      |   | $ | 7,139 |   |
| Income taxes paid                                                                  |       | 2,075                                               |       | 2,475 |   |
| Transfer of loans to foreclosed assets                                             |       | 51                                                  |       | 386 |   |

 

See accompanying notes tothe unaudited consolidated financial statements.

6

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# **PENNS WOODS BANCORP, INC. AND SUBSIDIARIES**

**NOTES TO**

**CONSOLIDATEDFINANCIAL STATEMENTS**

**(Unaudited)**

# **Note 1. Basis of Presentation**

# The consolidated financial statements include theaccounts of Penns Woods Bancorp, Inc. (the “Company”) and its wholly-ownedsubsidiaries: Woods Investment Company, Inc., Woods Real Estate DevelopmentCompany, Inc., and Jersey Shore State Bank (the “Bank”) and its wholly-ownedsubsidiary The M Group, Inc. D/B/A The Comprehensive Financial Group (“The MGroup”).  All significant inter-companybalances and transactions have been eliminated in the consolidation.

The interim financialstatements are unaudited but, in the opinion of management, reflect alladjustments necessary for the fair presentation of results for suchperiods.  All of those adjustments are ofa normal, recurring nature.  The resultsof operations for any interim period are not necessarily indicative of resultsfor the full year.  These financialstatements should be read in conjunction with financial statements and notesthereto contained in the Company’s annual report for the year ended December31, 2005.

Theaccounting policies followed in the presentation of interim financial resultsare the same as those followed on an annual basis.  These policies arepresented on pages 38 thru 43 of the Annual Report on Form 10-K for the yearended December 31, 2005.

**Note 2. Recent AccountingPronouncements**

InSeptember 2006, the FASB issued *FAS No. 157, FairValue Measurements*, which provides enhanced guidance for using fairvalue to measure assets and liabilities. The standard applies whenever otherstandards require or permit assets or liabilities to be measured at fair value.The Standard does not expand the use of fair value in any new circumstances.FAS No. 157 is effective for financial statements issued for fiscal yearsbeginning after November 15, 2007 and interim periods within those fiscalyears. Early adoption is permitted.  Theadoption of this standard is not expected to have a material effect on theCompany’s results of operations or financial position.

InSeptember 2006, the FASB issued *FAS No. 158, Employers’Accounting for Defined Benefit Pension and Other Post Retirement Plans*,an amendment of FASB Statements No.  87,88, 106, and 132(R).  FAS No. 158requires that a company recognize the overfunded or underfunded status of itsdefined benefit post retirement plans (other than multiemployer plans) as anasset or liability in its statement of financial position and that it recognizechanges in the funded status in the year in which the changes occur throughother comprehensive income.  FAS No. 158also requires the measurement of defined benefit plan assets and obligations asof the fiscal year end, in addition to footnote disclosures.  FAS No. 158 is effective for fiscal yearsending after December 15, 2006.  TheCompany is currently evaluating the impact the adoption of the standard willhave on the Company’s financial position.

7

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InSeptember 2006, the SEC issued *Staff Accounting BulletinNo. 108 (“SAB 108”), Considering the Effects of Prior YearMisstatements When Quantifying Misstatements in Current Year FinancialStatements*, providing guidance on quantifying financial statementmisstatement and implementation when first applying this guidance.  Under SAB No. 108, companies should evaluatea misstatement based on its impact on the current year income statement, aswell as the cumulative effect of correcting such misstatements that existed inprior years existing in the current year’s ending balance sheet.  SAB 108 is effective for fiscal years endingafter November 15, 2006. The adoption of this bulletin is not expected tohave a material effect on the Company’s results of operations or financialposition.

InSeptember 2006, the FASB reached consensus on the guidance provided by *Emerging Issues Task Force Issue 06-4 (“EITF 06-4”), Accounting forDeferred Compensation and Postretirement Benefit Aspects of EndorsementSplit-Dollar Life Insurance Arrangements*.  The guidance is applicable to endorsementsplit-dollar life insurance arrangements, whereby the employer owns andcontrols the insurance policy, that are associated with a postretirementbenefit.  EITF 06-4 requires that for asplit-dollar life insurance arrangement within the scope of the Issue, anemployer should recognize a liability for future benefits in accordance with FASNo. 106 (if, in substance, a postretirement benefit plan exists) or AccountingPrinciples Board Opinion No. 12 (if the arrangement is, in substance, anindividual deferred compensation contract) based on the substantive agreementwith the employee.  EITF 06-4 iseffective for fiscal years beginning after December 15, 2007.  The Company is currently evaluating theimpact the adoption of the standard will have on the Company’s results ofoperations or financial condition.

InSeptember 2006, the FASB reached consensus on the guidance provided by *Emerging Issues Task Force Issue 06-5(“EITF 06-5”), Accounting forPurchases of Life Insurance—Determining the Amount That Could Be Realized inAccordance with FASB Technical Bulletin No. 85-4, Accounting for Purchases ofLife Insurance*.  EITF 06-5states that a policyholder should consider any additional amounts included inthe contractual terms of the insurance policy other than the cash surrendervalue in determining the amount that could be realized under the insurancecontract.  EITF 06-5 also states that apolicyholder should determine the amount that could be realized under the lifeinsurance contract assuming the surrender of an individual-life byindividual-life policy (or certificate by certificate in a group policy). EITF06-5 is effective for fiscal years beginning after December 15, 2006.  The Company is currently evaluating theimpact the adoption of the standard will have on the Company’s results ofoperations or financial condition.

**Note 3. Per Share Data**

The following table sets forth the composition of theweighted average common shares (denominator) used in the basic and dilutive pershare computation.  There are noconvertible securities which would affect the numerator in calculating basicand diluted earnings per share; therefore, net income as presented on theconsolidated statement of income will be used as the numerator.

8

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| ** **                                                                                                | ** ** | **Three Months Ended September 30,**                                                             | ** ** | **Nine Months Ended September 30,**                                                              | ** ** |
|-----------------------------------------------------------------------------------------------------------|------------|----------------------------------------------------------------------------------------------------------------------|------------|----------------------------------------------------------------------------------------------------------------------|------------|
| ** **                                                                                                | ** ** | **         2006         ** | ** ** | **         2005         ** | ** ** | **         2006         ** | ** ** | **         2005         ** | ** ** |
| Weighted average common  shares outstanding                                                               |       | 4,002,340                                                                                                            |       | 3,986,506                                                                                                            |       | 4,002,220 |   | 3,986,256 |   |
|                                                                                                      |       |                                                                                                                 |       |                                                                                                                 |       |   |   |   |   |
| Average treasury stock  shares                                                                            |       | (75,079                                                                                                              | )          | (13,644                                                                                                              | )          | (59,687 | ) | (12,801 | ) |
|                                                                                                      |       |                                                                                                                 |       |                                                                                                                 |       |   |   |   |   |
| Weighted average common  shares and common stock equivalents used to calculate basic earnings per  share  |       | 3,927,261                                                                                                            |       | 3,972,862                                                                                                            |       | 3,942,533 |   | 3,973,455 |   |
|                                                                                                      |       |                                                                                                                 |       |                                                                                                                 |       |   |   |   |   |
| Additional common stock  equivalents (stock options) used to calculate diluted earnings per share         |       | 479                                                                                                                  |       | 2,094                                                                                                                |       | 483 |   | 2,314 |   |
|                                                                                                      |       |                                                                                                                 |       |                                                                                                                 |       |   |   |   |   |
| Weighted average common shares and common stock equivalents used to  calculate diluted earnings per share |       | 3,927,740                                                                                                            |       | 3,974,956                                                                                                            |       | 3,943,016 |   | 3,975,769 |   |

 

Options to purchase 8,999 shares and 9,728 sharesof common stock at the price of $40.29 were outstanding during the three andnine months ended September 30, 2006 and 2005, respectively, but were notincluded in the computation of diluted earnings per share as they wereanti-dilutive due to the strike price being greater than the market price as ofSeptember 30, 2006 and 2005, respectively.

**Note 4.****  NetPeriodic Benefit Cost-Defined Benefit Plans**

For adetailed disclosure on the Company’s pension and employee benefits plans,please refer to Note 11 of the Company’s Consolidated Financial Statementsincluded in the 2005 Annual Report on Form 10-K.

Thefollowing sets forth the components of the net periodic benefit cost of the domesticnon-contributory defined benefit plan for the three and nine months endedSeptember 30, 2006 and 2005, respectively.
| ** **                          | ** ** | **Three Months Ended** | ** ** | **Nine Months Ended** | ** ** |
|-------------------------------------|------------|----------------------------------|------------|---------------------------------|------------|
| ** **                          | ** ** | **September 30,**           | ** ** | **September 30,**          | ** ** |
| **(In Thousands)**             | ** ** | **2006**                         | ** ** | **2005**                        | ** ** | **2006** | ** ** | **2005** | ** ** |
|                                |       |                             |       |                            |       |   |   |   |   |
| Service cost                        |       | $                                | 117        |                            | $          | 125 |   | $ | 350 |   | $ | 379 |   |
| Interest cost                       |       | 108                              |       | 110                             |       | 325 |   | 335 |   |
| Expected return on plan  assets     |       | (121                             | )          | (112                            | )          | (364 | ) | (302 | ) |
| Amortization of  transition         |       | (1                               | )          | (1                              | )          | (2 | ) | (2 | ) |
| Amortization of prior  service cost |       | 6                                |       | 6                               |       | 19 |   | 19 |   |
| Amortization of net loss            |       | 6                                |       | 16                              |       | 17 |   | 49 |   |
| Net periodic cost                   |       | $                                | 115        |                            | $          | 144 |   | $ | 345 |   | $ | 478 |   |

 

9

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**Employer Contributions**

The Companypreviously disclosed in its consolidated financial statements, included in the2005 Annual Report on Form 10-K, that it expected to contribute $500,000 to itsdefined benefit plan in 2006. As of September 30, 2006, a contribution in theamount of $550,000 was made for the 2005 plan year with no additionalcontributions anticipated.

**Note5.  Off Balance Sheet Risk**

The Company is a party to financial instrumentswith off-balance sheet risk in the normal course of business to meet thefinancing needs of its customers. These financial instruments are primarilycomprised of commitments to extend credit and standby letters of credit. Theseinstruments involve, to varying degrees, elements of credit, interest rate, orliquidity risk in excess of the amount recognized in the consolidated balancesheet. The contract amounts of these instruments express the extent ofinvolvement the Company has in particular classes of financial instruments.

The Company’s exposure to credit loss fromnonperformance by the other party to the financial instruments for commitmentsto extend credit and standby letters of credit is represented by thecontractual amount of these instruments. The Company uses the same creditpolicies in making commitments and conditional obligations as it does foron-balance sheet instruments. The Company may require collateral or othersecurity to support financial instruments with off-balance sheet credit risk.

Outstanding financial instruments with offbalance sheet risk are as follows:
|                               | ** ** | **September 30,** | ** ** | **December 31,** | ** ** |
|-------------------------------|------------|------------------------|------------|-----------------------|------------|
| **(In Thousands)**       | ** ** | **2006**               | ** ** | **2005**              | ** ** |
| Commitments to  extend credit |       | $                      | 70,469     |                  | $          | 72,583 |   |
| Standby letters of  credit    |       | 1,041                  |       | 2,193                 |       |
|                               |            |                        |            |                       |            |  |  |

 

# **Note 6. Reclassification of Comparative Amounts**

Certaincomparative amounts for the prior periods have been reclassified to conform tocurrent period presentations. Such reclassifications had no effect on netincome or shareholders’ equity.

# **Note 7.  Stock Split**

During the fourth quarter of 2005 the Company initiated a 6 for 5 stocksplit. Previously reported share and per share amounts have been adjusted toreflect the split.

# **Note 8.  Employee Stock Purchase Plan**

Effective April 26, 2006 the Company implemented the Penns WoodsBancorp, Inc. 2006 Employee Stock Purchase Plan (“Plan”). The Plan is intendedto encourage employee participation in the ownership and economic progress ofthe Company. The Plan allows for up

10

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to 1,000,000 shares to be purchased by employees. The purchase price ofthe shares is 95% of market value with an employee eligible to purchase up tothe lesser of 15% of base compensation or $12,000 in market value annually.During the three and nine months ended September 30, 2006 there were 421 sharesissued under the plan.

**CAUTIONARYSTATEMENT FOR PURPOSES OF THE PRIVATE SECURITIES LITIGATION REFORM ACT OF 1995**

ThisReport contains certain “forward-looking statements” including statementsconcerning plans, objectives, future events or performance and assumptions andother statements which are other than statements of historical fact. TheCompany wishes to caution readers that the following important factors, amongothers, may have affected and could in the future affect the Company’s actualresults and could cause the Company’s actual results for subsequent periods todiffer materially from those expressed in any forward-looking statement made byor on behalf of the Company herein: (i) the effect of changes in laws andregulations, including federal and state banking laws and regulations, whichthe Company must comply, and the associated costs of compliance with such lawsand regulations either currently or in the future as applicable; (ii) theeffect of changes in accounting policies and practices, as may be adopted bythe regulatory agencies as well as by the Financial Accounting Standards Board,or of changes in the Company’s organization, compensation and benefit plans;(iii) the effect on the Company’s competitive position within its market areaof the increasing consolidation within the banking and financial servicesindustries, including the increased competition from larger regional andout-of-state banking organizations as well as non-bank providers of variousfinancial services; (iv) the effect of changes in interest rates; and (v) theeffect of changes in the business cycle and downturns in the local, regional ornational economies.

11

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**Item 2.   Management’s Discussion and Analysis ofFinancial Condition and Results of Operation**

# **EARNINGS SUMMARY**

**Comparisonof the Three and Nine Months Ended September 30, 2006 and 2005**

**SummaryResults**

Net income for thethree months ended September 30, 2006 was $2,464,000 compared to $2,948,000 forthe same period of 2005. Basic and diluted earnings per share for the threemonths ended September 30, 2006 were $0.63 as compared to $0.74 for the threemonths ended September 30, 2005. Return on average assets and return on averageequity were 1.70% and 13.41% for the three months ended September 30, 2006 ascompared to 2.12% and 16.54% for the corresponding period of 2005. Net incomefrom core operations for the three months ended September 30, 2006 and 2005,excluding after-tax net securities gains of $370,000 and $367,000,respectively, were $2,094,000 and $2,581,000.

The nine monthsended September 30, 2006 generated net income of $7,353,000 compared to$8,423,000 for the same period of 2005. Earnings per share, basic and diluted,for the nine months ended September 30, 2006 were $1.87 as compared to $2.12for the comparable period of 2005. Return on average assets and return onaverage equity were 1.71% and 13.20% for the nine months ended September 30,2006 as compared to 2.05% and 14.94% for the corresponding period of 2005. Netincome from core operations for the nine months ended September 30, 2006,excluding after-tax securities gains of $914,000, declined to $6,439,000 from$7,199,000 for the nine months ended September 30, 2005. (Management uses thenon-GAAP measure of net income from core operations in its analysis of theCompany’s performance. This measure, as used by the Company, adjusts net incomeby significant gains or losses that are unusual in nature. Because certain ofthese items and their impact on the Company’s performance are difficult topredict, management believes the presentation of financial measures excludingthe impact of such items provides useful supplemental information in evaluatingthe operating results of the Company’s core businesses. For purposes of thisQuarterly Report on Form 10-Q, net income from core operations meansnet income adjusted to exclude after-tax net securities gains. Thesedisclosures should not be viewed as a substitute for net income determined inaccordance with GAAP, nor are they necessarily comparable to non-GAAPperformance measures that may be presented by other companies.)

**InterestIncome**

Interest income for the three months ended September 30, 2006 increased$731,000 to $8,547,000 as compared to $7,816,000 for the same period of 2005.The increase in total interest income was primarily the result of growth inaverage loans of $24,037,000 for the three months ended September 30, 2006 ascompared to 2005. The average loan growth and a 38 basis point (“bp”) increasein loan portfolio yields accounted for $753,000 of the total interest incomegrowth. Over this time frame the average balance of investment securitiesdecreased $14,654,000. The decrease in the average investment portfolio wasoffset by an increase of 43

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bp in the investment portfolio yield which resulted in total interestincome from the investment portfolio declining $28,000 to $2,185,000 for thethree months ended September 30, 2006, while interest income on interestbearing deposits increased $6,000 for the same period. On a taxable equivalentbasis the interest income from the investment portfolio remained constant at$2,702,000. The increase in dividends received is the result of an increase inthe level of dividends from the Federal Home Loan Bank of Pittsburgh coupledwith an emphasis on purchasing stocks consistently having an above averagedividend yield.

During the nine months ended September 30, 2006, interest income was$24,916,000, an increase of $2,011,000 over the same period in 2005. Thereasons for the 8.8% growth in interest income for the nine month period areidentical to those for the three month period ending September 30, 2006discussed above. The growth in average loans of $21,754,000 coupled with a 34bp increase in the loan portfolio yield resulted in an increase of $1,909,000in loan interest and fee income. Average investment securities decreasedslightly to $184,820,000 resulting in interest income on the investmentportfolio increasing $118,000 when compared to September 30, 2005 due to anincrease of 44 bp in the investment portfolio yield, while interest income oninterest bearing deposits decreased $16,000 for the same period. The assetallocation between loans and the investment portfolio resulted in taxableequivalent interest income increasing $2,462,000 for the nine months endedSeptember 30, 2006 as compared to the same period of 2005.

Interest income composition for the three and nine months endedSeptember 30, 2006 and 2005 were as follows:
| ** **                         | ** ** | **For The Three Months Ended** | ** ** |
|------------------------------------|------------|----------------------------------------------------|------------|
| ** **                         | ** ** | **September 30, 2006**                   | ** ** | **September 30, 2005** | ** ** | **Change** | ** ** |
| **(In Thousands)**            | ** ** | **Amount**                                         | ** ** | **% Total** | ** ** | **Amount** | ** ** | **% Total** | ** ** | **Amount** | ** ** | **%** | ** ** |
| Loans including  fees              |       | $                                                  | 6,355      |   | 74.4 | % | $ | 5,602 |   | 71.6 | % | $ | 753 |   | 13.4 | % |
| Investment  securities:            |       |                                               |       |   |   |   |   |   |   |   |   |   |   |
| Taxable                            |       | 874                                                |       | 10.2 |   | 966 |   | 12.4 |   | (92 | ) | (9.5 | ) |
| Tax-exempt                         |       | 1,004                                              |       | 11.7 |   | 969 |   | 12.4 |   | 35 |   | 3.6 |   |
| Dividend and other interest income |       | 314                                                |       | 3.7 |   | 279 |   | 3.6 |   | 35 |   | 12.5 |   |
| Total interest income              |       | $                                                  | 8,547      |   | 100.0 | % | $ | 7,816 |   | 100.0 | % | $ | 731 |   | 9.4 | % |

 
| ** **                         | ** ** | **For The Nine Months Ended** | ** ** |
|------------------------------------|------------|---------------------------------------------------|------------|
| ** **                         | ** ** | **September 30, 2006**                  | ** ** | **September 30, 2005** | ** ** | **Change** | ** ** |
| **(In Thousands)**            | ** ** | **Amount**                                        | ** ** | **% Total** | ** ** | **Amount** | ** ** | **% Total** | ** ** | **Amount** | ** ** | **%** | ** ** |
| Loans including  fees              |       | $                                                 | 18,250     |   | 73.3 | % | $ | 16,341 |   | 71.4 | % | $ | 1,909 |   | 11.7 | % |
| Investment  securities:            |       |                                              |       |   |   |   |   |   |   |   |   |   |   |
| Taxable                            |       | 2,691                                             |       | 10.8 |   | 3,420 |   | 14.9 |   | (729 | ) | (21.3 | ) |
| Tax-exempt                         |       | 2,993                                             |       | 12.0 |   | 2,246 |   | 9.8 |   | 747 |   | 33.3 |   |
| Dividend and other interest income |       | 982                                               |       | 3.9 |   | 898 |   | 3.9 |   | 84 |   | 9.4 |   |
| Total interest  income             |       | $                                                 | 24,916     |   | 100.0 | % | $ | 22,905 |   | 100.0 | % | $ | 2,011 |   | 8.8 | % |

 

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**Interest Expense**

Interest expense for the three months ended September 30, 2006increased $1,006,000 to $3,707,000 as compared to $2,701,000 for the sameperiod of 2005. The increased expense associated with deposits is primarily theresult of rate increases for time deposits, which are comprised of variouscertificates of deposit (“CD”) accounts, from the three months ended September30, 2005 to the corresponding period of 2006. Factors that led to the rateincreases include, but are not limited to, several period prime rate increases,competitive market pricing pressure, and attracting new deposit customers whileretaining existing accounts. The increase in CD interest rates has exceeded theincrease for other deposit accounts. This has led to a shift of a portion ofthe money market and savings deposit portfolios into higher yielding CDs.

Short-term borrowing costs increased as rates paid increased 153 bp asa direct result of the prime rate increases over the past year and a minimalincrease in the average balance of $186,000. Long-term FHLB borrowing expensedecreased minimally due to the maturity of $1,600,000 earlier in 2006.

Interest expense for the nine months ended September 30, 2006 increased$2,910,000 to $10,317,000 from $7,407,000 for the comparable period of 2005.Interest on deposits accounted for $2,101,000 of the increase due to thereasons noted in the above three month analysis. Borrowing costs increased dueto the rate increases over the past year and increased average borrowings thatwere used to fund the growth in average earning assets.

Interestexpense composition for the three and nine months ended September 30, 2006 and2005 were as follows:
| ** **              | ** ** | **For The Three Months Ended** | ** ** |
|-------------------------|------------|----------------------------------------------------|------------|
| ** **              | ** ** | **September 30, 2006**                   | ** ** | **September 30, 2005** | ** ** | **Change** | ** ** |
| **(In Thousands)** | ** ** | **Amount**                                         | ** ** | **% Total** | ** ** | **Amount** | ** ** | **% Total** | ** ** | **Amount** | ** ** | **%** | ** ** |
| Deposits                |       | $                                                  | 2,447      |   | 66.0 | % | $ | 1,537 |   | 56.9 | % | $ | 910 |   | 59.2 | % |
| Short-term  borrowings  |       | 306                                                |       | 8.3 |   | 199 |   | 7.4 |   | 107 |   | 53.8 |   |
| Long-term  borrowings   |       | 954                                                |       | 25.7 |   | 965 |   | 35.7 |   | (11 | ) | (1.1 | ) |
| Total interest expense  |       | $                                                  | 3,707      |   | 100.0 | % | $ | 2,701 |   | 100.0 | % | $ | 1,006 |   | 37.2 | % |

 
| ** **              | ** ** | **For The Nine Months Ended** | ** ** |
|-------------------------|------------|---------------------------------------------------|------------|
| ** **              | ** ** | **September 30, 2006**                  | ** ** | **September 30, 2005** | ** ** | **Change** | ** ** |
| **(In Thousands)** | ** ** | **Amount**                                        | ** ** | **% Total** | ** ** | **Amount** | ** ** | **% Total** | ** ** | **Amount** | ** ** | **%** | ** ** |
| Deposits                |       | $                                                 | 6,252      |   | 60.6 | % | $ | 4,151 |   | 56.0 | % | $ | 2,101 |   | 50.6 | % |
| Short-term  borrowings  |       | 1,221                                             |       | 11.8 |   | 545 |   | 7.4 |   | 676 |   | 124.0 |   |
| Long-term  borrowings   |       | 2,844                                             |       | 27.6 |   | 2,711 |   | 36.6 |   | 133 |   | 4.9 |   |
| Total interest expense  |       | $                                                 | 10,317     |   | 100.0 | % | $ | 7,407 |   | 100.0 | % | $ | 2,910 |   | 39.3 | % |

 

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**Net Interest Margin**

The net interest margin (“NIM”) for the three months ended September30, 2006 was 4.00% as compared to 4.27% for the corresponding period of 2005.The decrease in the NIM was the result of the yield on earning assetsincreasing 44 bp to 6.74% for the three months ended September 30, 2006, ascompared to 2005; however, interest bearing liabilities increased 81 bp overthe same period. The increase in the yield on earning assets is attributable toa change in the mix of earning assets as previously discussed in the InterestIncome section of this Earnings Summary. The average taxable investmentsecurities portfolio declined by $15,337,000, as the cash flow from theportfolio was utilized to fund the growth in loans. The average loan growth of$24,037,000 was predominately comprised of residential and commercial realestate loans. The yield on total loans increased to 7.13% from 6.75% due to theimpact of the Federal Open Market Committee rate increases enacted over thepast year offset by competitive pressure. The investment portfolio yieldincreased to 5.97% from 5.54% primarily from the previously noted shift in theportfolio to a portfolio weighting of tax-exempt investments. The averageinterest rate paid on deposit accounts increased to 3.04% as compared to 2.04%for the 2005 period. This increase was driven by growth in average timedeposits of $35,623,000 and an increase in the rate paid on time deposits of115 bp. A portion of the increase in deposit volume and the average interestyield paid is due to several CD promotions during the past year to attract newcustomers while retaining existing customers. The promotions were designed togather deposits that would have maturities of two years or less. In addition,the promotions served as a catalyst to cross sell other deposit products and toimplement management’s strategy regarding the CD portfolio allocation amongvarious maturities and therefore, reducing the concentration of time depositmaturities within any single month.

Short-term borrowings realized an increase of 153 bp in interest ratescharged for the three months ended September 30, 2006. The prime rate increased150 bp to 8.25% at September 30, 2006 from 6.75% at September 30, 2005, asfurther evidence of the correlation between the Company’s primary source ofborrowed funds, the FHLB, and the primary lending rate indicator used on anational basis.

The NIM for the nine months ended September 30, 2006 was 4.06% ascompared to 4.32% for the corresponding period of 2005. The decrease in the NIMwas the result of the before mentioned growth and change in mix of the earningsassets offset by increased rates paid on interest bearing liabilities andgrowth in total borrowings of $13,265,000.

Following is a schedule of average balances and associated yields forthe three and nine month periods ended September 30, 2006 and 2005:

15

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| ** **                                       | ** ** | **AVERAGE BALANCES AND INTEREST RATES** | ** ** |
|--------------------------------------------------|------------|-------------------------------------------------------------|------------|
| ** **                                       | ** ** | **Three Months Ended**                            | ** ** | **Three Months Ended** | ** ** |
| ** **                                       | ** ** | **September 30, 2006**                            | ** ** | **September 30, 2005** | ** ** |
| **(In Thousands)**                          | ** ** | **Average Balance**                                    | ** ** | **Interest** | ** ** | **Average Rate** | ** ** | **Average Balance** | ** ** | **Interest** | ** ** | **Average Rate** | ** ** |
| Tax-exempt loans                                 |       | $                                                           | 8,275      |   | $ | 127 |   | 6.10 | % | $ | 7,959 |   | $ | 126 |   | 6.28 | % |
| All other loans                                  |       | 347,673                                                     |       | 6,271 |   | 7.16 | % | 323,952 |   | 5,519 |   | 6.76 | % |
| Total loans                                      |       | 355,948                                                     |       | 6,398 |   | 7.13 | % | 331,911 |   | 5,645 |   | 6.75 | % |
|                                             |       |                                                        |       |   |   |   |   |   |   |   |   |   |   |
| Taxable  investment securities                   |       | 89,849                                                      |       | 1,181 |   | 5.26 | % | 105,186 |   | 1,244 |   | 4.73 | % |
| Tax-exempt  investment securities                |       | 91,234                                                      |       | 1,521 |   | 6.67 | % | 90,551 |   | 1,468 |   | 6.48 | % |
| Total securities                                 |       | 181,083                                                     |       | 2,702 |   | 5.97 | % | 195,737 |   | 2,712 |   | 5.54 | % |
|                                             |       |                                                        |       |   |   |   |   |   |   |   |   |   |   |
| Interest bearing  deposits                       |       | 435                                                         |       | 7 |   | 6.38 | % | 183 |   | 1 |   | 2.17 | % |
|                                             |       |                                                        |       |   |   |   |   |   |   |   |   |   |   |
| Total  interest-earning assets                   |       | 537,466                                                     |       | 9,107 |   | 6.74 | % | 527,831 |   | 8,358 |   | 6.30 | % |
|                                             |       |                                                        |       |   |   |   |   |   |   |   |   |   |   |
| Other assets                                     |       | 42,042                                                      |       |   |   |   |   | 28,758 |   |   |   |   |   |
|                                             |       |                                                        |       |   |   |   |   |   |   |   |   |   |   |
| Total assets                                     |       | $                                                           | 579,508    |   |   |   |   |   | $ | 556,589 |   |   |   |   |   |
|                                             |       |                                                        |       |   |   |   |   |   |   |   |   |   |   |
| Savings                                          |       | $                                                           | 63,081     |   | 142 |   | 0.89 | % | $ | 69,366 |   | 139 |   | 0.80 | % |
| Super Now  deposits                              |       | 47,071                                                      |       | 170 |   | 1.43 | % | 50,001 |   | 106 |   | 0.84 | % |
| Money market  deposits                           |       | 23,300                                                      |       | 131 |   | 2.23 | % | 28,427 |   | 109 |   | 1.52 | % |
| Time deposits                                    |       | 186,187                                                     |       | 2,004 |   | 4.27 | % | 150,564 |   | 1,183 |   | 3.12 | % |
| Total deposits                                   |       | 319,639                                                     |       | 2,447 |   | 3.04 | % | 298,358 |   | 1,537 |   | 2.04 | % |
|                                             |       |                                                        |       |   |   |   |   |   |   |   |   |   |   |
| Short-term  borrowings                           |       | 27,255                                                      |       | 306 |   | 4.45 | % | 27,069 |   | 199 |   | 2.92 | % |
| Long-term  borrowings                            |       | 82,878                                                      |       | 954 |   | 4.57 | % | 84,478 |   | 965 |   | 4.53 | % |
| Total borrowings                                 |       | 110,133                                                     |       | 1,260 |   | 4.54 | % | 111,547 |   | 1,164 |   | 4.14 | % |
|                                             |       |                                                        |       |   |   |   |   |   |   |   |   |   |   |
| Total  interest-bearing liabilities              |       | 429,772                                                     |       | 3,707 |   | 3.42 | % | 409,905 |   | 2,701 |   | 2.61 | % |
|                                             |       |                                                        |       |   |   |   |   |   |   |   |   |   |   |
| Demand deposits                                  |       | 69,660                                                      |       |   |   |   |   | 70,134 |   |   |   |   |   |
| Other  liabilities                               |       | 6,596                                                       |       |   |   |   |   | 5,244 |   |   |   |   |   |
| Shareholders’  equity                       |       | 73,480                                                      |       |   |   |   |   | 71,306 |   |   |   |   |   |
| Total  liabilities and shareholders’ equity |       | $                                                           | 579,508    |   |   |   |   |   | $ | 556,589 |   |   |   |   |   |
|                                             |       |                                                        |       |   |   |   |   |   |   |   |   |   |   |
| Interest rate  spread                            |       |                                                        |       |   |   | 3.32 | % |   |   |   |   | 3.69 | % |
| Net interest  income/margin                      |       |                                                        |       | $ | 5,400 |   | 4.00 | % |   |   | $ | 5,657 |   | 4.27 | % |

 

1.               Information on thistable has been calculated using average daily balance sheets to obtain averagebalances.

2.               Nonaccrual loanshave been included with loans for the purpose of analyzing net interestearnings.

3.               Incomeand rates on a fully taxable equivalent basis include an adjustment for thedifference between annual income from tax-exempt obligations and the taxableequivalent of such income at the standard 34% tax rate.

16

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| ** **                          | ** ** | **AVERAGE BALANCES AND INTEREST RATES**   | ** ** |
|-------------------------------------|------------|---------------------------------------------------------------|------------|
| ** **                          | ** ** | **Nine Months Ended  September 30, 2006** | ** ** | **Nine Months Ended  September 30, 2005** | ** ** |
| **(In Thousands)**             | ** ** | **Average Balance**                                      | ** ** | **Interest** | ** ** | **Average Rate** | ** ** | **Average Balance** | ** ** | **Interest** | ** ** | **Average Rate** | ** ** |
|                                |       |                                                          |       |   |   |   |   |   |   |   |   |   |   |
| Tax-exempt loans                    |       | $                                                             | 8,155      |   | $ | 377 |   | 6.18 | % | $ | 4,179 |   | $ | 183 |   | 5.85 | % |
| All other loans                     |       | 341,250                                                       |       | 18,001 |   | 7.05 | % | 323,472 |   | 16,220 |   | 6.70 | % |
| Total loans                         |       | 349,405                                                       |       | 18,378 |   | 7.03 | % | 327,651 |   | 16,403 |   | 6.69 | % |
|                                |       |                                                          |       |   |   |   |   |   |   |   |   |   |   |
| Taxable securities                  |       | 93,848                                                        |       | 3,664 |   | 5.21 | % | 120,425 |   | 4,293 |   | 4.75 | % |
| Tax-exempt securities               |       | 90,972                                                        |       | 4,535 |   | 6.65 | % | 67,226 |   | 3,403 |   | 6.75 | % |
| Total securities                    |       | 184,820                                                       |       | 8,199 |   | 5.91 | % | 187,651 |   | 7,696 |   | 5.47 | % |
|                                |       |                                                          |       |   |   |   |   |   |   |   |   |   |   |
| Interest bearing  deposits          |       | 161                                                           |       | 9 |   | 7.47 | % | 1,117 |   | 25 |   | 2.99 | % |
|                                |       |                                                          |       |   |   |   |   |   |   |   |   |   |   |
| Total interest-earning  assets      |       | 534,386                                                       |       | 26,586 |   | 6.65 | % | 516,419 |   | 24,124 |   | 6.24 | % |
|                                |       |                                                          |       |   |   |   |   |   |   |   |   |   |   |
| Other assets                        |       | 39,747                                                        |       |   |   |   |   | 32,244 |   |   |   |   |   |
|                                |       |                                                          |       |   |   |   |   |   |   |   |   |   |   |
| Total assets                        |       | $                                                             | 574,133    |   |   |   |   |   | $ | 548,663 |   |   |   |   |   |
|                                |       |                                                          |       |   |   |   |   |   |   |   |   |   |   |
| Savings                             |       | $                                                             | 63,150     |   | 398 |   | 0.84 | % | $ | 69,255 |   | 411 |   | 0.79 | % |
| Super Now deposits                  |       | 47,835                                                        |       | 488 |   | 1.36 | % | 51,680 |   | 324 |   | 0.84 | % |
| Money market deposits               |       | 24,190                                                        |       | 367 |   | 2.03 | % | 30,398 |   | 306 |   | 1.35 | % |
| Time deposits                       |       | 169,119                                                       |       | 4,999 |   | 3.95 | % | 140,772 |   | 3,110 |   | 2.95 | % |
| Total Deposits                      |       | 304,294                                                       |       | 6,252 |   | 2.75 | % | 292,105 |   | 4,151 |   | 1.90 | % |
|                                |       |                                                          |       |   |   |   |   |   |   |   |   |   |   |
| Short-term borrowings               |       | 37,761                                                        |       | 1,221 |   | 4.32 | % | 28,268 |   | 545 |   | 2.58 | % |
| Other borrowings                    |       | 83,359                                                        |       | 2,844 |   | 4.56 | % | 79,587 |   | 2,711 |   | 4.55 | % |
| Total borrowings                    |       | 121,120                                                       |       | 4,065 |   | 4.49 | % | 107,855 |   | 3,256 |   | 4.04 | % |
|                                |       |                                                          |       |   |   |   |   |   |   |   |   |   |   |
| Total interest-bearing  liabilities |       | 425,414                                                       |       | 10,317 |   | 3.24 | % | 399,960 |   | 7,407 |   | 2.48 | % |
|                                |       |                                                          |       |   |   |   |   |   |   |   |   |   |   |
| Demand deposits                     |       | 69,219                                                        |       |   |   |   |   | 68,182 |   |   |   |   |   |
| Other liabilities                   |       | 5,245                                                         |       |   |   |   |   | 5,353 |   |   |   |   |   |
| Shareholders’ equity           |       | 74,255                                                        |       |   |   |   |   | 75,168 |   |   |   |   |   |
|                                |       |                                                          |       |   |   |   |   |   |   |   |   |   |   |
|                                |       | $                                                             | 574,133    |   |   |   |   |   | $ | 548,663 |   |   |   |   |   |
| Interest rate spread                |       |                                                          |       |   |   | 3.41 | % |   |   |   |   | 3.76 | % |
| Net interest income/margin          |       |                                                          |       | $ | 16,269 |   | 4.06 | % |   |   | $ | 16,717 |   | 4.32 | % |

 

1.               Information on thistable has been calculated using average daily balance sheets to obtain averagebalances.

2.               Nonaccrual loanshave been included with loans for the purpose of analyzing net interestearnings.

3.               Incomeand rates on a fully taxable equivalent basis include an adjustment for thedifference between annual income from tax-exempt obligations and the taxableequivalent of such income at the standard 34% tax rate.

17

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The followingtable presents the adjustment to convert net interest income to net interestincome on a fully taxable equivalent basis for the three and nine month periodsended September 30, 2006 and 2005.
| ** **                                      | ** ** | **For the Three Months Ended  September 30,** | ** ** | **For the Nine Months Ended  September 30,** | ** ** |
|-------------------------------------------------|------------|------------------------------------------------------------------------|------------|-----------------------------------------------------------------------|------------|
| **(In Thousands)**                         | ** ** | **2006**                                                               | ** ** | **2005**                                                              | ** ** | **2006** | ** ** | **2005** | ** ** |
|                                            |       |                                                                   |       |                                                                  |       |   |   |   |   |
| Total interest  income                          |       | $                                                                      | 8,547      |                                                                  | $          | 7,816 |   | $ | 24,916 |   | $ | 22,905 |   |
| Total interest  expense                         |       | 3,707                                                                  |       | 2,701                                                                 |       | 10,317 |   | 7,407 |   |
|                                            |       |                                                                   |       |                                                                  |       |   |   |   |   |
| Net interest  income                            |       | 4,840                                                                  |       | 5,115                                                                 |       | 14,599 |   | 15,498 |   |
| Tax equivalent  adjustment                      |       | 560                                                                    |       | 542                                                                   |       | 1,670 |   | 1,219 |   |
|                                            |       |                                                                   |       |                                                                  |       |   |   |   |   |
| Net interest income  (fully taxable equivalent) |       | $                                                                      | 5,400      |                                                                  | $          | 5,657 |   | $ | 16,269 |   | $ | 16,717 |   |

 

# Thefollowing table sets forth the respective impact that both volume and ratechanges have had on net interest income on a fully taxable equivalent basis forthe three and nine month periods ended September 30, 2006 and 2005:

| ** **                         | ** ** | **Three Months Ended September 30,**          | ** ** | **Nine Months Ended September 30,**           | ** ** |
|------------------------------------|------------|-------------------------------------------------------------------|------------|-------------------------------------------------------------------|------------|
| ** **                         | ** ** | **2006 vs 2005  Increase (Decrease)  Due to** | ** ** | **2006 vs 2005  Increase (Decrease)  Due to** | ** ** |
| **(In Thousands)**            | ** ** | **Volume**                                                        | ** ** | **Rate**                                                          | ** ** | **Net** | ** ** | **Volume** | ** ** | **Rate** | ** ** | **Net** | ** ** |
| Interest income:                   |       |                                                              |       |                                                              |       |   |   |   |   |   |   |   |   |
| Loans,  tax-exempt                 |       | $                                                                 | 4          |                                                              | $          | (3 | ) | $ | 1 |   | $ | 183 |   | $ | 11 |   | $ | 194 |   |
| Loans                              |       | 417                                                               |       | 335                                                               |       | 752 |   | 914 |   | 867 |   | 1,781 |   |
| Taxable  investment securities     |       | (240                                                              | )          | 177                                                               |       | (63 | ) | (1,083 | ) | 454 |   | (629 | ) |
| Tax-exempt  investment securities  |       | 11                                                                |       | 42                                                                |       | 53 |   | 1,183 |   | (51 | ) | 1,132 |   |
| Interest bearing  deposits         |       | 2                                                                 |       | 4                                                                 |       | 6 |   | (63 | ) | 47 |   | (16 | ) |
| Total interest-earning assets      |       | 194                                                               |       | 555                                                               |       | 749 |   | 1,134 |   | 1,328 |   | 2,462 |   |
|                               |       |                                                              |       |                                                              |       |   |   |   |   |   |   |   |   |
| Interest  expenses:                |       |                                                              |       |                                                              |       |   |   |   |   |   |   |   |   |
| Savings deposits                   |       | (5                                                                | )          | 8                                                                 |       | 3 |   | (42 | ) | 29 |   | (13 | ) |
| Super Now  deposits                |       | (6                                                                | )          | 70                                                                |       | 64 |   | (22 | ) | 186 |   | 164 |   |
| Money market  deposits             |       | (12                                                               | )          | 34                                                                |       | 22 |   | (30 | ) | 91 |   | 61 |   |
| Time deposits                      |       | 315                                                               |       | 506                                                               |       | 821 |   | 696 |   | 1,193 |   | 1,889 |   |
| Short-term  borrowings             |       | 1                                                                 |       | 106                                                               |       | 107 |   | 217 |   | 459 |   | 676 |   |
| Long-term  borrowings              |       | (18                                                               | )          | 7                                                                 |       | (11 | ) | 128 |   | 5 |   | 133 |   |
| Total interest-bearing liabilities |       | 275                                                               |       | 731                                                               |       | 1,006 |   | 947 |   | 1,963 |   | 2,910 |   |
| Change in net interest  income     |       | $                                                                 | (81        | )                                                                 | $          | (176 | ) | $ | (257 | ) | $ | 187 |   | $ | (635 | ) | $ | (448 | ) |

 

# **Provision for Loan Losses**

The provision forloan losses is based upon management’s quarterly review of the loanportfolio.  The purpose of the review isto assess loan quality, identify impaired loans, analyze delinquencies,ascertain loan growth, evaluate potential charge-offs and recoveries, andassess general economic conditions in the markets served.  An external independent loan review is also

18

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performed annually for the Bank.  Management remains committed to an aggressiveprogram of problem loan identification and resolution.

The allowance iscalculated by applying loss factors to outstanding loans by type, excludingloans for which a specific allowance has been determined.  Loss factors are based on management’sconsideration of the nature of the portfolio segments, changes in mix andvolume of the loan portfolio, and historical loan loss experience.  In addition, management considers industrystandards and trends with respect to non-performing loans and its knowledge andexperience with specific lending segments.

Although managementbelieves it uses the best information available to make such determinations andthat the allowance for loan losses is adequate at September 30, 2006, futureadjustments could be necessary if circumstances or economic conditions differsubstantially from the assumptions used in making the initialdeterminations.  A downturn in the localeconomy, employment, and delays in receiving financial information fromborrowers could result in increased levels of nonperforming assets andcharge-offs, increased loan loss provisions, and reductions in income.  Additionally, as an integral part of theexamination process, bank regulatory agencies periodically review the Bank’sloan loss allowance.  The bankingagencies could require the recognition of additions to the loan loss allowancebased on their judgment of information available to them at the time of theirexamination.

While determining theappropriate allowance level management has attributed the allowance for loanlosses to various portfolio segments; however, the allowance is available forthe entire portfolio as needed.

The allowance for loanlosses increased from $3,679,000 at December 31, 2005 to $4,045,000 atSeptember 30, 2006.  At September 30,2006, the allowance for loan losses was 1.13% of total loans compared to 1.09%of total loans at December 31, 2005. Management’s conclusion is that the allowance for loan losses isadequate to provide forpossible losses inherent in the loan portfolio as of the balance sheet date.

The provision for loanlosses totaled $89,000 and $485,000 for the three and nine months endedSeptember 30, 2006, respectively, as compared to $180,000 and $540,000 for thesame periods in 2005.  The decrease wasthe result of non-performing loans to total loans decreasing to 0.22% atSeptember 30, 2006 from 0.32% at September 30, 2005.  The decline in the ratio is the result ofgrowth in the loan portfolio outpacing an overall increase of $169,000 innon-performing loans (non-accrual and 90 days past due) from December 31, 2005to $771,000 at September 30, 2006.

Based upon this analysis,as well as the others noted above, senior management has concluded that theallowance for loan losses remains at a level adequate to provide for probablelosses inherent in its loan portfolio.

19

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**Non-interestIncome**

Totalnon-interest income for the three months ended September 30, 2006 compared tothe same period in 2005 decreased $160,000 to $2,387,000.  Excluding net security gains and additionalbank-owned life insurance (“BOLI”) income of $196,000 related to a deathbenefit during 2005, non-interest income would have increased $31,000.  Deposit service charges declined $16,000 asoverdraft protection fees declined due primarily to the loss of a singlecommercial account.  Other incomeincreased due primarily to revenue generated from increased debit cardtransactions and title insurance fees.

Insurancecommissions decreased slightly due to a reduction in the overall commissionfrom the underwriter that The M Group receives on each insurance contractwritten.  Management of The M Groupcontinues to pursue new and build upon current relationships.  However, the sales cycle for insurance andinvestment products can take typically from six months to one year or more tocomplete. The sales call program continues to expand to other financialinstitutions, which results in additional revenue for The M Group.

Totalnon-interest income for the nine months ended September 30, 2006 compared tothe same period in 2005 decreased $389,000. Excluding net security gains and additional BOLI income of $196,000related to a death benefit during 2005, non-interest income would haveincreased $276,000.  The implementationof Bounce Protection, overdraft protection, during May 2005, resulted in anincrease of $170,000 in service charge fees. The increase in other income is the result of the items noted above forthe three month period discussion.

Non-interestincome composition for the three and nine months ended September 30, 2006 and2005 were as follows:

20

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| ** **                 | ** ** | **For The Three Months Ended** | ** ** |
|----------------------------|------------|----------------------------------------------------|------------|
| ** **                 | ** ** | **September 30, 2006**                   | ** ** | **September 30, 2005** | ** ** | **Change** | ** ** |
| **(In Thousands)**    | ** ** | **Amount**                                         | ** ** | **% Total** | ** ** | **Amount** | ** ** | **% Total** | ** ** | **Amount** | ** ** | **%** | ** ** |
| Deposit service  charges   |       | $                                                  | 596        |   | 25.0 | % | $ | 612 |   | 24.0 | % | $ | (16 | ) | (2.6 | )% |
| Net security  gains        |       | 561                                                |       | 23.5 |   | 556 |   | 21.9 |   | 5 |   | 0.9 |   |
| Bank owned life  insurance |       | 94                                                 |       | 3.9 |   | 288 |   | 11.3 |   | (194 | ) | (67.4 | ) |
| Gain on sale of  loans     |       | 264                                                |       | 11.1 |   | 263 |   | 10.3 |   | 1 |   | 0.4 |   |
| Insurance  commissions     |       | 502                                                |       | 21.0 |   | 507 |   | 19.9 |   | (5 | ) | (1.0 | ) |
| Other                      |       | 370                                                |       | 15.5 |   | 321 |   | 12.6 |   | 49 |   | 15.3 |   |
| Total  non-interest income |       | $                                                  | 2,387      |   | 100.0 | % | $ | 2,547 |   | 100.0 | % | $ | (160 | ) | (6.3 | )% |

 
| ** **                 | ** ** | **For The Nine Months Ended** | ** ** |
|----------------------------|------------|---------------------------------------------------|------------|
| ** **                 | ** ** | **September 30, 2006**                  | ** ** | **September 30, 2005** | ** ** | **Change** | ** ** |
| **(In Thousands)**    | ** ** | **Amount**                                        | ** ** | **% Total** | ** ** | **Amount** | ** ** | **% Total** | ** ** | **Amount** | ** ** | **%** | ** ** |
| Deposit service  charges   |       | $                                                 | 1,773      |   | 25.5 | % | $ | 1,603 |   | 21.9 | % | $ | 170 |   | 10.6 | % |
| Net security  gains        |       | 1,385                                             |       | 20.0 |   | 1,854 |   | 25.3 |   | (469 | ) | (25.3 | ) |
| Bank owned life  insurance |       | 272                                               |       | 3.9 |   | 475 |   | 6.5 |   | (203 | ) | (42.7 | ) |
| Gain on sale of  loans     |       | 624                                               |       | 9.0 |   | 631 |   | 8.6 |   | (7 | ) | (1.1 | ) |
| Insurance  commissions     |       | 1,732                                             |       | 25.0 |   | 1,802 |   | 24.6 |   | (70 | ) | (3.9 | ) |
| Other                      |       | 1,154                                             |       | 16.6 |   | 964 |   | 13.1 |   | 190 |   | 19.7 |   |
| Total  non-interest income |       | $                                                 | 6,940      |   | 100.0 | % | $ | 7,329 |   | 100.0 | % | $ | (389 | ) | (5.3 | )% |

 

**Non-interestExpenses**

Totalnon-interest expenses increased $326,000 from the three months ended September30, 2005 compared to the same period of 2006. The increase in salaries and employee benefits was attributable toseveral items including: standard cost of living wage adjustments foremployees, new additions to our staff, and increased health insurancecost.  Furniture and equipment expenseand occupancy expense increased due to the new branch in Montoursville andincreased cost of maintenance.  Otherexpenses increased primarily due to normal anticipated inflationary adjustmentsto ongoing business operating costs and the Company’s share of operatingresults incurred through a limited partnership arrangement which was initiatedduring the fourth quarter of 2005 for the purposes of funding the constructionof affordable housing in the Company’s primary market area.

Totalnon-interest expenses increased $911,000 from the nine months ended September30, 2005 as compared to the same period of 2006.  As noted above in the three month discussion,the new Montoursville branch and the State College branch, opened in May 2005,in addition to normal increases in general business expenses, impacted thelevel of non-interest expenses. Decreased maintenance of buildings resulted in occupancy expensedeclining for the nine month period ended September 30, 2006 as compared to2005.

Non-interestexpense composition for the three and nine months ended September 30, 2006 and2005 were as follows:

21

----

 
| ** **                      | ** ** | **For The Three Months Ended** | ** ** |
|---------------------------------|------------|----------------------------------------------------|------------|
| ** **                      | ** ** | **Septmeber 30, 2006**                   | ** ** | **September 30, 2005** | ** ** | **Change** | ** ** |
| **(In Thousands)**         | ** ** | **Amount**                                         | ** ** | **% Total** | ** ** | **Amount** | ** ** | **% Total** | ** ** | **Amount** | ** ** | **%** | ** ** |
| Salaries and  employee benefits |       | $                                                  | 2,174      |   | 52.8 | % | $ | 2,096 |   | 55.3 | % | $ | 78 |   | 3.7 | % |
| Occupancy, net                  |       | 308                                                |       | 7.5 |   | 261 |   | 6.9 |   | 47 |   | 18.0 |   |
| Furniture and  equipment        |       | 309                                                |       | 7.5 |   | 262 |   | 6.9 |   | 47 |   | 17.9 |   |
| Pennsylvania  shares tax        |       | 151                                                |       | 3.7 |   | 138 |   | 3.7 |   | 13 |   | 9.4 |   |
| Other                           |       | 1,172                                              |       | 28.5 |   | 1,031 |   | 27.2 |   | 141 |   | 13.7 |   |
| Total  non-interest expense     |       | $                                                  | 4,114      |   | 100.0 | % | $ | 3,788 |   | 100.0 | % | $ | 326 |   | 8.6 | % |

 
| ** **                      | ** ** | **For The Nine Months Ended** | ** ** |
|---------------------------------|------------|---------------------------------------------------|------------|
| ** **                      | ** ** | **September 30, 2006**                  | ** ** | **September 30, 2005** | ** ** | **Change** | ** ** |
| **(In Thousands)**         | ** ** | **Amount**                                        | ** ** | **% Total** | ** ** | **Amount** | ** ** | **% Total** | ** ** | **Amount** | ** ** | **%** | ** ** |
| Salaries and  employee benefits |       | $                                                 | 6,620      |   | 54.5 | % | $ | 6,225 |   | 55.4 | % | $ | 395 |   | 6.3 | % |
| Occupancy, net                  |       | 826                                               |       | 6.8 |   | 838 |   | 7.5 |   | (12 | ) | (1.4 | ) |
| Furniture and  equipment        |       | 894                                               |       | 7.4 |   | 717 |   | 6.4 |   | 177 |   | 24.7 |   |
| Pennsylvania  shares tax        |       | 447                                               |       | 3.7 |   | 417 |   | 3.7 |   | 30 |   | 7.2 |   |
| Other                           |       | 3,356                                             |       | 27.6 |   | 3,035 |   | 27.0 |   | 321 |   | 10.6 |   |
| Total  non-interest expense     |       | $                                                 | 12,143     |   | 100.0 | % | $ | 11,232 |   | 100.0 | % | $ | 911 |   | 8.1 | % |

 

**Provisionfor Income Taxes**

Incometaxes decreased $186,000 and $1,074,000 for the three and nine month periodsended September 30, 2006 compared to the same periods of 2005.  The effective tax rates for the three monthsended September 30, 2006 and 2005 were 18.5% and 20.2%, respectively.  The nine months ended September 30, 2006 hadan effective tax rate of 17.5% compared to 23.8% for the comparable period of2005.  The decline in the effective taxrate is consistent with management’s repositioning of the investment portfoliofrom taxable investment securities to tax-exempt investment securities and taxcredits related to investments in low income housing projects.

# **ASSET/LIABILITY MANAGEMENT**

# **Cash and Cash Equivalents**

Cash and cash equivalentsdecreased $622,000 from $14,090,000 at December 31, 2005, primarily as a resultof the following activities during the nine months ended September 30, 2006:

# **Operating Activities**

The significantcomponents of operating activities are net income and the origination andproceeds of loans held for sale. Activity regarding loans held for sale resulted in sale proceeds, less$624,000 in realized gains, exceeding loan origination disbursements by $1,201,000for the period.

22

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**Loans**

Gross loans increased$18,118,000 since December 31, 2005 as residential real estate mortgagesincreased 5.1% or $7,593,000 in part due to the active marketing of a new homeequity line of credit product during 2006. The growth in commercial real estate mortgages is part of the Company’sstrategy to originate high quality, well secured commercial loans.

The allocation of the loan portfolio, by category,as of September 30, 2006 and December 31, 2005 is presented below:
| ** **                        | ** ** | **September 30,** | ** ** | **December 31,** | ** ** | **Change** | ** ** |
|-----------------------------------|------------|------------------------|------------|-----------------------|------------|------------|------------|
| **(In Thousands)**           | ** ** | **2006**               | ** ** | **2005**              | ** ** | **Amount** | ** ** | **%** | ** ** |
| Commercial and  agricultural      |       | $                      | 34,016     |                  | $          | 34,407     |       | $ | (391 | ) | (1.1 | )% |
| Real estate  mortgage:            |       |                   |       |                  |       |       |       |   |   |
| Residential                       |       | 157,593                |       | 150,000               |       | 7,593      |       | 5.1 |   |
| Commercial                        |       | 132,848                |       | 127,131               |       | 5,717      |       | 4.5 |   |
| Construction                      |       | 15,386                 |       | 10,681                |       | 4,705      |       | 44.1 |   |
| Installment  loans to individuals |       | 17,754                 |       | 17,281                |       | 473        |       | 2.7 |   |
| Less: Net  deferred loan fees     |       | 1,041                  |       | 1,062                 |       | (21        | )          | (2.0 | ) |
| Gross loans                       |       | $                      | 356,556    |                  | $          | 338,438    |       | $ | 18,118 |   | 5.4 | % |

 

The recorded investment in loans for which impairment has beenrecognized in accordance with Statement of Financial Accounting Standards No.114, *Accounting by Creditors for Impairment of a Loan*,amounted to $568,000 at September 30, 2006, as compared to no impaired loans atDecember 31, 2005.  The valuationallowance related to impaired loans amounted to $61,000 at September 30, 2006.

A loan is considered impaired, based on current information and events,if it is probable that the Bank will be unable to collect the scheduledpayments of principal or interest when due according to the contractual termsof the loan agreement. The measurement of impaired loans is generally based onthe present value of expected future cash flows discounted at the historicaleffective interest rate, except that all collateral-dependent loans are measuredfor impairment based on the fair value of the collateral.

**Investments**

Theamortized cost and fair market value of the investment securities portfolio intotal has declined modestly since December 31, 2005.  Over the first nine months of 2006, the amortizedcost of state and political securities has increased $5,701,000, while U.S.Government and agency securities decreased $6,054,000.  This shift is the result of a repositioningof the securities portfolio that began during 2005.  The shift from taxable to tax exempt bondshas been undertaken as a strategy to build call protection, maintain thetaxable equivalent yield, reduce the effective federal income tax rate, andinvest in communities across the Commonwealth of Pennsylvania and the country.

23

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Theamortized cost of investment securities and their approximate fair values areas follows:
| ** **                             | ** ** | **September 30, 2006** | ** ** |
|----------------------------------------|------------|----------------------------------|------------|
| ** **                             | ** ** | ** **                       | ** ** | **Gross** | ** ** | **Gross** | ** ** | ** ** | ** ** |
| ** **                             | ** ** | **Amortized**                    | ** ** | **Unrealized** | ** ** | **Unrealized** | ** ** | **Fair** | ** ** |
| **(In Thousands)**                | ** ** | **Cost**                         | ** ** | **Gains** | ** ** | **Losses** | ** ** | **Value** | ** ** |
| Available for  Sale (AFS)              |       |                             |       |   |   |   |   |   |   |
| U.S. Government  and agency securities |       | $                           | 59,442     |   | $  | 15 |   | $  | (1,472 | ) | $  | 57,985 |   |
| State and  political securities        |       | 99,470                           |       | 2,084 |   | (491 | ) | 101,063 |   |
| Other debt  securities                 |       | 1,999                            |       | 25 |   | (21 | ) | 2,003 |   |
| Total debt securities                  |       | 160,911                          |       | 2,124 |   | (1,984 | ) | 161,051 |   |
| Equity  securities                     |       | 21,044                           |       | 2,719 |   | (330 | ) | 23,433 |   |
| Total Investment  Securities AFS       |       | $                                | 181,955    |   | $ | 4,843 |   | $ | (2,314 | ) | $ | 184,484 |   |
|                                   |       |                             |       |   |   |   |   |   |   |
| Held to Maturity  (HTM)                |       |                             |       |   |   |   |   |   |   |
| U.S. Government  and agency securities |       | $                           | 27         |   | $  | 1 |   | $  | — |   | $  | 28 |   |
| Other debt securities                  |       | 255                              |       | 2 |   | — |   | 257 |   |
| Total Investment  Securities HTM       |       | $                                | 282        |   | $ | 3 |   | $ | — |   | $ | 285 |   |

 
| ** **                             | ** ** | **December 31, 2005** | ** ** |
|----------------------------------------|------------|---------------------------------|------------|
| ** **                             | ** ** | ** **                      | ** ** | **Gross** | ** ** | **Gross** | ** ** | ** ** | ** ** |
| ** **                             | ** ** | **Amortized**                   | ** ** | **Unrealized** | ** ** | **Unrealized** | ** ** | **Fair** | ** ** |
| **(In Thousands)**                | ** ** | **Cost**                        | ** ** | **Gains** | ** ** | **Losses** | ** ** | **Value** | ** ** |
| Available for  Sale (AFS)              |       |                            |       |   |   |   |   |   |   |
| U.S. Government  and agency securities |       | $                          | 65,496     |   | $  | 30 |   | $  | (1,573 | ) | $  | 63,953 |   |
| State and  political securities        |       | 93,769                          |       | 1,390 |   | (1,068 | ) | 94,091 |   |
| Other debt  securities                 |       | 1,750                           |       | 12 |   | (43 | ) | 1,719 |   |
| Total debt securities                  |       | 161,015                         |       | 1,432 |   | (2,684 | ) | 159,763 |   |
| Equity  securities                     |       | 24,715                          |       | 2,951 |   | (411 | ) | 27,255 |   |
| Total Investment  Securities AFS       |       | $                               | 185,730    |   | $ | 4,383 |   | $ | (3,095 | ) | $ | 187,018 |   |
|                                   |       |                            |       |   |   |   |   |   |   |
| Held to Maturity  (HTM)                |       |                            |       |   |   |   |   |   |   |
| U.S. Government  and agency securities |       | $                          | 28         |   | $  | 2 |   | $  | — |   | $  | 30 |   |
| Other debt  securities                 |       | 237                             |       | — |   | (29 | ) | 208 |   |
| Total Investment  Securities HTM       |       | $                               | 265        |   | $ | 2 |   | $ | (29 | ) | $ | 238 |   |

 

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# **Financing Activities**

# **Deposits**

Totaldeposits increased 14.0% or $49,430,000 from December 31, 2005 to September 30,2006.  The mix of deposits has shiftedtoward time deposits from December 31, 2005 to September 30, 2006.  The shift is the result of several shortmaturity time deposit gathering campaigns undertaken during the past year.  In addition, a campaign run in August of 2006to celebrate the grand opening of the Montoursville branch attracted$21,646,000 in time deposits with approximately 66% of the funds coming fromoutside the Bank.  During the second halfof 2005 the Bank began utilizing brokered deposits (time deposits) tosupplement the funding of loan originations and investment purchases.  These time deposits are generally for a termof either four or thirteen weeks with interest rates presently at or below thecost of alternative funding sources, such as short-term borrowing instrumentsfrom the FHLB.  The amount of brokereddeposits is continuously monitored and is used to supplement deposits, not as aprimary source of deposits.

Deposit balancesand their changes for the periods being discussed follow:
| ** **                | ** ** | **September 30, 2006** | ** ** | **December 31, 2005** | ** ** | **Change** | ** ** |
|---------------------------|------------|----------------------------------|------------|---------------------------------|------------|------------|------------|
| **(In Thousands)**   | ** ** | **Amount**                       | ** ** | **% Total**                | ** ** | **Amount** | ** ** | **% Total** | ** ** | **Amount** | ** ** | **%** | ** ** |
| Demand deposits           |       | $                                | 69,412     |                            | 17.3       | %          | $          | 71,142 |   | 20.2 | % | $ | (1,730 | ) | (2.4 | )% |
| NOW Accounts              |       | 46,508                           |       | 11.6                            |       | 48,678     |       | 13.8 |   | (2,170 | ) | (4.5 | ) |
| Money market deposits     |       | 22,120                           |       | 5.5                             |       | 24,446     |       | 6.9 |   | (2,326 | ) | (9.5 | ) |
| Savings deposits          |       | 61,977                           |       | 15.4                            |       | 61,906     |       | 17.6 |   | 71 |   | 0.1 |   |
| Time deposits             |       | 179,583                          |       | 44.7                            |       | 137,373    |       | 39.0 |   | 42,210 |   | 30.7 |   |
| Time deposits -  brokered |       | 22,122                           |       | 5.5                             |       | 8,747      |       | 2.5 |   | 13,375 |   | 152.9 |   |
| Total deposits            |       | $                                | 401,722    |                            | 100.0      | %          | $          | 352,292 |   | 100.0 | % | $ | 49,430 |   | 14.0 | % |

 

**Borrowed Funds**

Total borrowed fundsdecreased 27.1% to $100,904,000 at September 30, 2006 as compared to December31, 2005.  The decrease in borrowed fundsis the result of deposit growth that occurred primarily in time deposits sinceDecember 31, 2005.  FHLB short-termborrowings were utilized during the first nine months of 2006; however, therewere no such borrowings outstanding at September 30, 2006.  Long-term borrowings declined due to amaturity of $1,600,000 that carried a fixed rate of 2.67%.

25

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|                                                | ** ** | **September 30,** | ** ** | **December 31,** | ** ** |
|------------------------------------------------|------------|------------------------|------------|-----------------------|------------|
| **(In Thousands)**                        | ** ** | **2006**               | ** ** | **2005**              | ** ** |
| Short-term  borrowings:                        |       |                   |       |                  |       |
| FHLB repurchase  agreements                    |       | $                      | 1,480      |                  | $          | 1,740 |   |
| Short-term  borrowings, FHLB                   |       | —                 |       | 37,000                |       |
| Securities sold  under agreement to repurchase |       | 16,546                 |       | 15,263                |       |
| Total short-term  borrowings                   |       | 18,026                 |       | 54,003                |       |
|                                           |       |                   |       |                  |       |
| Long-term  borrowings, FHLB                    |       | 82,878                 |       | 84,478                |       |
| Total borrowed funds                           |       | $                      | 100,904    |                  | $          | 138,481 |   |

 

**Capital**

The adequacy of theCompany’s capital is reviewed on an ongoing basis with reference to the size,composition, and quality of the Company’s resources and regulatoryguidelines.  Management seeks to maintaina level of capital sufficient to support existing assets and anticipated assetgrowth, maintain favorable access to capital markets, and preserve high qualitycredit ratings.

Bank holding companiesare required to comply with the Federal Reserve Board’s risk-based capitalguidelines.  The risk-based capital rulesare designed to make regulatory capital requirements more sensitive todifferences in risk profiles among banks and bank holding companies and tominimize disincentives for holding liquid assets.  Specifically, each is required to maintaincertain minimum dollar amounts and ratios of Total risk-based, Tier Irisk-based, and Tier I leverage capital requirements. In addition to thecapital requirements, the Federal Deposit Insurance Corporation ImprovementsAct (FDICIA) established five capital categories ranging from “well capitalized”to “critically undercapitalized.” To be classified as “well capitalized”, Totalrisk-based, Tier I risked-based, and Tier I leverage capital ratios must be atleast 10%, 6%, and 5%,respectively.

Capitalratios as of September 30, 2006 and December 31, 2005 were as follows:

26

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| ** **                             | ** ** | **2006**   | ** ** | **2005**  | ** ** |
|----------------------------------------|------------|------------|------------|-----------|------------|
| **(In Thousands)**                | ** ** | **Amount** | ** ** | **Ratio** | ** ** | **Amount** | ** ** | **Ratio** | ** ** |
| Total Capital                          |       |       |       |      |       |   |   |   |   |
|   (to  Risk-weighted Assets) |       |       |       |      |       |   |   |   |   |
|                                   |       |       |       |      |       |   |   |   |   |
| Actual                                 |       | $          | 73,388     |      | 20.2       | % | $ | 73,210 |   | 21.0 | % |
| For Capital  Adequacy Purposes         |       | 29,057     |       | 8.0       |       | 27,937 |   | 8.0 |   |
| To Be Well  Capitalized                |       | 36,321     |       | 10.0      |       | 34,921 |   | 10.0 |   |
|                                   |       |       |       |      |       |   |   |   |   |
| Tier I Capital                         |       |       |       |      |       |   |   |   |   |
|   (to  Risk-weighted Assets) |       |       |       |      |       |   |   |   |   |
|                                   |       |       |       |      |       |   |   |   |   |
| Actual                                 |       | $          | 68,265     |      | 18.8       | % | $ | 68,388 |   | 19.6 | % |
| For Capital  Adequacy Purposes         |       | 14,528     |       | 4.0       |       | 13,968 |   | 4.0 |   |
| To Be Well  Capitalized                |       | 21,793     |       | 6.0       |       | 20,952 |   | 6.0 |   |
|                                   |       |       |       |      |       |   |   |   |   |
| Tier I Capital                         |       |       |       |      |       |   |   |   |   |
|   (to  Average Assets)       |       |       |       |      |       |   |   |   |   |
|                                   |       |       |       |      |       |   |   |   |   |
| Actual                                 |       | $          | 68,265     |      | 11.9       | % | $ | 68,388 |   | 12.2 | % |
| For Capital  Adequacy Purposes         |       | 23,029     |       | 4.0       |       | 22,495 |   | 4.0 |   |
| To Be Well Capitalized                 |       | 28,786     |       | 5.0       |       | 28,119 |   | 5.0 |   |

 

**Liquidity and Interest RateSensitivity**

The asset/liabilitycommittee addresses the liquidity needs of the Company to see that sufficientfunds are available to meet credit demands and deposit withdrawals as well asto the placement of available funds in the investment portfolio.  In assessing liquidity requirements, equalconsideration is given to the current position as well as the future outlook.

The following liquiditymeasures are monitored for compliance within the limits cited:

1.  Net Loans to Total Assets,100% maximum

2.  Net Loans to Total Deposits,100% maximum

3.  Cumulative 90 day MaturityGAP %, +/- 20% maximum

4.  Cumulative 1 Year Maturity GAP %, +/- 20%,maximum

Fundamental objectives of the Company’sasset/liability management process are to maintain adequate liquidity whileminimizing interest rate risk.  Themaintenance of adequate liquidity provides the Company with the ability to meetits financial obligations to depositors, loan customers, and shareholders.  Additionally, it provides funds for normaloperating expenditures

27

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andbusiness opportunities as they arise. The objective of interest rate sensitivity management is to increase netinterest income by managing interest sensitive assets and liabilities in such away that they can be repriced in response to changes in market interest rates.

TheBank, like other financial institutions, must have sufficient funds availableto meet its liquidity needs for deposit withdrawals, loan commitments andoriginations, and expenses.  In order tocontrol cash flow, the Bank estimates future flows of cash from deposits, loanpayments, and investment security payments. The primary sources of funds are deposits, principal and interestpayments on loans and investment securities, as well as Federal Home Loan Bankborrowings.  Management believes the Bankhas adequate resources to meet its normal funding requirements.

Managementmonitors the Company’s liquidity on both a long and short-term basis, therebyproviding management necessary information to react to current balance sheettrends.  Cash flow needs are assessed andsources of funds are determined.  Fundingstrategies consider both customer needs and economical cost.  Both short and long-term funding needs areaddressed by maturities and sales of available for sale investment securities,loan repayments and maturities, and liquidating money market investments suchas federal funds sold.  The use of theseresources, in conjunction with access to credit provides core ingredients tosatisfy depositor, borrower, and creditor needs.

Managementmonitors and determines the desirable level of liquidity.  Consideration is given to loan demand,investment opportunities, deposit pricing and growth potential, as well as thecurrent cost of borrowing funds.  TheCompany has a current borrowing capacity at the Federal Home Loan Bank of $217,104,000.  Inaddition to this credit arrangement, the Company has additional lines of creditwith correspondent banks of $25,500,000. Management believes it has sufficientliquidity to satisfy estimated short-term and long-term funding needs.  Federal Home Loan Bank borrowings totaled$84,358,000 as of September 30, 2006.

Interestrate sensitivity, which is closely related to liquidity management, is afunction of the repricing characteristics of the Company’s portfolio of assetsand liabilities.  Asset/liabilitymanagement strives to match maturities and rates between loan and investmentsecurity assets with the deposit liabilities and borrowings that fundthem.  Successful asset/liabilitymanagement results in a balance sheet structure which can cope effectively withmarket rate fluctuations. The matching process is affected by segmenting bothassets and liabilities into future time periods (usually 12 months, or less)based upon when repricing can be effected. Repriceable assets are subtracted from repriceable liabilities, for aspecific time period to determine the “gap”, or difference. Once known, the gapis managed based on predictions about future market interest rates.  Intentional mismatching, or gapping, canenhance net interest income if market rates move as predicted.  However, if market rates behave in a mannercontrary to predictions, net interest income will suffer.  Gaps, therefore, contain an element of riskand must be prudently managed.  Inaddition to gap management, the Company has an asset/liability managementpolicy which incorporates a market value at risk calculation which is used todetermine the effects of interest rate movements on shareholders’ equity and asimulation analysis to monitor the effects of interest rate changes on theCompany’s balance sheet.

28

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Therehave been no substantial changes in the Company’s gap analyses or simulationanalyses compared to the information provided in the Company’s Form 10-K forthe period ended December 31, 2005.

Generally,management believes the Company is well positioned to respond in a timely mannerwhen the market interest rate outlook changes.

**Inflation**

The asset and liabilitystructure of a financial institution is primarily monetary in nature.  Therefore, interest rates rather thaninflation have a more significant impact on the Company’s performance.  Interest rates are not always affected in thesame direction or magnitude as prices of other goods and services, but arereflective of fiscal policy initiatives or economic factors which are notmeasured by a price index.

In reference to theattached financial statements, all adjustments are of a normal recurring naturepursuant to Rule 10-01 (b) (8) of Regulation S-X.

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

Marketrisk for the Company is comprised primarily from interest rate risk exposureand liquidity risk.  Interest rate riskand liquidity risk management is performed at the Bank level as well as theCompany level.  The Company’s interestrate sensitivity is monitored by management through selected interest rate riskmeasures produced by an independent third party.  There have been no substantial changes in theCompany’s gap analyses or simulation analyses compared to the informationprovided in the Annual Report on Form 10-K for the period ended December 31,2005.  Additional information and detailsare provided in the Liquidity and Interest Rate Sensitivity section of Item 2.Management’s Discussion and Analysis of Financial Condition and Results ofOperations.

Generally,management believes the Company is well positioned to respond in a timelymanner when the market interest rate outlook changes.

**Item 4. Controls and Procedures**

An analysis was performed under the supervision and with theparticipation of the Company’s management, including the Chief ExecutiveOfficer and the Principal Financial Officer, of the effectiveness of the designand operation of the Company’s disclosure controls and procedures. Based onthat evaluation, the Company’s Chief Executive Officer and Principal FinancialOfficer concluded that the Company’s disclosure controls and procedures wereeffective as of September 30, 2006. There were no changes in the Company’s internal control over financialreporting that occurred during the quarter ended September 30, 2006, that havematerially affected, or are reasonably likely to materially affect, the Company’sinternal control over financial reporting.

29

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### **Part II. OTHER INFORMATION**

**Item 1.          LegalProceedings**

None.

**Item1A.      ****Risk Factors**

There are no materialchanges to the risk factors set forth in Part I, Item 1A, “Risk Factors,” ofthe Company’s Annual Report on Form 10-K for the year ended December 31,2005.  Please refer to that section fordisclosures regarding the risks and uncertainties related to the Company’sbusiness.

**Item 2.          UnregisteredSales of Equity Securities and Use of Proceeds**

On April 25, 2006 theBoard of Directors authorized the repurchase of approximately 5% of theoutstanding shares of the Registrant. The repurchase plan is for a one year period and allows for therepurchase of 197,000 shares of the 3,941,787 shares outstanding at April 25,2006.  To date, there have been 26,000shares repurchased under this plan.

During the three monthsended September 30, 2006 there were 16,000 shares of the Company’s common stockrepurchased as part of the previously announced repurchase program.
| ** **                                  | ** ** | **Total**           | ** ** | **Average**         | ** ** | **Total Number of**           | ** ** | **Maximum Number (or**                    | ** ** |
|---------------------------------------------|------------|---------------------|------------|---------------------|------------|-----------------------------------------|------------|-----------------------------------------------------|------------|
| ** **                                  | ** ** | **Number of**  | ** ** | **Price Paid** | ** ** | **Shares (or Units)**         | ** ** | **Approximate Dollar Value)**             | ** ** |
| ** **                                  | ** ** | **Shares (or** | ** ** | **per Share**  | ** ** | **Purchased as Part of** | ** ** | **of Shares (or Units) that**   | ** ** |
| ** **                                  | ** ** | **Units)**          | ** ** | **(or Units)** | ** ** | **Publicly Announced**             | ** ** | **May Yet Be Purchased**             | ** ** |
| **Period**                                  | ** ** | **Purchased**       | ** ** | **Purchased**       | ** ** | **Plans or Programs**         | ** ** | **Under the Plans or Programs** | ** ** |
|                                        |       |                |       |                |       |                                    |       |                                                |       |
| Month#1(July 1- July  31, 2006)             |       | 5,000               |       | $                   | 38.20      |                                    | 5,000      |                                                | 182,000    |   |
|                                        |       |                |       |                |       |                                    |       |                                                |       |
| Month#2 (August  1- August 31, 2006)        |       | —              |       | —              |       | —                                  |       | —                                              |       |
|                                        |       |                |       |                |       |                                    |       |                                                |       |
| Month#3 (September 1,- September  30, 2006) |       | 11,000              |       | 37.75               |       | 11,000                                  |       | 171,000                                             |       |
|                                             |            |                     |            |                     |            |                                         |            |                                                     |            |  |

 

**Item 3.          DefaultsUpon Senior Securities**

None

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

None

30

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### **Item 5.          OtherInformation**

None

**Item 6.          Exhibits**
| (3)   (i)  |   | Articles of Incorporation of the Registrant, as  presently in effect (incorporated by reference to Exhibit 3(i) of the  Registrant’s Annual Report on Form 10-K for the year ended December 31,  2005). |
|----------------------|--------|--------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
| (3)   (ii) |   | Bylaws of the Registrant as presently in effect  (incorporated by reference to Exhibit 3 (ii) of the Registrant’s Current  Report on Form 8-K filed June 17, 2005).                                     |
| (31) (i)             |   | Rule 13a-14(a)  Certification of Chief Executive Officer.                                                                                                                                                    |
| (31) (ii)            |   | Rule 13a-14(a) Certification of Principal Financial  Officer.                                                                                                                                                |
| (32) (i)             |   | Section 1350 Certification of Chief Executive  Officer.                                                                                                                                                      |
| (32) (ii)            |   | Section 1350 Certification of Principal Financial  Officer.                                                                                                                                                  |

 

31

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**SIGNATURES**

Pursuant to therequirements of the Securities Exchange Act of 1934, the Registrant has dulycaused this report to be signed on its behalf by the undersigned thereunto dulyauthorized.
|                                          |   | PENNS WOODS BANCORP, INC. |
|------------------------------------------|--------|---------------------------|
|                                     |   | (Registrant)              |
|                                     |   |                      |
|                                     |   |                      |
| Date:   November  7, 2006 |   |                      | /s/ Ronald A. Walko |   |
|                                     |   |                      | Ronald A. Walko, President and Chief Executive  Officer |
|                                     |   |                      |   |
|                                     |   |                      |   |
| Date:   November  7, 2006 |   |                      | /s/ Brian L. Knepp |   |
|                                     |   |                      | Brian L. Knepp, Vice President of Finance (Principal  Financial Officer) |

 

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**EXHIBIT INDEX**
| Exhibit 31(i)  |   | Rule 13a-14(a)/Rule 15d-14(a) Certification of Chief  Executive Officer     |
|----------------|--------|-----------------------------------------------------------------------------|
| Exhibit 31(ii) |   | Rule 13a-14(a)/Rule 15d-14(a) Certification of  Principal Financial Officer |
| Exhibit 32(i)  |   | Section 1350 Certification of Chief Executive  Officer                      |
| Exhibit 32(ii) |   | Section 1350 Certification of Principal Financial  Officer                  |

 

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