Table of Contents

** **

 

** **

**UNITED STATES**

**SECURITIES AND EXCHANGECOMMISSION**

**WASHINGTON, D.C.  20549**

 

**FORM 10-Q**

 

**x****  Quarterly Report pursuant to Section 13or 15 (d) of the Securities Exchange**

 

**Act of 1934 for the QuarterlyPeriod Ended June 30, 2009.**

 

**o****  Transitionreport pursuant to Section 13 or 15 (d) of the Exchange Act for the**

 

**Transition Period from                              to                               .**

 

**No. 0-17077**

(Commission File Number)

 

**PENNS WOODS BANCORP, INC.**

(Exact name of Registrant 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, P.O. Box 967  Williamsport, Pennsylvania** | ** ** | **17703-0967**      |
| (Address of principal executive offices)                             |       | (Zip Code)          |

 

**(570) 322-1111**

Registrant’s telephone number, including area code

 

Indicateby check mark whether the registrant (1) has filed all reports required tobe filed by Section 13 or 15(d) of the Securities Exchange Act of1934 during the preceding 12 months (or for such shorter period that theregistrant was required to file such reports), and (2) has been subject tosuch filing requirements for the past 90 days.YES x  NO o

 

Indicateby check mark whether the registrant has submitted electronically and posted onits corporate Web site, if any, every Interactive Data File required to besubmitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of thischapter) during the preceding 12 months (or for such shorter period that theregistrant was required to submit and post such files). YES o  NO o

 

Indicateby check mark whether the registrant is a large accelerated filer, anaccelerated filer, a non-accelerated filer, or a smaller reportingcompany.  See the definition of “largeaccelerated filer”, “accelerated filer” and “smaller reporting company” in Rule 12b-2of the Exchange Act.  (Check one):

 

| Large accelerated filer o |   | Accelerated filer x       |
|---------------------------|--------|---------------------------|
|                      |   |                      |
| Non-accelerated filer o   |   | Small reporting company o |

 

Indicateby check mark whether the registrant is a shell company (as defined in Rule 12b-2of the Exchange Act).YESo  NO x

 

OnJuly 30, 2009 there were 3,832,957 shares of the Registrant’s common stockoutstanding.

 

 

 

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**PENNSWOODS BANCORP, INC.**

**INDEX TO QUARTERLY REPORT ON FORM**** 10-Q**

 
| ** **                                                                                                                        | ** **                                                                                      | **Page**   |
|-----------------------------------------------------------------------------------------------------------------------------------|-------------------------------------------------------------------------------------------------|------------|
| ** **                                                                                                                        | ** **                                                                                      | **Number** |
|                                                                                                                              |                                                                                            |       |
| **Part I**                                                                                                                   | **Financial Information**                                                                       |       |
|                                                                                                                              |                                                                                            |       |
| **Item 1.**                                                                                                                       | **Financial Statements**                                                                        |       |
|                                                                                                                              |                                                                                            |       |
| Consolidated Balance Sheet  (unaudited) as of June 30, 2009 and December 31, 2008                                       | 3                                                                                               |
|                                                                                                                              |                                                                                            |       |
| Consolidated Statement  of Income (unaudited) for the Three and Six Months ended June 30, 2009  and 2008                     | 4                                                                                               |
|                                                                                                                              |                                                                                            |       |
| Consolidated Statement  of Changes in Shareholders’ Equity (unaudited) for the Six Months ended  June 30, 2009 and 2008 | 5                                                                                               |
|                                                                                                                              |                                                                                            |       |
| Consolidated Statement  of Comprehensive Income (unaudited) for the Three and Six Months ended  June 30, 2009 and 2008       | 5                                                                                               |
|                                                                                                                              |                                                                                            |       |
| Consolidated Statement of Cash  Flows (unaudited) for the Six Months ended June 30, 2009 and 2008                            | 6                                                                                               |
|                                                                                                                              |                                                                                            |       |
| Notes to Consolidated Financial Statements (unaudited)                                                                            | 7                                                                                               |
|                                                                                                                              |                                                                                            |       |
| **Item 2.**                                                                                                                       | **Management’s  Discussion and Analysis of Financial Condition and Results of Operations** | 21         |
| **Item 3.**                                                                                                                       | **Quantitative  and Qualitative Disclosures About Market Risk**                                 | 42         |
| **Item 4.**                                                                                                                       | **Controls and  Procedures**                                                                    | 42         |
|                                                                                                                              |                                                                                            |       |
| **Part II**                                                                                                                  | **Other Information**                                                                           |       |
|                                                                                                                              |                                                                                            |       |
| **Item 1.**                                                                                                                       | **Legal Proceedings**                                                                           | 43         |
| **Item 1A.**                                                                                                                      | **Risk Factors**                                                                                | 43         |
| **Item 2.**                                                                                                                       | **Unregistered  Sales of Equity Securities and Use of Proceeds**                                | 43         |
| **Item 3.**                                                                                                                       | **Defaults  Upon Senior Securities**                                                            | 43         |
| **Item 4.**                                                                                                                       | **Submission  of Matters to a Vote of Security Holders**                                        | 43         |
| **Item 5.**                                                                                                                       | **Other Information**                                                                           | 44         |
| **Item 6.**                                                                                                                       | **Exhibits**                                                                                    | 44         |
| **Signatures**                                                                                                                    | 45                                                                                              |
| **Exhibit Index  and Exhibits**                                                                                              | 46                                                                                              |

 

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**Part I.  FINANCIAL INFORMATION**

 

**Item 1.  Financial Statements**

** **

PENNS WOODS BANCORP, INC.

CONSOLIDATED BALANCE SHEET

(UNAUDITED)

 
| ** **                                                                                           | ** ** | **June 30,** | ** ** | **December 31,** | ** ** |
|------------------------------------------------------------------------------------------------------|------------|-------------------|------------|-----------------------|------------|
| **(In  Thousands, Except Share Data)**                                                               | ** ** | **2009**          | ** ** | **2008**              | ** ** |
|                                                                                                 |       |              |       |                  |       |
| ASSETS                                                                                               |       |              |       |                  |       |
| Noninterest-bearing  balances                                                                        |       | $                 | 10,832     |                  | $          | 16,563 |   |
| Interest-bearing  deposits in other financial institutions                                           |       | 7,815             |       | 18                    |       |
| Total  cash and cash equivalents                                                                     |       | 18,647            |       | 16,581                |       |
|                                                                                                 |       |              |       |                  |       |
| Investment  securities, available for sale, at fair value                                            |       | 207,901           |       | 208,251               |       |
| Investment  securities held to maturity (fair value of $111 and $136)                                |       | 110               |       | 135                   |       |
| Loans  held for sale                                                                                 |       | 4,595             |       | 3,622                 |       |
| Loans                                                                                                |       | 392,074           |       | 381,478               |       |
| Less:  Allowance for loan losses                                                                     |       | 4,377             |       | 4,356                 |       |
| Loans,  net                                                                                          |       | 387,697           |       | 377,122               |       |
| Premises  and equipment, net                                                                         |       | 7,656             |       | 7,865                 |       |
| Accrued  interest receivable                                                                         |       | 3,468             |       | 3,614                 |       |
| Bank-owned  life insurance                                                                           |       | 14,862            |       | 14,546                |       |
| Investment  in limited partnerships                                                                  |       | 5,182             |       | 4,727                 |       |
| Goodwill                                                                                             |       | 3,032             |       | 3,032                 |       |
| Deferred  tax asset                                                                                  |       | 11,583            |       | 10,879                |       |
| Other  assets                                                                                        |       | 3,128             |       | 2,429                 |       |
| TOTAL  ASSETS                                                                                        |       | $                 | 667,861    |                  | $          | 652,803 |   |
|                                                                                                 |       |              |       |                  |       |
| LIABILITIES                                                                                          |       |              |       |                  |       |
| Interest-bearing  deposits                                                                           |       | $                 | 420,492    |                  | $          | 345,333 |   |
| Noninterest-bearing  deposits                                                                        |       | 74,509            |       | 76,035                |       |
| Total  deposits                                                                                      |       | 495,001           |       | 421,368               |       |
|                                                                                                 |       |              |       |                  |       |
| Short-term  borrowings                                                                               |       | 14,880            |       | 73,946                |       |
| Long-term  borrowings, Federal Home Loan Bank (FHLB)                                                 |       | 86,778            |       | 86,778                |       |
| Accrued  interest payable                                                                            |       | 1,220             |       | 1,317                 |       |
| Other  liabilities                                                                                   |       | 8,611             |       | 8,367                 |       |
| TOTAL  LIABILITIES                                                                                   |       | 606,490           |       | 591,776               |       |
|                                                                                                 |       |              |       |                  |       |
| SHAREHOLDERS’  EQUITY                                                                           |       |              |       |                  |       |
| Common  stock, par value $8.33, 10,000,000 shares authorized; 4,011,985 and 4,010,528  shares issued |       | 33,433            |       | 33,421                |       |
| Additional  paid-in capital                                                                          |       | 17,983            |       | 17,959                |       |
| Retained  earnings                                                                                   |       | 26,322            |       | 28,177                |       |
| Accumulated  other comprehensive loss:                                                               |       |              |       |                  |       |
| Net  unrealized loss on available for sale securities                                                |       | (6,323            | )          | (8,486                | )          |
| Defined  benefit plan                                                                                |       | (3,780            | )          | (3,780                | )          |
| Less:  Treasury stock at cost, 179,028 and 179,028 shares                                            |       | (6,264            | )          | (6,264                | )          |
| TOTAL  SHAREHOLDERS’ EQUITY                                                                     |       | 61,371            |       | 61,027                |       |
| TOTAL  LIABILITIES AND SHAREHOLDERS’ EQUITY                                                     |       | $                 | 667,861    |                  | $          | 652,803 |   |

 

See accompanyingnotes to the unaudited consolidated financial statements.

 

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PENNS WOODS BANCORP, INC.

CONSOLIDATED STATEMENT OFINCOME

(UNAUDITED)

 
| ** **                                           | ** ** | **Three  Months Ended** | ** ** | **Six  Months Ended** | ** ** |
|------------------------------------------------------|------------|-------------------------|------------|-----------------------|------------|
| ** **                                           | ** ** | **June 30,**       | ** ** | **June 30,**     | ** ** |
| **(In  Thousands, Except Per Share Data)**           | ** ** | **2009**                | ** ** | **2008**              | ** ** | **2009** | ** ** | **2008** | ** ** |
|                                                 |       |                    |       |                  |       |   |   |   |   |
| INTEREST AND DIVIDEND  INCOME                        |       |                    |       |                  |       |   |   |   |   |
| Loans including fees                                 |       | $                       | 6,349      |                  | $          | 6,246 |   | $ | 12,568 |   | $ | 12,625 |   |
| Investment Securities:                               |       |                    |       |                  |       |   |   |   |   |
| Taxable                                              |       | 1,374                   |       | 1,276                 |       | 2,737 |   | 2,466 |   |
| Tax-exempt                                           |       | 1,249                   |       | 1,210                 |       | 2,495 |   | 2,436 |   |
| Dividend and other  interest income                  |       | 41                      |       | 204                   |       | 130 |   | 457 |   |
| TOTAL INTEREST AND  DIVIDEND INCOME                  |       | 9,013                   |       | 8,936                 |       | 17,930 |   | 17,984 |   |
|                                                 |       |                    |       |                  |       |   |   |   |   |
| INTEREST EXPENSE                                     |       |                    |       |                  |       |   |   |   |   |
| Deposits                                             |       | 2,204                   |       | 2,551                 |       | 4,209 |   | 5,092 |   |
| Short-term borrowings                                |       | 78                      |       | 257                   |       | 236 |   | 686 |   |
| Long-term borrowings,  FHLB                          |       | 926                     |       | 972                   |       | 1,843 |   | 2,169 |   |
| TOTAL INTEREST EXPENSE                               |       | 3,208                   |       | 3,780                 |       | 6,288 |   | 7,947 |   |
|                                                 |       |                    |       |                  |       |   |   |   |   |
| NET INTEREST INCOME                                  |       | 5,805                   |       | 5,156                 |       | 11,642 |   | 10,037 |   |
|                                                 |       |                    |       |                  |       |   |   |   |   |
| PROVISION FOR LOAN  LOSSES                           |       | 186                     |       | 60                    |       | 312 |   | 120 |   |
|                                                 |       |                    |       |                  |       |   |   |   |   |
| NET INTEREST INCOME  AFTER PROVISION FOR LOAN LOSSES |       | 5,619                   |       | 5,096                 |       | 11,330 |   | 9,917 |   |
|                                                 |       |                    |       |                  |       |   |   |   |   |
| NON-INTEREST INCOME                                  |       |                    |       |                  |       |   |   |   |   |
| Service charges                                      |       | 541                     |       | 540                   |       | 1,066 |   | 1,110 |   |
| Securities losses, net                               |       | (2,086                  | )          | (251                  | )          | (4,455 | ) | (213 | ) |
| Earnings on bank-owned  life insurance               |       | 112                     |       | 91                    |       | 274 |   | 246 |   |
| Gain on sale of loans                                |       | 103                     |       | 212                   |       | 221 |   | 364 |   |
| Insurance commissions                                |       | 347                     |       | 486                   |       | 701 |   | 1,066 |   |
| Other                                                |       | 591                     |       | 543                   |       | 1,025 |   | 962 |   |
| TOTAL NON-INTEREST  INCOME                           |       | (392                    | )          | 1,621                 |       | (1,168 | ) | 3,535 |   |
|                                                 |       |                    |       |                  |       |   |   |   |   |
| NON-INTEREST EXPENSE                                 |       |                    |       |                  |       |   |   |   |   |
| Salaries and employee  benefits                      |       | 2,595                   |       | 2,469                 |       | 5,077 |   | 4,920 |   |
| Occupancy, net                                       |       | 318                     |       | 314                   |       | 657 |   | 652 |   |
| Furniture and equipment                              |       | 306                     |       | 287                   |       | 613 |   | 572 |   |
| Pennsylvania shares tax                              |       | 172                     |       | 105                   |       | 343 |   | 210 |   |
| Amortization of  investment in limited partnerships  |       | 141                     |       | 178                   |       | 283 |   | 356 |   |
| Other                                                |       | 1,353                   |       | 1,158                 |       | 2,557 |   | 2,246 |   |
| TOTAL NON-INTEREST  EXPENSE                          |       | 4,885                   |       | 4,511                 |       | 9,530 |   | 8,956 |   |
|                                                 |       |                    |       |                  |       |   |   |   |   |
| INCOME BEFORE INCOME  TAX (BENEFIT) PROVISION        |       | 342                     |       | 2,206                 |       | 632 |   | 4,496 |   |
| INCOME TAX (BENEFIT)  PROVISION                      |       | (490                    | )          | 149                   |       | (1,039 | ) | 308 |   |
| NET INCOME                                           |       | $                       | 832        |                  | $          | 2,057 |   | $ | 1,671 |   | $ | 4,188 |   |
|                                                 |       |                    |       |                  |       |   |   |   |   |
| EARNINGS PER SHARE -  BASIC                          |       | $                       | 0.22       |                  | $          | 0.53 |   | $ | 0.44 |   | $ | 1.08 |   |
|                                                 |       |                    |       |                  |       |   |   |   |   |
| EARNINGS PER SHARE -  DILUTED                        |       | $                       | 0.22       |                  | $          | 0.53 |   | $ | 0.44 |   | $ | 1.08 |   |
|                                                 |       |                    |       |                  |       |   |   |   |   |
| WEIGHTED AVERAGE SHARES  OUTSTANDING - BASIC         |       | 3,832,520               |       | 3,865,977             |       | 3,832,135 |   | 3,870,359 |   |
|                                                 |       |                    |       |                  |       |   |   |   |   |
| WEIGHTED AVERAGE SHARES  OUTSTANDING - DILUTED       |       | 3,832,596               |       | 3,866,115             |       | 3,832,173 |   | 3,870,523 |   |
|                                                 |       |                    |       |                  |       |   |   |   |   |
| DIVIDENDS PER SHARE                                  |       | $                       | 0.46       |                  | $          | 0.46 |   | $ | 0.92 |   | $ | 0.92 |   |

 

Seeaccompanying notes to the unaudited consolidated financial statements.

 

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PENNS WOODS BANCORP, INC.

CONSOLIDATED STATEMENT OFCHANGES IN SHAREHOLDERS’ EQUITY

(UNAUDITED)

 
| ** **                                             | ** ** | ** ** | ** ** | ** **     | ** ** | ** **   | ** ** | ** **        | ** ** | **ACCUMULATED** | ** ** | ** **             | ** ** | ** ** | ** ** |
|--------------------------------------------------------|------------|------------|------------|----------------|------------|--------------|------------|-------------------|------------|-----------------|------------|------------------------|------------|------------|------------|
| ** **                                             | ** ** | **COMMON** | ** ** | **ADDITIONAL** | ** ** | ** **   | ** ** | **OTHER**         | ** ** | ** **      | ** ** | **TOTAL**              | ** ** |
| ** **                                             | ** ** | **STOCK**  | ** ** | **PAID-IN**    | ** ** | **RETAINED** | ** ** | **COMPREHENSIVE** | ** ** | **TREASURY**    | ** ** | **SHAREHOLDERS’** | ** ** |
| **(In Thousands, Except Per Share Data)**              | ** ** | **SHARES** | ** ** | **AMOUNT**     | ** ** | **CAPITAL**  | ** ** | **EARNINGS**      | ** ** | **LOSS**        | ** ** | **STOCK**              | ** ** | **EQUITY** | ** ** |
| Balance,  December 31, 2008                       |       | 4,010,528  |       | $              | 33,421     |         | $          | 17,959            |       | $               | 28,177     |                   | $          | (12,266    | )          | $ | (6,264 | ) | $ | 61,027 |   |
|                                                   |       |       |       |           |       |         |       |              |       |            |       |                   |       |       |       |
| Comprehensive income  (loss):                          |       |       |       |           |       |         |       |              |       |            |       |                   |       |       |       |
| Net income                                             |       |       |       |           |       |         |       | 1,671             |       |            |       |                   |       | 1,671      |       |
| Other comprehensive  income (loss)                     |       |       |       |           |       |         |       |              |       | 2,163           |       |                   |       | 2,163      |       |
| Dividends declared  ($0.92 per share)                  |       |       |       |           |       |         |       | (3,526            | )          |            |       |                   |       | (3,526     | )          |
| Common shares issued for  employee stock purchase plan |       | 1,457      |       | 12             |       | 24           |       |              |       |            |       |                   |       | 36         |       |
| Balance, June 30,  2009                           |       | 4,011,985  |       | $              | 33,433     |         | $          | 17,983            |       | $               | 26,322     |                   | $          | (10,103    | )          | $ | (6,264 | ) | $ | 61,371 |   |

 
| ** **                                                             | ** ** | ** ** | ** ** | ** **     | ** ** | ** **   | ** ** | ** **        | ** ** | **ACCUMULATED** | ** ** | ** **             | ** ** | ** ** | ** ** |
|------------------------------------------------------------------------|------------|------------|------------|----------------|------------|--------------|------------|-------------------|------------|-----------------|------------|------------------------|------------|------------|------------|
| ** **                                                             | ** ** | **COMMON** | ** ** | **ADDITIONAL** | ** ** | ** **   | ** ** | **OTHER**         | ** ** | ** **      | ** ** | **TOTAL**              | ** ** |
| ** **                                                             | ** ** | **STOCK**  | ** ** | **PAID-IN**    | ** ** | **RETAINED** | ** ** | **COMPREHENSIVE** | ** ** | **TREASURY**    | ** ** | **SHAREHOLDERS’** | ** ** |
| **(In Thousands, Except Per Share Data)**                              | ** ** | **SHARES** | ** ** | **AMOUNT**     | ** ** | **CAPITAL**  | ** ** | **EARNINGS**      | ** ** | **LOSS**        | ** ** | **STOCK**              | ** ** | **EQUITY** | ** ** |
| Balance,  December 31, 2007                                       |       | 4,006,934  |       | $              | 33,391     |         | $          | 17,888            |       | $               | 27,707     |                   | $          | (3,534     | )          | $ | (4,893 | ) | $ | 70,559 |   |
|                                                                   |       |       |       |           |       |         |       |              |       |            |       |                   |       |       |       |
| Cumulative effect of  change in accounting for postretirement benefits |       |       |       |           |       |         |       | (437              | )          |            |       |                   |       | (437       | )          |
| Comprehensive loss:                                                    |       |       |       |           |       |         |       |              |       |            |       |                   |       |       |       |
| Net income                                                             |       |       |       |           |       |         |       | 4,188             |       |            |       |                   |       | 4,188      |       |
| Other comprehensive loss                                               |       |       |       |           |       |         |       |              |       | (5,701          | )          |                   |       | (5,701     | )          |
| Dividends declared,  ($0.92 per share)                                 |       |       |       |           |       |         |       | (3,560            | )          |            |       |                   |       | (3,560     | )          |
| Stock options exercised                                                |       | 330        |       | 3              |       | 8            |       |              |       |            |       |                   |       | 11         |       |
| Common shares issued for  employee stock purchase plan                 |       | 1,569      |       | 13             |       | 34           |       |              |       |            |       |                   |       | 47         |       |
| Purchase of treasury  stock (18,516 shares)                            |       |       |       |           |       |         |       |              |       |            |       | (585                   | )          | (585       | )          |
| Balance, June 30,  2008                                           |       | 4,008,833  |       | $              | 33,407     |         | $          | 17,930            |       | $               | 27,898     |                   | $          | (9,235     | )          | $ | (5,478 | ) | $ | 64,522 |   |

 

PENNSWOODS BANCORP, INC.

CONSOLIDATEDSTATEMENT OF COMPREHENSIVE INCOME

(UNAUDITED)

 
| ** **                                                                 | ** ** | **Three  Months Ended June 30,** | ** ** | **Six  Months Ended June 30,** | ** ** |
|----------------------------------------------------------------------------|------------|---------------------------------------|------------|-------------------------------------|------------|
| **(In  Thousands)**                                                        | ** ** | **2009**                              | ** ** | **2008**                            | ** ** | **2009** | ** ** | **2008** | ** ** |
|                                                                       |       |                                  |       |                                |       |   |   |   |   |   |   |   |   |   |   |   |   |
| Net  Income                                                                |       |                                  |       | $                                   | 832        |   |   |   | $ | 2,057 |   |   |   | $ | 1,671 |   |   |   | $ | 4,188 |   |
| Other  comprehensive income (loss):                                        |       |                                  |       |                                |       |   |   |   |   |   |   |   |   |   |   |   |   |
| Change  in net unrealized gains (losses) on available for sale securities  |       | 3,520                                 |       |                                |       | (7,061 | ) |   |   | (1,178 | ) |   |   | (8,852 | ) |   |   |
| Less:  Reclassification adjustment for net losses included in net income   |       | (2,086                                | )          |                                |       | (251 | ) |   |   | (4,455 | ) |   |   | (213 | ) |   |   |
| Other  comprehensive income (loss) before tax expense (benefit)            |       |                                  |       | 5,606                               |       |   |   | (6,810 | ) |   |   | 3,277 |   |   |   | (8,639 | ) |
| Income  tax expense (benefit) related to other comprehensive income (loss) |       |                                  |       | 1,906                               |       |   |   | (2,315 | ) |   |   | 1,114 |   |   |   | (2,938 | ) |
| Other  comprehensive income (loss), net of tax                             |       |                                  |       | 3,700                               |       |   |   | (4,495 | ) |   |   | 2,163 |   |   |   | (5,701 | ) |
| Comprehensive  income (loss)                                               |       |                                  |       | $                                   | 4,532      |   |   |   | $ | (2,438 | ) |   |   | $ | 3,834 |   |   |   | $ | (1,513 | ) |

 

Seeaccompanying notes to the unaudited consolidated financial statements.

 

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PENNS WOODS BANCORP, INC.

CONSOLIDATED STATEMENT OF CASH FLOWS

(UNAUDITED)

 
| ** **                                                                         | ** ** | **Six  Months Ended** | ** ** |
|------------------------------------------------------------------------------------|------------|-----------------------|------------|
| ** **                                                                         | ** ** | **June 30,**     | ** ** |
| **(In  Thousands)**                                                                | ** ** | **2009**              | ** ** | **2008** | ** ** |
|                                                                               |       |                  |       |   |   |
| OPERATING ACTIVITIES                                                               |       |                  |       |   |   |
| Net Income                                                                         |       | $                     | 1,671      |   | $ | 4,188 |   |
| Adjustments to  reconcile net income to net cash provided by operating activities: |       |                  |       |   |   |
| Depreciation and  amortization                                                     |       | 364                   |       | 323 |   |
| Provision for loan  losses                                                         |       | 312                   |       | 120 |   |
| Accretion and  amortization of investment security discounts and premiums          |       | (518                  | )          | (636 | ) |
| Securities losses, net                                                             |       | 4,455                 |       | 213 |   |
| Originations of loans held  for sale                                               |       | (10,202               | )          | (16,137 | ) |
| Proceeds of loans held  for sale                                                   |       | 9,450                 |       | 17,125 |   |
| Gain on sale of loans                                                              |       | (221                  | )          | (364 | ) |
| Earnings on bank-owned  life insurance                                             |       | (274                  | )          | (246 | ) |
| Other, net                                                                         |       | (1,327                | )          | (1,465 | ) |
| Net cash provided by  operating activities                                         |       | 3,710                 |       | 3,121 |   |
| INVESTING ACTIVITIES                                                               |       |                  |       |   |   |
| Investment securities  available for sale:                                         |       |                  |       |   |   |
| Proceeds from sales                                                                |       | 4,682                 |       | 36,098 |   |
| Proceeds from calls and  maturities                                                |       | 5,132                 |       | 5,139 |   |
| Purchases                                                                          |       | (9,955                | )          | (45,132 | ) |
| Investment securities  held to maturity:                                           |       |                  |       |   |   |
| Proceeds from calls and  maturities                                                |       | 26                    |       | 154 |   |
| Net increase in loans                                                              |       | (11,501               | )          | (5,520 | ) |
| Acquisition of bank  premises and equipment                                        |       | (155                  | )          | (998 | ) |
| Proceeds from the sale  of foreclosed assets                                       |       | —                |       | 70 |   |
| Purchase of bank-owned  life insurance                                             |       | (42                   | )          | (698 | ) |
| Investment in limited  partnership                                                 |       | (738                  | )          | — |   |
| Proceeds from  redemption of regulatory stock                                      |       | —                |       | 3,560 |   |
| Purchases of regulatory  stock                                                     |       | (170                  | )          | (1,996 | ) |
| Net cash used for  investing activities                                            |       | (12,721               | )          | (9,323 | ) |
| FINANCING ACTIVITIES                                                               |       |                  |       |   |   |
| Net increase in  interest-bearing deposits                                         |       | 75,159                |       | 43,662 |   |
| Net (decrease) increase  in noninterest-bearing deposits                           |       | (1,526                | )          | 5,237 |   |
| Repayment of long-term  borrowings, FHLB                                           |       | —                |       | (29,600 | ) |
| Net decrease in  short-term borrowings                                             |       | (59,066               | )          | (7,234 | ) |
| Dividends paid                                                                     |       | (3,526                | )          | (3,560 | ) |
| Issuance of common  stock                                                          |       | 36                    |       | 47 |   |
| Stock options exercised                                                            |       | —                |       | 11 |   |
| Purchase of treasury  stock                                                        |       | —                |       | (585 | ) |
| Net cash provided by  financing activities                                         |       | 11,077                |       | 7,978 |   |
| NET NCREASE IN CASH AND  CASH EQUIVALENTS                                          |       | 2,066                 |       | 1,776 |   |
| CASH AND CASH  EQUIVALENTS, BEGINNING                                              |       | 16,581                |       | 15,433 |   |
| CASH AND CASH  EQUIVALENTS, ENDING                                                 |       | $                     | 18,647     |   | $ | 17,209 |   |
|                                                                               |       |                  |       |   |   |
| SUPPLEMENTAL  DISCLOSURES OF CASH FLOW INFORMATION                                 |       |                  |       |   |   |
|                                                                               |       |                  |       |   |   |
| Interest paid                                                                      |       | $                     | 6,385      |   | $ | 8,228 |   |
| Income taxes paid                                                                  |       | 1,175                 |       | 1,075 |   |
| Transfer of loans to  foreclosed real estate                                       |       | 614                   |       | — |   |

 

See accompanying notes tothe unaudited consolidated financial statements.

 

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

**NOTES TO**

** CONSOLIDATED FINANCIAL STATEMENTS**

**(Unaudited)**

 

# **Note 1.  Basis of Presentation**

# ** **

# **The consolidated financial statementsinclude the accounts of Penns Woods Bancorp, Inc. (the “Company”) and itswholly-owned subsidiaries: Woods Investment Company, Inc., Woods RealEstate Development Company, Inc., and Jersey Shore State Bank (the “Bank”)and its wholly-owned subsidiary, The M Group, Inc. D/B/A The ComprehensiveFinancial Group (“The M Group”).  Allsignificant inter-company balances and transactions have been eliminated in theconsolidation.**

# ** **

The interim financialstatements are unaudited but, in the opinion of management, reflect alladjustments necessary for the fair presentation of results for suchperiods.  The results of operations forany interim period are not necessarily indicative of results for the full year.  These financial statements should be read inconjunction with financial statements and notes thereto contained in theCompany’s Annual Report on Form 10-K for the year ended December 31,2008.

 

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 through 44 of the Annual Report on Form 10-Kfor the year ended December 31, 2008.

 

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

 

**Note 2. RecentAccounting Pronouncements**

** **

In April 2009, the FASB issued FASB StaffPosition (“FSP”) No. FAS 141(R)-1, *Accounting for AssetsAcquired and Liabilities Assumed in a Business Combination That Arise fromContingencies*(“FAS 141(R)-1”).* *This FSP requires companiesacquiring contingent assets or assuming contingent liabilities in businesscombination to either (a) if the assets’ or liabilities’ fair value can bedetermined, recognize them at fair value, at the acquisition date, or (b) ifthe assets’ or liabilities’ fair value cannot be determined, but (i) it isprobable that an asset existed or that a liability had been incurred at theacquisition date and (ii) the amount of the asset or liability can be reasonablyestimated, recognize them at their estimated amount, at the acquisitiondate.  If the fair value of thesecontingencies cannot be determined and they are not probable or cannot bereasonably estimated, then companies should not recognize these contingenciesas of the acquisition date and instead should account for them in subsequentperiods by following other applicable GAAP. This FSP also eliminates the FAS 141(R)-1 requirement of disclosing inthe footnotes to the financial statements the range of expected outcomes for arecognized contingency.  This FSP shallbe effective for assets or liabilities arising from contingencies in businesscombinations for which the acquisition date is on or after the beginning of thefirst annual reporting period beginning on or after December 15,2008.  The adoption of this FSP has

 

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not and is not expected to have a material effect onthe Company’s results of operations or financial position.

 

In April 2009, the FASBissued FSP No. FAS 157-4, *Determining Fair ValueWhen the Volume and Level of Activity for the Asset or Liability HaveSignificantly Decreased and Identifying Transactions That Are Not Orderly*(“FAS157-4”).  This FSP relates to determiningfair values when there is no active market or where the price inputs being usedrepresent distressed sales.  It reaffirmsthe need to use judgment to ascertain if a formerly active market has becomeinactive and in determining fair values when markets have become inactive. FAS157-4 is effective for interim and annual periods ending after June 15,2009, but entities may early adopt this FSP for the interim and annual periodsending after March 15, 2009. The adoption of this FSP has not and is notexpected to have a material effect on the Company’s results of operations orfinancial position.

 

In April 2009, the FASBissued FSP No. FAS 107-1 and APB 28-1, *Interim Disclosures aboutFair Value of Financial Instruments*(“FAS 107-1 and APB 28-1”),which relates to fair value disclosures for any financial instruments that arenot currently reflected on the balance sheet of companies at fair value.  Prior to issuing this FSP, fair values forthese assets and liabilities were only disclosed once a year. The FSP nowrequires these disclosures on a quarterly basis, providing qualitative andquantitative information about fair value estimates for all those financialinstruments not measured on the balance sheet at fair value.  FAS 107-1 and APB 28-1 is effective forinterim and annual periods ending after June 15, 2009, but entities mayearly adopt this FSP for the interim and annual periods ending after March 15,2009.  The adoption of this FSP has notand is not expected to have a material effect on the Company’s results ofoperations or financial position.

 

In April 2009, the FASBissued FSP No. FAS 115-2 and FAS 124-2, *Recognitionand Presentation of Other-Than-Temporary Impairments*(“FAS 115-2 andFAS 124-2”), which provides additional guidance designed to create greaterclarity and consistency in accounting for and presenting impairment losses onsecurities.  FAS 115-2 and FAS 124-2 areeffective for interim and annual periods ending after June 15, 2009, butentities may early adopt this FSP for the interim and annual periods endingafter March 15, 2009.  The adoptionof this FSP has not and is not expected to have a material effect on theCompany’s results of operations or financial position.

 

In May 2009, the FASBissued FAS No. 165, *Subsequent Events*(“FAS 165”), which requires companies to evaluate events and transactions thatoccur after the balance sheet date but before the date the financial statementsare issued, or available to be issued in the case of non-publicentities.  FAS 165 requires entities to recognize in the financialstatements the effect of all events or transactions that provide additionalevidence of conditions that existed at the balance sheet date, including theestimates inherent in the financial preparation process.  Entitiesshall not recognize the impact of events or transactions that provide evidenceabout conditions that did not exist at the balance sheet date but arose afterthat date.  FAS 165 also requires entities to disclose the datethrough which subsequent events have been evaluated.  FAS 165 waseffective for interim and annual reporting periods ending after June 15,2009.  The Company adopted the

 

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provisions of FAS 165 forthe quarter ended June 30, 2009, as required, and adoption did not have amaterial impact on Company’s results of operations or financial position.

 

In June 2009, the FASBissued FAS No. 166, *Accounting for Transfersof Financial Assets* (“FAS 166”). FAS 166 removes the concept of aqualifying special-purpose entity (QSPE) from FAS No. 140, *Accounting for Transfers and Servicing of Financial Assets andExtinguishment of Liabilities*, and removes the exception fromapplying FIN 46(R). This statement also clarifies the requirements forisolation and limitations on portions of financial assets that are eligible forsale accounting. This statement is effective for fiscal years beginning after November 15,2009. As such, the Company plans to adopt FAS 166 effective January 1,2010. The adoption of this standard is not expected to have a material effecton the Company’s results of operations or financial position.

 

In June 2009, the FASB issued FAS No. 167, *Amendments to FASB Interpretation No. 46(R) *(“FAS167”). FAS 167, which amends FASB Interpretation No. 46 (revised December 2003),*Consolidation of Variable Interest Entities*,(FIN 46(R)), prescribes a qualitative model for identifying whether a companyhas a controlling financial interest in a variable interest entity (VIE) andeliminates the quantitative model prescribed by FIN 46(R). The new modelidentifies two primary characteristics of a controlling financial interest: (1) itprovides a company with the power to direct significant activities of the VIE,and (2) it obligates a company to absorb losses of and/or provides rightsto receive benefits from the VIE. FAS 167 requires a company to reassess on anongoing basis whether it holds a controlling financial interest in a VIE. Acompany that holds a controlling financial interest is deemed to be the primarybeneficiary of the VIE and is required to consolidate the VIE. This statementis effective for fiscal years beginning after November 15, 2009. Theadoption of this standard is not expected to have a material effect on theCompany’s results of operations or financial position.

 

In June 2009, the FASB issued FAS No. 168, *The ‘FASB Accounting Standards Codification’ and the Hierarchy ofGenerally Accepted Accounting Principles* (“FAS 168”). FAS No. 168establishes the *FASB Accounting Standards Codification*(Codification), which was officially launched on July 1, 2009, and becamethe primary source of authoritative U.S. GAAP recognized by the FASB to beapplied by nongovernmental entities. Rules and interpretive releases ofthe Securities and Exchange Commission (SEC) under the authority of Federalsecurities laws are also sources of authoritative GAAP for SEC registrants. Thesubsequent issuances of new standards will be in the form of AccountingStandards Updates that will be included in the Codification. FAS No. 168is effective for financial statements issued for interim and annual periodsending after September 15, 2009. As such, the Company plans to adopt FASNo.168 in connection with its third quarter 2009 reporting. As the Codificationis neither expected nor intended to change GAAP, the adoption of FAS 168 willnot have a material impact on its results of operations or financial position.

 

**Note 3. Per Share Data**

 

There are no convertible securities which would affectthe denominator in calculating basic and dilutive earnings per share;therefore, net income as presented on the consolidated statement of income willbe used as the numerator.  The followingtable sets forth the composition of the

 

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weighted average common shares (denominator) used in thebasic and dilutive per share computation.

 
| ** **                                                                                                 | ** ** | **Three  Months Ended June 30,** | ** ** | **Six  Months Ended June 30,** | ** ** |
|------------------------------------------------------------------------------------------------------------|------------|---------------------------------------|------------|-------------------------------------|------------|
| ** **                                                                                                 | ** ** | **2009**                              | ** ** | **2008**                            | ** ** | **2009** | ** ** | **2008** | ** ** |
|                                                                                                       |       |                                  |       |                                |       |   |   |   |   |
| Weighted  average common shares issued                                                                     |       | 4,011,548                             |       | 4,008,030                           |       | 4,011,163 |   | 4,007,603 |   |
|                                                                                                       |       |                                  |       |                                |       |   |   |   |   |
| Average  treasury stock shares                                                                             |       | (179,028                              | )          | (142,053                            | )          | (179,028 | ) | (137,244 | ) |
|                                                                                                       |       |                                  |       |                                |       |   |   |   |   |
| Weighted  average common shares and common stock equivalents used to calculate basic  earnings per share   |       | 3,832,520                             |       | 3,865,977                           |       | 3,832,135 |   | 3,870,359 |   |
|                                                                                                       |       |                                  |       |                                |       |   |   |   |   |
| Additional  common stock equivalents (stock options) used to calculate diluted earnings  per share         |       | 76                                    |       | 138                                 |       | 38 |   | 164 |   |
|                                                                                                       |       |                                  |       |                                |       |   |   |   |   |
| Weighted  average common shares and common stock equivalents used to calculate diluted  earnings per share |       | 3,832,596                             |       | 3,866,115                           |       | 3,832,173 |   | 3,870,523 |   |

 

Options to purchase 990 shares of common stock wereoutstanding during the three and six months ended June 30, 2009 but werenot included in the computation of diluted earnings per share as they wereanti-dilutive due to the strike price of $31.82 being greater than the averagemarket price of $28.00 and $26.31 for the three and six months ended June 30,2009.  Options to purchase 8,273 and9,923 shares of common stock were outstanding during the three and six months endedJune 30, 2008 but were not included in the computation of diluted earningsper share as they were anti-dilutive due to the strike price being greater thanthe average market price for the three and six months ended June 30, 2008.

 

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

 

For a detailed disclosure on the Company’s pension andemployee benefits plans, please refer to Note 11 of the Company’s ConsolidatedFinancial Statements included in the Annual Report on Form 10-K for theyear ended December 31, 2008.

 

The following sets forth the components of the netperiodic benefit cost of the domestic non-contributory defined benefit plan forthe three and six months ended June 30, 2009 and 2008, respectively:

 

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| ** **                             | ** ** | **Three  Months Ended** | ** ** | **Six  Months Ended** | ** ** |
|----------------------------------------|------------|-------------------------|------------|-----------------------|------------|
| ** **                             | ** ** | **June 30,**       | ** ** | **June 30,**     | ** ** |
| **(In  Thousands)**                    | ** ** | **2009**                | ** ** | **2008**              | ** ** | **2009** | ** ** | **2008** | ** ** |
|                                   |       |                    |       |                  |       |   |   |   |   |
| Service  cost                          |       | $                       | 136        |                  | $          | 136 |   | $ | 272 |   | $ | 273 |   |
| Interest  cost                         |       | 170                     |       | 152                   |       | 340 |   | 304 |   |
| Expected  return on plan assets        |       | (127                    | )          | (163                  | )          | (254 | ) | (320 | ) |
| Amortization  of transition obligation |       | —                  |       | —                |       | (1 | ) | (1 | ) |
| Amortization  of prior service cost    |       | 7                       |       | 7                     |       | 13 |   | 13 |   |
| Amortization  of net loss              |       | 84                      |       | 14                    |       | 169 |   | 28 |   |
| Net  periodic cost                     |       | $                       | 270        |                  | $          | 146 |   | $ | 539 |   | $ | 297 |   |

 

**Employer Contributions**

** **

The Company previously disclosed in its consolidatedfinancial statements, included in the Annual Report on Form 10-K for theyear ended December 31, 2008, that it expected to contribute a minimum of$325,000 to its defined benefit plan in 2009.  As of June 30, 2009,there were contributions $519,000 made to the plan.  The Company expects to contribute a minimumof $287,000 to the defined benefit plan during the remaining period of 2009.

 

**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.  Thesefinancial instruments are primarily comprised of commitments to extend creditand 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 theseinstruments express the extent of involvement the Company has in particularclasses 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 credit policies in making commitments andconditional obligations as it does for on-balance sheet instruments.  The Company may require collateral or othersecurity to support financial instruments with off-balance sheet credit risk.

 

Financial instruments whose contract amountsrepresent credit risk are as follows at June 30, 2009 and December 31,2008:

 
| ** **                    | ** ** | **June 30,** | ** ** | **December 31,** | ** ** |
|-------------------------------|------------|-------------------|------------|-----------------------|------------|
| **(In  Thousands)**           | ** ** | **2009**          | ** ** | **2008**              | ** ** |
| Commitments  to extend credit |       | $                 | 88,763     |                  | $          | 85,871 |   |
| Standby  letters of credit    |       | 1,532             |       | 841                   |       |
|                               |            |                   |            |                       |            |  |  |

 

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# **Commitments to extend credit arelegally binding agreements to lend to customers.  Commitments generally have fixed expirationdates or other termination clauses and may require payment of fees.  Since many of the commitments are expected toexpire without being drawn upon, the total commitment amounts do notnecessarily represent future liquidity requirements.  The Company evaluates each customer’s creditworthiness on a case-by-case basis.  Theamount of collateral obtained, if deemed necessary by the Company, on anextension of credit is based on management’s credit assessment of thecounterparty.**

# ** **

# **Standby letters of credit representconditional commitments issued by the Company to guarantee the performance of acustomer to a third party.  Theseinstruments are issued primarily to support bid or performance relatedcontracts.  The coverage period for theseinstruments is typically a one year period with an annual renewal optionsubject to prior approval by management. Fees earned from the issuance of these letters are recognized uponexpiration of the coverage period.  Forsecured letters of credit, the collateral is typically Bank deposit instrumentsor customer business assets.**

# ** **

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

# ** **

Certain comparativeamounts for the prior period have been reclassified to conform to currentperiod presentations. Such reclassifications had no effect on net income orshareholders’ equity.

 

# **Note 7.  Employee Stock PurchasePlan**

# ** **

TheCompany maintains the Penns Woods Bancorp, Inc. 2006 Employee StockPurchase Plan (“Plan”). The Plan is intended to encourage employeeparticipation in the ownership and economic progress of the Company. The Planallows for up to 1,000,000 shares to be purchased by employees.  The purchase price of the shares is 95% ofmarket value with an employee eligible to purchase up to the lesser of 15% ofbase compensation or $12,000 in market value annually.  During the six months ended June 30,2009 and 2008, there were 1,457 and 1,569 shares issued under the plan,respectively.

 

# **Note 8.  Fair Value Measurements**

# ** **

Effective January 1, 2008, the Company adoptedthe provisions of FAS No. 157, *Fair Value Measurements*(“FAS157”), for financial assets and financial liabilities.  FAS 157 provides enhanced guidance for usingfair value to measure assets and liabilities. The standard applies whenever other standards require or permit assetsor liabilities to be measured at fair value. The standard does not expand the use of fair value in any newcircumstances.  The FASB issued StaffPosition No. 157-1, *Application of FASBStatement No. 157 to FASB Statement No. 13 and Other AccountingPronouncements That Address Fair Value Measurements for Purposes of LeaseClassification or Measurement under Statement 13*, which removedleasing transactions accounted for under FAS 13 and related guidance from thescope of FAS No. 157.  The FASB alsoissued Staff Position No. 157-2, *Partial Deferral of theEffective Date of Statement 157*, which deferred the effective dateof FAS 157 for all nonfinancial assets and nonfinancial liabilities to fiscalyears beginning after November 15, 2008.

 

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FAS 157 establishes a hierarchal disclosure frameworkassociated with the level of pricing observability utilized in measuring assetsand liabilities at fair value. The three broad levels defined by FAS 157hierarchy are as follows:

 
| Level  I:   |   | Quoted  prices are available in active markets for identical assets or liabilities as  of the reported date.                                                                                                                                                                                                                                                                                    |
|-------------|--------|-------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
|        |   |                                                                                                                                                                                                                                                                                                                                                                                            |
| Level  II:  |   | Pricing  inputs are other than quoted prices in active markets, which are either  directly or indirectly observable as of the reported date. The nature of  these assets and liabilities include items for which quoted prices are  available but traded less frequently, and items that are fair valued using  other financial instruments, the parameters of which can be directly  observed. |
|        |   |                                                                                                                                                                                                                                                                                                                                                                                            |
| Level  III: |   | Assets  and liabilities that have little to no pricing observability as of the  reported date. These items do not have two-way markets and are measured using  management’s best estimate of fair value, where the inputs into the  determination of fair value require significant management judgment or  estimation.                                                                    |

 

Thefollowing table presents the assets reported on the balance sheet at their fairvalue on a recurring basis as of June 30, 2009 and December 31, 2008,by level within the fair value hierarchy. As required by FAS 157, financialassets and liabilities are classified in their entirety based on the lowestlevel of input that is significant to the fair value measurement.

 
| ** **                                 | ** ** | **June 30,  2009** | ** ** |
|--------------------------------------------|------------|-------------------------|------------|
| **(In  Thousands)**                        | ** ** | **Level  I**            | ** ** | **Level  II** | ** ** | **Level  III** | ** ** | **Total** | ** ** |
| Assets Measured on a  Recurring Basis:     |       |                    |       |   |   |   |   |   |   |
| Investment Securities,  available-for-sale |       | $                       | 11,728     |   | $ | 196,173 |   | $ | — |   | $ | 207,901 |   |
|                                            |            |                         |            |  |  |  |  |  |  |  |  |  |  |

 
| ** **                                 | ** ** | **December 31,  2008** | ** ** |
|--------------------------------------------|------------|-----------------------------|------------|
| **(In  Thousands)**                        | ** ** | **Level  I**                | ** ** | **Level  II** | ** ** | **Level  III** | ** ** | **Total** | ** ** |
| Assets Measured on a  Recurring Basis:     |       |                        |       |   |   |   |   |   |   |
| Investment Securities,  available-for-sale |       | $                           | 13,269     |   | $ | 194,982 |   | $ | — |   | $ | 208,251 |   |
|                                            |            |                             |            |  |  |  |  |  |  |  |  |  |  |

 

Thefollowing table presents the assets reported on the balance sheet at their fairvalue on a non-recurring basis as of June 30, 2009 and December 31,2008, by level within the fair value hierarchy. As required by FAS 157,financial assets and liabilities are classified in their entirety based on thelowest level of input that is significant to the fair value measurement.

 
| ** **                                 | ** ** | **June 30,  2009** | ** ** |
|--------------------------------------------|------------|-------------------------|------------|
| **(In  Thousands)**                        | ** ** | **Level  I**            | ** ** | **Level  II** | ** ** | **Level  III** | ** ** | **Total** | ** ** |
| Assets Measured on a  Non-recurring Basis: |       |                    |       |   |   |   |   |   |   |
| Impaired Loans                             |       | $                       | —     |   | $ | 6,044 |   | $ | — |   | $ | 6,044 |   |
|                                            |            |                         |            |  |  |  |  |  |  |  |  |  |  |

 
| ** **                                 | ** ** | **December 31,  2008** | ** ** |
|--------------------------------------------|------------|-----------------------------|------------|
| **(In  Thousands)**                        | ** ** | **Level  I**                | ** ** | **Level  II** | ** ** | **Level  III** | ** ** | **Total** | ** ** |
| Assets Measured on a  Non-recurring Basis: |       |                        |       |   |   |   |   |   |   |
| Impaired Loans                             |       | $                           | —     |   | $ | 4,876 |   | $ | — |   | $ | 4,876 |   |
|                                            |            |                             |            |  |  |  |  |  |  |  |  |  |  |

 

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**NOTE 9. ESTIMATED FAIR VALUE OF FINANCIAL INSTRUMENTS**

 

TheCompany is required to disclose estimated fair values for its financialinstruments.  Fair value estimates aremade at a specific point in time, based on relevant market information andinformation about the financial instrument. These estimates do not reflect any premium or discount that could resultfrom offering for sale at one time the Company’s entire holdings of aparticular financial instrument.  Also,it is the Company’s general practice and intention to hold most of itsfinancial instruments to maturity and not to engage in trading or salesactivities.  Because no market exists fora significant portion of the Company’s financial instruments, fair valueestimates are based on judgments regarding future expected loss experience,current economic conditions, risk characteristics of various financialinstruments, and other factors.  Theseestimates are subjective in nature and involve uncertainties and matters ofsignificant judgment and therefore cannot be determined with precision.  Changes in assumptions can significantlyaffect the estimates.

 

Estimatedfair values have been determined by the Company using historical data and anestimation methodology suitable for each category of financialinstruments.  The Company’s fair valueestimates, methods, and assumptions are set forth below for the Company’s otherfinancial instruments.

 

Ascertain assets and liabilities, such as deferred tax assets, premises andequipment, and many other operational elements of the Company, are notconsidered financial instruments but have value, this estimated fair value offinancial instruments would not represent the full market value of the Company.

 

Theestimated fair values of the Company’s financial instruments are as follows at June 30,2009 and December 31, 2008:

 
| ** **                    | ** ** | **June 30,  2009** | ** ** | **December 31,  2008** | ** ** |
|-------------------------------|------------|-------------------------|------------|-----------------------------|------------|
| ** **                    | ** ** | **Carrying**            | ** ** | **Fair**                    | ** ** | **Carrying** | ** ** | **Fair** | ** ** |
| **(In  Thousands)**           | ** ** | **Value**               | ** ** | **Value**                   | ** ** | **Value** | ** ** | **Value** | ** ** |
| Financial  assets:            |       |                    |       |                        |       |   |   |   |   |
| Cash  and cash equivalents    |       | $                       | 18,647     |                        | $          | 18,647 |   | $ | 16,581 |   | $ | 16,581 |   |
| Investment  securities:       |       |                    |       |                        |       |   |   |   |   |
| Available  for sale           |       | 207,901                 |       | 207,901                     |       | 208,251 |   | 208,251 |   |
| Held  to maturity             |       | 110                     |       | 111                         |       | 135 |   | 136 |   |
| Loans  held for sale          |       | 4,595                   |       | 4,595                       |       | 3,622 |   | 3,622 |   |
| Loans,  net                   |       | 387,697                 |       | 394,297                     |       | 377,122 |   | 380,771 |   |
| Bank-owned  life insurance    |       | 14,862                  |       | 14,862                      |       | 14,546 |   | 14,546 |   |
| Accrued  interest receivable  |       | 3,468                   |       | 3,468                       |       | 3,614 |   | 3,614 |   |
|                          |       |                    |       |                        |       |   |   |   |   |
| Financial  liabilities:       |       |                    |       |                        |       |   |   |   |   |
| Interest-bearing  deposits    |       | $                       | 420,492    |                        | $          | 423,268 |   | $ | 345,333 |   | $ | 347,657 |   |
| Noninterest-bearing  deposits |       | 74,509                  |       | 74,509                      |       | 76,035 |   | 76,035 |   |
| Short-term  borrowings        |       | 14,880                  |       | 14,880                      |       | 73,946 |   | 73,946 |   |
| Long-term  borrowings, FHLB   |       | 86,778                  |       | 85,772                      |       | 86,778 |   | 88,188 |   |
| Accrued  interest payable     |       | 1,220                   |       | 1,220                       |       | 1,317 |   | 1,317 |   |

 

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**Cash and Cash Equivalents,Loans Held for Sale, Accrued Interest Receivable, Short-term Borrowings, andAccrued Interest Payable:**

 

Thefair value is equal to the carrying value.

 

**Investment Securities:**

 

Thefair value of investment securities available for sale and held to maturity isequal to the available quoted market price. If no quoted market price isavailable, fair value is estimated using the quoted market price for similarsecurities.  Regulatory stocks’ fairvalue is equal to the carrying value.

 

**Loans:**

 

Fairvalues are estimated for portfolios of loans with similar financialcharacteristics.  Loans are segregated bytype such as commercial, commercial real estate, residential real estate,construction real estate, and other consumer. Each loan category is further segmented into fixed and adjustable rateinterest terms and by performing and nonperforming categories.

 

The fair value of performing loans is calculatedby discounting scheduled cash flows through the estimated maturity usingestimated market discount rates that reflect the credit and interest rate riskinherent in the loan.  The estimate ofmaturity is based on the Company’s historical experience with repayments foreach loan classification, modified, as required, by an estimate of the effectof current economic and lending conditions.

 

Fairvalue for significant nonperforming loans is based on recent externalappraisals.  If appraisals are notavailable, estimated cash flows are discounted using a rate commensurate withthe risk associated with the estimated cash flows.  Assumptions regarding credit risk, cashflows, and discounted rates are judgmentally determined using available marketinformation and specific borrower information.

 

**Bank-Owned Life Insurance:**

 

Thefair value is equal to the cash surrender value of the life insurance policies.

 

**Deposits:**

 

Thefair value of deposits with no stated maturity, such as noninterest-bearingdemand deposits, savings, NOW, and money market accounts, is equal to theamount payable on demand as of June 30, 2009 and December 31,2008.  The fair value of certificates ofdeposit is based on the discounted value of contractual cash flows.

 

Thefair value estimates above do not include the benefit that results from thelow-cost funding provided by the deposit liabilities compared to the cost ofborrowing funds in the market, commonly referred to as the core depositintangible.

 

**LongTerm Borrowings:**

 

Thefair value of long term borrowings is based on the discounted value ofcontractual cash flows.

 

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**Commitments to Extend Credit,Standby Letters of Credit, and Financial Guarantees Written:**

 

There is no material difference between the notional amount and theestimated fair value of off-balance sheet items at June 30, 2009 and December 31,2008.  The contractual amounts ofunfunded commitments and letters of credit are presented in Note 5.

 

# **Note 10.  Federal Home Loan BankStock**

# ** **

TheBank is a member of the Federal Home Loan Bank of Pittsburgh (the “FHLB”),which is one of 12 regional Federal Home Loan Banks. Each Federal Home LoanBank serves as a reserve or central bank for its members within its assignedregion.  It is funded primarily from funds deposited by memberinstitutions and proceeds from the sale of consolidated obligations of theFederal Home Loan Bank System. It makes loans to members (i.e., advances) inaccordance with policies and procedures established by the board of directorsof the Federal Home Loan Bank.  As a member, the Bank is required topurchase and maintain stock in the FHLB in an amount equal to the greater of 1%of its aggregate unpaid residential mortgage loans, home purchase contracts orsimilar obligations at the beginning of each year or 5% of its outstandingadvances from the FHLB.  At June 30, 2009, the Bank held $7,271,300in stock of the FHLB, which was in compliance with this requirement.

 

The Company evaluated its holding of FHLB stockfor impairment and deemed the stock to not be impaired due to the expectedrecoverability of the par value, which equals the value reflected within theCompany’s financial statements.  Thedecision was based on several items ranging from the estimated true economiclosses embedded within the FHLB’s mortgage portfolio to the FHLB’s liquidityposition and credit rating.  The Companyutilizes the impairment framework outlined in paragraph 8(i) of SOP 01-06and paragraphs 12.21 — 12.25 of the AICPA Audit Guide for Depository andLending Institutions to evaluate FHLB stock for impairment.

 

The following factors were evaluated todetermine the ultimate recoverability of the par value of the Company’s FHLBstock holding; (i) the significance of the decline in net assets of theFHLB as compared to the capital stock amount for the FHLB and the length oftime this situation has persisted; (ii) commitments by the FHLB to makepayments required by law or regulation and the level of such payments inrelation to the operating performance of the FHLB; (iii) the impact oflegislative and regulatory changes on the institutions and, accordingly, on thecustomer base of the FHLB; (iv) the liquidity position of the FHLB; and (v) whethera decline is temporary or whether it affects the ultimate recoverability of theFHLB stock based on (a) the materiality of the carrying amount to themember institution and (b) whether an assessment of the institution’soperational needs for the foreseeable future allow management to dispose of thestock.

 

Based on its analysis of these factors, theCompany determined that its holding of FHLB stock was not impaired on June 30,2009.

 

**Note 11. Investment Securities**

 

The amortized cost andestimated fair values of investment securities at June 30, 2009 and December 31,2008 are as follows:

 

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| ** **                             | ** ** | **June 30,  2009** | ** ** |
|----------------------------------------|------------|-------------------------|------------|
| ** **                             | ** ** | ** **              | ** ** | **Gross** | ** ** | **Gross** | ** ** | **Estimated** | ** ** |
| ** **                             | ** ** | **Amortized**           | ** ** | **Unrealized** | **  ** | **Unrealized** | ** ** | **Fair** | ** ** |
| **(In  Thousands)**                    | ** ** | **Cost**                | ** ** | **Gains** | ** ** | **Losses** | ** ** | **Value** | ** ** |
| Available  for sale (AFS)              |       |                    |       |   |   |   |   |   |   |
| U.S.  Government and agency securities |       | $                       | 40,968     |   | $ | 1,690 |   | $ | — |   | $ | 42,658 |   |
| State  and political securities        |       | 143,057                 |       | 323 |   | (10,713 | ) | 132,667 |   |
| Other  debt securities                 |       | 21,463                  |       | 596 |   | (1,211 | ) | 20,848 |   |
| Total  debt securities                 |       | 205,488                 |       | 2,609 |   | (11,924 | ) | 196,173 |   |
| Equity  securities                     |       | 11,994                  |       | 425 |   | (691 | ) | 11,728 |   |
| Total  investment securities AFS       |       | $                       | 217,482    |   | $ | 3,034 |   | $ | (12,615 | ) | $ | 207,901 |   |
|                                   |       |                    |       |   |   |   |   |   |   |
| Held  to maturity (HTM)                |       |                    |       |   |   |   |   |   |   |
| U.S.  Government and agency securities |       | $                       | 9          |   | $ | 1 |   | $ | — |   | $ | 10 |   |
| Other  debt securities                 |       | 101                     |       | — |   | — |   | 101 |   |
| Total  investment securities HTM       |       | $                       | 110        |   | $ | 1 |   | $ | — |   | $ | 111 |   |

 
| ** **                             | ** ** | **December 31, 2008** | ** ** |
|----------------------------------------|------------|----------------------------|------------|
| ** **                             | ** ** | ** **                 | ** ** | **Gross** | ** ** | **Gross** | ** ** | **Estimated** | ** ** |
| ** **                             | ** ** | **Amortized**              | ** ** | **Unrealized** | **  ** | **Unrealized** | ** ** | **Fair** | ** ** |
| **(In Thousands)**                     | ** ** | **Cost**                   | ** ** | **Gains** | ** ** | **Losses** | ** ** | **Value** | ** ** |
| Available  for sale (AFS)              |       |                       |       |   |   |   |   |   |   |
| U.S.  Government and agency securities |       | $                          | 46,452     |   | $ | 1,134 |   | $ | — |   | $ | 47,586 |   |
| State  and political securities        |       | 142,258                    |       | 348 |   | (10,764 | ) | 131,842 |   |
| Other  debt securities                 |       | 15,970                     |       | 649 |   | (1,065 | ) | 15,554 |   |
| Total  debt securities                 |       | 204,680                    |       | 2,131 |   | (11,829 | ) | 194,982 |   |
| Equity  securities                     |       | 16,429                     |       | 225 |   | (3,385 | ) | 13,269 |   |
| Total  investment securities AFS       |       | $                          | 221,109    |   | $ | 2,356 |   | $ | (15,214 | ) | $ | 208,251 |   |
|                                   |       |                       |       |   |   |   |   |   |   |
| Held  to maturity (HTM)                |       |                       |       |   |   |   |   |   |   |
| U.S.  Government and agency securities |       | $                          | 10         |   | $ | 1 |   | $ | — |   | $ | 11 |   |
| Other  debt securities                 |       | 125                        |       | — |   | — |   | 125 |   |
| Total  investment securities HTM       |       | $                          | 135        |   | $ | 1 |   | $ | — |   | $ | 136 |   |

 

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Thefollowing tables show the Company’s gross unrealized losses and estimated fairvalue, aggregated by investment category and length of time, that theindividual securities have been in a continuous unrealized loss position, at June 30,2009 and December 31, 2008.

 
| ** **                             | ** ** | **June 30,  2009**      | ** ** |
|----------------------------------------|------------|------------------------------|------------|
| ** **                             | ** ** | **Less  than Twelve Months** | ** ** | **Twelve  Months or Greater** | ** ** | **Total** | ** ** |
| ** **                             | ** ** | **Estimated**                | ** ** | **Gross** | ** ** | **Estimated** | ** ** | **Gross** | ** ** | **Estimated** | ** ** | **Gross** | ** ** |
| ** **                             | ** ** | **Fair**                     | ** ** | **Unrealized** | ** ** | **Fair** | ** ** | **Unrealized** | ** ** | **Fair** | ** ** | **Unrealized** | ** ** |
| **(In  Thousands)**                    | ** ** | **Value**                    | ** ** | **Losses** | ** ** | **Value** | ** ** | **Losses** | ** ** | **Value** | ** ** | **Losses** | ** ** |
|                                   |       |                         |       |   |   |   |   |   |   |   |   |   |   |
| U.S.  Government and agency securities |       | $                            | —     |   | $ | — |   | $ | — |   | $ | — |   | $ | — |   | $ | — |   |
| State  and political securities        |       | 18,872                       |       | 502 |   | 94,980 |   | 10,211 |   | 113,852 |   | 10,713 |   |
| Other  debt securities                 |       | 354                          |       | 24 |   | 6,810 |   | 1,187 |   | 7,164 |   | 1,211 |   |
| Total  debt securities                 |       | 19,226                       |       | 526 |   | 101,790 |   | 11,398 |   | 121,016 |   | 11,924 |   |
| Equity  securities                     |       | 802                          |       | 369 |   | 444 |   | 322 |   | 1,246 |   | 691 |   |
| Total                                  |       | $                            | 20,028     |   | $ | 895 |   | $ | 102,234 |   | $ | 11,720 |   | $ | 122,262 |   | $ | 12,615 |   |

 
| ** **                             | ** ** | **December 31,  2008**  | ** ** |
|----------------------------------------|------------|------------------------------|------------|
| ** **                             | ** ** | **Less  than Twelve Months** | ** ** | **Twelve  Months or Greater** | ** ** | **Total** | ** ** |
| ** **                             | ** ** | **Estimated**                | ** ** | **Gross** | ** ** | **Estimated** | ** ** | **Gross** | ** ** | **Estimated** | ** ** | **Gross** | ** ** |
| ** **                             | ** ** | **Fair**                     | ** ** | **Unrealized** | ** ** | **Fair** | ** ** | **Unrealized** | ** ** | **Fair** | ** ** | **Unrealized** | ** ** |
| **(In  Thousands)**                    | ** ** | **Value**                    | ** ** | **Losses** | ** ** | **Value** | ** ** | **Losses** | ** ** | **Value** | ** ** | **Losses** | ** ** |
|                                   |       |                         |       |   |   |   |   |   |   |   |   |   |   |
| U.S.  Government and agency securities |       | $                            | —     |   | $ | — |   | $ | — |   | $ | — |   | $ | — |   | $ | — |   |
| State  and political securities        |       | 48,388                       |       | 4,378 |   | 67,412 |   | 6,386 |   | 115,800 |   | 10,764 |   |
| Other  debt securities                 |       | 6,341                        |       | 451 |   | 2,012 |   | 614 |   | 8,353 |   | 1,065 |   |
| Total  debt securities                 |       | 54,729                       |       | 4,829 |   | 69,424 |   | 7,000 |   | 124,153 |   | 11,829 |   |
| Equity  securities                     |       | 164                          |       | 80 |   | 5,364 |   | 3,305 |   | 5,528 |   | 3,385 |   |
| Total                                  |       | $                            | 54,893     |   | $ | 4,909 |   | $ | 74,788 |   | $ | 10,305 |   | $ | 129,681 |   | $ | 15,214 |   |

 

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AtJune 30, 2009 there were a total of 47 and 223 individual securities thatwere in a continuous unrealized loss position for less than twelve months andgreater than twelve months, respectively.

 

The Company reviews its position quarterly and hasasserted that at June 30, 2009, the declines outlined in the above tablerepresent temporary declines and the Company does have the intent and abilityeither to hold those securities to maturity or to allow a market recovery.  There were 270 positions that weretemporarily impaired at June 30, 2009. The Company has concluded that the unrealized losses disclosed above arenot other than temporary but are the result of interest rate changes, sectorcredit ratings changes, or Company-specific ratings changes that are notexpected to result in the non-collection of principal and interest during theperiod.

 

Theamortized cost and estimated fair value of debt securities at June 30,2009, by contractual maturity, are shown below. Expected maturities may differfrom contractual maturities since borrowers may have the right to call orprepay obligations with or without call or prepayment penalties.

 
| ** **                         | ** ** | **Available  for Sale** | ** ** | **Held  to Maturity** | ** ** |
|------------------------------------|------------|-------------------------|------------|-----------------------|------------|
| ** **                         | ** ** | **Amortized**           | ** ** | **Estimated**         | ** ** | **Amortized** | ** ** | **Estimated** | ** ** |
| **(In  Thousands)**                | ** ** | **Cost**                | ** ** | **Fair  Value**       | ** ** | **Cost** | ** ** | **Fair  Value** | ** ** |
| Due  in one year or less           |       | $                       | 25         |                  | $          | 25 |   | $ | 25 |   | $ | 25 |   |
| Due  after one year to five years  |       | 10,092                  |       | 10,564                |       | 76 |   | 76 |   |
| Due  after five years to ten years |       | 784                     |       | 805                   |       | — |   | — |   |
| Due  after ten years               |       | 194,587                 |       | 184,779               |       | 9 |   | 10 |   |
| Total                              |       | $                       | 205,488    |                  | $          | 196,173 |   | $ | 110 |   | $ | 111 |   |

 

Totalgross proceeds from sales of securities available for sale were $4,682,000 and$40,169,000, for June 30, 2009 and December 31, 2008,respectively.  The following tablerepresents gross realized gains and losses on those transactions:

 
| ** **                             | ** ** | **June 30,** | ** ** | **December 31,** |   |   |   |
|----------------------------------------|------------|-------------------|------------|-----------------------|--------|--------|--------|
| **(In  Thousands)**                    | ** ** | **2009**          | ** ** | **2008**              |   |   |   |
| Gross  realized gains:                 |       |              |       |                  |   |   |   |
| U.S.  Government and agency securities |       | $                 | —     |                  | $      | 253    |   |   |   |
| State  and political securities        |       | —            |       | 236                   |   |   |   |
| Other  debt securities                 |       | 162               |       | 6                     |   |   |   |
| Equity  securities                     |       | 4                 |       | 539                   |   |   |   |
| Total  gross realized gains            |       | $                 | 166        |                  | $      | 1,034  |   |   |   |
|                                   |       |              |       |                  |   |   |   |
| Gross  realized losses:                |       |              |       |                  |   |   |   |
| U.S.  Government and agency securities |       | $                 | —     |                  | $      | 36     |   |   |   |
| State  and political securities        |       | —            |       | 204                   |   |   |   |
| Other  debt securities                 |       | 37                |       | 510                   |   |   |   |
| Equity  securities                     |       | 4,584             |       | 2,315                 |   |   |   |
| Total  gross realized losses           |       | $                 | 4,621      |                  | $      | 3,065  |   |   |   |

 

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Gross realized losses for the equity securitiesportfolio include impairment charges of $4,584,000 and $2,797,000 for the sixmonths ended June 30, 2009 and year ended December 31, 2008, respectively.

 

**Note 12. Subsequent Events**

 

TheCompany assessed events occurring subsequent to June 30, 2009 through August 10,2009 for potential recognition and disclosure in the consolidated financialstatements.  No events have occurred thatwould require adjustment to or disclosure in the consolidated financialstatements which were issued on August 10, 2009.

 

**CAUTIONARYSTATEMENT FOR PURPOSES OF THE PRIVATE SECURITIES LITIGATION REFORM ACT OF1995**

 

This Report containscertain “forward-looking statements” including statements concerning plans,objectives, future events or performance and assumptions and other statementswhich are other than statements of historical fact.  The Company wishes to caution readers thatthe following important factors, among others, may have affected and could inthe future affect the Company’s actual results and could cause the Company’sactual results for subsequent periods to differ materially from those expressedin any forward-looking statement made by or on behalf of the Companyherein:  (i) the effect of changesin laws and regulations, including federal and state banking laws andregulations, with which the Company must comply, and the associated costs ofcompliance with such laws and regulations either currently or in the future asapplicable; (ii) the effect of changes in accounting policies andpractices, as may be adopted by the regulatory agencies as well as by theFinancial Accounting Standards Board, or of changes in the Company’sorganization, compensation and benefit plans; (iii) the effect on theCompany’s competitive position within its market area of the  increasing consolidation within the bankingand financial services industries, including the increased competition fromlarger regional and out-of-state banking organizations as well as non-bankproviders of various financial services; (iv) the effect of changes ininterest rates; and (v) the effect of changes in the business cycle anddownturns in the local, regional or national economies.

 

Youshould not put undue reliance on any forward-looking statements.  These statements speak only as of the date ofthis Quarterly Report on Form 10-Q, even if subsequently made available bythe Company on its website or otherwise. The Company undertakes no obligation to update or revise thesestatements to reflect events or circumstances occurring after the date of thisQuarterly Report on Form 10-Q.

 

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

 

# **EARNINGS SUMMARY**

# ** **

**Comparisonof the Three and Six Months Ended June 30, 2009 and 2008**

 

**SummaryResults**

 

Netincome for the three months ended June 30, 2009 was $832,000 compared to$2,057,000 for the same period of 2008 as after-tax securities losses increased$1,210,000 (from a loss of $166,000 to a loss of $1,376,000).  Included within the change in after-taxsecurities losses was an other than temporary impairment charge relating tocertain equity securities held in the investment portfolio of $2,251,000. Basicand diluted earnings per share for the three months ended June 30, 2009were $0.22 compared to $0.53 for the three months ended June 30,2008.  Return on average assets andreturn on average equity were 0.51% and 5.45% for the three months ended June 30,2009 compared to 1.30% and 11.73% for the corresponding period of 2008.  Net income from core operations (“operatingearnings”) remained stable at $2,208,000 for the three months ended June 30,2009 compared to $2,223,000 for the same period of 2008.  Operating earnings per share for the threemonths ended June 30, 2009 were $0.58 basic and dilutive compared to $0.58basic and $0.57 dilutive for the three months ended June 30, 2008.

 

The six months ended June 30,2009 generated net income of $1,671,000 compared to $4,188,000 for the sameperiod of 2008.  Comparable results wereimpacted by an increase in after-tax securities losses of $2,799,000 (from aloss of $141,000 to a loss of $2,940,000). Earnings per share, basic anddiluted, for the six months ended June 30, 2009 were $0.44 as compared to$1.08 for the comparable period of 2008. Return on average assets and return on average equity were 0.51% and5.54% for the six months ended June 30, 2009 compared to 1.33% and 11.87%for the corresponding period of 2008.  Operating earnings increased6.5% to $4,611,000 for the six months ended June 30, 2009 compared to$4,329,000 for the comparable period of 2008, resulting in basic and dilutiveoperating earnings per share increasing 7.1% to $1.20 from $1.12 for the sixmonth periods ended June 30, 2009 and 2008, respectively.

 

Management uses thenon-GAAP measure of net income from core operations, or operating earnings, inits analysis of the Company’s performance. This measure, as used by the Company, adjusts net income by excludingsignificant gains or losses that are unusual in nature.  Because certain of these items and theirimpact on the Company’s performance are difficult to predict, managementbelieves the presentation of financial measures excluding the impact of suchitems provides useful supplemental information in evaluating the operatingresults of the Company’s core businesses. For purposes of this Quarterly Report on Form 10-Q, net income fromcore operations, or operating earnings, means net income adjusted to excludeafter-tax net securities gains or losses. These disclosures should not be viewed as a substitute for net incomedetermined in accordance with GAAP, nor are they necessarily comparable tonon-GAAP performance measures that may be presented by other companies.

 

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**Reconciliationof GAAP and non-GAAP Income**

 
| ** **                     | ** ** | **Three  Months Ended** | ** ** | **Six  Months Ended** | ** ** |
|--------------------------------|------------|-------------------------|------------|-----------------------|------------|
| ** **                     | ** ** | **June 30,**       | ** ** | **June 30,**     | ** ** |
| **(In  Thousands)**            | ** ** | **2009**                | ** ** | **2008**              | ** ** | **2009** | ** ** | **2008** | ** ** |
| GAAP net income                |       | 832                     |       | 2,057                 |       | 1,671 |   | 4,188 |   |
| Securities losses, net  of tax |       | (1,376                  | )          | (166                  | )          | (2,940 | ) | (141 | ) |
| Non-GAAP operating  earnings   |       | 2,208                   |       | 2,223                 |       | 4,611 |   | 4,329 |   |

 

**InterestAnd Dividend Income**

 

Interestand dividend income for the three months ended June 30, 2009 increased$77,000 to $9,013,000 compared to $8,936,000 for the same period of 2008.  The increase in interest income was theresult of an increase in loan interest of $103,000 which offset the slightdecline in investment securities income of $26,000.  The increase in loan interest is the resultof growth in the average gross loan portfolio of $26,772,000.  The growth offset a decline in the averagetaxable equivalent yield of 26 basis points (“bp”) caused by the low interestrate environment that has existed over the past year.   Dividend income decreased as a direct resultof the current status of the economy that has caused many of the issuers ofequity holdings in our portfolio to decrease or suspend their dividend.  In addition, the Federal Home Loan Bank ofPittsburgh (“FHLB”) has suspended payment of dividends on shares of its commonstock, which resulted in a decrease of approximately $81,000 in dividend incomethe second quarter of 2009.  On a taxableequivalent basis, total interest income increased $143,000 as the tax-exemptloan and investment securities portfolios were able to obtain better yieldsthan in the comparable period of 2008.

 

Duringthe six months ended June 30, 2009, interest and dividend income was$17,930,000, a decrease of $54,000 over the same period in 2008.  Interest income on the loan portfolioremained stable as the growth in the portfolio countered a 44 bp decline inaverage yield.  The investment portfoliointerest income was negatively impacted by approximately $160,000 due to thesuspension of FHLB dividends which resulted in total interest income frominvestment securities being flat to the comparable period of 2008.   Tax-equivalent interest income increased$69,000 due to better yields on the loan and investment tax-exempt portfolios,an overall increase in earning assets of $17,732,000, and a shift in theearning asset portfolio towards loans from investments.

 

Interestand dividend income composition for the three and six months ended June 30,2009 and 2008 was as follows:

 

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| ** **                          | ** ** | **For  The Three Months Ended** | ** ** |
|-------------------------------------|------------|---------------------------------|------------|
| ** **                          | ** ** | **June 30,  2009**         | ** ** | **June 30,  2008** | ** ** | **Change** | ** ** |
| **(In  Thousands)**                 | ** ** | **Amount**                      | ** ** | **%  Total** | ** ** | **Amount** | ** ** | **%  Total** | ** ** | **Amount** | ** ** | **%** | ** ** |
| Loans  including fees               |       | $                               | 6,349      |   | 70.4 | % | $ | 6,246 |   | 69.9 | % | $ | 103 |   | 1.6 | % |
| Investment  securities:             |       |                            |       |   |   |   |   |   |   |   |   |   |   |
| Taxable                             |       | 1,374                           |       | 15.2 |   | 1,276 |   | 14.3 |   | 98 |   | 7.7 |   |
| Tax-exempt                          |       | 1,249                           |       | 13.9 |   | 1,210 |   | 13.5 |   | 39 |   | 3.2 |   |
| Dividend  and other interest income |       | 41                              |       | 0.5 |   | 204 |   | 2.3 |   | (163 | ) | (79.9 | ) |
| Total  interest and dividend income |       | $                               | 9,013      |   | 100.0 | % | $ | 8,936 |   | 100.0 | % | $ | 77 |   | 0.9 | % |

 
| ** **                          | ** ** | **For  The Six Months Ended** | ** ** |
|-------------------------------------|------------|-------------------------------|------------|
| ** **                          | ** ** | **June 30,  2009**       | ** ** | **June 30,  2008** | ** ** | **Change** | ** ** |
| **(In  Thousands)**                 | ** ** | **Amount**                    | ** ** | **%  Total** | ** ** | **Amount** | ** ** | **%  Total** | ** ** | **Amount** | ** ** | **%** | ** ** |
| Loans  including fees               |       | $                             | 12,568     |   | 70.1 | % | $ | 12,625 |   | 70.2 | % | $ | (57 | ) | (0.5 | )% |
| Investment  securities:             |       |                          |       |   |   |   |   |   |   |   |   |   |   |
| Taxable                             |       | 2,737                         |       | 15.3 |   | 2,466 |   | 13.7 |   | 271 |   | 11.0 |   |
| Tax-exempt                          |       | 2,495                         |       | 13.9 |   | 2,436 |   | 13.6 |   | 59 |   | 2.4 |   |
| Dividend  and other interest income |       | 130                           |       | 0.7 |   | 457 |   | 2.5 |   | (327 | ) | (71.6 | ) |
| Total  interest and dividend income |       | $                             | 17,930     |   | 100.0 | % | $ | 17,984 |   | 100.0 | % | $ | (54 | ) | (0.3 | )% |

 

**InterestExpense**

 

Interestexpense for the three months ended June 30, 2009 decreased $572,000 to$3,208,000 compared to $3,780,000 for the same period of 2008.  The decreased expense of $347,000 associatedwith deposits is primarily the result of a reduction of 110 bp in rates paid ontime deposits.  Factors that led to therate decreases include, but are not limited to, Federal Open Market Committee (“FOMC”)interest rate actions and campaigns conducted by the Company during the pasttwo years to attract short-term CDs resulting in an increased repricingfrequency.  Short-term borrowingsinterest expense decreased $179,000 as the average balance of such borrowingsdecreased $23,284,000, while the rate paid declined 72 bp.  Long-term borrowing interest expensedecreased $46,000 as the average balance of such borrowings increased slightly,while the average rate decreased 21 bp to 4.22%.  The change in average balance and rate isreflective of various long-term borrowing maturities and acquisitions during2008.

 

Interestexpense for the six months ended June 30, 2009 decreased $1,659,000 fromthe same period of 2008.  The reasons notedfor the decline in interest expense for the three month period comparison alsoapply to the six month period.

 

Interestexpense composition for the three and six months ended June 30, 2009 and2008 was as follows:

 

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| ** **                  | ** ** | **For  The Three Months Ended** | ** ** |
|-----------------------------|------------|---------------------------------|------------|
| ** **                  | ** ** | **June 30,  2009**         | ** ** | **June 30,  2008** | ** ** | **Change** | ** ** |
| **(In  Thousands)**         | ** ** | **Amount**                      | ** ** | **%  Total** | ** ** | **Amount** | ** ** | **%  Total** | ** ** | **Amount** | ** ** | **%** | ** ** |
| Deposits                    |       | $                               | 2,204      |   | 68.7 | % | $ | 2,551 |   | 67.5 | % | $ | (347 | ) | (13.6 | )% |
| Short-term  borrowings      |       | 78                              |       | 2.4 |   | 257 |   | 6.8 |   | (179 | ) | (69.6 | ) |
| Long-term  borrowings, FHLB |       | 926                             |       | 28.9 |   | 972 |   | 25.7 |   | (46 | ) | (4.7 | ) |
| Total  interest expense     |       | $                               | 3,208      |   | 100.0 | % | $ | 3,780 |   | 100.0 | % | $ | (572 | ) | (15.1 | )% |

 
| ** **                  | ** ** | **For  The Six Months Ended** | ** ** |
|-----------------------------|------------|-------------------------------|------------|
| ** **                  | ** ** | **June 30,  2009**       | ** ** | **June 30,  2008** | ** ** | **Change** | ** ** |
| **(In  Thousands)**         | ** ** | **Amount**                    | ** ** | **%  Total** | ** ** | **Amount** | ** ** | **%  Total** | ** ** | **Amount** | ** ** | **%** | ** ** |
| Deposits                    |       | $                             | 4,209      |   | 66.9 | % | $ | 5,092 |   | 64.1 | % | $ | (883 | ) | (17.3 | )% |
| Short-term  borrowings      |       | 236                           |       | 3.8 |   | 686 |   | 8.6 |   | (450 | ) | (65.6 | ) |
| Long-term  borrowings, FHLB |       | 1,843                         |       | 29.3 |   | 2,169 |   | 27.3 |   | (326 | ) | (15.0 | ) |
| Total  interest expense     |       | $                             | 6,288      |   | 100.0 | % | $ | 7,947 |   | 100.0 | % | $ | (1,659 | ) | (20.9 | )% |

 

**Net Interest Margin**

** **

Thenet interest margin (“NIM”) for the three months ended June 30, 2009 was4.36% compared to 4.01% for the corresponding period of 2008.  The increase in the NIM was driven by a 62 bpdecline in the rate paid on interest bearing liabilities that more thancompensated for a 6 bp decline in the yield on earning assets.  The decrease in earning asset yield is due tothe impact on the loan portfolio of the current low rate environment offset inpart by an increase in yield for the investment portfolio.  The increase in the investment portfolioyield was driven by a strategic initiative to increase tax equivalent netinterest income by purchasing tax-exempt and taxable municipal bonds inanticipation of the decreasing rate environment that has continued todate.  The decrease in the cost ofinterest bearing liabilities to 2.50% from 3.12% was driven by a reduction inthe rate paid on time deposits of 110 bp. The reduction in the rate paid on time deposits was the result of ashortening of the time deposit portfolio that has resulted in an increasingrepricing frequency during this period of decreasing rates.

 

TheNIM for the six months ended June 30, 2009 was 4.42% compared to 3.95% forthe same period of 2008.  The impact ofthe items mentioned in the three month discussion also applies to the six monthperiod.  A 127 bp decline in the ratepaid on time deposits served as the foundation for an 84 bp decline in ratepaid on deposits, while the FOMC and general market actions affected the yieldon earning assets and cost of borrowings.

 

Thefollowing is a schedule of average balances and associated yields for the threeand six months ended June 30, 2009 and 2008:

 

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| ** **                                       | ** ** | **AVERAGE BALANCES AND INTEREST  RATES** | ** ** |
|--------------------------------------------------|------------|------------------------------------------|------------|
|                                             |       | **Three  Months Ended**                  |       | **Three  Months Ended** |   |
|                                             |       | **June 30,  2009**                  |       | **June 30,  2008** |   |
| **(In  Thousands)**                              | ** ** | **Average  Balance**                     | ** ** | **Interest** | ** ** | **Average  Rate** | ** ** | **Average  Balance** | ** ** | **Interest** | ** ** | **Average  Rate** | ** ** |
| Assets:                                          |       |                                     |       |   |   |   |   |   |   |   |   |   |   |
| Tax-exempt loans                                 |       | $                                        | 16,934     |   | $ | 271 |   | 6.42 | % | $ | 8,506 |   | $ | 135 |   | 6.31 | % |
| All other loans                                  |       | 377,324                                  |       | 6,170 |   | 6.56 | % | 358,980 |   | 6,157 |   | 6.82 | % |
| Total loans                                      |       | 394,258                                  |       | 6,441 |   | 6.55 | % | 367,486 |   | 6,292 |   | 6.81 | % |
|                                             |       |                                     |       |   |   |   |   |   |   |   |   |   |   |
| Taxable investment  securities                   |       | 101,984                                  |       | 1,415 |   | 5.55 | % | 105,295 |   | 1,480 |   | 5.62 | % |
| Tax-exempt investment  securities                |       | 103,848                                  |       | 1,892 |   | 7.29 | % | 108,670 |   | 1,833 |   | 6.75 | % |
| Total securities                                 |       | 205,832                                  |       | 3,307 |   | 6.43 | % | 213,965 |   | 3,313 |   | 6.19 | % |
|                                             |       |                                     |       |   |   |   |   |   |   |   |   |   |   |
| Interest bearing  deposits                       |       | 1,371                                    |       | — |   | 0.00 | % | 34 |   | — |   | 0.00 | % |
|                                             |       |                                     |       |   |   |   |   |   |   |   |   |   |   |
| Total interest-earning  assets                   |       | 601,461                                  |       | 9,748 |   | 6.52 | % | 581,485 |   | 9,605 |   | 6.58 | % |
|                                             |       |                                     |       |   |   |   |   |   |   |   |   |   |   |
| Other assets                                     |       | 55,793                                   |       |   |   |   |   | 50,186 |   |   |   |   |   |
|                                             |       |                                     |       |   |   |   |   |   |   |   |   |   |   |
| Total assets                                     |       | $                                        | 657,254    |   |   |   |   |   | $ | 631,671 |   |   |   |   |   |
|                                             |       |                                     |       |   |   |   |   |   |   |   |   |   |   |
| Liabilities and  shareholders’ equity:      |       |                                     |       |   |   |   |   |   |   |   |   |   |   |
| Savings                                          |       | $                                        | 61,383     |   | 81 |   | 0.53 | % | $ | 61,197 |   | 115 |   | 0.75 | % |
| Super Now deposits                               |       | 56,645                                   |       | 131 |   | 0.93 | % | 54,327 |   | 183 |   | 1.34 | % |
| Money market deposits                            |       | 64,374                                   |       | 367 |   | 2.29 | % | 26,803 |   | 146 |   | 2.17 | % |
| Time deposits                                    |       | 224,918                                  |       | 1,625 |   | 2.90 | % | 209,539 |   | 2,107 |   | 4.00 | % |
| Total deposits                                   |       | 407,320                                  |       | 2,204 |   | 2.17 | % | 351,866 |   | 2,551 |   | 2.88 | % |
|                                             |       |                                     |       |   |   |   |   |   |   |   |   |   |   |
| Short-term borrowings                            |       | 18,035                                   |       | 78 |   | 1.73 | % | 41,319 |   | 257 |   | 2.45 | % |
| Long-term borrowings,  FHLB                      |       | 86,778                                   |       | 926 |   | 4.22 | % | 85,789 |   | 972 |   | 4.43 | % |
| Total borrowings                                 |       | 104,813                                  |       | 1,004 |   | 3.79 | % | 127,108 |   | 1,229 |   | 3.79 | % |
|                                             |       |                                     |       |   |   |   |   |   |   |   |   |   |   |
| Total interest-bearing  liabilities              |       | 512,133                                  |       | 3,208 |   | 2.50 | % | 478,974 |   | 3,780 |   | 3.12 | % |
|                                             |       |                                     |       |   |   |   |   |   |   |   |   |   |   |
| Demand deposits                                  |       | 73,930                                   |       |   |   |   |   | 73,485 |   |   |   |   |   |
| Other liabilities                                |       | 10,113                                   |       |   |   |   |   | 9,095 |   |   |   |   |   |
| Shareholders’ equity                        |       | 61,078                                   |       |   |   |   |   | 70,117 |   |   |   |   |   |
| Total liabilities and  shareholders’ equity |       | $                                        | 657,254    |   |   |   |   |   | $ | 631,671 |   |   |   |   |   |
|                                             |       |                                     |       |   |   |   |   |   |   |   |   |   |   |
| Interest rate spread                             |       |                                     |       |   |   | 4.02 | % |   |   |   |   | 3.46 | % |
| Net interest  income/margin                      |       |                                     |       | $ | 6,540 |   | 4.36 | % |   |   | $ | 5,825 |   | 4.01 | % |

 

1.               Informationon this table has been calculated using average daily balance sheets to obtainaverage balances.

2.               Nonaccrualloans have 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.

 

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| ** **                                       | ** ** | **AVERAGE BALANCES AND INTEREST  RATES** | ** ** |
|--------------------------------------------------|------------|------------------------------------------|------------|
|                                             |       | **Six  Months Ended**                    |       | **Six  Months Ended** |   |
|                                             |       | **June 30,  2009**                  |       | **June 30,  2008** |   |
| **(In  Thousands)**                              | ** ** | **Average  Balance**                     | ** ** | **Interest** | ** ** | **Average  Rate** | ** ** | **Average  Balance** | ** ** | **Interest** | ** ** | **Average  Rate** | ** ** |
| Assets:                                          |       |                                     |       |   |   |   |   |   |   |   |   |   |   |
| Tax-exempt loans                                 |       | $                                        | 16,420     |   | $ | 538 |   | 6.61 | % | $ | 8,277 |   | $ | 262 |   | 6.37 | % |
| All other loans                                  |       | 375,687                                  |       | 12,213 |   | 6.56 | % | 356,830 |   | 12,453 |   | 7.02 | % |
| Total loans                                      |       | 392,107                                  |       | 12,751 |   | 6.56 | % | 365,107 |   | 12,715 |   | 7.00 | % |
|                                             |       |                                     |       |   |   |   |   |   |   |   |   |   |   |
| Taxable securities                               |       | 101,937                                  |       | 2,867 |   | 5.63 | % | 103,013 |   | 2,923 |   | 5.68 | % |
| Tax-exempt securities                            |       | 102,757                                  |       | 3,780 |   | 7.36 | % | 111,630 |   | 3,691 |   | 6.61 | % |
| Total securities                                 |       | 204,694                                  |       | 6,647 |   | 6.49 | % | 214,643 |   | 6,614 |   | 6.16 | % |
|                                             |       |                                     |       |   |   |   |   |   |   |   |   |   |   |
| Interest bearing  deposits                       |       | 700                                      |       | — |   | 0.00 | % | 19 |   | — |   | 0.00 | % |
|                                             |       |                                     |       |   |   |   |   |   |   |   |   |   |   |
| Total interest-earning  assets                   |       | 597,501                                  |       | 19,398 |   | 6.53 | % | 579,769 |   | 19,329 |   | 6.69 | % |
|                                             |       |                                     |       |   |   |   |   |   |   |   |   |   |   |
| Other assets                                     |       | 55,459                                   |       |   |   |   |   | 49,325 |   |   |   |   |   |
|                                             |       |                                     |       |   |   |   |   |   |   |   |   |   |   |
| Total assets                                     |       | $                                        | 652,960    |   |   |   |   |   | $ | 629,094 |   |   |   |   |   |
|                                             |       |                                     |       |   |   |   |   |   |   |   |   |   |   |
| Liabilities and  shareholders’ equity:      |       |                                     |       |   |   |   |   |   |   |   |   |   |   |
| Savings                                          |       | $                                        | 60,517     |   | 159 |   | 0.53 | % | $ | 59,880 |   | 224 |   | 0.75 | % |
| Super Now deposits                               |       | 55,276                                   |       | 260 |   | 0.95 | % | 50,347 |   | 338 |   | 1.35 | % |
| Money market deposits                            |       | 52,888                                   |       | 580 |   | 2.21 | % | 25,064 |   | 273 |   | 2.19 | % |
| Time deposits                                    |       | 215,069                                  |       | 3,210 |   | 3.01 | % | 200,233 |   | 4,257 |   | 4.28 | % |
| Total Deposits                                   |       | 383,750                                  |       | 4,209 |   | 2.21 | % | 335,524 |   | 5,092 |   | 3.05 | % |
|                                             |       |                                     |       |   |   |   |   |   |   |   |   |   |   |
| Short-term borrowings                            |       | 39,641                                   |       | 236 |   | 1.19 | % | 46,216 |   | 686 |   | 2.95 | % |
| Other borrowings                                 |       | 86,778                                   |       | 1,843 |   | 4.22 | % | 95,661 |   | 2,169 |   | 4.48 | % |
| Total borrowings                                 |       | 126,419                                  |       | 2,079 |   | 3.27 | % | 141,877 |   | 2,855 |   | 3.99 | % |
|                                             |       |                                     |       |   |   |   |   |   |   |   |   |   |   |
| Total interest-bearing  liabilities              |       | 510,169                                  |       | 6,288 |   | 2.48 | % | 477,401 |   | 7,947 |   | 3.33 | % |
|                                             |       |                                     |       |   |   |   |   |   |   |   |   |   |   |
| Demand deposits                                  |       | 72,633                                   |       |   |   |   |   | 71,864 |   |   |   |   |   |
| Other liabilities                                |       | 9,870                                    |       |   |   |   |   | 9,280 |   |   |   |   |   |
| Shareholders’ equity                        |       | 60,288                                   |       |   |   |   |   | 70,459 |   |   |   |   |   |
|                                             |       |                                     |       |   |   |   |   |   |   |   |   |   |   |
| Total liabilities and  shareholders’ equity |       | $                                        | 652,960    |   |   |   |   |   | $ | 629,004 |   |   |   |   |   |
| Interest rate spread                             |       |                                     |       |   |   | 4.05 | % |   |   |   |   | 3.36 | % |
| Net interest  income/margin                      |       |                                     |       | $ | 13,110 |   | 4.42 | % |   |   | $ | 11,382 |   | 3.95 | % |

# ** **

1.               Informationon this table has been calculated using average daily balance sheets to obtainaverage balances.

2.               Nonaccrualloans have 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.

 

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# **The following table presents theadjustment to convert net interest income to net interest income on a fullytaxable equivalent basis for the three and six months ended June 30, 2009and 2008.**

 
| ** **                                      | ** ** | **For  the Three Months Ended** | ** ** | **For  the Six Months Ended** | ** ** |
|-------------------------------------------------|------------|---------------------------------|------------|-------------------------------|------------|
| ** **                                      | ** ** | **June 30,**               | ** ** | **June 30,**             | ** ** |
| **(In  Thousands)**                             | ** ** | **2009**                        | ** ** | **2008**                      | ** ** | **2009** | ** ** | **2008** | ** ** |
|                                            |       |                            |       |                          |       |   |   |   |   |
| Total  interest income                          |       | $                               | 9,013      |                          | $          | 8,936 |   | $ | 17,930 |   | $ | 17,984 |   |
| Total  interest expense                         |       | 3,208                           |       | 3,780                         |       | 6,288 |   | 7,947 |   |
|                                            |       |                            |       |                          |       |   |   |   |   |
| Net  interest income                            |       | 5,805                           |       | 5,156                         |       | 11,642 |   | 10,037 |   |
| Tax  equivalent adjustment                      |       | 735                             |       | 669                           |       | 1,468 |   | 1,345 |   |
|                                            |       |                            |       |                          |       |   |   |   |   |
| Net  interest income (fully taxable equivalent) |       | $                               | 6,540      |                          | $          | 5,825 |   | $ | 13,110 |   | $ | 11,382 |   |

 

# **The following table sets forth therespective impact that both volume and rate changes have had on net interestincome on a fully taxable equivalent basis for the three month periods ended June 30,2009 and 2008:**

 
| ** **                          | ** ** | **Three  Months Ended June 30,** | ** ** | **Six  Months Ended June 30,** | ** ** |
|-------------------------------------|------------|---------------------------------------|------------|-------------------------------------|------------|
| ** **                          | ** ** | **2009  vs 2008**                     | ** ** | **2009  vs 2008**                   | ** ** |
| ** **                          | ** ** | **Increase  (Decrease)**              | ** ** | **Increase  (Decrease)**            | ** ** |
| ** **                          | ** ** | **Due  to**                           | ** ** | **Due  to**                         | ** ** |
| **(In  Thousands)**                 | ** ** | **Volume**                            | ** ** | **Rate**                            | ** ** | **Net** | ** ** | **Volume** | ** ** | **Rate** | ** ** | **Net** | ** ** |
| Interest  income:                   |       |                                  |       |                                |       |   |   |   |   |   |   |   |   |
| Loans,  tax-exempt                  |       | $                                     | 134        |                                | $          | 2 |   | $ | 136 |   | $ | 256 |   | $ | 20 |   | $ | 276 |   |
| Loans                               |       | 277                                   |       | (264                                | )          | 13 |   | 990 |   | (1,230 | ) | (240 | ) |
| Taxable  investment securities      |       | (48                                   | )          | (17                                 | )          | (65 | ) | (22 | ) | (34 | ) | (56 | ) |
| Tax-exempt  investment securities   |       | (79                                   | )          | 138                                 |       | 59 |   | (401 | ) | 490 |   | 89 |   |
| Interest  bearing deposits          |       | —                                |       | —                              |       | — |   | — |   | — |   | — |   |
| Total  interest-earning assets      |       | 284                                   |       | (141                                | )          | 143 |   | 823 |   | (754 | ) | 69 |   |
|                                |       |                                  |       |                                |       |   |   |   |   |   |   |   |   |
| Interest  expense:                  |       |                                  |       |                                |       |   |   |   |   |   |   |   |   |
| Savings  deposits                   |       | —                                |       | (34                                 | )          | (34 | ) | 5 |   | (70 | ) | (65 | ) |
| Super  Now deposits                 |       | 8                                     |       | (60                                 | )          | (52 | ) | 56 |   | (134 | ) | (78 | ) |
| Money  market deposits              |       | 213                                   |       | 8                                   |       | 221 |   | 302 |   | 5 |   | 307 |   |
| Time  deposits                      |       | 142                                   |       | (624                                | )          | (482 | ) | 550 |   | (1,597 | ) | (1,047 | ) |
| Short-term  borrowings              |       | (65                                   | )          | (114                                | )          | (179 | ) | (50 | ) | (400 | ) | (450 | ) |
| Long-term  borrowings, FHLB         |       | 9                                     |       | (55                                 | )          | (46 | ) | (200 | ) | (126 | ) | (326 | ) |
| Total  interest-bearing liabilities |       | 307                                   |       | (879                                | )          | (572 | ) | 663 |   | (2,322 | ) | (1,659 | ) |
| Change  in net interest income      |       | $                                     | (23        | )                                   | $          | 738 |   | $ | 715 |   | $ | 160 |   | $ | 1,568 |   | $ | 1,728 |   |

 

# **Provision for LoanLosses**

# ** **

Theprovision for loan losses is based upon management’s quarterly review of theloan portfolio.  The purpose of thereview is to assess loan quality, identify impaired loans, analyzedelinquencies, ascertain loan growth, evaluate potential charge-offs andrecoveries, and assess general economic conditions in the markets served.  An external independent loan review is alsoperformed annually for the Bank. Management remains committed to an aggressive program of problem loanidentification and resolution.

 

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The allowance for loanlosses is determined by applying loss factors to outstanding loans by type,excluding loans 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 June 30, 2009, futureadjustments could be necessary if circumstances or economic conditions differsubstantially from the assumptions used in making the initialdeterminations.  A downturn in the localeconomy, increased unemployment, and delays in receiving financial informationfrom borrowers could result in increased levels of nonperforming assets,charge-offs, 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 $4,356,000 at December 31, 2008 to $4,377,000 at June 30,2009.  At June 30, 2009 and December 31,2008, the allowance for loan losses to total loans was 1.12% and 1.14%,respectively.

 

The provision for loanlosses totaled $186,000 and $312,000 for the three and six months ended June 30,2009, compared to $60,000 and $120,000 for the same period in 2008.  The amount of the increase in the provisionwas the result of several factors, including but not limited to, an increase ingross loans of $10,596,000 since December 31, 2008, a ratio of net chargeoffs to average loans of 0.07% for the six months ended June 30, 2009, aratio of nonperforming loans to total loans of 0.68%, and a ratio of theallowance for loan losses to nonperforming loans of 164.12% at June 30,2009.  As noted in the followingschedules, there has been an increase in nonperforming loans and netcharge-offs over the past year.  Thefollowing increases, coupled with the ratios noted previously, dictated anincrease in the provision for loan losses: continued uncertainty surroundingthe economy and internal loan review and analysis.  The increase did not equate to the increasein charge-offs and nonperforming loans due to the well collateralized status ofthe nonperforming loans and overall loan portfolio in general, which limits theloan specific allocation of the allowance for loan losses.

 

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Followingis a table showing the changes in the allowance for loan losses for the sixmonth periods ended June 30, 2009 and 2008:

 
| **(In  Thousands)**                                                                        | ** ** | **2009** | ** ** | **2008** | ** ** |
|--------------------------------------------------------------------------------------------|------------|----------|------------|----------|------------|
| Balance at beginning of  period                                                            |       | $        | 4,356      |     | $          | 4,130 |   |
| Charge-offs:                                                                               |       |     |       |     |       |
| Real estate                                                                                |       | 192      |       | 9        |       |
| Commercial and  industrial                                                                 |       | 64       |       | 31       |       |
| Installment loans to  individuals                                                          |       | 90       |       | 92       |       |
| Total charge-offs                                                                          |       | 346      |       | 132      |       |
|                                                                                       |       |     |       |     |       |
| Recoveries:                                                                                |       |     |       |     |       |
| Real estate                                                                                |       | 8        |       | 11       |       |
| Commercial and  industrial                                                                 |       | —   |       | 37       |       |
| Installment loans to  individuals                                                          |       | 47       |       | 41       |       |
| Total recoveries                                                                           |       | 55       |       | 89       |       |
| Net charge-offs                                                                            |       | 291      |       | 43       |       |
| Additions charged to  operations                                                           |       | 312      |       | 120      |       |
| Balance at end of  period                                                                  |       | $        | 4,377      |     | $          | 4,207 |   |
| Ratio of net  charge-offs during the period to average loans outstanding during the period |       | 0.07     | %          | 0.01     | %          |

 

Followingis a table showing the changes in total nonperforming loans as of:

 
| ** **          | ** ** | **Total  Nonperforming Loans** | ** ** |
|---------------------|------------|--------------------------------|------------|
| ** **          | ** ** | ** **                     | ** ** | **90  Days** | ** ** | ** ** | ** ** |
| **(In  Thousands)** | ** ** | **Nonaccrual**                 | ** ** | **Past  Due** | ** ** | **Total** | ** ** |
| 06/30/09            |       | $                              | 2,089      |   | $ | 578 |   | $ | 2,667 |   |
| 12/31/08            |       | 1,476                          |       | 259 |   | 1,735 |   |
| 06/30/08            |       | 605                            |       | 304 |   | 909 |   |
|                     |            |                                |            |  |  |  |  |  |  |  |

 

Loansnot included above which are “troubled debt restructurings” as defined in FAS15, *Accounting by Debtors and Creditors for TroubledDebt Restructurings*, totaled $31,000 and $214,000 at December 31,2008 and June 30, 2008; however, there were no troubled debtrestructurings at June 30, 2009.

 

**Non-interestIncome**

 

Totalnon-interest income for the three months ended June 30, 2009 compared tothe same period in 2008 decreased $2,013,000 to $(392,000) due to a $1,835,000decrease in net securities gains and losses when comparing the three monthperiods ended June 30, 2009 and 2008. Excluding net securities gains and losses, non-interest income for thefirst quarter of 2009 would have decreased $178,000 compared to the 2008period.  Deposit service charges werestagnant as overdraft fee income increased $11,000 offsetting a decline inrevenue due to customers migrating to no service charge checking accounts thatwere introduced as part of a customer acquisition and retention program.  Gain on sale of loans decreased $109,000 dueprimarily from a change in product mix which has resulted in a greaterpercentage of the fee collected being

 

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categorizedas other income.  This shift in productmix resulted in other income increasing 8.8% or $48,000.

 

Insurancecommissions for the three months ended June 30, 2009 decreased $139,000compared to the same period in 2008 due to a softening market and shift inproduct mix.  Management of The M Groupcontinues to pursue new and build upon current relationships.  The sales call program continues to expand toother financial institutions, which results in additional revenue for The MGroup if another sales outlet is added. However, the addition of another sales outlet for The M Group can takeup to a year or more to be completed.

 

Totalnon-interest income for the six months ended June 30, 2009 compared to thesame period in 2008 decreased $4,703,000. Excluding net securities gains, non-interest income would have decreased$461,000 compared to the 2008 period.  The decrease in non-interest income for the six month period is theresult of the same items noted in the three month discussion.

 

Non-interestincome composition for the three months ended June 30, 2009 and 2008 wasas follows:

 
| ** **                      | ** ** | **For  The Three Months Ended** | ** ** |
|---------------------------------|------------|---------------------------------|------------|
| ** **                      | ** ** | **June 30,  2009**         | ** ** | **June 30,  2008** | ** ** | **Change** | ** ** |
| **(In  Thousands)**             | ** ** | **Amount**                      | ** ** | **%  Total** | ** ** | **Amount** | ** ** | **%  Total** | ** ** | **Amount** | ** ** | **%** | ** ** |
| Deposit  service charges        |       | $                               | 541        |   | (138.0 | )% | $ | 540 |   | 33.3 | % | $ | 1 |   | 0.2 | % |
| Securities  (losses) gains, net |       | (2,086                          | )          | 532.2 |   | (251 | ) | (15.5 | ) | (1,835 | ) | 731.1 |   |
| Bank  owned life insurance      |       | 112                             |       | (28.6 | ) | 91 |   | 5.6 |   | 21 |   | 23.1 |   |
| Gain  on sale of loans          |       | 103                             |       | (26.3 | ) | 212 |   | 13.1 |   | (109 | ) | (51.4 | ) |
| Insurance  commissions          |       | 347                             |       | (88.5 | ) | 486 |   | 30.0 |   | (139 | ) | (28.6 | ) |
| Other                           |       | 591                             |       | (150.8 | ) | 543 |   | 33.5 |   | 48 |   | 8.8 |   |
| Total  non-interest income      |       | $                               | (392       | ) | 100.0 | % | $ | 1,621 |   | 100.0 | % | $ | (2,013 | ) | (124.2 | )% |

 
| ** **                      | ** ** | **For  The Six Months Ended** | ** ** |
|---------------------------------|------------|-------------------------------|------------|
| ** **                      | ** ** | **June 30,  2009**       | ** ** | **June 30,  2008** | ** ** | **Change** | ** ** |
| **(In  Thousands)**             | ** ** | **Amount**                    | ** ** | **%  Total** | ** ** | **Amount** | ** ** | **%  Total** | ** ** | **Amount** | ** ** | **%** | ** ** |
| Deposit  service charges        |       | $                             | 1,066      |   | (91.3 | )% | $ | 1,110 |   | 31.4 | % | $ | (44 | ) | (4.0 | )% |
| Securities  (losses) gains, net |       | (4,455                        | )          | 381.5 |   | (213 | ) | (6.0 | ) | (4,242 | ) | 1,991.5 |   |
| Bank  owned life insurance      |       | 274                           |       | (23.5 | ) | 246 |   | 7.0 |   | 28 |   | 11.4 |   |
| Gain  on sale of loans          |       | 221                           |       | (18.9 | ) | 364 |   | 10.3 |   | (143 | ) | (39.3 | ) |
| Insurance  commissions          |       | 701                           |       | (60.0 | ) | 1,066 |   | 30.1 |   | (365 | ) | (34.2 | ) |
| Other                           |       | 1,025                         |       | (87.8 | ) | 962 |   | 27.2 |   | 63 |   | 6.5 |   |
| Total  non-interest income      |       | $                             | (1,168     | ) | 100.0 | % | $ | 3,535 |   | 100.0 | % | $ | (4,703 | ) | (133.0 | )% |

 

**Non-interestExpense**

 

Totalnon-interest expense increased $374,000 for the three months ended June 30,2009 compared to the same period of 2008. The $126,000 increase in salaries and employee benefits was attributableto several items including standard cost of living wage adjustments for employees,increased pension expense, and other benefit costs.  Pennsylvania shares tax increased $67,000 dueto the utilization of Pennsylvania Enterprise Zone tax credits from a lowincome housing partnership during 2008. Other expenses increased primarily due to normal

 

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anticipatedinflationary adjustments to ongoing business operating costs in addition toincreased FDIC insurance cost, including an industry-wide special assessment.

 

Totalnon-interest expense increased $574,000 for the six months ended June 30,2009 compared to the same period of 2008. The increase in non-interest expense for the six month period is theresult of the same items noted in the three month discussion.

 

Non-interestexpense composition for the three months ended June 30, 2009 and 2008 wasas follows:

 
| ** **                                          | ** ** | **For  The Three Months Ended** | ** ** |
|-----------------------------------------------------|------------|---------------------------------|------------|
| ** **                                          | ** ** | **June 30,  2009**         | ** ** | **June 30,  2008** | ** ** | **Change** | ** ** |
| **(In  Thousands)**                                 | ** ** | **Amount**                      | ** ** | **%  Total** | ** ** | **Amount** | ** ** | **%  Total** | ** ** | **Amount** | ** ** | **%** | ** ** |
| Salaries  and employee benefits                     |       | $                               | 2,595      |   | 53.1 | % | $ | 2,469 |   | 54.7 | % | $ | 126 |   | 5.1 | % |
| Occupancy,  net                                     |       | 318                             |       | 6.5 |   | 314 |   | 7.0 |   | 4 |   | 1.3 |   |
| Furniture  and equipment                            |       | 306                             |       | 6.3 |   | 287 |   | 6.4 |   | 19 |   | 6.6 |   |
| Pennsylvania  shares tax                            |       | 172                             |       | 3.5 |   | 105 |   | 2.3 |   | 67 |   | 63.8 |   |
| Amortization  of investment in limited partnerships |       | 141                             |       | 2.9 |   | 178 |   | 3.9 |   | (37 | ) | (20.8 | ) |
| Other                                               |       | 1,353                           |       | 27.7 |   | 1,158 |   | 25.7 |   | 195 |   | 16.8 |   |
| Total  non-interest expense                         |       | $                               | 4,885      |   | 100.0 | % | $ | 4,511 |   | 100.0 | % | $ | 374 |   | 8.3 | % |

 
| ** **                                          | ** ** | **For  The Six Months Ended** | ** ** |
|-----------------------------------------------------|------------|-------------------------------|------------|
| ** **                                          | ** ** | **June 30,  2009**       | ** ** | **June 30,  2008** | ** ** | **Change** | ** ** |
| **(In  Thousands)**                                 | ** ** | **Amount**                    | ** ** | **%  Total** | ** ** | **Amount** | ** ** | **%  Total** | ** ** | **Amount** | ** ** | **%** | ** ** |
| Salaries  and employee benefits                     |       | $                             | 5,077      |   | 53.3 | % | $ | 4,920 |   | 54.9 | % | $ | 157 |   | 3.2 | % |
| Occupancy,  net                                     |       | 657                           |       | 6.9 |   | 652 |   | 7.3 |   | 5 |   | 0.8 |   |
| Furniture  and equipment                            |       | 613                           |       | 6.4 |   | 572 |   | 6.4 |   | 41 |   | 7.2 |   |
| Pennsylvania  shares tax                            |       | 343                           |       | 3.6 |   | 210 |   | 2.3 |   | 133 |   | 63.3 |   |
| Amortization  of investment in limited partnerships |       | 283                           |       | 3.0 |   | 356 |   | 4.0 |   | (73 | ) | (20.5 | ) |
| Other                                               |       | 2,557                         |       | 26.8 |   | 2,246 |   | 25.1 |   | 311 |   | 13.8 |   |
| Total  non-interest expense                         |       | $                             | 9,530      |   | 100.0 | % | $ | 8,956 |   | 100.0 | % | $ | 574 |   | 6.4 | % |

 

**Provisionfor Income Taxes**

 

Incometaxes decreased $639,000 and $1,347,000 for the three and six months ended June 30,2009 compared to the same periods of 2008. The decreases, due to net securities losses of $2,086,00 and $4,455,000,resulted in a tax benefit of $490,000 and $1,039,000 for the three and sixmonths ended June 30, 2009. Excluding the impact of the net securities gains and losses, theeffective tax rate for the three and six months ended June 30, 2009 was9.02% and 9.36% as compared to 9.52% and 8.07% for the same period of2008.  The Company currently is in adeferred tax asset position due to the low income housing tax credits earnedboth currently and previously. Management has reviewed the deferred tax asset and has determined thatthe asset will be utilized within the appropriate carry forward period andtherefore does not require a valuation allowance.

 

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# **ASSET/LIABILITYMANAGEMENT**

# ** **

# **Cash and CashEquivalents**

# ** **

Cash and cash equivalentsincreased $2,066,000 from $16,581,000 at December 31, 2008 to $18,647,000at June 30, 2009 primarily as a result of the following activities duringthe six months ended June 30, 2009:

 

# **Loans Held forSale**

# ** **

Activity regarding loansheld for sale resulted in loan originations exceeding sale proceeds, less$221,000 in realized gains, by $973,000 for the six months ended June 30,2009.

 

**Loans**

 

Gross loans increased$10,596,000 since December 31, 2008 due to the increase of commercialrelated loans, while non-commercial loans remained relatively constant.

 

The allocation of the loan portfolio, by category,as of June 30, 2009 and December 31, 2008 is presented below:

** **
| ** **                              | ** ** | **June 30,  2009** | ** ** | **December 31,  2008** | ** ** | **Change** | ** ** |
|-----------------------------------------|------------|-------------------------|------------|-----------------------------|------------|------------|------------|
| **(In  Thousands)**                     | ** ** | **Amount**              | ** ** | **%  Total**                | ** ** | **Amount** | ** ** | **%  Total** | ** ** | **Amount** | ** ** | **%** | ** ** |
| Commercial,  financial and agricultural |       | $                       | 43,906     |                        | 11.2       | %          | $          | 40,602 |   | 10.6 | % | $ | 3,304 |   | 8.1 | % |
| Real  estate mortgage:                  |       |                    |       |                        |       |       |       |   |   |   |   |   |   |
| Residential                             |       | 175,982                 |       | 44.9                        |       | 177,406    |       | 46.5 |   | (1,424 | ) | (0.8 | ) |
| Commercial                              |       | 143,204                 |       | 36.5                        |       | 136,158    |       | 35.7 |   | 7,046 |   | 5.2 |   |
| Construction                            |       | 18,005                  |       | 4.6                         |       | 15,838     |       | 4.2 |   | 2,167 |   | 13.7 |   |
| Installment  loans to individuals       |       | 11,962                  |       | 3.1                         |       | 12,487     |       | 3.3 |   | (525 | ) | (4.2 | ) |
| Less:  Net deferred loan fees           |       | 985                     |       | (0.3                        | )          | 1,013      |       | (0.3 | ) | (28 | ) | (2.8 | ) |
| Gross  loans                            |       | $                       | 392,074    |                        | 100.0      | %          | $          | 381,478 |   | 100.0 | % | $ | 10,596 |   | 2.8 | % |

 

The allocation of the loan portfolio, by delinquencystatus, as of June 30, 2009 and December 31, 2008 is presented below:

 

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| ** **                        | ** ** | **June 30,  2009** | ** ** |
|-----------------------------------|------------|-------------------------|------------|
| ** **                        | ** ** | ** **              | ** ** | ** ** | ** ** | **Past  Due** | ** ** | ** ** | ** ** | ** ** | ** ** |
| ** **                        | ** ** | ** **              | ** ** | ** ** | ** ** | **90  Days** | ** ** | ** ** | ** ** | ** ** | ** ** |
| ** **                        | ** ** | ** **              | ** ** | **Past  Due** | ** ** | **Or  More** | ** ** | ** ** | ** ** | ** ** | ** ** |
| ** **                        | ** ** | ** **              | ** ** | **30 To  90** | ** ** | **&  Still** | ** ** | **Non-** | ** ** | ** ** | ** ** |
| **(In  Thousands)**               | ** ** | **Current**             | ** ** | **Days** | ** ** | **Accruing** | ** ** | **Accrual** | ** ** | **Total** | ** ** |
| Commercial and  agricultural      |       | $                       | 43,419     |   | $ | 353 |   | $ | 94 |   | $ | 40 |   | $ | 43,906 |   |
| Real estate mortgage:             |       |                    |       |   |   |   |   |   |   |   |   |
| Residential                       |       | 171,800                 |       | 3,042 |   | 337 |   | 803 |   | 175,982 |   |
| Commercial                        |       | 140,875                 |       | 1,565 |   | 120 |   | 644 |   | 143,204 |   |
| Construction                      |       | 17,270                  |       | 186 |   | — |   | 549 |   | 18,005 |   |
| Installment loans to  individuals |       | 11,631                  |       | 251 |   | 27 |   | 53 |   | 11,962 |   |
|                              |       | 384,995                 |       | $ | 5,397 |   | $ | 578 |   | $ | 2,089 |   | 393,059 |   |
| Less: Net deferred loan  fees     |       | 985                     |       |   |   |   |   |   |   | 985 |   |
| Allowance for loan  losses        |       | 4,377                   |       |   |   |   |   |   |   | 4,377 |   |
| Loans, net                        |       | $                       | 379,633    |   |   |   |   |   |   |   | $ | 387,697 |   |

 
| ** **                        | ** ** | **Decmeber  31, 2008** | ** ** |
|-----------------------------------|------------|------------------------|------------|
| ** **                        | ** ** | ** **             | ** ** | ** ** | ** ** | **Past  Due** | ** ** | ** ** | ** ** | ** ** | ** ** |
| ** **                        | ** ** | ** **             | ** ** | ** ** | ** ** | **90  Days** | ** ** | ** ** | ** ** | ** ** | ** ** |
| ** **                        | ** ** | ** **             | ** ** | **Past  Due** | ** ** | **Or  More** | ** ** | ** ** | ** ** | ** ** | ** ** |
| ** **                        | ** ** | ** **             | ** ** | **30 To  90** | ** ** | **&  Still** | ** ** | **Non-** | ** ** | ** ** | ** ** |
| **(In  Thousands)**               | ** ** | **Current**            | ** ** | **Days** | ** ** | **Accruing** | ** ** | **Accrual** | ** ** | **Total** | ** ** |
| Commercial and  agricultural      |       | $                      | 40,006     |   | $ | 517 |   | $ | — |   | $ | 79 |   | $ | 40,602 |   |
| Real estate mortgage:             |       |                   |       |   |   |   |   |   |   |   |   |
| Residential                       |       | 170,011                |       | 6,582 |   | 223 |   | 590 |   | 177,406 |   |
| Commercial                        |       | 134,647                |       | 775 |   | — |   | 736 |   | 136,158 |   |
| Construction                      |       | 15,652                 |       | 167 |   | — |   | 19 |   | 15,838 |   |
| Installment loans to  individuals |       | 12,053                 |       | 346 |   | 36 |   | 52 |   | 12,487 |   |
|                              |       | 372,369                |       | $ | 8,387 |   | $ | 259 |   | $ | 1,476 |   | 382,491 |   |
| Less: Net deferred loan  fees     |       | 1,013                  |       |   |   |   |   |   |   | 1,013 |   |
| Allowance for loan  losses        |       | 4,356                  |       |   |   |   |   |   |   | 4,356 |   |
| Loans, net                        |       | $                      | 367,000    |   |   |   |   |   |   |   | $ | 377,122 |   |

 

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 $6,597,000 at June 30, 2009, compared to $5,042,000 at December 31,2008.  The valuation allowance related toimpaired loans amounted to $553,000 at June 30, 2009 and $166,000 at December 31,2008.  The increase in impaired loans andvaluation allowance is primarily from a few commercial relationships.

 

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 aremeasured for impairment based on the fair value of the collateral.

 

**Investments**

 

Theestimated fair value of the investment securities portfolio at June 30,2009 has decreased $375,000 since December 31, 2008.  The change is primarily due to a reduction inagency securities caused by normal principal payments as the cash flows havenot been fully reinvested

 

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backinto the portfolio.  The unrealizedlosses within the debt securities portfolio are the result of market activity,not credit issues/ratings, as approximately 90% of the debt securitiesportfolio is currently rated A or higher by either S&P or Moody’s.

 

TheCompany considers various factors, which include examples from applicableaccounting guidance, when analyzing the available for sale portfolio forpossible other than temporary impairment. The Company primarily considers the following factors in its analysis:length of time and severity of the market value being less than carrying value,reduction of dividend paid (equities), continued payment of dividend/interest,credit rating, and financial condition of an issuer, intent and ability to holduntil anticipated recovery (which may be maturity), and general outlook for theeconomy, specific industry, and entity in question.

 

Thebond portion of the portfolio review is conducted with emphases on severalfactors.  Continued payment of principaland interest is given primary importance with credit rating and financialcondition of the issuer following as the next most important.  Credit ratings were reviewed with the ratingsof the bonds being satisfactory.  Thosethat were not currently rated were discussed with a third party and/orunderwent an internal financial review. The Company also monitors whether each of the investments incurred adecline in market value from carrying value of at least 20% for twelveconsecutive months or a similar decline of at least 50% for three consecutivemonths.  Each bond is reviewed todetermine whether it is a general obligation bond, which is backed by thecredit and taxing power of the issuing jurisdiction, or revenue bond, which isonly payable from specified revenues. Based on the review undertaken by the Company and the intent and abilityto hold the bonds until anticipated recovery (which may be maturity) theCompany determined that the decline in value of the various bond holdings weredeemed to be temporary and were the result of the general market downturns andinterest rate/yield curve changes, not credit issues.  Consistent with the Company’s review of theportfolio as a whole, the intent and ability to hold such bonds untilanticipated recovery and the fact that almost all of such bonds are generalobligation bonds, the Company determined that the decline in the value of thesebond holdings were deemed to be temporary.

 

Theequity portfolio continues to feel the effects of the economic turbulence thatis affecting the financial sector.  Thissector of the portfolio, as of June 30, 2009, held $691,000 in unrealizedlosses on an amortized cost basis of $11,994,000.  The amount of the declines has caused severalof our equity holdings to be deemed other than temporarily impaired resultingin a write down in value of these holdings of $2,251,000 and $4,584,000 for thethree and six months ended June 30, 2009. Certain positions may be liquidated, in whole or part, through thebalance of 2009 so that the losses can be carried back for tax purposes andoffset against gains that have been recognized over the past several years.

 

Theequity portion of the portfolio, which is invested entirely in financialinstitutions, is reviewed for possible other than temporary impairment in asimilar manner to the bond portfolio with greater emphasis placed on the lengthof time the market value has been less than the carrying value and financialsector outlook.  The Company also reviewsdividend payment activities and, in the case of financial institutions, whetheror not such issuer was participating in the TARP Capital Purchase Program.  The starting point for the equity analysis isthe length and severity of a market price decline.  The Company monitors two primary measures:20% decline

 

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for twelve consecutive months and 50% declinefor three consecutive months in market value from carrying value.

 

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Theamortized cost of investment securities and their estimated fair values at June 30,2009 and December 31, 2008 are as follows:

 
| ** **                             | ** ** | **June 30,  2009** | ** ** |
|----------------------------------------|------------|-------------------------|------------|
| ** **                             | ** ** | ** **              | ** ** | **Gross** | ** ** | **Gross** | ** ** | **Estimated** | ** ** |
| ** **                             | ** ** | **Amortized**           | ** ** | **Unrealized** | ** ** | **Unrealized** | ** ** | **Fair** | ** ** |
| **(In  Thousands)**                    | ** ** | **Cost**                | ** ** | **Gains** | ** ** | **Losses** | ** ** | **Value** | ** ** |
| Available  for sale (AFS)              |       |                    |       |   |   |   |   |   |   |
| U.S.  Government and agency securities |       | $                       | 40,968     |   | $ | 1,690 |   | $ | — |   | $ | 42,658 |   |
| State  and political securities        |       | 143,057                 |       | 323 |   | (10,713 | ) | 132,667 |   |
| Other  debt securities                 |       | 21,463                  |       | 596 |   | (1,211 | ) | 20,848 |   |
| Total  debt securities                 |       | 205,488                 |       | 2,609 |   | (11,924 | ) | 196,173 |   |
| Equity  securities                     |       | 11,994                  |       | 425 |   | (691 | ) | 11,728 |   |
| Total  investment securities AFS       |       | $                       | 217,482    |   | $ | 3,034 |   | $ | (12,615 | ) | $ | 207,901 |   |
|                                   |       |                    |       |   |   |   |   |   |   |
| Held  to maturity (HTM)                |       |                    |       |   |   |   |   |   |   |
| U.S.  Government and agency securities |       | $                       | 9          |   | $ | 1 |   | $ | — |   | $ | 10 |   |
| Other  debt securities                 |       | 101                     |       | — |   | — |   | 101 |   |
| Total  investment securities HTM       |       | $                       | 110        |   | $ | 1 |   | $ | — |   | $ | 111 |   |

 
| ** **                             | ** ** | **December 31,  2008** | ** ** |
|----------------------------------------|------------|-----------------------------|------------|
| ** **                             | ** ** | ** **                  | ** ** | **Gross** | ** ** | **Gross** | ** ** | **Estimated** | ** ** |
| ** **                             | ** ** | **Amortized**               | ** ** | **Unrealized** | ** ** | **Unrealized** | ** ** | **Fair** | ** ** |
| **(In  Thousands)**                    |       | **Cost**                    | ** ** | **Gains** | ** ** | **Losses** | ** ** | **Value** |   |
| Available  for sale (AFS)              |       |                        |       |   |   |   |   |   |   |
| U.S.  Government and agency securities |       | $                           | 46,452     |   | $ | 1,134 |   | $ | — |   | $ | 47,586 |   |
| State  and political securities        |       | 142,258                     |       | 348 |   | (10,764 | ) | 131,842 |   |
| Other  debt securities                 |       | 15,970                      |       | 649 |   | (1,065 | ) | 15,554 |   |
| Total  debt securities                 |       | 204,680                     |       | 2,131 |   | (11,829 | ) | 194,982 |   |
| Equity  securities                     |       | 16,429                      |       | 225 |   | (3,385 | ) | 13,269 |   |
| Total  investment securities AFS       |       | $                           | 221,109    |   | $ | 2,356 |   | $ | (15,214 | ) | $ | 208,251 |   |
|                                   |       |                        |       |   |   |   |   |   |   |
| Held  to maturity (HTM)                |       |                        |       |   |   |   |   |   |   |
| U.S.  Government and agency securities |       | $                           | 10         |   | $ | 1 |   | $ | — |   | $ | 11 |   |
| Other  debt securities                 |       | 125                         |       | — |   | — |   | 125 |   |
| Total  investment securities HTM       |       | $                           | 135        |   | $ | 1 |   | $ | — |   | $ | 136 |   |

 

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Thedistribution of credit ratings by amortized cost and estimated fair values forthe debt security portfolio at June 30, 2009 follows:

 
| ** **                             | ** ** | **A- to AAA** | ** ** | **B- to BBB+** | ** ** | **C to CCC+** | ** ** | **Not Rated** | ** ** | **Total**     | ** ** |
|----------------------------------------|------------|---------------|------------|----------------|------------|---------------|------------|---------------|------------|---------------|------------|
| ** **                             | ** ** | ** **    | ** ** | **Estimated**  | ** ** | ** **    | ** ** | **Estimated** | ** ** | ** **    | ** ** | **Estimated** | ** ** | ** ** | ** ** | **Estimated** | ** ** | ** ** | ** ** | **Estimated** | ** ** |
| ** **                             | ** ** | **Amortized** | ** ** | **Fair**       | ** ** | **Amortized** | ** ** | **Fair**      | ** ** | **Amortized** | ** ** | **Fair** | ** ** | **Amortized** | ** ** | **Fair** | ** ** | **Amortized** | ** ** | **Fair** | ** ** |
| **(In Thousands)**                     | ** ** | **Cost**      | ** ** | **Value**      | ** ** | **Cost**      | ** ** | **Value**     | ** ** | **Cost**      | ** ** | **Value** | ** ** | **Cost** | ** ** | **Value** | ** ** | **Cost** | ** ** | **Value** | ** ** |
| Available for sale (AFS)               |       |          |       |           |       |          |       |          |       |          |       |   |   |   |   |   |   |   |   |   |   |
| U.S. Government and  agency securities |       | $             | 40,968     |           | $          | 42,658        |       | $             | —     |          | $          | — |   | $ | — |   | $ | — |   | $ | — |   | $ | — |   | $ | 40,968 |   | $ | 42,658 |   |
| State and political  securities        |       | 124,873       |       | 116,525        |       | 11,619        |       | 10,355        |       | —        |       | — |   | 6,565 |   | 5,787 |   | 143,057 |   | 132,667 |   |
| Other debt securities                  |       | 19,442        |       | 19,061         |       | 1,010         |       | 798           |       | 50            |       | 37 |   | 961 |   | 952 |   | 21,463 |   | 20,848 |   |
| Total debt securities  AFS             |       | $             | 185,283    |           | $          | 178,244       |       | $             | 12,629     |          | $          | 11,153 |   | $ | 50 |   | $ | 37 |   | $ | 7,526 |   | $ | 6,739 |   | $ | 205,488 |   | $ | 196,173 |   |
|                                   |       |          |       |           |       |          |       |          |       |          |       |   |   |   |   |   |   |   |   |   |   |
| Held to maturity (HTM)                 |       |          |       |           |       |          |       |          |       |          |       |   |   |   |   |   |   |   |   |   |   |
| U.S. Government and  agency securities |       | $             | 9          |           | $          | 10            |       | $             | —     |          | $          | — |   | $ | — |   | $ | — |   | $ | — |   | $ | — |   | $ | 9 |   | $ | 10 |   |
| Other debt securities                  |       | 101           |       | 101            |       | —        |       | —        |       | —        |       | — |   | — |   | — |   | 101 |   | 101 |   |
| Total debt securities  HTM             |       | $             | 110        |           | $          | 111           |       | $             | —     |          | $          | — |   | $ | — |   | $ | — |   | $ | — |   | $ | — |   | $ | 110 |   | $ | 111 |   |

# ** **

# **Financing Activities**

# ** **

# **Deposits**

# ** **

Totaldeposits increased 17.5% or $73,633,000 from December 31, 2008 to June 30,2009.  The growth was led by a 100.1% or$35,900,000 increase in money market deposits from December 31, 2008 to June 30,2009.  The increase in core deposits(deposits less time deposits) of 18.6% or $41,829,000 has provided relationshipdriven funding for the loan portfolio, while also reducing the utilization ofFHLB borrowings.  The increase indeposits is the result of a deposit gathering program coupled with customerscoming back to their hometown bank in the wake of the economic turbulence.

 

# **Deposit balances and their changesfor the periods being discussed follow:**

 
| ** **             | ** ** | **June 30,  2009** | ** ** | **December 31,  2008** | ** ** | **Change** | ** ** |
|------------------------|------------|-------------------------|------------|-----------------------------|------------|------------|------------|
| **(In  Thousands)**    | ** ** | **Amount**              | ** ** | **%  Total**                | ** ** | **Amount** | ** ** | **%  Total** | ** ** | **Amount** | ** ** | **%** | ** ** |
| Demand  deposits       |       | $                       | 74,509     |                        | 15.1       | %          | $          | 76,035 |   | 18.0 | % | $ | (1,526 | ) | (2.0 | )% |
| NOW  accounts          |       | 58,020                  |       | 11.7                        |       | 53,821     |       | 12.8 |   | 4,199 |   | 7.8 |   |
| Money  market deposits |       | 71,748                  |       | 14.5                        |       | 35,848     |       | 8.5 |   | 35,900 |   | 100.1 |   |
| Savings  deposits      |       | 61,924                  |       | 12.5                        |       | 58,668     |       | 13.9 |   | 3,256 |   | 5.5 |   |
| Time  deposits         |       | 228,800                 |       | 46.2                        |       | 196,996    |       | 46.8 |   | 31,804 |   | 16.1 |   |
| Total  deposits        |       | $                       | 495,001    |                        | 100.0      | %          | $          | 421,368 |   | 100.0 | % | $ | 73,633 |   | 17.5 | % |

# ** **

# **Borrowed Funds**

# ** **

Total borrowed fundsdecreased 36.7% or $59,066,000 to $101,658,000 at June 30, 2009 comparedto $160,724,000 at December 31, 2008. The decrease in borrowed funds is primarily the result of growth indeposits as part of the previously discussed deposit gathering campaigns thatwere utilized to provide loan portfolio funding and to reduce the level oftotal borrowings.  FHLB repurchaseagreements were utilized as their structure allowed for a reduction in interestexpense, while providing the ability to reduce the borrowings at our discretionas deposit levels increased.

 

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| ** **                                     | ** ** | **June 30,  2009** | ** ** | **December 31,  2008** | ** ** | **Change** | ** ** |
|------------------------------------------------|------------|-------------------------|------------|-----------------------------|------------|------------|------------|
| **(In  Thousands)**                            | ** ** | **Amount**              | ** ** | **%  Total**                | ** ** | **Amount** | ** ** | **%  Total** | ** ** | **Amount** | ** ** | **%** | ** ** |
| Short-term borrowings:                         |       |                    |       |                        |       |       |       |   |   |   |   |   |   |
| FHLB  repurchase agreements                    |       | $                       | —     |                        | —     | %          | $          | 61,013 |   | 38.0 | % | $ | (61,013 | ) | (100.0 | )% |
| Securities  sold under agreement to repurchase |       | 14,880                  |       | 14.6                        |       | 12,933     |       | 8.0 |   | 1,947 |   | 15.1 |   |
| Total  short-term borrowings                   |       | 14,880                  |       | 14.6                        | %          | 73,946     |       | 46.0 | % | (59,066 | ) | (79.9 | ) |
|                                           |       |                    |       |                        |       |       |       |   |   |   |   |   |   |
| Long-term  borrowings, FHLB                    |       | 86,778                  |       | 85.4                        |       | 86,778     |       | 54.0 |   | — |   | — |   |
| Total  borrowed funds                          |       | $                       | 101,658    |                        | 100.0      | %          | $          | 160,724 |   | 100.0 | % | $ | (59,066 | ) | (36.7 | )% |

# ** **

# **Capital**

# ** **

## The adequacy of the Company’s capital is reviewed onan ongoing basis with reference to the size, composition, and quality of theCompany’s resources and regulatory guidelines. Management seeks to maintain a level of capital sufficient to supportexisting assets and anticipated asset growth, maintain favorable access tocapital markets, and preserve high quality credit ratings.

##  

## Bank holding companies are required to comply with theFederal Reserve Board’s risk-based capital guidelines.  The risk-based capital rules aredesigned to make regulatory capital requirements more sensitive to differencesin risk profiles among banks and bank holding companies and to minimizedisincentives for holding liquid assets. Specifically, each is required to maintain certain minimum dollaramounts and ratios of total risk-based, tier I risk-based, and tier I leveragecapital. In addition to the capital requirements, the Federal Deposit InsuranceCorporation Improvements Act (FDICIA) established five capital categoriesranging from “well capitalized” to “critically undercapitalized.” To beclassified as “well capitalized”, total risk-based, tier I risked-based, andtier I leverage capital ratios must be at least 10%, 6%, and 5%,respectively.

 

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Capitalratios as of June 30, 2009 and December 31, 2008 were as follows:

 
| ** **                     | ** ** | **2009**   | ** ** | **2008**  | ** ** |
|--------------------------------|------------|------------|------------|-----------|------------|
| **(In  Thousands)**            | ** ** | **Amount** | ** ** | **Ratio** | ** ** | **Amount** | ** ** | **Ratio** | ** ** |
| Total  Capital                 |       |       |       |      |       |   |   |   |   |
| (to  Risk-weighted Assets)     |       |       |       |      |       |   |   |   |   |
|                           |       |       |       |      |       |   |   |   |   |
| Actual                         |       | $          | 66,175     |      | 15.2       | % | $ | 66,891 |   | 16.0 | % |
| For  Capital Adequacy Purposes |       | 34,788     |       | 8.0       |       | 33,410 |   | 8.0 |   |
| To  Be Well Capitalized        |       | 43,485     |       | 10.0      |       | 41,763 |   | 10.0 |   |
|                           |       |       |       |      |       |   |   |   |   |
| Tier  I Capital                |       |       |       |      |       |   |   |   |   |
| (to  Risk-weighted Assets)     |       |       |       |      |       |   |   |   |   |
|                           |       |       |       |      |       |   |   |   |   |
| Actual                         |       | $          | 61,798     |      | 14.2       | % | $ | 62,540 |   | 15.0 | % |
| For  Capital Adequacy Purposes |       | 17,394     |       | 4.0       |       | 16,705 |   | 4.0 |   |
| To  Be Well Capitalized        |       | 26,091     |       | 6.0       |       | 25,058 |   | 6.0 |   |
|                           |       |       |       |      |       |   |   |   |   |
| Tier  I Capital                |       |       |       |      |       |   |   |   |   |
| (to  Average Assets)           |       |       |       |      |       |   |   |   |   |
|                           |       |       |       |      |       |   |   |   |   |
| Actual                         |       | $          | 61,798     |      | 9.4        | % | $ | 62,540 |   | 9.7 | % |
| For  Capital Adequacy Purposes |       | 26,329     |       | 4.0       |       | 25,773 |   | 4.0 |   |
| To  Be Well Capitalized        |       | 32,912     |       | 5.0       |       | 32,216 |   | 5.0 |   |

 

# **Liquidity;Interest Rate Sensitivity and Market Risk**

# ** **

## The asset/liability committee addresses the liquidityneeds of the Company to ensure that sufficient funds are available to meetcredit demands and deposit withdrawals as well as to the placement of availablefunds in the investment portfolio.  Inassessing liquidity requirements, equal consideration is given to the currentposition as well as the future outlook.

##  

The following liquiditymeasures are monitored for compliance and were within the limits cited at June 30,2009:

 

1.  Net Loans to Total Assets, 85% maximum

2.  Net Loans to Total Deposits, 100% maximum

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

4.  Cumulative 1 Year Maturity GAP %, +/- 25%maximum

 

Fundamentalobjectives of the Company’s asset/liability management process are to maintainadequate liquidity while minimizing interest rate risk.  The maintenance of adequate liquidityprovides the Company with the ability to meet its financial obligations todepositors, loan customers, and shareholders. Additionally, it provides funds for normal operating expenditures

 

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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 cash flows from deposits, loanpayments, and investment security payments. The primary sources of funds are deposits, principal and interestpayments on loans and investment securities, FHLB borrowings, and brokereddeposits.  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 funding 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 FHLB of $196,482,000.  In addition to this credit arrangement, theCompany has additional lines of credit with correspondent banks of $13,101,000.Management believes it has sufficient liquidity to satisfy estimated short-termand long-term funding needs.  FHLB borrowings totaled$86,778,000 as of June 30, 2009.

 

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 fund them.  Successful asset/liability management resultsin a balance sheet structure which can cope effectively with market ratefluctuations. The matching process is affected by segmenting both assets andliabilities into future time periods (usually 12 months, or less) based uponwhen 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 risk andmust be prudently managed.  In additionto gap management, the Company has an asset/liability management policy whichincorporates a market value at risk calculation which is used to determine theeffects of interest rate movements on shareholders’ equity and a simulationanalysis to monitor the effects of interest rate changes on the Company’sbalance sheet.

 

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TheCompany currently maintains a GAP position of being liability sensitive.  The Company has strategically taken thisposition as it has decreased the duration of the time deposit portfolio, whilecontinuing to maintain a primarily fixed rate earning asset portfolio with aduration greater than the liabilities utilized to fund earning assets.  Lengthening of the liability portfoliocoupled with the addition of limited short-term assets is beingundertaken.  These actions are expectedto reduce, but not eliminate, the liability sensitive structure of the balancesheet.

 

Amarket value at risk calculation is utilized to monitor the effects of interestrate changes on the Company’s balance sheet and more specifically shareholdersequity.  The Company does not manage thebalance sheet structure in order to maintain compliance with thiscalculation.  The calculation serves as aguideline with greater emphases placed on interest rate sensitivity.  Changes to calculation results from period toperiod are reviewed as changes in results could be a signal of futureevents.  As of the most recent analysis,the results of the market value at risk calculation were outside of establishedguidelines due to the strategic direction being taken.

 

**InterestRate Sensitivity**

 

Inthis analysis the Company examines the result of a 100 and 200 basis pointchange in market interest rates and the effect on net interest income. It isassumed that the change is instantaneous and that all rates move in a parallelmanner.  Assumptions are also madeconcerning prepayment speeds on mortgage loans and mortgage securities.

 

Thefollowing is a rate shock forecast for the twelve month period ended December 31,2009 assuming a static balance sheet as of December 31, 2008.

 
| ** **                  | ** ** | **Parallel  Rate Shock in Basis Points** | ** ** |
|-----------------------------|------------|------------------------------------------|------------|
| **(In  Thousands)**         | ** ** | **-200**                                 | ** ** | **-100** | ** ** | **Static** | ** ** | **+100** | ** ** | **+200** | ** ** |
| Net  interest income        |       | $                                        | 21,415     |   | $ | 21,606 |   | $ | 21,407 |   | $ | 20,954 |   | $ | 20,497 |   |
| Change  from static         |       | 8                                        |       | 199 |   | — |   | (453 | ) | (910 | ) |
| Percent  change from static |       | 0.04                                     | %          | 0.93 | % | — |   | -2.12 | % | -4.25 | % |
|                             |            |                                          |            |  |  |  |  |  |  |  |  |  |  |  |  |  |

 

Themodel utilized to create the report presented above makes various estimates ateach level of interest rate change regarding cash flow from principal repaymenton loans and mortgage-backed securities and or call activity on investmentsecurities.  Actual results could differsignificantly from these estimates which would result in significantdifferences in the calculated projected change. In addition, the limits stated above do not necessarily represent thelevel of change under which management would undertake specific measures torealign its portfolio in order to reduce the projected level of change.  Generally, management believes the Company iswell positioned to respond expeditiously when the market interest rate outlookchanges.

 

# **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

 

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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.

 

**Item 3.  Quantitative andQualitative Disclosures About Market Risk**

 

Marketrisk for the Company is comprised primarily of interest rate risk exposure andliquidity risk.  Interest rate risk andliquidity risk management is performed at the Bank level as well as the Companylevel.  The Company’s interest ratesensitivity 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 31,2008.  Additional information and detailsare provided in the “Liquidity and Interest Rate Sensitivity” section of “Item2. 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 Chief Financial Officer, of the effectiveness of the design andoperation of the Company’s disclosure controls and procedures. Based on thatevaluation, the Company’s Chief Executive Officer and Chief Financial Officerconcluded that the Company’s disclosure controls and procedures were effectiveas of June 30, 2009.  There were nochanges in the Company’s internal control over financial reporting thatoccurred during the quarter ended June 30, 2009, that have materially affected,or are reasonably likely to materially affect, the Company’s internal controlover financial reporting.

 

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

### ** **

**Item 1.          LegalProceedings**

 

None.

 

**Item 1A.       RiskFactors**

 

There are no materialchanges to the risk factors set forth in Part I, Item 1A, “Risk Factors,”of the Company’s Annual Report on Form 10-K for the year ended December 31,2008.  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**

 
| ** **                                     | ** ** | **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 (April 1 - April 30, 2009) |       | —          |       | —          |       | —                         |       | —                           |       |
|                                           |       |            |       |            |       |                           |       |                             |       |
| Month  #2 (May 1 - May 31, 2009)     |       | —          |       | —          |       | —                         |       | —                           |       |
|                                           |       |            |       |            |       |                           |       |                             |       |
| Month  #3 (June 1 - June 30, 2009)   |       | —          |       | —          |       | —                         |       | —                           |       |

 

On April 28, 2009,the Board of Directors extended the previously approved authorization torepurchase up to 197,000 shares, or approximately 5%, of the outstanding sharesof the Company for an additional year to April 30, 2010.  To date, there have been 118,656 sharesrepurchased under this plan.

 

**Item 3.          DefaultsUpon Senior Securities**

 

None

 

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

 

Penns Woods Bancorp, Inc.’sannual meeting of the shareholders was held on April 29, 2009.  The results of the items voted on are listedbelow:

 

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| **Issue** | ** ** | **Description**                              | ** ** | **For**   | ** ** | **Withhold** | ** ** | ** ** | ** ** |
|-----------|------------|----------------------------------------------|------------|-----------|------------|--------------|------------|------------|------------|
| 1.        |       | Election of Directors for  a Three Year Term |       |      |       |         |       | ** ** | ** ** |
|      |       |                                         |       |      |       |         |       | ** ** | ** ** |
|      |       | Leroy H. Keiler, III                    |       | 2,913,359 |       | 62,278       |       | ** ** | ** ** |
|      |       | James E. Plummer                             |       | 2,853,717 |       | 121,920      |       | ** ** | ** ** |
|      |       | Hubert A. Valencik                           |       | 2,856,984 |       | 118,653      |       | ** ** | ** ** |

 
| **Issue** | ** ** | **Description**                                                                             | ** ** | **For**   | ** ** | **Against** | ** ** | **Abstain** | ** ** |
|-----------|------------|---------------------------------------------------------------------------------------------|------------|-----------|------------|-------------|------------|-------------|------------|
| 2.        |       | Ratification of S.R.  Snodgrass, A.C., Certified Public Accountants as independent auditors |       | 2,913,135 |       | 52,048      |       | 10,454      |       |

 

### **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’s 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)/Rule 15d-14(a) Certification  of Chief Executive Officer.                                                                                                                                          |
| (31) | (ii) |   | Rule 13a-14(a)/Rule 15d-14(a) Certification  of Chief Financial Officer.                                                                                                                                          |
| (32) | (i)  |   | Section 1350  Certification of Chief Executive Officer.                                                                                                                                                                     |
| (32) | (ii) |   | Section 1350  Certification of Chief Financial Officer.                                                                                                                                                                     |

 

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## **SIGNATURES**

##  

Pursuant to therequirements of the Securities Exchange Act of 1934, the Registrant has duly causedthis report to be signed on its behalf by the undersigned thereunto dulyauthorized.

 
|   |                 | PENNS WOODS BANCORP,  INC.                              |
|--------|----------------------|---------------------------------------------------------|
|   |                 | (Registrant)                                            |
|   |                 |                                                    |
|   |                 |                                                    |
| Date:  | August 10, 2009 | /s/ Ronald A. Walko                                     |
|   |                 | Ronald A. Walko,  President and Chief Executive Officer |
|   |                 | (Principal Executive  Officer)                          |
|   |                 |                                                    |
|   |                 |                                                    |
| Date:  | August 10, 2009 | /s/ Brian L. Knepp                                      |
|   |                 | Brian L. Knepp, Chief  Financial Officer                |
|   |                 | (Principal Financial  Officer and Principal Accounting  |
|   |                 | 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 Chief Financial Officer |
| Exhibit 32(i)  |   | Section 1350  Certification of Chief Executive Officer                            |
| Exhibit 32(ii) |   | Section 1350  Certification of Chief Financial Officer                            |

 

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