**UNITEDSTATES**

**SECURITIESAND EXCHANGE COMMISSION**

**WASHINGTON,D.C.  20549**

**FORM 10-Q**

**x****  QuarterlyReport pursuant to Section 13 or 15 (d) of the Securities Exchange Act of 1934**

**for theQuarterly Period Ended June 30, 2007.**

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

**TransitionPeriod from                               to                               .**

**No. 0-17077**

**(CommissionFile Number)**

**PENNSWOODS BANCORP, INC.**

(Exact name ofRegistrant as specified in its charter)

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

 

**(570) 322-1111**

Registrant’stelephone number, including area code

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

YESx                       NO  o

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

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

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

YESo                        NO x

On August 1, 2007 therewere 3,881,782 shares of the Registrant’s common stock outstanding.

 

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**PENNS WOODS BANCORP, INC.**

**INDEX TOQUARTERLY REPORT ON FORM 10-Q**
|                                                                                                                              | ** ** | **Page  Number**                                                                                |
|------------------------------------------------------------------------------------------------------------------------------|------------|-------------------------------------------------------------------------------------------------|
| **Part  I**                                                                                                                  | ** ** | **Financial  Information**                                                                      |   |   |
|                                                                                                                         |       |                                                                                            |   |   |
| **Item  1.**                                                                                                                 | ** ** | **Financial  Statements**                                                                       |   |   |
|                                                                                                                         |       |                                                                                            |   |   |
| Consolidated  Balance Sheet (unaudited) as of June 30, 2007 and December 31, 2006                                            |       | 4                                                                                               |
|                                                                                                                         |       |                                                                                            |
| Consolidated  Statement of Income (unaudited) for the Three and Six Months ended June 30,  2007 and 2006                     |       | 5                                                                                               |
|                                                                                                                         |       |                                                                                            |
| Consolidated  Statement of Changes in Shareholders’ Equity (unaudited) for the Six Months  ended June 30, 2007 and 2006 |       | 6                                                                                               |
|                                                                                                                         |       |                                                                                            |
| Consolidated  Statement of Comprehensive Income (unaudited) for the Three and Six Months  ended June 30, 2007 and 2006       |       | 6                                                                                               |
|                                                                                                                         |       |                                                                                            |
| Consolidated  Statement of Cash Flows (unaudited) for the Six Months ended June 30, 2007 and  2006                           |       | 7                                                                                               |
|                                                                                                                         |       |                                                                                            |
| Notes to  Consolidated Financial Statements (unaudited)                                                                      |       | 8                                                                                               |
|                                                                                                                         |       |                                                                                            |
| **Item 2.**                                                                                                                  |       | **Management’s  Discussion and Analysis of Financial Condition and Results of Operations** | ** ** | 14 |
| **Item 3.**                                                                                                                  |       | **Quantitative  and Qualitative Disclosures About Market Risk**                                 | ** ** | 30 |
| **Item 4.**                                                                                                                  |       | **Controls and  Procedures**                                                                    | ** ** | 31 |
| ** **                                                                                                                   |       | ** **                                                                                      | ** ** |   |
| **Part II**                                                                                                                  |       | **Other Information**                                                                           |   |   |
| ** **                                                                                                                   |       | ** **                                                                                      |   |   |
| **Item 1.**                                                                                                                  | ** ** | **Legal Proceedings**                                                                           |   | 31 |
| **Item 1A.**                                                                                                                 | ** ** | **Risk Factors**                                                                                |   | 31 |
| **Item 2.**                                                                                                                  | ** ** | **Unregistered  Sales of Equity Securities and Use of Proceeds**                                |   | 31 |
| **Item 3.**                                                                                                                  | ** ** | **Defaults  Upon Senior Securities**                                                            |   | 32 |
| **Item 4.**                                                                                                                  | ** ** | **Submission  of Matters to a Vote of Security Holders**                                        |   | 32 |
| **Item 5.**                                                                                                                  | ** ** | **Other Information**                                                                           |   | 32 |
| **Item  6.**                                                                                                                 | ** ** | **Exhibits**                                                                                    |   | 32 |
| **Signatures**                                                                                                               |       | 33                                                                                              |
| **Exhibit  Index and Exhibits**                                                                                              |       | 34                                                                                              |
|                                                                                                                              |            |                                                                                                 |  |  |  |

 

2

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**Part I.  FINANCIAL INFORMATION**

**Item 1.  Financial Statements**

3

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PENNS WOODS BANCORP, INC.

CONSOLIDATEDBALANCE SHEET

(UNAUDITED)
| ** **                                                                                          | ** ** | **June 30,** | ** ** | **December 31,** | ** ** |
|-----------------------------------------------------------------------------------------------------|------------|-------------------|------------|-----------------------|------------|
| **(In Thousands, Except Share Data)**                                           | ** ** | **2007**          | ** ** | **2006**              | ** ** |
|                                                                                                |       |              |       |                  |       |
| ASSETS                                                                                              |       |              |       |                  |       |
| Noninterest-bearing  balances                                                                       |       | $                 | 11,315     |                  | $          | 15,348 |   |
| Interest-bearing  deposits in other financial institutions                                          |       | 16                |       | 25                    |       |
| Total cash and  cash equivalents                                                                    |       | 11,331            |       | 15,373                |       |
|                                                                                                |       |              |       |                  |       |
| Investment securities,  available for sale, at fair value                                           |       | 181,308           |       | 185,200               |       |
| Investment securities  held to maturity (fair value of $277 and $286)                               |       | 275               |       | 283                   |       |
| Loans held for sale                                                                                 |       | 5,345             |       | 3,716                 |       |
| Loans                                                                                               |       | 356,175           |       | 360,384               |       |
| Less: Allowance for  loan losses                                                                    |       | 4,162             |       | 4,185                 |       |
| Loans, net                                                                                          |       | 352,013           |       | 356,199               |       |
| Premises and equipment,  net                                                                        |       | 6,964             |       | 6,737                 |       |
| Accrued interest  receivable                                                                        |       | 3,015             |       | 2,939                 |       |
| Bank-owned life  insurance                                                                          |       | 12,149            |       | 11,346                |       |
| Investment in limited  partnerships                                                                 |       | 4,666             |       | 4,950                 |       |
| Goodwill                                                                                            |       | 3,032             |       | 3,032                 |       |
| Other assets                                                                                        |       | 6,474             |       | 2,510                 |       |
| TOTAL ASSETS                                                                                        |       | $                 | 586,572    |                  | $          | 592,285 |   |
|                                                                                                |       |              |       |                  |       |
| LIABILITIES                                                                                         |       |              |       |                  |       |
| Interest-bearing  deposits                                                                          |       | $                 | 335,903    |                  | $          | 322,031 |   |
| Noninterest-bearing  deposits                                                                       |       | 70,000            |       | 73,160                |       |
| Total deposits                                                                                      |       | 405,903           |       | 395,191               |       |
|                                                                                                |       |              |       |                  |       |
| Short-term borrowings                                                                               |       | 28,359            |       | 34,697                |       |
| Long-term borrowings,  Federal Home Loan Bank (FHLB)                                                |       | 76,378            |       | 82,878                |       |
| Accrued interest  payable                                                                           |       | 1,647             |       | 1,532                 |       |
| Other liabilities                                                                                   |       | 4,565             |       | 3,393                 |       |
| TOTAL LIABILITIES                                                                                   |       | 516,852           |       | 517,691               |       |
|                                                                                                |       |              |       |                  |       |
| SHAREHOLDERS’ EQUITY                                                                           |       |              |       |                  |       |
| Common stock, par value  $8.33, 10,000,000 shares authorized; 4,005,342 and 4,003,514 shares issued |       | 33,378            |       | 33,362                |       |
| Additional paid-in  capital                                                                         |       | 17,852            |       | 17,810                |       |
| Retained earnings                                                                                   |       | 26,974            |       | 25,783                |       |
| Accumulated other  comprehensive income (loss):                                                     |       |              |       |                  |       |
| Net unrealized  (loss) gain on available for sale securities                                        |       | (3,455            | )          | 2,139                 |       |
| Defined benefit  plan                                                                               |       | (579              | )          | (579                  | )          |
| Less: Treasury stock at  cost, 117,802 and 102,772 shares                                           |       | (4,450            | )          | (3,921                | )          |
| TOTAL SHAREHOLDERS’ EQUITY                                                                     |       | 69,720            |       | 74,594                |       |
| TOTAL LIABILITIES AND SHAREHOLDERS’ EQUITY                                                     |       | $                 | 586,572    |                  | $          | 592,285 |   |

 

See accompanyingnotes to the unaudited consolidated financial statements.

4

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PENNS WOODS BANCORP, INC.

CONSOLIDATEDSTATEMENT OF INCOME 

(UNAUDITED)
| ** **                                                         | ** ** | **Three Months Ended** | ** ** | **Six Months Ended** | ** ** |
|--------------------------------------------------------------------|------------|----------------------------------|------------|--------------------------------|------------|
| ** **                                                         | ** ** | **June 30,**                | ** ** | **June 30,**              | ** ** |
| **(In Thousands, Except Per Share Data)** | ** ** | **2007**                         | ** ** | **2006**                       | ** ** | **2007** | ** ** | **2006** | ** ** |
|                                                               |       |                             |       |                           |       |   |   |   |   |
| INTEREST AND DIVIDEND  INCOME                                      |       |                             |       |                           |       |   |   |   |   |
| Loans including fees                                               |       | $                                | 6,516      |                           | $          | 6,086 |   | $ | 12,939 |   | $ | 11,895 |   |
| Investment Securities:                                             |       |                             |       |                           |       |   |   |   |   |
| Taxable                                                            |       | 924                              |       | 896                            |       | 1,747 |   | 1,819 |   |
| Tax-exempt                                                         |       | 1,052                            |       | 1,000                          |       | 2,163 |   | 1,989 |   |
| Dividend and  other interest income                                |       | 301                              |       | 365                            |       | 623 |   | 666 |   |
| TOTAL INTEREST AND  DIVIDEND INCOME                                |       | 8,793                            |       | 8,347                          |       | 17,472 |   | 16,369 |   |
|                                                               |       |                             |       |                           |       |   |   |   |   |
| INTEREST EXPENSE                                                   |       |                             |       |                           |       |   |   |   |   |
| Deposits                                                           |       | 2,868                            |       | 1,968                          |       | 5,380 |   | 3,805 |   |
| Short-term borrowings                                              |       | 227                              |       | 509                            |       | 732 |   | 915 |   |
| Long-term borrowings,  FHLB                                        |       | 904                              |       | 944                            |       | 1,826 |   | 1,890 |   |
| TOTAL INTEREST EXPENSE                                             |       | 3,999                            |       | 3,421                          |       | 7,938 |   | 6,610 |   |
|                                                               |       |                             |       |                           |       |   |   |   |   |
| NET INTEREST INCOME                                                |       | 4,794                            |       | 4,926                          |       | 9,534 |   | 9,759 |   |
|                                                               |       |                             |       |                           |       |   |   |   |   |
| PROVISION FOR LOAN  LOSSES                                         |       | 10                               |       | 198                            |       | 50 |   | 396 |   |
|                                                               |       |                             |       |                           |       |   |   |   |   |
| NET INTEREST INCOME  AFTER PROVISION FOR LOAN LOSSES               |       | 4,784                            |       | 4,728                          |       | 9,484 |   | 9,363 |   |
|                                                               |       |                             |       |                           |       |   |   |   |   |
| NON-INTEREST INCOME                                                |       |                             |       |                           |       |   |   |   |   |
| Deposit service charges                                            |       | 567                              |       | 587                            |       | 1,108 |   | 1,177 |   |
| Securities gains, net                                              |       | 293                              |       | 265                            |       | 619 |   | 824 |   |
| Bank-owned life  insurance                                         |       | 86                               |       | 90                             |       | 201 |   | 178 |   |
| Gain on sale of loans                                              |       | 234                              |       | 210                            |       | 372 |   | 360 |   |
| Insurance commissions                                              |       | 550                              |       | 670                            |       | 988 |   | 1,230 |   |
| Other                                                              |       | 456                              |       | 394                            |       | 872 |   | 784 |   |
| TOTAL NON-INTEREST  INCOME                                         |       | 2,186                            |       | 2,216                          |       | 4,160 |   | 4,553 |   |
|                                                               |       |                             |       |                           |       |   |   |   |   |
| NON-INTEREST EXPENSE                                               |       |                             |       |                           |       |   |   |   |   |
| Salaries and employee  benefits                                    |       | 2,301                            |       | 2,214                          |       | 4,582 |   | 4,446 |   |
| Occupancy, net                                                     |       | 337                              |       | 275                            |       | 668 |   | 518 |   |
| Furniture and equipment                                            |       | 297                              |       | 288                            |       | 583 |   | 585 |   |
| Pennsylvania shares tax                                            |       | 161                              |       | 151                            |       | 322 |   | 296 |   |
| Other                                                              |       | 1,244                            |       | 1,150                          |       | 2,313 |   | 2,184 |   |
| TOTAL NON-INTEREST EXPENSE                                         |       | 4,340                            |       | 4,078                          |       | 8,468 |   | 8,029 |   |
|                                                               |       |                             |       |                           |       |   |   |   |   |
| INCOME BEFORE INCOME  TAX PROVISION                                |       | 2,630                            |       | 2,866                          |       | 5,176 |   | 5,887 |   |
| INCOME TAX PROVISION                                               |       | 295                              |       | 432                            |       | 560 |   | 998 |   |
| NET INCOME                                                         |       | $                                | 2,335      |                           | $          | 2,434 |   | $ | 4,616 |   | $ | 4,889 |   |
|                                                               |       |                             |       |                           |       |   |   |   |   |
| EARNINGS PER SHARE -  BASIC                                        |       | $                                | 0.60       |                           | $          | 0.62 |   | $ | 1.19 |   | $ | 1.24 |   |
|                                                               |       |                             |       |                           |       |   |   |   |   |
| EARNINGS PER SHARE -  DILUTED                                      |       | $                                | 0.60       |                           | $          | 0.62 |   | $ | 1.19 |   | $ | 1.24 |   |
|                                                               |       |                             |       |                           |       |   |   |   |   |
| WEIGHTED AVERAGE SHARES  OUTSTANDING - BASIC                       |       | 3,889,139                        |       | 3,939,424                      |       | 3,893,286 |   | 3,950,295 |   |
|                                                               |       |                             |       |                           |       |   |   |   |   |
| WEIGHTED AVERAGE SHARES  OUTSTANDING - DILUTED                     |       | 3,889,401                        |       | 3,939,911                      |       | 3,893,586 |   | 3,950,781 |   |
|                                                               |       |                             |       |                           |       |   |   |   |   |
| DIVIDENDS PER SHARE                                                |       | $                                | 0.44       |                           | $          | 0.43 |   | $ | 0.88 |   | $ | 0.85 |   |

 

See accompanyingnotes to the unaudited consolidated financial statements.

5

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CONSOLIDATEDSTATEMENT OF CHANGES 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**      | ** ** | **INCOME (LOSS)** | ** ** | **STOCK**              | ** ** | **EQUITY** | ** ** |
| Balance,  December 31, 2006                                                                                                                       |       | 4,003,514  |       | $              | 33,362     |         | $          | 17,810            |       | $                      | 25,783     |                   | $          | 1,560      |       | $ | (3,921 | ) | $ | 74,594 |   |
|                                                                                                                                              |       |       |       |           |       |         |       |              |       |                   |       |                   |       |       |       |
| Comprehensive  Income:                                                                                                                            |       |       |       |           |       |         |       |              |       |                   |       |                   |       |       |       |
| Net  income                                                                                                                                       |       |       |       |           |       |         |       | 4,616             |       |                   |       |                   |       | 4,616      |       |
| Net  change in unrealized gain (loss) on investments available for sale, net of reclassification  adjustment, net of income tax benefit of $2,882 |       |       |       |           |       |         |       |              |       | (5,594                 | )          |                   |       | (5,594     | )          |
| Total  comprehensive loss                                                                                                                         |       |       |       |           |       |         |       |              |       |                   |       |                   |       | (978       | )          |
| Dividends  declared, ($0.88 per share)                                                                                                            |       |       |       |           |       |         |       | (3,425            | )          |                   |       |                   |       | (3,425     | )          |
| Purchase  of treasury stock (15,030 shares)                                                                                                       |       |       |       |           |       |         |       |              |       |                   |       | (529                   | )          | (529       | )          |
| Stock  options exercised                                                                                                                          |       | 330        |       | 3              |       | 5            |       |              |       |                   |       |                   |       | 8          |       |
| Common  shares issued for employee stock purchase plan                                                                                            |       | 1,498      |       | 13             |       | 37           |       |              |       |                   |       |                   |       | 50         |       |
| Balance, June 30, 2007                                                                                                                            |       | 4,005,342  |       | $              | 33,378     |         | $          | 17,852            |       | $                      | 26,974     |                   | $          | (4,034     | )          | $ | (4,450 | ) | $ | 69,720 |   |

 
| ** **                                                                                                                                        | ** ** | ** ** | ** ** | ** **     | ** ** | ** **   | ** ** | ** **        | ** ** | **ACCUMULATED**        | ** ** | ** **             | ** ** | ** ** | ** ** |
|---------------------------------------------------------------------------------------------------------------------------------------------------|------------|------------|------------|----------------|------------|--------------|------------|-------------------|------------|------------------------|------------|------------------------|------------|------------|------------|
| ** **                                                                                                                                        | ** ** | **COMMON** | ** ** | **ADDITIONAL** | ** ** | ** **   | ** ** | **OTHER**         | ** ** | ** **             | ** ** | **TOTAL**              | ** ** |
| ** **                                                                                                                                        | ** ** | **STOCK**  | ** ** | **PAID-IN**    | ** ** | **RETAINED** | ** ** | **COMPREHENSIVE** | ** ** | **TREASURY**           | ** ** | **SHAREHOLDERS’** | ** ** |
| **(In Thousands Except Per Share Data)**                                                                                 | ** ** | **SHARES** | ** ** | **AMOUNT**     | ** ** | **CAPITAL**  | ** ** | **EARNINGS**      | ** ** | **INCOME (LOSS)** | ** ** | **STOCK**              | ** ** | **EQUITY** | ** ** |
| Balance,  December 31, 2005                                                                                                                       |       | 4,002,159  |       | $              | 33,351     |         | $          | 17,772            |       | $                      | 22,938     |                   | $          | 850        |       | $ | (992 | ) | $ | 73,919 |   |
|                                                                                                                                              |       |       |       |           |       |         |       |              |       |                   |       |                   |       |       |       |
| Comprehensive  Income:                                                                                                                            |       |       |       |           |       |         |       |              |       |                   |       |                   |       |       |       |
| Net  income                                                                                                                                       |       |       |       |           |       |         |       | 4,889             |       |                   |       |                   |       | 4,889      |       |
| Net  change in unrealized gain (loss) on investments available for sale, net of reclassification  adjustment, net of income tax benefit of $1,094 |       |       |       |           |       |         |       |              |       | (2,123                 | )          |                   |       | (2,123     | )          |
| Total  comprehensive income                                                                                                                       |       |       |       |           |       |         |       |              |       |                   |       |                   |       | 2,766      |       |
| Dividends  declared, ($0.85 per share)                                                                                                            |       |       |       |           |       |         |       | (3,356            | )          |                   |       |                   |       | (3,356     | )          |
| Purchase  of treasury stock (44,000 shares)                                                                                                       |       |       |       |           |       |         |       |              |       |                   |       | (1,697                 | )          | (1,697     | )          |
| Balance, June 30, 2006                                                                                                                            |       | 4,002,159  |       | $              | 33,351     |         | $          | 17,772            |       | $                      | 24,471     |                   | $          | (1,273     | )          | $ | (2,689 | ) | $ | 71,632 |   |

 

See accompanyingnotes to the unaudited consolidated financial statements.

PENNS WOODS BANCORP, INC.

 CONSOLIDATED STATEMENT OF COMPREHENSIVE INCOME

(UNAUDITED)
| ** **                                                              | ** ** | **Three Months Ended June 30,** | ** ** | **Six Months Ended June 30,** | ** ** |
|-------------------------------------------------------------------------|------------|-----------------------------------------------------|------------|---------------------------------------------------|------------|
| **(In Thousands)**                                                 | ** ** | **2007**                                            | ** ** | **2006**                                          | ** ** | **2007** | ** ** | **2006** | ** ** |
|                                                                    |       |                                                |       |                                              |       |   |   |   |   |   |   |   |   |   |   |   |   |
| Net  Income                                                             |       |                                                |       | $                                                 | 2,335      |   |   |   | $ | 2,434 |   |   |   | $ | 4,616 |   |   |   | $ | 4,889 |   |
| Other  comprehensive (loss) income:                                     |       |                                                |       |                                              |       |   |   |   |   |   |   |   |   |   |   |   |   |
| Change in net unrealized gains on available for  sale securities        |       | (7,194                                              | )          |                                              |       | (3,581 | ) |   |   | (7,857 | ) |   |   | (2,393 | ) |   |   |
| Less: Reclassification adjustment for net gains  included in net income |       | 293                                                 |       |                                              |       | 265 |   |   |   | 619 |   |   |   | 824 |   |   |   |
| Other  comprehensive loss before tax                                    |       |                                                |       | (7,487                                            | )          |   |   | (3,846 | ) |   |   | (8,476 | ) |   |   | (3,217 | ) |
| Income  tax benefit related to other comprehensive loss                 |       |                                                |       | (2,546                                            | )          |   |   | (1,308 | ) |   |   | (2,882 | ) |   |   | (1,094 | ) |
| Other  comprehensive loss, net of tax benefit                           |       |                                                |       | (4,941                                            | )          |   |   | (2,538 | ) |   |   | (5,594 | ) |   |   | (2,123 | ) |
| Comprehensive  (loss) income                                            |       |                                                |       | $                                                 | (2,606     | ) |   |   | $ | (104 | ) |   |   | $ | (978 | ) |   |   | $ | 2,766 |   |

 

See accompanying notes tothe unaudited consolidated financial statements.

6

----

PENNS WOODS BANCORP, INC.

CONSOLIDATEDSTATEMENT OF CASH FLOWS

(UNAUDITED)

 
| ** **                                                                         | ** ** | **Six Months Ended** | ** ** |
|------------------------------------------------------------------------------------|------------|--------------------------------|------------|
| ** **                                                                         | ** ** | **June 30,**              | ** ** |
| **(In Thousands)**                                                            | ** ** | **2007**                       | ** ** | **2006** | ** ** |
|                                                                               |       |                           |       |   |   |
| OPERATING ACTIVITIES                                                               |       |                           |       |   |   |
| Net Income                                                                         |       | $                              | 4,616      |   | $ | 4,889 |   |
| Adjustments to  reconcile net income to net cash provided by operating activities: |       |                           |       |   |   |
| Depreciation                                                                       |       | 366                            |       | 360 |   |
| Provision for  loan losses                                                         |       | 50                             |       | 396 |   |
| Accretion and  amortization of investment security discounts and premiums          |       | (479                           | )          | (381 | ) |
| Securities  gains, net                                                             |       | (619                           | )          | (824 | ) |
| Originations of  loans held for sale                                               |       | (19,875                        | )          | (17,466 | ) |
| Proceeds of  loans held for sale                                                   |       | 18,618                         |       | 15,594 |   |
| Gain on sale of  loans                                                             |       | (372                           | )          | (360 | ) |
| Earnings on  bank-owned life insurance                                             |       | (201                           | )          | (178 | ) |
| Other, net                                                                         |       | 207                            |       | (641 | ) |
| Net cash  provided by operating activities                                         |       | 2,311                          |       | 1,389 |   |
| INVESTING ACTIVITIES                                                               |       |                           |       |   |   |
| Investment  securities available for sale:                                         |       |                           |       |   |   |
| Proceeds from  sales                                                               |       | 39,212                         |       | 18,171 |   |
| Proceeds from  calls and maturities                                                |       | 3,165                          |       | 3,702 |   |
| Purchases                                                                          |       | (46,179                        | )          | (17,910 | ) |
| Investment  securities held to maturity:                                           |       |                           |       |   |   |
| Proceeds from  calls and maturities                                                |       | 11                             |       | — |   |
| Net decrease  (increase) in loans                                                  |       | 4,136                          |       | (8,262 | ) |
| Acquisition of  bank premises and equipment                                        |       | (593                           | )          | (556 | ) |
| Proceeds from  the sale of foreclosed assets                                       |       | 66                             |       | 61 |   |
| Purchase of  bank-owned life insurance                                             |       | (602                           | )          | — |   |
| Investment in limited  partnership                                                 |       | —                         |       | (1,535 | ) |
| Proceeds from  redemption of regulatory stock                                      |       | 2,550                          |       | 1,509 |   |
| Purchases of  regulatory stock                                                     |       | (2,097                         | )          | (1,135 | ) |
| Net cash used  for investing activities                                            |       | (331                           | )          | (5,955 | ) |
| FINANCING ACTIVITIES                                                               |       |                           |       |   |   |
| Net increase in  interest-bearing deposits                                         |       | 13,872                         |       | 21,484 |   |
| Net (decrease)  increase in noninterest-bearing deposits                           |       | (3,160                         | )          | 2,931 |   |
| Proceeds of  long-term borrowings, FHLB                                            |       | 10,000                         |       | — |   |
| Repayment of  long-term borrowings, FHLB                                           |       | (16,500                        | )          | (1,600 | ) |
| Net decrease in  short-term borrowings                                             |       | (6,338                         | )          | (13,078 | ) |
| Dividends paid                                                                     |       | (3,425                         | )          | (3,356 | ) |
| Issuance of  common stock                                                          |       | 50                             |       | — |   |
| Stock options  exercised                                                           |       | 8                              |       | — |   |
| Purchase of  treasury stock                                                        |       | (529                           | )          | (1,697 | ) |
| Net cash (used  for) provided by financing activities                              |       | (6,022                         | )          | 4,684 |   |
| NET (DECREASE) INCREASE  IN CASH AND CASH EQUIVALENTS                              |       | (4,042                         | )          | 118 |   |
| CASH AND CASH  EQUIVALENTS, BEGINNING                                              |       | 15,373                         |       | 14,090 |   |
| CASH AND CASH  EQUIVALENTS, ENDING                                                 |       | $                              | 11,331     |   | $ | 14,208 |   |
|                                                                               |       |                           |       |   |   |
| SUPPLEMENTAL  DISCLOSURES OF CASH FLOW INFORMATION                                 |       |                           |       |   |   |
|                                                                               |       |                           |       |   |   |
| Interest paid                                                                      |       | $                              | 7,823      |   | $ | 6,547 |   |
| Income taxes paid                                                                  |       | 1,185                          |       | 2,000 |   |
| Transfer of loans to foreclosed real estate                                        |       | —                         |       | 51 |   |

 

See accompanyingnotes to the unaudited consolidated financial statements.

7

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**PENNSWOODS BANCORP, INC. AND SUBSIDIARIESNOTES TO****CONSOLIDATED FINANCIAL STATEMENTS****(Unaudited)**

**Note 1.  Basis of Presentation**

The consolidatedfinancial statements include the accounts of Penns Woods Bancorp, Inc. (the “Company”)and its wholly-owned subsidiaries: Woods Investment Company, Inc., Woods RealEstate Development Company, Inc., and Jersey Shore State Bank (the “Bank”) andits wholly-owned subsidiary The M Group, Inc. D/B/A The Comprehensive FinancialGroup (“The M Group”).  All significantinter-company balances and transactions have been eliminated in theconsolidation.

The interimfinancial statements are unaudited but, in the opinion of management, reflectall adjustments necessary for the fair presentation of results for suchperiods.  All of those adjustments are ofa normal, recurring nature.  The resultsof operations for any interim period are not necessarily indicative of resultsfor the full year.  These financialstatements should be read in conjunction with financial statements and notesthereto contained in the Company’s Annual Report on Form 10-K for the year endedDecember 31, 2006.

The accounting policies followed in the presentation of interimfinancial results are the same as those followed on an annual basis. These policies are presented on pages 40 thru 46 of the Annual Report on Form10-K for the year ended December 31, 2006.

In reference tothe attached financial statements, all adjustments are of a normal recurringnature pursuant to Rule 10-01 (b) (8) of Regulation S-X.

**Note 2. Recent AccountingPronouncements**

In February 2006, theFinancial Accounting Standards Board (“FASB”) issued Statement of FinancialAccounting Standards (“FAS”) No. 155, *Accounting for CertainHybrid Instruments, as an amendment of FASB Statements No. 133 and 140*.  FAS No. 155 allows financial instruments thathave embedded derivatives to be accounted for as a whole (eliminating the needto bifurcate the derivative from its host) if the holder elects to account forthe whole instrument on a fair value basis. This statement is effective for all financial instruments acquired orissued after the beginning of an entity’s first fiscal year that begins afterSeptember 15, 2006.  The adoption of thisstandard is not expected to have a material effect on the Company’s results ofoperations or financial position.

In March 2006, the FASB issuedFAS No. 156, *Accounting for Servicing of Financial Assets*.  This Statement, which is an amendment to FASNo. 140, will simplify the accounting for servicing assets and liabilities,such as those common with mortgage securitization activities.  Specifically, FAS No. 156 addresses therecognition and measurement of separately recognized servicing assets andliabilities and provides an approach to simplify efforts to obtain hedge-like

8

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(offset) accounting.  FAS No. 156 also clarifies when an obligationto service financial assets should be separately recognized as a servicingasset or a servicing liability, requires that a separately recognized servicingasset or servicing liability be initially measured at fair value, ifpracticable, and permits an entity with a separately recognized servicing assetor servicing liability to choose either of the amortization or fair valuemethods for subsequent measurement.  Theprovisions of FAS No. 156 are effective as of the beginning of the first fiscalyear that begins after September 15, 2006.  The adoption of this standard is not expected to have a material effecton the Company’s results of operations or financial position.  

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

In September 2006, the FASB issued FAS No. 158, *Employers’ Accounting for Defined Benefit Pension and Other Post  Retirement  Plans, an amendment of FASB Statements  No.  87, 88, 106 and 132(R)*.  FAS No. 158 requires that a company  recognize the overfunded or underfunded  status of its defined benefit post  retirement  plans (other than  multiemployer  plans) as an asset or liability in its statement of financial  position and that it recognize changes  in the funded  status in the year in which the  changes  occur  through other  comprehensive  income.  FAS No. 158 also requires the  measurement  of defined  benefit  plan  assets and  obligations  as of the fiscal  year end,  in addition  to  footnote  disclosures.  On December 31, 2006, the Company adopted FAS No. 158, except for the measurement provisions, which are effective for fiscal years ending after December 15, 2008.  The adoption of this standard is not expected to have a material effect on the Company’s results of operations or financial position.

InFebruary 2007, the FASB issued FAS No. 159, *The Fair Value Option forFinancial Assets and Financial Liabilities — Including an amendment of FASBStatement No. 115*, which provides all entities with an option toreport selected financial assets and liabilities at fair value. The objectiveof the FAS No. 159 is to improve financial reporting by providing entities withthe opportunity to mitigate volatility in earnings caused by measuring relatedassets and liabilities differently without having to apply the complexprovisions of hedge accounting.  FAS No.159 is effective as of the beginning of an entity’s first fiscal year beginningafter November 15, 2007.  Early adoptionis permitted as of the beginning of a fiscal year that begins on or beforeNovember 15, 2007 provided the entity also elects to apply the provisions ofFAS No. 157, *Fair Value Measurements*.  The adoption of this standard is not expectedto have a material effect on the Company’s results of operations or financialposition.  

InJune 2006, the FASB issued FASB Interpretation No. 48 (“FIN 48”), *Accounting for Uncertainty in Income Taxes*. FIN 48 is aninterpretation of FAS No. 109, *Accounting for Income*

9

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*Taxes*, and it seeks to reduce the diversity inpractice associated with certain aspects of measurement and recognition inaccounting for income taxes. In addition, FIN No. 48 requires expandeddisclosure with respect to the uncertainty in income taxes and is effective forfiscal years beginning after December 15, 2006. The adoption of this standard is not expected to have a material effecton the Company’s results of operations or financial position.  

In September 2006, the FASBreached consensus on the guidance provided by Emerging Issues Task Force Issue06-4 (“EITF 06-4”), *Accounting for DeferredCompensation and Postretirement Benefit Aspects of Endorsement Split-DollarLife Insurance Arrangements*. The guidance is applicable to endorsement split-dollar life insurancearrangements, whereby the employer owns and controls the insurance policy, thatare associated with a postretirement benefit. EITF 06-4 requires that for a split-dollar life insurance arrangementwithin the scope of the Issue, an employer should recognize a liability forfuture benefits in accordance with FAS No. 106 (if, in substance, apostretirement benefit plan exists) or Accounting Principles Board Opinion No.12 (if the arrangement is, in substance, an individual deferred compensationcontract) based on the substantive agreement with the employee.  EITF 06-4 is effective for fiscal yearsbeginning after December 15, 2007.  TheCompany is currently evaluating the impact the adoption of the EITF will haveon the Company’s results of operations or financial condition. 

In September 2006, theFASB reached consensus on the guidance provided by Emerging Issues Task ForceIssue 06-5 (“EITF 06-5”), *Accounting for Purchasesof Life Insurance—Determining the Amount That Could Be Realized in Accordancewith FASB Technical Bulletin No. 85-4, Accounting for Purchases of LifeInsurance*.  EITF 06-5 statesthat a policyholder should consider any additional amounts included in thecontractual terms of the insurance policy other than the cash surrender valuein determining the amount that could be realized under the insurancecontract.  EITF 06-5 also states that apolicyholder should determine the amount that could be realized under the lifeinsurance contract assuming the surrender of an individual-life by individual-lifepolicy (or certificate by certificate in a group policy). EITF 06-5 iseffective for fiscal years beginning after December 15, 2006.   The Company is currently evaluating theimpact the adoption of the standard will have on the Company’s results of operationsor financial condition. 

In March 2007, the FASBratified Emerging Issues Task Force Issue No. 06-10 (“EITF 06-10”), *Accounting for Collateral Assignment Split-Dollar Life InsuranceAgreements*. EITF 06-10 provides guidance for determining a liabilityfor the postretirement benefit obligation as well as recognition andmeasurement of the associated asset on the basis of the terms of the collateralassignment agreement. EITF 06-10 is effective for fiscal years beginning afterDecember 15, 2007. The Company is currently evaluating the impact the adoptionof the EITF will have on the Company’s results of operations or financialcondition. 

In June 2007, the FASBratified Emerging Issues Task Force Issue No. 06-11 (“EITF 06-11”), *Accounting for Income Tax Benefits of Dividends on Share-Based PaymentAwards*.  EITF 06-11

10

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applies to share-basedpayment arrangements with dividend protection features that entitle employeesto receive (a) dividends on equity-classified nonvested shares, (b) dividendequivalents on equity-classified nonvested share units, or (c) payments equalto the dividends paid on the underlying shares while an equity-classified shareoption is outstanding, when those dividends or dividend equivalents are chargedto retained earnings under FAS No. 123R, *Share-Based Payment*,and result in an income tax deduction for the employer. A consensus was reachedthat a realized income tax benefit from dividends or dividend equivalents thatare charged to retained earnings and are paid to employees forequity-classified nonvested equity shares, nonvested equity share units, andoutstanding equity share options should be recognized as an increase inadditional paid-in capital.  EITF 06-11is effective for fiscal years beginning after December 15, 2007, and interimperiods within those fiscal years.  Theimpact of the adoption of the EITF will not have an impact on the Company’sfinancial condition. 

**Note 3. Per Share Data**

The following table sets forth the composition ofthe weighted average common shares (denominator) used in the basic and dilutiveper share computation.  There are noconvertible securities which would affect the numerator in calculating basicand diluted earnings per share; therefore, net income as presented on theconsolidated statement of income will be used as the numerator.  
| ** **                                                                                                 | ** ** | **Three Months Ended June 30,** | ** ** | **Six Months Ended June 30,** | ** ** |
|------------------------------------------------------------------------------------------------------------|------------|-----------------------------------------------------|------------|---------------------------------------------------|------------|
| ** **                                                                                                 | ** ** | **2007**                                            | ** ** | **2006**                                          | ** ** | **2007** | ** ** | **2006** | ** ** |
|                                                                                                       |       |                                                |       |                                              |       |   |   |   |   |
| Weighted average  common shares outstanding                                                                |       | 4,004,798                                           |       | 4,002,159                                         |       | 4,004,369 |   | 4,002,159 |   |
|                                                                                                       |       |                                                |       |                                              |       |   |   |   |   |
| Average treasury  stock shares                                                                             |       | (115,659                                            | )          | (62,735                                           | )          | (111,083 | ) | (51,864 | ) |
|                                                                                                       |       |                                                |       |                                              |       |   |   |   |   |
| Weighted average  common shares and common  stock equivalents used to calculate basic earnings per share   |       | 3,889,139                                           |       | 3,939,424                                         |       | 3,893,286 |   | 3,950,295 |   |
|                                                                                                       |       |                                                |       |                                              |       |   |   |   |   |
| Additional  common stock equivalents (stock options) used to calculate diluted earnings  per share         |       | 262                                                 |       | 487                                               |       | 300 |   | 486 |   |
|                                                                                                       |       |                                                |       |                                              |       |   |   |   |   |
| Weighted average common  shares and common stock equivalents used to calculate diluted earnings per  share |       | 3,889,401                                           |       | 3,939,911                                         |       | 3,893,586 |   | 3,950,781 |   |

 

Options to purchase 8,276 and 9,002 shares ofcommon stock at the price of $40.29 were outstanding during the three and sixmonths ended June 30, 2007 and 2006, respectively, but were not included in thecomputation of diluted earnings per share as they were anti-dilutive due to thestrike price being greater than the market price as of June 30, 2007 and 2006,respectively.  

11

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

For adetailed disclosure on the Company’s pension and employee benefits plans,please refer to Note 11 of the Company’s Consolidated Financial Statementsincluded in the Annual Report on Form 10-K for the year ended December 31,2006.

Thefollowing sets forth the components of the net periodic benefit cost of thedomestic non-contributory defined benefit plan for the three and six monthsended June 30, 2007 and 2006, respectively:
| ** **                             | ** ** | **Three Months Ended** | ** ** | **Six Months Ended** | ** ** |
|----------------------------------------|------------|----------------------------------|------------|--------------------------------|------------|
| ** **                             | ** ** | **June 30,**                | ** ** | **June 30,**              | ** ** |
| **(In Thousands)**                | ** ** | **2007**                         | ** ** | **2006**                       | ** ** | **2007** | ** ** | **2006** | ** ** |
|                                   |       |                             |       |                           |       |   |   |   |   |
| Service cost                           |       | $                                | 117        |                           | $          | 117 |   | $ | 233 |   | $ | 233 |   |
| Interest cost                          |       | 121                              |       | 108                            |       | 243 |   | 217 |   |
| Expected return  on plan assets        |       | (140                             | )          | (121                           | )          | (281 | ) | (242 | ) |
| Amortization of  transition obligation |       | (1                               | )          | (1                             | )          | (1 | ) | (2 | ) |
| Amortization of  prior service cost    |       | 6                                |       | 6                              |       | 13 |   | 13 |   |
| Amortization of  net loss              |       | —                           |       | 6                              |       | — |   | 11 |   |
| Net periodic cost                      |       | $                                | 103        |                           | $          | 115 |   | $ | 207 |   | $ | 230 |   |

 

**Employer Contributions**

The Companypreviously disclosed in its consolidated financial statements, included in theAnnual Report on Form 10-K for the year ended December 31, 2006, that itexpected to contribute $500,000 to its defined benefit plan in 2007.  Asof June 30, 2007, there were no contributions made to the plan. 

**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.

Outstanding financial instruments with offbalance sheet risk are as follows:

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|                               | ** ** | **June 30,** | ** ** | **December 31,** | ** ** |
|-------------------------------|------------|-------------------|------------|-----------------------|------------|
| **(In Thousands)**       | ** ** | ** **        | ** ** | **2007**              | ** ** | **2006** | ** ** |
| Commitments to  extend credit |       | $                 | 73,689     |                  | $          | 61,736 |   |
| Standby letters of  credit    |       | 1,411             |       | 1,033                 |       |
|                               |            |                   |            |                       |            |  |  |  |  |

 

**Note 6.  Reclassification of Comparative Amounts**

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

**Note 7.  Employee Stock Purchase Plan**

Effective April 26, 2006, the Company implemented the Penns WoodsBancorp, Inc. 2006 Employee Stock Purchase Plan (“Plan”).  The Plan is intended to encourage employeeparticipation in the ownership and economic progress of the Company.  The Plan allows for up to 1,000,000 shares tobe purchased by employees.  The purchaseprice of the shares is 95% of market value with an employee eligible topurchase up to the lesser of 15% of base compensation or $12,000 in marketvalue annually.  During the three and sixmonths ended June 30, 2007, there were 826 and 1,498 shares issued under theplan, respectively.

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

ThisReport contains certain “forward-looking statements” including statementsconcerning plans, objectives, future events or performance and assumptions andother statements which are other than statements of historical fact.  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 changes inlaws and regulations, including federal and state banking laws and regulationswith which the Company must comply, and the associated costs of compliance withsuch laws and regulations either currently or in the future as applicable; (ii)the effect of changes in accounting policies and practices, as may be adoptedby the regulatory agencies as well as by the Financial Accounting StandardsBoard, or of changes in the Company’s organization, compensation and benefitplans; (iii) the effect on the Company’s competitive position within its marketarea of the  increasing consolidationwithin the banking and financial services industries, including the increasedcompetition from larger regional and out-of-state banking organizations as wellas non-bank providers of various financial services; (iv) the effect of changesin interest rates; and (v) the effect of changes in the business cycle anddownturns in the local, regional or national economies.

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

**EARNINGS SUMMARY**

**Comparisonof the Three Months Ended June 30, 2007 and 2006**

**SummaryResults**

Net income for thethree months ended June 30, 2007 was $2,335,000 compared to $2,434,000 for thesame period of 2006.  Basic and dilutedearnings per share for the three months ended June 30, 2007 were $0.60 ascompared to $0.62 for the three months ended June 30, 2006.  Return on average assets and return onaverage equity were 1.58% and 12.57% for the three months ended June 30, 2007as compared to 1.70% and 13.34% for the corresponding period of 2006.  Net income from core operations for the threemonths ended June 30, 2007 and 2006, excluding after-tax net securities gainsof $193,000 and $175,000, respectively, were $2,142,000 and $2,259,000 or $0.55and $0.57 per share, respectively, for the periods being compared.

The six monthsended June 30, 2007 generated net income of $4,616,000 compared to $4,889,000for the same period of 2006.  Earningsper share, basic and diluted, for the six months ended June 30, 2007 were $1.19as compared to $1.24 for the comparable period of 2006.  Return on average assets and return onaverage equity were 1.57% and 12.35% for the six months ended June 30, 2007 ascompared to 1.71% and 13.12% for the corresponding period of 2006.  Net income from core operations for the sixmonths ended June 30, 2007, excluding after-tax securities gains of $409,000,declined to $4,207,000 from $4,345,000 for the six months ended June 30, 2006resulting in basic and dilutive operating earnings per share of $1.08 ascompared to $1.10 for the six months ended June 30, 2006.  (Management uses the non-GAAP measure of netincome from core operations in its analysis of the Company’s performance.  This measure, as used by the Company, adjustsnet income by significant 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 from coreoperations means net income adjusted to exclude after-tax net securitiesgains.  These disclosures should not beviewed as a substitute for net income determined in accordance with GAAP, norare they necessarily comparable to non-GAAP performance measures that may bepresented by other companies.)

**InterestIncome**

Interest income for the three months ended June 30, 2007 increased$446,000 to $8,793,000 as compared to $8,347,000 for the same period of2006.  The increase in total interestincome was primarily the result of growth in average loans of $11,860,000 forthe three months ended June 30, 2007 as compared to 2006.  The average loan growth and a 25 basis point(“bp”) increase in loan portfolio yields accounted for $430,000 of the totalinterest income growth.  Over this timeframe, the average balance of investment securities and interest bearingdeposits remained stable

14

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with the portfolio yield increasing 9 bp resulting in a $16,000increase in interest income.  On ataxable equivalent basis, the interest income from the investment portfolio andinterest bearing deposits increased $43,000 as the investment portfolio was strategicallyshifted toward tax-exempt instruments. The decrease in dividends received is the result of a decrease in theaverage book value investment in stocks of $5,000,000 when comparing the threemonth periods ended June 30, 2007 and 2006. 

During the six months ended June 30, 2007, interest income was$17,472,000, an increase of $1,103,000 over the same period in 2006.  The reasons for the 6.7% growth in interestincome for the six month period are identical to those for the three monthperiod ending June 30, 2007 discussed above. The growth in average loans of $14,772,000 coupled with a 30 bp increasein the loan portfolio yield resulted in an increase of $1,044,000 in loaninterest and fee income.   Averageinvestment securities and interest bearing deposits decreased slightly to$185,169,000 resulting in interest income increasing $59,000 when compared toJune 30, 2006 due to an increase of 21 bp in the investment portfolio yield,while interest income on interest bearing deposits increased $15,000 for thesame period.  The asset allocationbetween loans and the investment portfolio composition resulted in taxableequivalent interest income increasing $1,192,000 for the six months ended June30, 2007 as compared to the same period of 2006.

Interest income composition for the three and six months ended June 30,2007 and 2006 was as follows:
| ** **                          | ** ** | **For The Three Months Ended** | ** ** |
|-------------------------------------|------------|----------------------------------------------------|------------|
| ** **                          | ** ** | **June 30, 2007**                        | ** ** | **June 30, 2006** | ** ** | **Change** | ** ** |
| **(In Thousands)**             | ** ** | **Amount**                                         | ** ** | **% Total** | ** ** | **Amount** | ** ** | **% Total** | ** ** | **Amount** | ** ** | **%** | ** ** |
| Loans including fees                |       | $                                                  | 6,516      |   | 74.1 | % | $ | 6,086 |   | 72.9 | % | $ | 430 |   | 7.1 | % |
| Investment securities:              |       |                                               |       |   |   |   |   |   |   |   |   |   |   |
| Taxable                             |       | 924                                                |       | 10.5 |   | 896 |   | 10.7 |   | 28 |   | 3.1 |   |
| Tax-exempt                          |       | 1,052                                              |       | 12.0 |   | 1,000 |   | 12.0 |   | 52 |   | 5.2 |   |
| Dividend and  other interest income |       | 301                                                |       | 3.4 |   | 365 |   | 4.4 |   | (64 | ) | (17.5 | ) |
| Total interest income               |       | $                                                  | 8,793      |   | 100.0 | % | $ | 8,347 |   | 100.0 | % | $ | 446 |   | 5.3 | % |

 
| ** **                          | ** ** | **For The Six Months Ended** | ** ** |
|-------------------------------------|------------|--------------------------------------------------|------------|
| ** **                          | ** ** | **June 30, 2007**                      | ** ** | **June 30, 2006** | ** ** | **Change** | ** ** |
| **(In Thousands)**             | ** ** | **Amount**                                       | ** ** | **% Total** | ** ** | **Amount** | ** ** | **% Total** | ** ** | **Amount** | ** ** | **%** | ** ** |
| Loans including fees                |       | $                                                | 12,939     |   | 74.0 | % | $ | 11,895 |   | 72.6 | % | $ | 1,044 |   | 8.8 | % |
| Investment securities:              |       |                                             |       |   |   |   |   |   |   |   |   |   |   |
| Taxable                             |       | 1,747                                            |       | 10.0 |   | 1,819 |   | 11.1 |   | (72 | ) | (4.0 | ) |
| Tax-exempt                          |       | 2,163                                            |       | 12.4 |   | 1,989 |   | 12.2 |   | 174 |   | 8.7 |   |
| Dividend and  other interest income |       | 623                                              |       | 3.6 |   | 666 |   | 4.1 |   | (43 | ) | (6.5 | ) |
| Total interest income               |       | $                                                | 17,472     |   | 100.0 | % | $ | 16,369 |   | 100.0 | % | $ | 1,103 |   | 6.7 | % |

 

15

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**InterestExpense**

Interest expense for the three months ended June 30, 2007 increased$578,000 to $3,999,000 as compared to $3,421,000 for the same period of2006.  The increased expense associatedwith deposits is primarily the result of rate increases for time deposits,which are comprised of various certificates of deposit (“CD”) accounts, fromthe three months ended June 30, 2006 to the corresponding period of 2007.  Factors that led to the rate increasesinclude, but are not limited to, a prime rate increase, competitive marketpricing pressure, and campaigns conducted to attract 8 to 12 month maturity CDsto replace higher cost short-term FHLB advances. The increase in CD interestrates has exceeded the increase for other deposit accounts.  This has led to a shift of a portion of themoney market and savings deposit portfolios into higher yielding CDs.  

Short-term borrowing interest expense on FHLB advances and customerrepurchase accounts decreased $282,000 as rates paid decreased 47 bp.  The decrease in rates paid was a result of achange in the composition of the short-term borrowing due to the previouslynoted CD campaigns.  The successfulcampaigns caused a reduction in the higher cost average FHLB short-termadvances of $18,082,000. Long-term FHLB borrowing expense decreased minimallydue to a decline in average borrowings of $4,907,000. 

Interest expense for the six months ended June 30, 2007 increased$1,328,000 to $7,938,000 from $6,610,000 for the comparable period of 2006.  Interest on deposits accounted for $1,575,000of the increase due to the reasons noted in the above three monthanalysis.  Borrowing costs declinedprimarily due to the before noted CD campaigns that allowed for FHLB advancesto be reduced.

Interestexpense composition for the three and six months ended June 30, 2007 and 2006were as follows:
| ** **                  | ** ** | **For The Three Months Ended** | ** ** |
|-----------------------------|------------|----------------------------------------------------|------------|
| ** **                  | ** ** | **June 30, 2007**                        | ** ** | **June 30, 2006** | ** ** | **Change** | ** ** |
| **(In Thousands)**     | ** ** | **Amount**                                         | ** ** | **% Total** | ** ** | **Amount** | ** ** | **% Total** | ** ** | **Amount** | ** ** | **%** | ** ** |
| Deposits                    |       | $                                                  | 2,868      |   | 71.7 | % | $ | 1,968 |   | 57.5 | % | $ | 900 |   | 45.7 | % |
| Short-term  borrowings      |       | 227                                                |       | 5.7 |   | 509 |   | 14.9 |   | (282 | ) | (55.4 | ) |
| Long-term  borrowings, FHLB |       | 904                                                |       | 22.6 |   | 944 |   | 27.6 |   | (40 | ) | (4.2 | ) |
| Total interest  expense     |       | $                                                  | 3,999      |   | 100.0 | % | $ | 3,421 |   | 100.0 | % | $ | 578 |   | 16.9 | % |

 
| ** **                  | ** ** | **For The Six Months Ended** | ** ** |
|-----------------------------|------------|--------------------------------------------------|------------|
| ** **                  | ** ** | **June 30, 2007**                      | ** ** | **June 30, 2006** | ** ** | **Change** | ** ** |
| **(In Thousands)**     | ** ** | **Amount**                                       | ** ** | **% Total** | ** ** | **Amount** | ** ** | **% Total** | ** ** | **Amount** | ** ** | **%** | ** ** |
| Deposits                    |       | $                                                | 5,380      |   | 67.8 | % | $ | 3,805 |   | 57.6 | % | $ | 1,575 |   | 41.4 | % |
| Short-term  borrowings      |       | 732                                              |       | 9.2 |   | 915 |   | 13.8 |   | (183 | ) | (20.0 | ) |
| Long-term  borrowings, FHLB |       | 1,826                                            |       | 23.0 |   | 1,890 |   | 28.6 |   | (64 | ) | (3.4 | ) |
| Total interest  expense     |       | $                                                | 7,938      |   | 100.0 | % | $ | 6,610 |   | 100.0 | % | $ | 1,328 |   | 20.1 | % |

 

16

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**Net Interest Margin**

The net interest margin (“NIM”) for the three months ended June 30,2007 was 3.95% as compared to 4.12% for the corresponding period of 2006.  The decrease in the NIM was the result of theyield on earning assets increasing 19 bp to 6.88% for the three months endedJune 30, 2007, as compared to 2006; however, interest bearing liabilities increased42 bp over the same period.  The increasein the yield on earning assets is attributable to growth in the taxable loanportfolio of $11,928,000 in addition to the yield on taxable loans increasing25 bp coupled with an increase of 45 bp on the taxable investment portfolio.  The average loan growth was predominatelycomprised of residential and commercial real estate loans.  The yield on total loans increased to 7.29%from 7.04% due to the impact of the Federal Open Market Committee rateincreases enacted since the start of the three month period ended June 30, 2006offset by competitive factors.  Theaverage taxable investment securities portfolio declined by $10,806,000, as thecash flow from the portfolio was invested in tax-exempt securities as part ofthe Company’s tax strategy. The average interest rate paid on deposit accountsincreased to 3.39% as compared to 2.66% for the 2006 period.  This increase was driven by growth in averagetime deposits of $44,577,000 and an increase in the rate paid on time depositsof 93 bp.  A portion of the increase indeposit volume and the average interest yield paid is due to several CDpromotions during the past year to attract new customers while retainingexisting customers.  The promotions weredesigned to gather deposits that would have maturities of one year orless.  In addition, the promotions servedas a catalyst to cross sell other deposit products and to implement management’sstrategy to shorten the duration of the CD portfolio. 

The rate paid on short-term borrowings, FHLB advances and customerrepurchase accounts, decreased 47 bp to 4.09% for the three months ended June30, 2007.  The decrease was the result ofhigher cost average short-term FHLB advances decreasing $18,082,000 due to thefunding generated by the before mentioned CD promotions.  

The NIM for the six months ended June 30, 2007 was 3.95% as compared to4.10% for the corresponding period of 2006. The decrease in the NIM was the result of the before mentioned growthand change in mix of the earnings assets offset by increased rates paid oninterest bearing liabilities and growth in the CD portfolio of$35,224,000.  

Following is a schedule of average balances and associated yields forthe three and six month periods ended June 30, 2007 and 2006:

17

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| ** **                                       | ** ** | **AVERAGE BALANCES AND INTEREST RATES** | ** ** |
|--------------------------------------------------|------------|-------------------------------------------------------------|------------|
| ** **                                       | ** ** | **Three Months Ended**                            | ** ** | **Three Months Ended** | ** ** |
| ** **                                       | ** ** | **June 30, 2007**                                 | ** ** | **June 30, 2006** | ** ** |
| **(In Thousands)**                          | ** ** | **Average Balance**                                    | ** ** | **Interest** | ** ** | **Average Rate** | ** ** | **Average Balance** | ** ** | **Interest** | ** ** | **Average Rate** | ** ** |
| Assets:                                          |       |                                                        |       |   |   |   |   |   |   |   |   |   |   |
| Tax-exempt loans                                 |       | $                                                           | 7,819      |   | $ | 120 |   | 6.16 | % | $ | 7,887 |   | $ | 123 |   | 6.26 | % |
| All other loans                                  |       | 353,019                                                     |       | 6,437 |   | 7.31 | % | 341,091 |   | 6,005 |   | 7.06 | % |
| Total loans                                      |       | 360,838                                                     |       | 6,557 |   | 7.29 | % | 348,978 |   | 6,128 |   | 7.04 | % |
|                                             |       |                                                        |       |   |   |   |   |   |   |   |   |   |   |
| Taxable  investment securities                   |       | 83,328                                                      |       | 1,209 |   | 5.80 | % | 94,134 |   | 1,259 |   | 5.35 | % |
| Tax-exempt  investment securities                |       | 100,403                                                     |       | 1,594 |   | 6.35 | % | 90,530 |   | 1,515 |   | 6.69 | % |
| Total securities                                 |       | 183,731                                                     |       | 2,803 |   | 6.10 | % | 184,664 |   | 2,774 |   | 6.01 | % |
|                                             |       |                                                        |       |   |   |   |   |   |   |   |   |   |   |
| Interest bearing  deposits                       |       | 1,230                                                       |       | 16 |   | 5.22 | % | 32 |   | 2 |   | 25.07 | % |
|                                             |       |                                                        |       |   |   |   |   |   |   |   |   |   |   |
| Total  interest-earning assets                   |       | 545,799                                                     |       | 9,376 |   | 6.88 | % | 533,674 |   | 8,904 |   | 6.69 | % |
|                                             |       |                                                        |       |   |   |   |   |   |   |   |   |   |   |
| Other assets                                     |       | 43,594                                                      |       |   |   |   |   | 39,143 |   |   |   |   |   |
|                                             |       |                                                        |       |   |   |   |   |   |   |   |   |   |   |
| Total assets                                     |       | $                                                           | 589,393    |   |   |   |   |   | $ | 572,817 |   |   |   |   |   |
|                                             |       |                                                        |       |   |   |   |   |   |   |   |   |   |   |
| Liabilities:                                     |       |                                                        |       |   |   |   |   |   |   |   |   |   |   |
| Savings                                          |       | $                                                           | 59,906     |   | 110 |   | 0.74 | % | $ | 63,648 |   | 136 |   | 0.86 | % |
| Super Now deposits                               |       | 47,531                                                      |       | 153 |   | 1.29 | % | 48,282 |   | 169 |   | 1.40 | % |
| Money market  deposits                           |       | 26,346                                                      |       | 158 |   | 2.41 | % | 24,165 |   | 121 |   | 2.01 | % |
| Time deposits                                    |       | 205,554                                                     |       | 2,447 |   | 4.77 | % | 160,977 |   | 1,542 |   | 3.84 | % |
| Total deposits                                   |       | 339,337                                                     |       | 2,868 |   | 3.39 | % | 297,072 |   | 1,968 |   | 2.66 | % |
|                                             |       |                                                        |       |   |   |   |   |   |   |   |   |   |   |
| Short-term  borrowings                           |       | 22,239                                                      |       | 227 |   | 4.09 | % | 44,793 |   | 509 |   | 4.56 | % |
| Long-term  borrowings, FHLB                      |       | 77,971                                                      |       | 904 |   | 4.65 | % | 82,878 |   | 944 |   | 4.57 | % |
| Total borrowings                                 |       | 100,210                                                     |       | 1,131 |   | 4.53 | % | 127,671 |   | 1,453 |   | 4.56 | % |
|                                             |       |                                                        |       |   |   |   |   |   |   |   |   |   |   |
| Total  interest-bearing liabilities              |       | 439,547                                                     |       | 3,999 |   | 3.65 | % | 424,743 |   | 3,421 |   | 3.23 | % |
|                                             |       |                                                        |       |   |   |   |   |   |   |   |   |   |   |
| Demand deposits                                  |       | 68,677                                                      |       |   |   |   |   | 70,961 |   |   |   |   |   |
| Other  liabilities                               |       | 6,888                                                       |       |   |   |   |   | 4,129 |   |   |   |   |   |
| Shareholders’  equity                       |       | 74,281                                                      |       |   |   |   |   | 72,984 |   |   |   |   |   |
| Total  liabilities and shareholders’ equity |       | $                                                           | 589,393    |   |   |   |   |   | $ | 572,817 |   |   |   |   |   |
|                                             |       |                                                        |       |   |   |   |   |   |   |   |   |   |   |
| Interest rate  spread                            |       |                                                        |       |   |   | 3.23 | % |   |   |   |   | 3.46 | % |
| Net interest  income/margin                      |       |                                                        |       | $ | 5,377 |   | 3.95 | % |   |   | $ | 5,483 |   | 4.12 | % |

 

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

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

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

18

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| ** **                          | ** ** | **AVERAGE BALANCES AND INTEREST RATES** | ** ** |
|-------------------------------------|------------|-------------------------------------------------------------|------------|
| ** **                          | ** ** | **Six Months Ended**                              | ** ** | **Six Months Ended** | ** ** |
| ** **                          | ** ** | **June 30, 2007**                                 | ** ** | **June 30, 2006** | ** ** |
| **(In Thousands)**             | ** ** | **Average Balance**                                    | ** ** | **Interest** | ** ** | **Average Rate** | ** ** | **Average Balance** | ** ** | **Interest** | ** ** | **Average Rate** | ** ** |
| Assets:                             |       |                                                        |       |   |   |   |   |   |   |   |   |   |   |
| Tax-exempt loans                    |       | $                                                           | 8,022      |   | $ | 247 |   | 6.21 | % | $ | 8,038 |   | $ | 248 |   | 6.22 | % |
| All other loans                     |       | 352,829                                                     |       | 12,776 |   | 7.30 | % | 338,041 |   | 11,731 |   | 7.00 | % |
| Total loans                         |       | 360,851                                                     |       | 13,023 |   | 7.28 | % | 346,079 |   | 11,979 |   | 6.98 | % |
|                                |       |                                                        |       |   |   |   |   |   |   |   |   |   |   |
| Taxable  securities                 |       | 82,952                                                      |       | 2,353 |   | 5.67 | % | 95,880 |   | 2,483 |   | 5.18 | % |
| Tax-exempt  securities              |       | 101,588                                                     |       | 3,277 |   | 6.45 | % | 90,839 |   | 3,014 |   | 6.64 | % |
| Total securities                    |       | 184,540                                                     |       | 5,630 |   | 6.10 | % | 186,719 |   | 5,497 |   | 5.89 | % |
|                                |       |                                                        |       |   |   |   |   |   |   |   |   |   |   |
| Interest bearing  deposits          |       | 629                                                         |       | 17 |   | 5.45 | % | 22 |   | 2 |   | 18.33 | % |
|                                |       |                                                        |       |   |   |   |   |   |   |   |   |   |   |
| Total  interest-earning assets      |       | 546,020                                                     |       | 18,670 |   | 6.88 | % | 532,820 |   | 17,478 |   | 6.60 | % |
|                                |       |                                                        |       |   |   |   |   |   |   |   |   |   |   |
| Other assets                        |       | 41,723                                                      |       |   |   |   |   | 38,669 |   |   |   |   |   |
|                                |       |                                                        |       |   |   |   |   |   |   |   |   |   |   |
| Total assets                        |       | $                                                           | 587,743    |   |   |   |   |   | $ | 571,489 |   |   |   |   |   |
|                                |       |                                                        |       |   |   |   |   |   |   |   |   |   |   |
| Liabilities:                        |       |                                                        |       |   |   |   |   |   |   |   |   |   |   |
| Savings                             |       | $                                                           | 59,454     |   | 215 |   | 0.73 | % | $ | 63,184 |   | 256 |   | 0.82 | % |
| Super Now  deposits                 |       | 46,196                                                      |       | 302 |   | 1.32 | % | 48,223 |   | 318 |   | 1.33 | % |
| Money market  deposits              |       | 24,962                                                      |       | 283 |   | 2.29 | % | 24,642 |   | 237 |   | 1.94 | % |
| Time deposits                       |       | 195,712                                                     |       | 4,580 |   | 4.72 | % | 160,488 |   | 2,994 |   | 3.76 | % |
| Total Deposits                      |       | 326,324                                                     |       | 5,380 |   | 3.32 | % | 296,537 |   | 3,805 |   | 2.59 | % |
|                                |       |                                                        |       |   |   |   |   |   |   |   |   |   |   |
| Short-term  borrowings              |       | 32,206                                                      |       | 732 |   | 4.58 | % | 43,100 |   | 915 |   | 4.28 | % |
| Other borrowings                    |       | 79,339                                                      |       | 1,826 |   | 4.64 | % | 83,603 |   | 1,890 |   | 4.56 | % |
| Total borrowings                    |       | 111,545                                                     |       | 2,558 |   | 4.62 | % | 126,703 |   | 2,805 |   | 4.46 | % |
|                                |       |                                                        |       |   |   |   |   |   |   |   |   |   |   |
| Total  interest-bearing liabilities |       | 437,869                                                     |       | 7,938 |   | 3.66 | % | 423,240 |   | 6,610 |   | 3.15 | % |
|                                |       |                                                        |       |   |   |   |   |   |   |   |   |   |   |
| Demand deposits                     |       | 68,446                                                      |       |   |   |   |   | 68,996 |   |   |   |   |   |
| Other  liabilities                  |       | 6,673                                                       |       |   |   |   |   | 4,709 |   |   |   |   |   |
| Shareholders’  equity          |       | 74,755                                                      |       |   |   |   |   | 74,544 |   |   |   |   |   |
|                                |       |                                                        |       |   |   |   |   |   |   |   |   |   |   |
|                                |       | $                                                           | 587,743    |   |   |   |   |   | $ | 571,489 |   |   |   |   |   |
| Interest rate  spread               |       |                                                        |       |   |   | 3.22 | % |   |   |   |   | 3.45 | % |
| Net interest  income/margin         |       |                                                        |       | $ | 10,732 |   | 3.95 | % |   |   | $ | 10,868 |   | 4.10 | % |

 

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

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

3.               Income and rates ona fully taxable equivalent basis include an adjustment for the differencebetween annual income from tax-exempt obligations and the taxable equivalent ofsuch income at the standard 34% tax rate.

19

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The followingtable presents the adjustment to convert net interest income to net interestincome on a fully taxable equivalent basis for the three and six month periodsended June 30, 2007 and 2006.
| ** **                                      | ** ** | **For the Three Months Ended** | ** ** | **For the Six Months Ended** | ** ** |
|-------------------------------------------------|------------|----------------------------------------------------|------------|--------------------------------------------------|------------|
| ** **                                      | ** ** | **June 30,**                                  | ** ** | **June 30,**                                | ** ** |
| **(In Thousands)**                         | ** ** | **2007**                                           | ** ** | **2006**                                         | ** ** | **2007** | ** ** | **2006** | ** ** |
|                                            |       |                                               |       |                                             |       |   |   |   |   |
| Total interest  income                          |       | $                                                  | 8,793      |                                             | $          | 8,347 |   | $ | 17,472 |   | $ | 16,369 |   |
| Total interest  expense                         |       | 3,999                                              |       | 3,421                                            |       | 7,938 |   | 6,610 |   |
|                                            |       |                                               |       |                                             |       |   |   |   |   |
| Net interest  income                            |       | 4,794                                              |       | 4,926                                            |       | 9,534 |   | 9,759 |   |
| Tax equivalent  adjustment                      |       | 583                                                |       | 557                                              |       | 1,198 |   | 1,109 |   |
|                                            |       |                                               |       |                                             |       |   |   |   |   |
| Net interest income  (fully taxable equivalent) |       | $                                                  | 5,377      |                                             | $          | 5,483 |   | $ | 10,732 |   | $ | 10,868 |   |

 

# The followingtable sets forth the respective impact that both volume and rate changes havehad on net interest income on a fully taxable equivalent basis for the threeand six month periods ended June 30, 2007 and 2006:

| ** **                         | ** ** | **Three Months Ended June 30,** | ** ** | **Six Months Ended June 30,** | ** ** |
|------------------------------------|------------|-----------------------------------------------------|------------|---------------------------------------------------|------------|
| ** **                         | ** ** | **2007 vs 2006**                          | ** ** | **2007 vs 2006**                        | ** ** |
| ** **                         | ** ** | **Increase (Decrease)**                        | ** ** | **Increase (Decrease)**                      | ** ** |
| ** **                         | ** ** | **Due to**                                     | ** ** | **Due to**                                   | ** ** |
| **(In Thousands)**            | ** ** | **Volume**                                          | ** ** | **Rate**                                          | ** ** | **Net** | ** ** | **Volume** | ** ** | **Rate** | ** ** | **Net** | ** ** |
| Interest income:                   |       |                                                |       |                                              |       |   |   |   |   |   |   |   |   |
| Loans,  tax-exempt                 |       | $                                                   | (1         | )                                                 | $          | (2 | ) | $ | (3 | ) | $ | — |   | $ | (1 | ) | $ | (1 | ) |
| Loans                              |       | 214                                                 |       | 218                                               |       | 432 |   | 527 |   | 518 |   | 1,045 |   |
| Taxable  investment securities     |       | (180                                                | )          | 130                                               |       | (50 | ) | (417 | ) | 287 |   | (130 | ) |
| Tax-exempt  investment securities  |       | 147                                                 |       | (68                                               | )          | 79 |   | 344 |   | (81 | ) | 263 |   |
| Interest bearing  deposits         |       | 72                                                  |       | (58                                               | )          | 14 |   | 54 |   | (39 | ) | 15 |   |
| Total interest-earning assets      |       | 252                                                 |       | 220                                               |       | 472 |   | 508 |   | 684 |   | 1,192 |   |
|                               |       |                                                |       |                                              |       |   |   |   |   |   |   |   |   |
| Interest  expense:                 |       |                                                |       |                                              |       |   |   |   |   |   |   |   |   |
| Savings deposits                   |       | (8                                                  | )          | (18                                               | )          | (26 | ) | (14 | ) | (27 | ) | (41 | ) |
| Super Now  deposits                |       | (3                                                  | )          | (13                                               | )          | (16 | ) | (13 | ) | (3 | ) | (16 | ) |
| Money market  deposits             |       | 12                                                  |       | 25                                                |       | 37 |   | 3 |   | 43 |   | 46 |   |
| Time deposits                      |       | 476                                                 |       | 429                                               |       | 905 |   | 726 |   | 860 |   | 1,586 |   |
| Short-term  borrowings             |       | (232                                                | )          | (50                                               | )          | (282 | ) | (252 | ) | 69 |   | (183 | ) |
| Long-term  borrowings, FHLB        |       | (57                                                 | )          | 17                                                |       | (40 | ) | (99 | ) | 35 |   | (64 | ) |
| Total interest-bearing liabilities |       | 188                                                 |       | 390                                               |       | 578 |   | 351 |   | 977 |   | 1,328 |   |
| Change in net interest  income     |       | $                                                   | 64         |                                              | $          | (170 | ) | $ | (106 | ) | $ | 157 |   | $ | (293 | ) | $ | (136 | ) |

 

**Provision for Loan Losses**

The provision for loanlosses is based upon management’s quarterly review of the loan portfolio.  The purpose of the review is to assess loanquality, identify impaired loans, analyze delinquencies, ascertain loan growth,evaluate potential charge-offs and recoveries, and assess general economicconditions in the markets served.  Anexternal independent loan review is also

20

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performed annually forthe Bank.  Management remains committedto an aggressive program of problem loan identification and resolution.

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

Althoughmanagement believes it uses the best information available to make suchdeterminations and that the allowance for loan losses is adequate at June 30,2007, future adjustments could be necessary if circumstances or economicconditions differ substantially from the assumptions used in making the initialdeterminations.  A downturn in the localeconomy, employment, and delays in receiving financial information fromborrowers could result in increased levels of nonperforming assets,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 determiningthe appropriate allowance level, management has attributed the allowance forloan losses to various portfolio segments; however, the allowance is availablefor the entire portfolio as needed.

The allowance forloan losses decreased from $4,185,000 at December 31, 2006 to $4,162,000 atJune 30, 2007.  At June 30, 2007, theallowance for loan losses was 1.17% of total loans compared to 1.16% of totalloans at December 31, 2006.  Management’sconclusion is that the allowance for loan losses is adequate to provide for possible losses inherent inthe loan portfolio as of the balance sheet date.

The provision forloan losses totaled $10,000 and $50,000 for the three and six months ended June30, 2007, respectively, as compared to $198,000 and $396,000 for the same periodsin 2006.  The decrease in the provisionwas the result of several continuing positive factors, including but notlimited to, annualized net charge offs to average loans of 0.05%, nonperformingloans to total loans of 0.31%, and an allowance for losses to nonperformingloans of 379.05%.  In addition, grossloans have declined $4,209,000 since December 31, 2006 due to a softening ofthe loan market and the payoff of several commercial loans.

Based upon thisanalysis, as well as the others noted above, senior management has concludedthat the allowance for loan losses remains at a level adequate to provide forprobable losses inherent in its loan portfolio.

**Non-interestIncome**

Total non-interest income for the three months ended June 30, 2007compared to the same period in 2006 decreased $30,000 to $2,186,000.  Excluding net security gains, non-interestincome

21

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would have decreased $58,000. Deposit service charges declined $20,000 as overdraft protection feesdeclined and customers migrated to new checking accounts having reduced or noservice charges.  Other income increaseddue primarily to revenue generated from increased debit card transactions,merchant card commissions, and commissions generated by The M Group forsecurities transactions.  

Insurance commissions for the three months ended June 30, 2007decreased $120,000 as compared to the same period in 2006 due to a 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 typically results in additional revenue forThe M Group.  

Total non-interest income for the six months ended June 30, 2007compared to the same period in 2006 decreased $393,000.  Excluding net security gains, non-interestincome would have decreased $188,000.  The decrease in non-interest income for the six month period is theresult of the same items noted in the three month discussion.

Non-interest income composition for the three and six months ended June30, 2007 and 2006 were as follows:
| ** **                 | ** ** | **For The Three Months Ended** | ** ** |
|----------------------------|------------|----------------------------------------------------|------------|
| ** **                 | ** ** | **June 30, 2007**                        | ** ** | **June 30, 2006** | ** ** | **Change** | ** ** |
| **(In Thousands)**    | ** ** | **Amount**                                         | ** ** | **% Total** | ** ** | **Amount** | ** ** | **% Total** | ** ** | **Amount** | ** ** | **%** | ** ** |
| Deposit service  charges   |       | $                                                  | 567        |   | 25.9 | % | $ | 587 |   | 26.5 | % | $ | (20 | ) | (3.4 | )% |
| Security gains,  net       |       | 293                                                |       | 13.4 |   | 265 |   | 12.0 |   | 28 |   | 10.6 |   |
| Bank owned life  insurance |       | 86                                                 |       | 3.9 |   | 90 |   | 4.1 |   | (4 | ) | (4.4 | ) |
| Gain on sale of  loans     |       | 234                                                |       | 10.7 |   | 210 |   | 9.5 |   | 24 |   | 11.4 |   |
| Insurance  commissions     |       | 550                                                |       | 25.2 |   | 670 |   | 30.2 |   | (120 | ) | (17.9 | ) |
| Other                      |       | 456                                                |       | 20.9 |   | 394 |   | 17.7 |   | 62 |   | 15.6 |   |
| Total  non-interest income |       | $                                                  | 2,186      |   | 100.0 | % | $ | 2,216 |   | 100.0 | % | $ | (30 | ) | (1.4 | )% |

 
| ** **                 | ** ** | **For The Six Months Ended** | ** ** |
|----------------------------|------------|--------------------------------------------------|------------|
| ** **                 | ** ** | **June 30, 2007**                      | ** ** | **June 30, 2006** | ** ** | **Change** | ** ** |
| **(In Thousands)**    | ** ** | **Amount**                                       | ** ** | **% Total** | ** ** | **Amount** | ** ** | **% Total** | ** ** | **Amount** | ** ** | **%** | ** ** |
| Deposit service  charges   |       | $                                                | 1,108      |   | 26.6 | % | $ | 1,177 |   | 25.9 | % | $ | (69 | ) | (5.9 | )% |
| Net security  gains        |       | 619                                              |       | 14.9 |   | 824 |   | 18.1 |   | (205 | ) | (24.9 | ) |
| Bank owned life  insurance |       | 201                                              |       | 4.8 |   | 178 |   | 3.9 |   | 23 |   | 12.9 |   |
| Gain on sale of  loans     |       | 372                                              |       | 8.9 |   | 360 |   | 7.9 |   | 12 |   | 3.3 |   |
| Insurance  commissions     |       | 988                                              |       | 23.8 |   | 1,230 |   | 27.0 |   | (242 | ) | (19.7 | ) |
| Other                      |       | 872                                              |       | 21.0 |   | 784 |   | 17.2 |   | 88 |   | 11.2 |   |
| Total  non-interest income |       | $                                                | 4,160      |   | 100.0 | % | $ | 4,553 |   | 100.0 | % | $ | (393 | ) | (8.6 | )% |

 

**Non-interestExpense**

Total non-interest expense increased $262,000 for the three monthsended June 30, 2007 compared to the same period of 2006.  The increase in salaries and employeebenefits was attributable to several items including standard cost of livingwage adjustments for employees, new additions to our staff, and increased benefitcost.  Occupancy expense increased due tothe

22

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new branch in Montoursville, which opened in the third quarter of 2006,and increased cost of maintenance and property taxes.  Other expenses increased primarily due tonormal anticipated inflationary adjustments to ongoing business operating costsand the amortization related to a low income housing partnership that beganoperation during the fourth quarter of 2006.

Total non-interest expenses increased $439,000 for the six months endedJune 30, 2007 as compared to the same period of 2006.  As noted above in the three month discussion,the new Montoursville branch in addition to normal increases in generalbusiness expenses and the amortization of a low income housing partnership,impacted the level of non-interest expenses. 

Non-interest expense composition for the three and six months endedJune 30, 2007 and 2006 were as follows:
| ** **                      | ** ** | **For The Three Months Ended** | ** ** |
|---------------------------------|------------|----------------------------------------------------|------------|
| ** **                      | ** ** | **June 30, 2007**                        | ** ** | **June 30, 2006** | ** ** | **Change** | ** ** |
| **(In Thousands)**         | ** ** | **Amount**                                         | ** ** | **% Total** | ** ** | **Amount** | ** ** | **% Total** | ** ** | **Amount** | ** ** | **%** | ** ** |
| Salaries and  employee benefits |       | $                                                  | 2,301      |   | 53.0 | % | $ | 2,214 |   | 54.3 | % | $ | 87 |   | 3.9 | % |
| Occupancy, net                  |       | 337                                                |       | 7.8 |   | 275 |   | 6.7 |   | 62 |   | 22.5 |   |
| Furniture and  equipment        |       | 297                                                |       | 6.8 |   | 288 |   | 7.1 |   | 9 |   | 3.1 |   |
| Pennsylvania  shares tax        |       | 161                                                |       | 3.7 |   | 151 |   | 3.8 |   | 10 |   | 6.6 |   |
| Other                           |       | 1,244                                              |       | 28.7 |   | 1,150 |   | 28.1 |   | 94 |   | 8.2 |   |
| Total non-interest  expense     |       | $                                                  | 4,340      |   | 100.0 | % | $ | 4,078 |   | 100.0 | % | $ | 262 |   | 6.4 | % |

 
| ** **                      | ** ** | **For The Six Months Ended** | ** ** |
|---------------------------------|------------|--------------------------------------------------|------------|
| ** **                      | ** ** | **June 30, 2007**                      | ** ** | **June 30, 2006** | ** ** | **Change** | ** ** |
| **(In Thousands)**         | ** ** | **Amount**                                       | ** ** | **% Total** | ** ** | **Amount** | ** ** | **% Total** | ** ** | **Amount** | ** ** | **%** | ** ** |
| Salaries and  employee benefits |       | $                                                | 4,582      |   | 54.1 | % | $ | 4,446 |   | 55.3 | % | $ | 136 |   | 3.1 | % |
| Occupancy, net                  |       | 668                                              |       | 7.9 |   | 518 |   | 6.5 |   | 150 |   | 29.0 |   |
| Furniture and  equipment        |       | 583                                              |       | 6.9 |   | 585 |   | 7.3 |   | (2 | ) | (0.3 | ) |
| Pennsylvania  shares tax        |       | 322                                              |       | 3.8 |   | 296 |   | 3.7 |   | 26 |   | 8.8 |   |
| Other                           |       | 2,313                                            |       | 27.3 |   | 2,184 |   | 27.2 |   | 129 |   | 5.9 |   |
| Total  non-interest expense     |       | $                                                | 8,468      |   | 100.0 | % | $ | 8,029 |   | 100.0 | % | $ | 439 |   | 5.5 | % |

 

**Provisionfor Income Taxes**

Income taxes decreased $137,000 and $438,000 for the three and sixmonth periods ended June 30, 2007 compared to the same periods of 2006.  The effective tax rates for the three and sixmonths ended June 30, 2007 were 11.22% and 10.82%, respectively, as compared to15.07% and 16.95% for the same periods of 2006. The decline in the effective tax rate is consistent with management’srepositioning of the investment portfolio from taxable investment securities totax-exempt investment securities and tax credits related to investments in lowincome housing projects.  

23

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**ASSET/LIABILITY MANAGEMENT**

**Cash and Cash Equivalents**

Cash and cashequivalents decreased $4,042,000 from $15,373,000 at December 31, 2006, to$11,331,000 at June 30, 2007 primarily as a result of the following activitiesduring the six months ended June 30, 2007: 

**Loans Held for Sale**

Activity regardingloans held for sale resulted in loan originations exceeding sale proceeds, less$372,000 in realized gains, by $1,629,000 for the six months ended June 30,2007.   

**Loans**

Gross loansdecreased $4,209,000 since December 31, 2006 due to the early payoff of severallarge commercial loans coupled with increased competition for commercial loansand a softening of the market.

The allocation of the loan portfolio, bycategory, as of June 30, 2007 and December 31, 2006 is presented below:
| ** **                               | ** ** | **June 30,** | ** ** | **December 31,** | ** ** | **Change** | ** ** |
|------------------------------------------|------------|-------------------|------------|-----------------------|------------|------------|------------|
| **(In Thousands)**                  | ** ** | **2007**          | ** ** | **2006**              | ** ** | **Amount** | ** ** | **%** | ** ** |
| Commercial,  financial, and agricultural |       | $                 | 35,924     |                  | $          | 36,995     |       | $ | (1,071 | ) | (2.9 | )% |
| Real estate  mortgage:                   |       |              |       |                  |       |       |       |   |   |
| Residential                              |       | 158,151           |       | 158,219               |       | (68        | )          | (0.0 | ) |
| Commercial                               |       | 132,046           |       | 135,404               |       | (3,358     | )          | (2.5 | ) |
| Construction                             |       | 17,231            |       | 16,749                |       | 482        |       | 2.9 |   |
| Installment  loans to individuals        |       | 13,774            |       | 14,035                |       | (261       | )          | (1.9 | ) |
| Less: Net  deferred loan fees            |       | 951               |       | 1,018                 |       | (67        | )          | (6.6 | ) |
| Gross loans                              |       | $                 | 356,175    |                  | $          | 360,384    |       | $ | (4,209 | ) | (1.2 | )% |

 

Therecorded investment in loans for which impairment has been recognized inaccordance with Statement of Financial Accounting Standards No. 114, *Accounting by Creditors for Impairment of a Loan*, amountedto $1,194,000 at June 30, 2007, as compared to $574,000 at December 31,2006.  The valuation allowance related toimpaired loans amounted to $98,000 at June 30, 2007 and $42,000 at December 31,2006.  The increase in impaired loans isprimarily from a single commercial relationship that accounted for $523,000 ofthe increase, while the increase in valuation allowance is the result of asecond commercial relationship that had a specific collateral weakness.

Aloan is considered impaired, based on current information and events, if it isprobable that the Bank will be unable to collect the scheduled payments ofprincipal or interest when due

24

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accordingto the contractual terms of the loan agreement. The measurement of impairedloans is generally based on the present value of expected future cash flowsdiscounted at the historical effective interest rate, except that allcollateral-dependent loans are measured for impairment based on the fairvalue of the collateral.

**Investments**

The estimated fair value of the investment securities portfolio intotal has decreased $3,901,000 since December 31, 2006, while the amortizedcost increased $4,578,000.  The majorityof the changes in value incurred within the state and political segment of theportfolio.  The amortized cost positionin state and political securities increased $3,605,000 as the Bank continuedits strategy to build call protection, maintain taxable equivalent yields, reducethe effective federal income tax rate, and invest in communities across theCommonwealth of Pennsylvania and the country. The increased level of unrealized losses, which offset the increase inamortized cost, was the result of changes in the yield curve toward the end ofthe three months ended June 30, 2007.  

Theamortized cost of investment securities and their estimated fair values are asfollows:

25

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| ** **                             | ** ** | **June 30, 2007** | ** ** |
|----------------------------------------|------------|-----------------------------|------------|
| ** **                             | ** ** | ** **                  | ** ** | **Gross** | ** ** | **Gross** | ** ** | **Estimated** | ** ** |
| ** **                             | ** ** | **Amortized**               | ** ** | **Unrealized** | ** ** | **Unrealized** | ** ** | **Fair** | ** ** |
| **(In Thousands)**                | ** ** | **Cost**                    | ** ** | **Gains** | ** ** | **Losses** | ** ** | **Value** | ** ** |
| Available for  sale (AFS)              |       |                        |       |   |   |   |   |   |   |
| U.S. Government  and agency securities |       | $                           | 56,797     |   | $ | — |   | $ | (1,529 | ) | $ | 55,268 |   |
| State and  political securities        |       | 108,263                     |       | 184 |   | (4,505 | ) | 103,942 |   |
| Other debt  securities                 |       | 2,223                       |       | 7 |   | (64 | ) | 2,166 |   |
| Total debt securities                  |       | 167,283                     |       | 191 |   | (6,098 | ) | 161,376 |   |
| Equity  securities                     |       | 19,261                      |       | 1,414 |   | (743 | ) | 19,932 |   |
| Total investment  securities AFS       |       | $                           | 186,544    |   | $ | 1,605 |   | $ | (6,841 | ) | $ | 181,308 |   |
|                                   |       |                        |       |   |   |   |   |   |   |
| Held to maturity  (HTM)                |       |                        |       |   |   |   |   |   |   |
| U.S. Government  and agency securities |       | $                           | 15         |   | $ | 1 |   | $ | — |   | $ | 16 |   |
| Other debt  securities                 |       | 260                         |       | 1 |   | — |   | 261 |   |
| Total investment  securities HTM       |       | $                           | 275        |   | $ | 2 |   | $ | — |   | $ | 277 |   |

 
| ** **                             | ** ** | **December 31, 2006** | ** ** |
|----------------------------------------|------------|---------------------------------|------------|
| ** **                             | ** ** | ** **                      | ** ** | **Gross** | ** ** | **Gross** | ** ** | **Estimated** | ** ** |
| ** **                             | ** ** | **Amortized**                   | ** ** | **Unrealized** | ** ** | **Unrealized** | ** ** | **Fair** | ** ** |
| **(In Thousands)**                | ** ** | **Cost**                        | ** ** | **Gains** | ** ** | **Losses** | ** ** | **Value** | ** ** |
| Available for  sale (AFS)              |       |                            |       |   |   |   |   |   |   |
| U.S. Government  and agency securities |       | $                               | 54,949     |   | $ | 24 |   | $ | (821 | ) | $ | 54,152 |   |
| State and  political securities        |       | 104,658                         |       | 1,646 |   | (358 | ) | 105,946 |   |
| Other debt  securities                 |       | 1,998                           |       | 37 |   | (11 | ) | 2,024 |   |
| Total debt securities                  |       | 161,605                         |       | 1,707 |   | (1,190 | ) | 162,122 |   |
| Equity  securities                     |       | 20,353                          |       | 2,883 |   | (158 | ) | 23,078 |   |
| Total investment  securities AFS       |       | $                               | 181,958    |   | $ | 4,590 |   | $ | (1,348 | ) | $ | 185,200 |   |
|                                   |       |                            |       |   |   |   |   |   |   |
| Held to maturity  (HTM)                |       |                            |       |   |   |   |   |   |   |
| U.S. Government  and agency securities |       | $                               | 26         |   | $ | 2 |   | $ | — |   | $ | 28 |   |
| Other debt  securities                 |       | 257                             |       | 1 |   | — |   | 258 |   |
| Total investment  securities HTM       |       | $                               | 283        |   | $ | 3 |   | $ | — |   | $ | 286 |   |

 

26

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**Financing Activities**

**Deposits**

Total deposits increased 2.7% or $10,712,000 from December 31, 2006 toJune 30, 2007.  The mix of deposits hasshifted from brokered time deposits at December 31, 2006 to customer timedeposits at June 30, 2007.  The shift isthe result of the Bank strategically attracting short-term customer timedeposits and utilizing the funds gathered to replace maturing brokered timedeposits and higher cost short-term FHLB advances.  The amount of brokered deposits iscontinuously monitored and is used to supplement deposits, not as a primarysource of deposits.  

Deposit balances andtheir changes for the periods being discussed follow:
| ** **                | ** ** | **June 30, 2007** | ** ** | **December 31, 2006** | ** ** | **Change** | ** ** |
|---------------------------|------------|-----------------------------|------------|---------------------------------|------------|------------|------------|
| **(In Thousands)**   | ** ** | **Amount**                  | ** ** | **% Total**                | ** ** | **Amount** | ** ** | **% Total** | ** ** | **Amount** | ** ** | **%** | ** ** |
| Demand deposits           |       | $                           | 70,000     |                            | 17.2       | %          | $          | 73,160 |   | 18.5 | % | $ | (3,160 | ) | (4.3 | )% |
| NOW accounts              |       | 48,555                      |       | 12.0                            |       | 46,156     |       | 11.7 |   | 2,399 |   | 5.2 |   |
| Money market deposits     |       | 23,422                      |       | 5.8                             |       | 23,137     |       | 5.9 |   | 285 |   | 1.2 |   |
| Savings deposits          |       | 59,798                      |       | 14.7                            |       | 59,289     |       | 15.0 |   | 509 |   | 0.9 |   |
| Time deposits             |       | 191,509                     |       | 47.2                            |       | 168,420    |       | 42.6 |   | 23,089 |   | 13.7 |   |
| Time deposits -  brokered |       | 12,619                      |       | 3.1                             |       | 25,029     |       | 6.3 |   | (12,410 | ) | (49.6 | ) |
| Total deposits            |       | $                           | 405,903    |                            | 100.0      | %          | $          | 395,191 |   | 100.0 | % | $ | 10,712 |   | 2.7 | % |

 

**Borrowed Funds**

Total borrowedfunds decreased 10.9% to $104,737,000 at June 30, 2007 as compared to December31, 2006.  The decrease in borrowed fundsis the result of the previously discussed time deposit gathering campaigns thatwere utilized to provide funds to reduce the level of higher cost short-termborrowings and to assist in replacing long-term borrowing maturities.  Long-term borrowings declined due to thematurity of four borrowings totaling $16,500,000 that carried an average rateof 3.99% offset by a new FHLB $10,000,000 borrowing that carries a 4.28% rateand matures in 2017. 
| ** **                                     | ** ** | **June 30, 2007** | ** ** | **December 31, 2006** | ** ** | **Change** | ** ** |
|------------------------------------------------|------------|-----------------------------|------------|---------------------------------|------------|------------|------------|
| **(In Thousands)**                        | ** ** | **Amount**                  | ** ** | **% Total**                | ** ** | **Amount** | ** ** | **% Total** | ** ** | **Amount** | ** ** | **%** | ** ** |
| Short-term borrowings:                         |       |                        |       |                            |       |       |       |   |   |   |   |   |   |
| FHLB repurchase  agreements                    |       | $                           | 12,200     |                            | 11.6       | %          | $          | 18,706 |   | 15.9 | % | $ | (6,506 | ) | (34.8 | )% |
| Securities sold under  agreement to repurchase |       | 16,159                      |       | 15.4                            |       | 15,991     |       | 13.6 |   | 168 |   | 1.1 |   |
| Total short-term  borrowings                   |       | 28,359                      |       | 27.1                            | %          | 34,697     |       | 29.5 | % | (6,338 | ) | (18.3 | ) |
|                                           |       |                        |       |                            |       |       |       |   |   |   |   |   |   |
| Long-term borrowings,  FHLB                    |       | 76,378                      |       | 72.9                            |       | 82,878     |       | 70.5 |   | (6,500 | ) | (7.8 | ) |
| Total borrowed funds                           |       | $                           | 104,737    |                            | 100.0      | %          | $          | 117,575 |   | 100.0 | % | $ | (12,838 | ) | (10.9 | )% |

 

**Capital**

The adequacy ofthe Company’s capital is reviewed on an ongoing basis with reference to thesize, composition, and quality of the Company’s resources and regulatoryguidelines.

27

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Management seeksto maintain a level of capital sufficient to support existing assets andanticipated asset growth, maintain favorable access to capital markets, andpreserve high quality credit ratings.

## Bank holding companies are required to complywith the Federal Reserve Board’s risk-based capital guidelines.  The risk-based capital rules are designed tomake regulatory capital requirements more sensitive to differences in riskprofiles among banks and bank holding companies and to minimize disincentivesfor holding liquid assets.  Specifically,each is required to maintain certain minimum dollar amounts and ratios of Totalrisk-based, Tier I risk-based, and Tier I leverage capital requirements. Inaddition to the capital requirements, the Federal Deposit Insurance CorporationImprovements Act (FDICIA) established five capital categories ranging from “wellcapitalized” to “critically undercapitalized.” To be classified as “wellcapitalized”, Total risk-based, Tier I risked-based, and Tier I leverage capitalratios must be at least 10%, 6%, and 5%, respectively.

Capitalratios as of June 30, 2007 and December 31, 2006 were as follows:
| ** **                              | ** ** | **2007**   | ** ** | **2006**  | ** ** |
|-----------------------------------------|------------|------------|------------|-----------|------------|
| **(In Thousands)**                 | ** ** | **Amount** | ** ** | **Ratio** | ** ** | **Amount** | ** ** | **Ratio** | ** ** |
| Total Capital(to Risk-weighted Assets)  |       |       |       |      |       |   |   |   |   |
|                                    |       |       |       |      |       |   |   |   |   |
| Actual                                  |       | $          | 73,181     |      | 19.6       | % | $ | 73,098 |   | 20.5 | % |
| For Capital  Adequacy Purposes          |       | 29,927     |       | 8.0       |       | 28,515 |   | 8.0 |   |
| To Be Well  Capitalized                 |       | 37,409     |       | 10.0      |       | 35,643 |   | 10.0 |   |
|                                    |       |       |       |      |       |   |   |   |   |
| Tier I Capital(to Risk-weighted Assets) |       |       |       |      |       |   |   |   |   |
|                                    |       |       |       |      |       |   |   |   |   |
| Actual                                  |       | $          | 68,717     |      | 18.4       | % | $ | 67,869 |   | 19.0 | % |
| For Capital  Adequacy Purposes          |       | 14,964     |       | 4.0       |       | 14,257 |   | 4.0 |   |
| To Be Well  Capitalized                 |       | 22,445     |       | 6.0       |       | 21,386 |   | 6.0 |   |
|                                    |       |       |       |      |       |   |   |   |   |
| Tier I Capital(to Average Assets)       |       |       |       |      |       |   |   |   |   |
|                                    |       |       |       |      |       |   |   |   |   |
| Actual                                  |       | $          | 68,717     |      | 11.8       | % | $ | 67,869 |   | 12.0 | % |
| For Capital  Adequacy Purposes          |       | 23,329     |       | 4.0       |       | 22,591 |   | 4.0 |   |
| To Be Well Capitalized                  |       | 29,161     |       | 5.0       |       | 28,239 |   | 5.0 |   |

 

28

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# **Liquidity and Interest RateSensitivity**

## The asset/liability committee addresses theliquidity needs of the Company to ensure that sufficient funds are available tomeet credit demands and deposit withdrawals as well as to the placement ofavailable funds in the investment portfolio. In assessing liquidity requirements, equal consideration is given to thecurrent position as well as the future outlook.

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

1.  Net Loans to Total Assets,85% maximum

2.  Net Loans to Total Deposits,100% maximum

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

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

Fundamental objectives of the Company’s asset/liability managementprocess are to maintain adequate liquidity while minimizing interest raterisk.  The maintenance of adequateliquidity provides the Company with the ability to meet its financialobligations to depositors, loan customers, and shareholders.  Additionally, it provides funds for normaloperating expenditures and business opportunities as they arise.  The objective of interest rate sensitivitymanagement is to increase net interest income by managing interest sensitiveassets and liabilities in such a way that they can be repriced in response tochanges in market interest rates.

The Bank, like other financial institutions, must have sufficient fundsavailable to meet its liquidity needs for deposit withdrawals, loan commitmentsand originations, and expenses.  In orderto control cash flow, the Bank estimates future flows of cash from deposits,loan payments, and investment security payments.  The primary sources of funds are deposits,principal and interest payments on loans and investment securities, as well asFHLB borrowings.  Management believes theBank has adequate resources to meet its normal funding requirements.

Management monitors the Company’s liquidity on both a long and short-termbasis, thereby providing management necessary information to react to currentbalance sheet trends.  Cash flow needsare assessed and sources of funds are determined.  Funding strategies consider both customerneeds and economical cost.  Both shortand long-term funding needs are addressed by maturities and sales of availablefor sale investment securities, loan repayments and maturities, and liquidatingmoney market investments such as federal funds sold.  The use of these resources, in conjunctionwith access to credit provides core ingredients to satisfy depositor, borrower,and creditor needs.

Management monitors and determines the desirable level ofliquidity.  Consideration is given toloan demand, investment opportunities, deposit pricing and growth potential, aswell as the current cost of borrowing funds. The Company has a current borrowing capacity at the FHLB of $216,502,000.  Inaddition to this credit arrangement, the Company has additional lines of creditwith correspondent banks of $29,538,000. Management believes it has sufficientliquidity to satisfy estimated short-term and long-term funding needs.  FHLB borrowings totaled $88,578,000 as of June30, 2007.

29

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Interest rate sensitivity, which is closely related to liquiditymanagement, is a function of the repricing characteristics of the Company’sportfolio of assets and liabilities. Asset/liability management strives to match maturities and rates betweenloan and investment security assets with the deposit liabilities and borrowingsthat fund them.  Successfulasset/liability management results in a balance sheet structure which can copeeffectively with market rate fluctuations. The matching process is affected bysegmenting both assets and liabilities into future time periods (usually 12months, or less) based upon when repricing can be effected.  Repriceable assets are subtracted fromrepriceable liabilities, for a specific time period to determine the “gap”, ordifference. Once known, the gap is managed based on predictions about futuremarket interest rates.  Intentionalmismatching, or gapping, can enhance net interest income if market rates moveas predicted.  However, if market ratesbehave in a manner contrary to predictions, net interest income willsuffer.  Gaps, therefore, contain anelement of risk and must be prudently managed. In addition to gap management, the Company has an asset/liabilitymanagement policy which incorporates a market value at risk calculation whichis used to determine the effects of interest rate movements on shareholders’equity and a simulation analysis to monitor the effects of interest ratechanges on the Company’s balance sheet.

There have been no substantial changes in the Company’s gap analyses orsimulation analyses compared to the information provided in the Company’s Form10-K for the year ended December 31, 2006.

Generally, management believes the Company is well positioned torespond in a timely manner when the market interest rate outlook changes.

**Inflation**

The asset andliability structure of a financial institution is primarily monetary innature.  Therefore, interest rates ratherthan inflation have a more significant impact on the Company’sperformance.  Interest rates are notalways affected in the same direction or magnitude as prices of other goods andservices, but are reflective of fiscal policy initiatives or economic factorswhich are not measured by a price index.

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

Market risk for the Company is comprised primarily of interest raterisk exposure and liquidity risk. Interest rate risk and liquidity risk management is performed at theBank level as well as the Company level. The Company’s interest rate sensitivity is monitored by managementthrough selected interest rate risk measures produced by an independent thirdparty.  There have been no substantialchanges in the Company’s gap analyses or simulation analyses compared to theinformation provided in the Annual Report on Form 10-K for the period endedDecember 31, 2006.  Additionalinformation and details are provided in the “Liquidity and Interest RateSensitivity” section of “Item 2. Management’s Discussion and Analysis ofFinancial Condition and Results of Operations.”

Generally, management believes the Company is well positioned torespond in a timely manner when the market interest rate outlook changes.

30

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**Item 4.  Controls and Procedures**

Ananalysis was performed under the supervision and with the participation of theCompany’s management, including the Chief Executive Officer and the PrincipalFinancial Officer, of the effectiveness of the design and operation of theCompany’s disclosure controls and procedures. Based on that evaluation, theCompany’s Chief Executive Officer and Principal Financial Officer concludedthat the Company’s disclosure controls and procedures were effective as of June30, 2007.  There were no changes in theCompany’s internal control over financial reporting that occurred during thequarter ended June 30, 2007, that have materially affected, or are reasonablylikely to materially affect, the Company’s internal control over financialreporting.

**Part II. OTHER INFORMATION**

**Item 1.          LegalProceedings**

None.

**Item 1A.       Risk Factors**

There are no materialchanges to the risk factors set forth in Part I, Item 1A, “Risk Factors,” ofthe Company’s Annual Report on Form 10-K for the year ended December 31,2006.  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**
| **Period**                        | ** ** | **Total** Number of Shares (or Units) Purchased | ** ** | **Average** Price Paid per Share (or Units) Purchased | ** ** | **Total Number of** Shares (or Units) Purchased as Part of Publicly Announced Plans or Programs | ** ** | **Maximum Number (or** Approximate Dollar Value) of Shares (or Units) that May Yet Be Purchased Under the Plans or Programs | ** ** |
|-----------------------------------|------------|-----------------------------------------------------------|------------|----------------------------------------------------------------------|------------|---------------------------------------------------------------------------------------------------------------------------------------------------|------------|--------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|------------|
|                              |       |                                                      |       |                                                                 |       |                                                                                                                                              |       |                                                                                                                                                                                                   |       |
| Month#1 (April  1-April 30, 2007) |       | —                                                    |       | —                                                               |       | —                                                                                                                                            |       | 144,570                                                                                                                                                                                                |       |
|                              |       |                                                      |       |                                                                 |       |                                                                                                                                              |       |                                                                                                                                                                                                   |       |
| Month#2 (May  1-May 31, 2007)     |       | 5,000                                                     |       | $                                                                    | 34.40      |                                                                                                                                              | 5,000      |                                                                                                                                                                                                   | 139,570    |   |
|                              |       |                                                      |       |                                                                 |       |                                                                                                                                              |       |                                                                                                                                                                                                   |       |
| Month#3 (June 1-June  30, 2007)   |       | —                                                    |       | —                                                               |       | —                                                                                                                                            |       | 139,570                                                                                                                                                                                                |       |
|                                   |            |                                                           |            |                                                                      |            |                                                                                                                                                   |            |                                                                                                                                                                                                        |            |  |

 

On April 24, 2007,the Board of Directors extended the authorization to repurchase up to 197,000shares, or approximately 5%, of the outstanding shares of the Company for anadditional year to April 25, 2008.  Therepurchase plan was originally for a one year period expiring on April 25,2007.  To date, there have been 57,430shares repurchased under this plan.

31

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**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 25, 2007.  The results of the items voted on are listedbelow:
| Issue  | ** ** | **Description**                              | ** ** | **For**   | ** ** | **Withhold** | ** ** |
|--------|------------|----------------------------------------------|------------|-----------|------------|--------------|------------|
| 1.     |       | Election of  Directors for a Three Year Term |       |      |       |         |       |
|   |       |                                         |       |      |       |         |       |
|   |       | Michael J.  Casale, Jr.                      |       | 3,112,171 |       | 56,464       |       |
|   |       | R. Edward  Nestlerode, Jr.                   |       | 3,116,868 |       | 51,767       |       |
|   |       | William H.  Rockey                           |       | 2,953,880 |       | 214,755      |       |
|   |       | Ronald A. Walko                              |       | 2,965,033 |       | 203,602      |       |

 
| **Issue** | ** ** | **Description**                                                                            | ** ** | **For**   | ** ** | **Against** | ** ** | **Abstain** | ** ** |
|-----------|------------|--------------------------------------------------------------------------------------------|------------|-----------|------------|-------------|------------|-------------|------------|
| 2.        |       | Ratification of  S.R. Snodgrass A.C., Certified Public Accountants as independent auditors |       | 3,140,017 |       | 15,153      |       | 13,465      |       |

 

**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,  2006). |
|------|--------|------|--------|--------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
| (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) Certification of Chief Executive  Officer.                                                                                                                                                    |
| (31) |   | (ii) |   | Rule 13a-14(a) Certification of Principal Financial  Officer.                                                                                                                                                |
| (32) |   | (i)  |   | Section 1350 Certification of Chief Executive  Officer Section 1350.                                                                                                                                         |
| (32) |   | (ii) |   | Section 1350 Certification of Principal Financial  Officer Section 1350.                                                                                                                                     |

 

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**SIGNATURES**

Pursuant to therequirements of the Securities Exchange Act of 1934, the Registrant has dulycaused this report to be signed on its behalf by the undersigned thereunto dulyauthorized.
|        | PENNS WOODS BANCORP, INC. |
|--------|---------------------------|
|   | (Registrant)              |

 
| Date:  August 7, 2007 |   | /s/ Ronald A. Walko                                                      |
|---------------------------------|--------|--------------------------------------------------------------------------|
|                            |   | Ronald A. Walko, President and Chief Executive  Officer                  |
|                            |   |                                                                     |
|                            |   |                                                                     |
| Date:  August 7, 2007 |   | /s/ Brian L. Knepp                                                       |
|                            |   | Brian L. Knepp, Vice President of Finance (Principal  Financial Officer) |

 

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

 

34

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