**UNITEDSTATES**

**SECURITIESAND EXCHANGE COMMISSION**

**WASHINGTON,D.C.  20549**

 

**FORM10-Q**

 

| **ý** | **Quarterly Report pursuant to Section 13 or 15  (d) of the Securities Exchange Act of 1934 for the Quarterly Period Ended  March 31, 2006,**                                                                                                                                                                                                                                                                                                          |
|------------|--------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
|       |                                                                                                                                                                                                                                                                                                                                                                                                                                                   |
| **o**      | **Transition report pursuant to Section 13 or 15  (d) of the Exchange Act for the Transition Period from                               to                            .** |

 

**No. 0-17077**

(Commission File Number)

 

**PENNS WOODS BANCORP, INC.**

(Exact name of Registrantas 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’s telephone  number, including area code |

 

Indicate by check mark whether the registrant (1) has filed all reportsrequired to be filed by Section 13 or 15(d) of the Securities Exchange Act of1934 during the preceding 12 months (or for such shorter period that Registrantwas required to file such reports), and (2) has been subject to such filingrequirements for the past 90 days.
| YES  ý |   | NO | o |   |
|------------------|--------|----|---|--------|

 

Indicate by check mark whether the registrant is a large acceleratedfiler, an accelerated filer, or a non-accelerated filer.  See definition of “accelerated filer andlarge accelerated filer” in Rule 12b-2 of the Exchange Act.  (Check one):
| Large accelerated filer  o |   | Accelerated filer   ý |   | Non-accelerated filer  o |
|---------------------------------|--------|---------------------------------|--------|-------------------------------|

 

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

 
| YES  o |   | NO | ý |   |
|-------------|--------|----|--------|--------|

 

On April 28, 2006 there were 3,941,787 of the Registrant’s common stockoutstanding.

 

 

----

 

**PENNSWOODS BANCORP, INC.**

**INDEX TOQUARTERLY REPORT ON FORM 10-Q**

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

 

2

----

 

**Part I.  FINANCIAL INFORMATION**

 

**Item1.  Financial Statements**

 

PENNS WOODSBANCORP, INC.

CONSOLIDATED BALANCESHEET

(UNAUDITED)

 
| ** **                                                                            | ** ** | **March 31,** | ** ** | **December 31,** | ** ** |
|---------------------------------------------------------------------------------------|------------|---------------|------------|------------------|------------|
| **(In Thousands, Except Share  Data)**                                                | ** ** | **2006**      | ** ** | **2005**         | ** ** |
|                                                                                  |       |          |       |             |       |
| ASSETS:                                                                               |       |          |       |             |       |
| Noninterest-bearing balances                                                          |       | $             | 14,858     |             | $          | 14,065 |   |
| Interest-bearing deposits in other financial  institutions                            |       | 24            |       | 25               |       |
| Total cash and  cash equivalents                                                      |       | 14,882        |       | 14,090           |       |
|                                                                                  |       |          |       |             |       |
| Investment securities, available for sale, at fair  value                             |       | 187,425       |       | 187,018          |       |
| Investment securities held to maturity (fair value  of $284 and $238)                 |       | 280           |       | 265              |       |
| Loans held for sale                                                                   |       | 2,925         |       | 3,545            |       |
| Loans                                                                                 |       | 346,012       |       | 338,438          |       |
| Less: Allowance for loan losses                                                       |       | 3,834         |       | 3,679            |       |
| Loans, net                                                                            |       | 342,178       |       | 334,759          |       |
| Premises and equipment, net                                                           |       | 6,531         |       | 6,409            |       |
| Accrued interest receivable                                                           |       | 2,610         |       | 2,828            |       |
| Bank-owned life insurance                                                             |       | 10,806        |       | 10,718           |       |
| Investment in limited partnerships                                                    |       | 4,960         |       | 3,549            |       |
| Goodwill                                                                              |       | 3,032         |       | 3,032            |       |
| Other assets                                                                          |       | 3,768         |       | 2,455            |       |
| TOTAL ASSETS                                                                          |       | $             | 579,397    |             | $          | 568,668 |   |
|                                                                                  |       |          |       |             |       |
| LIABILITIES:                                                                          |       |          |       |             |       |
| Interest-bearing deposits                                                             |       | $             | 293,317    |             | $          | 281,150 |   |
| Noninterest-bearing deposits                                                          |       | 74,329        |       | 71,379           |       |
| Total deposits                                                                        |       | 367,646       |       | 352,529          |       |
|                                                                                  |       |          |       |             |       |
| Short-term borrowings                                                                 |       | 49,394        |       | 54,003           |       |
| Long-term borrowings, Federal Home Loan Bank (FHLB)                                   |       | 82,878        |       | 84,478           |       |
| Accrued interest payable                                                              |       | 1,096         |       | 1,108            |       |
| Other liabilities                                                                     |       | 4,568         |       | 2,631            |       |
| TOTAL  LIABILITIES                                                                    |       | 505,582       |       | 494,749          |       |
|                                                                                  |       |          |       |             |       |
| SHAREHOLDERS’ EQUITY:                                                            |       |          |       |             |       |
| Common stock,  par value $8.33, 10,000,000 shares authorized; 4,002,159 shares issued |       | 33,351        |       | 33,351           |       |
| Additional paid-in capital                                                            |       | 17,772        |       | 17,772           |       |
| Retained earnings                                                                     |       | 23,727        |       | 22,938           |       |
| Accumulated other comprehensive income                                                |       | 1,266         |       | 850              |       |
| Less: Treasury stock at cost, 60,372 and 26,372  shares                               |       | (2,301        | )          | (992             | )          |
| TOTAL  SHAREHOLDERS’ EQUITY                                                      |       | 73,815        |       | 73,919           |       |
| TOTAL LIABILITIES AND SHAREHOLDERS’ EQUITY                                       |       | $             | 579,397    |             | $          | 568,668 |   |

 

See accompanying notes tothe unaudited consolidated financial statements.

 

3

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PENNS WOODSBANCORP, INC.

CONSOLIDATED STATEMENT OF INCOME

(UNAUDITED)

 
| ** **                                          | ** ** | **Three Months Ended  March 31,** | ** ** |
|-----------------------------------------------------|------------|-----------------------------------|------------|
| **(In Thousands, Except Per Share  Data)**          | ** ** | **2006**                          | ** ** | **2005** | ** ** |
|                                                |       |                              |       |   |   |
| INTEREST AND DIVIDEND INCOME:                       |       |                              |       |   |   |
| Loans including fees                                |       | $                                 | 5,809      |   | $ | 5,284 |   |
| Investment Securities:                              |       |                              |       |   |   |
| Taxable                                             |       | 923                               |       | 1,264 |   |
| Tax-exempt                                          |       | 989                               |       | 589 |   |
| Dividend                                            |       | 301                               |       | 298 |   |
| TOTAL INTEREST AND DIVIDEND INCOME                  |       | 8,022                             |       | 7,435 |   |
|                                                |       |                              |       |   |   |
| INTEREST EXPENSE:                                   |       |                              |       |   |   |
| Deposits                                            |       | 1,837                             |       | 1,194 |   |
| Short-term borrowings                               |       | 406                               |       | 202 |   |
| Long-term borrowings                                |       | 946                               |       | 853 |   |
| TOTAL INTEREST EXPENSE                              |       | 3,189                             |       | 2,249 |   |
|                                                |       |                              |       |   |   |
| NET INTEREST INCOME                                 |       | 4,833                             |       | 5,186 |   |
|                                                |       |                              |       |   |   |
| PROVISION FOR LOAN LOSSES                           |       | 198                               |       | 180 |   |
|                                                |       |                              |       |   |   |
| NET INTEREST INCOME AFTER PROVISION FOR LOAN LOSSES |       | 4,635                             |       | 5,006 |   |
|                                                |       |                              |       |   |   |
| NON-INTEREST INCOME:                                |       |                              |       |   |   |
| Deposit service charges                             |       | 590                               |       | 455 |   |
| Securities gains, net                               |       | 559                               |       | 611 |   |
| Bank-owned life insurance                           |       | 88                                |       | 94 |   |
| Gain on sale of loans                               |       | 150                               |       | 190 |   |
| Insurance commissions                               |       | 560                               |       | 643 |   |
| Other                                               |       | 390                               |       | 314 |   |
| TOTAL NON-INTEREST INCOME                           |       | 2,337                             |       | 2,307 |   |
|                                                |       |                              |       |   |   |
| NON-INTEREST EXPENSE:                               |       |                              |       |   |   |
| Salaries and employee benefits                      |       | 2,232                             |       | 1,994 |   |
| Occupancy, net                                      |       | 243                               |       | 291 |   |
| Furniture and equipment                             |       | 297                               |       | 221 |   |
| Pennsylvania shares tax                             |       | 145                               |       | 139 |   |
| Other                                               |       | 1,034                             |       | 950 |   |
| TOTAL NON-INTEREST EXPENSE                          |       | 3,951                             |       | 3,595 |   |
|                                                |       |                              |       |   |   |
| INCOME BEFORE INCOME TAX PROVISION                  |       | 3,021                             |       | 3,718 |   |
| INCOME TAX PROVISION                                |       | 566                               |       | 1,003 |   |
| NET INCOME                                          |       | $                                 | 2,455      |   | $ | 2,715 |   |
|                                                |       |                              |       |   |   |
| EARNINGS PER SHARE - BASIC                          |       | $                                 | 0.62       |   | $ | 0.68 |   |
| EARNINGS PER SHARE - DILUTED                        |       | $                                 | 0.62       |   | $ | 0.68 |   |
| WEIGHTED AVERAGE SHARES OUTSTANDING - BASIC         |       | 3,934,915                         |       | 3,973,526 |   |
| WEIGHTED AVERAGE SHARES OUTSTANDING - DILUTED       |       | 3,935,400                         |       | 3,976,106 |   |
| DIVIDENDS PER SHARE                                 |       | $                                 | 0.42       |   | $ | 0.38 |   |

 

See accompanying notes tothe unaudited consolidated financial statements.

 

4

----

 

PENNS WOODSBANCORP, INC.

CONSOLIDATEDSTATEMENT OF CHANGES IN SHAREHOLDERS’ EQUITY

(UNAUDITED)

 
| **(In Thousands Except Per Share Data)**                                                     | ** ** | **COMMON  STOCK** | ** ** | **ADDITIONAL  PAID-IN  CAPITAL** | ** ** | **RETAINED  EARNINGS** | ** ** | **ACCUMULATED  OTHER  COMPREHENSIVE  INCOME** | ** ** | **TREASURY  STOCK** | ** ** | **TOTAL  SHAREHOLDERS’  EQUITY** | ** ** |
|----------------------------------------------------------------------------------------------|------------|-------------------|------------|----------------------------------|------------|------------------------|------------|-----------------------------------------------|------------|---------------------|------------|---------------------------------------|------------|
| **SHARES**                                                                                   | ** ** | **AMOUNT**        |
| Balance, December  31, 2005                                                                  |       | 4,002,159         |       | $                                | 33,351     |                   | $          | 17,772                                        |       | $                   | 22,938     |                                  | $          | 850 |   | $ | (992 | ) | $ | 73,919 |   |
|                                                                                         |       |              |       |                             |       |                   |       |                                          |       |                |       |                                  |       |   |   |
| Comprehensive  Income:                                                                       |       |              |       |                             |       |                   |       |                                          |       |                |       |                                  |       |   |   |
| Net income                                                                                   |       |              |       |                             |       |                   |       | 2,455                                         |       |                |       |                                  |       | 2,455 |   |
| Net change in  unrealized gain on investments available for sale, net of tax expense of $214 |       |              |       |                             |       |                   |       |                                          |       | 416                 |       |                                  |       | 416 |   |
| Total comprehensive  income                                                                  |       |              |       |                             |       |                   |       |                                          |       |                |       |                                  |       | 2,871 |   |
| Dividends  declared, ($0.42 per share)                                                       |       |              |       |                             |       |                   |       | (1,666                                        | )          |                |       |                                  |       | (1,666 | ) |
| Purchase of  treasury stock (34,000 shares)                                                  |       |              |       |                             |       |                   |       |                                          |       |                |       | (1,309                                | )          | (1,309 | ) |
| Balance, March  31, 2006                                                                     |       | 4,002,159         |       | $                                | 33,351     |                   | $          | 17,772                                        |       | $                   | 23,727     |                                  | $          | 1,266 |   | $ | (2,301 | ) | $ | 73,815 |   |

 
|                                                                                            |   |       |   |   |   | **ADDITIONAL  PAID-IN  CAPITAL** |   | **RETAINED  EARNINGS** |   | **ACCUMULATED  OTHER  COMPREHENSIVE  INCOME** |   | **TREASURY  STOCK** |   | **TOTAL  SHAREHOLDERS’  EQUITY** |   |
|-------------------------------------------------------------------------------------------------|--------|------------|--------|--------|--------|----------------------------------|--------|------------------------|--------|-----------------------------------------------|--------|---------------------|--------|---------------------------------------|--------|
| **COMMON  STOCK**                                                                               |
| **SHARES**                                                                                      |   | **AMOUNT** |
| Balance, December  31, 2004                                                                     |   | 3,998,204  |   | $      | 33,318 |                             | $      | 17,700                 |   | $                                             | 18,262 |                | $      | 4,331                                 |   | $ | (446 | ) | $ | 73,165 |   |
|                                                                                            |   |       |   |   |   |                             |   |                   |   |                                          |   |                |   |                                  |   |
| Comprehensive  Income:                                                                          |   |       |   |   |   |                             |   |                   |   |                                          |   |                |   |                                  |   |
| Net income                                                                                      |   |       |   |   |   |                             |   | 2,715                  |   |                                          |   |                |   | 2,715                                 |   |
| Net change in  unrealized gain on investments available for sale, net of tax benefit of  $1,280 |   |       |   |   |   |                             |   |                   |   | (2,484                                        | )      |                |   | (2,484                                | )      |
| Total  comprehensive income                                                                     |   |       |   |   |   |                             |   |                   |   |                                          |   |                |   | 231                                   |   |
| Dividends  declared, ($0.38 per share)                                                          |   |       |   |   |   |                             |   | (1,496                 | )      |                                          |   |                |   | (1,496                                | )      |
| Stock options  exercised                                                                        |   | 411        |   | 4      |   | 7                                |   |                   |   |                                          |   |                |   | 11                                    |   |
| Balance, March  31, 2005                                                                        |   | 3,998,615  |   | $      | 33,322 |                             | $      | 17,707                 |   | $                                             | 19,481 |                | $      | 1,847                                 |   | $ | (446 | ) | $ | 71,911 |   |

 

See accompanying notes tothe unaudited consolidated financial statements.

 

5

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PENNS WOODSBANCORP, INC.

CONSOLIDATED STATEMENT OF COMPREHENSIVE INCOME

(UNAUDITED)

 
| ** **                                                                 | ** ** | **Three Months Ended March 31,** | ** ** |
|----------------------------------------------------------------------------|------------|----------------------------------|------------|
| **(In Thousands)**                                                         | ** ** | **2006**                         | ** ** | **2005** | ** ** |
|                                                                       |       |                             |       |   |   |   |   |   |   |
| Net Income                                                                 |       |                             |       | $ | 2,455 |   |   |   | $ | 2,715 |   |
| Other  comprehensive income (loss):                                        |       |                             |       |   |   |   |   |   |   |
| Net unrealized  gains (losses) on available for sale securities            |       | 1,189                            |       |   |   | (3,153 | ) |   |   |
| Less:  Reclassification adjustment for gain included in net income         |       | 559                              |       |   |   | 611 |   |   |   |
| Other  comprehensive income (loss) before tax                              |       |                             |       | 630 |   |   |   | (3,764 | ) |
| Income tax  expense (benefit) related to other comprehensive income (loss) |       |                             |       | 214 |   |   |   | (1,280 | ) |
| Other  comprehensive income (loss), net of tax                             |       |                             |       | 416 |   |   |   | (2,484 | ) |
| Comprehensive  income                                                      |       |                             |       | $ | 2,871 |   |   |   | $ | 231 |   |

 

See accompanying notes tothe unaudited consolidated financial statements.

 

6

----

 

PENNS WOODSBANCORP, INC.

CONSOLIDATED STATEMENT OF CASH FLOWS

(UNAUDITED)

 
| ** **                                                                         | ** ** | **Three Months Ended  March 31,** | ** ** |
|------------------------------------------------------------------------------------|------------|-----------------------------------|------------|
| **(In Thousands)**                                                                 | ** ** | **2006**                          | ** ** | **2005** | ** ** |
|                                                                               |       |                              |       |   |   |
| OPERATING  ACTIVITIES:                                                             |       |                              |       |   |   |
| Net Income                                                                         |       | $                                 | 2,455      |   | $ | 2,715 |   |
| Adjustments to  reconcile net income to net cash provided by operating activities: |       |                              |       |   |   |
| Depreciation                                                                       |       | 176                               |       | 143 |   |
| Provision for  loan losses                                                         |       | 198                               |       | 180 |   |
| Accretion and  amortization of investment security discounts and premiums          |       | (191                              | )          | (105 | ) |
| Securities  gains, net                                                             |       | (559                              | )          | (611 | ) |
| Originations of  loans held for sale                                               |       | (5,735                            | )          | (4,838 | ) |
| Proceeds of  loans held for sale                                                   |       | 6,505                             |       | 7,077 |   |
| Gain on sale of  loans                                                             |       | (150                              | )          | (190 | ) |
| Increases in  bank-owned life insurance                                            |       | (88                               | )          | (94 | ) |
| Other, net                                                                         |       | 150                               |       | 1,010 |   |
| Net cash  provided by operating activities                                         |       | 2,761                             |       | 5,287 |   |
| INVESTING  ACTIVITIES:                                                             |       |                              |       |   |   |
| Investment  securities available for sale:                                         |       |                              |       |   |   |
| Proceeds from  sales                                                               |       | 16,732                            |       | 64,880 |   |
| Proceeds from  calls and maturities                                                |       | 1,744                             |       | 3,517 |   |
| Purchases                                                                          |       | (17,057                           | )          | (64,930 | ) |
| Investment  securities held to maturity:                                           |       |                              |       |   |   |
| Proceeds from  calls and maturities                                                |       | —                            |       | 249 |   |
| Net (increase)  decrease in loans                                                  |       | (7,638                            | )          | 1,169 |   |
| Acquisition of  bank premises and equipment                                        |       | (298                              | )          | (849 | ) |
| Proceeds from  the sale of foreclosed assets                                       |       | 61                                |       | 28 |   |
| Investment in  limited partnership                                                 |       | (1,446                            | )          | — |   |
| Net cash (used  for) provided by investing activities                              |       | (7,902                            | )          | 4,064 |   |
| FINANCING  ACTIVITIES:                                                             |       |                              |       |   |   |
| Net increase  (decrease) in interest-bearing deposits                              |       | 12,167                            |       | (1,193 | ) |
| Net increase  (decrease) in noninterest-bearing deposits                           |       | 2,950                             |       | (1,342 | ) |
| Repayment of  long-term borrowings                                                 |       | (1,600                            | )          | (1,400 | ) |
| Net (decrease)  increase in short-term borrowings                                  |       | (4,609                            | )          | 787 |   |
| Dividends paid                                                                     |       | (1,666                            | )          | (1,496 | ) |
| Stock options  exercised                                                           |       | —                            |       | 11 |   |
| Purchase of  treasury stock                                                        |       | (1,309                            | )          | — |   |
| Net cash provided  by (used for) financing activities                              |       | 5,933                             |       | (4,633 | ) |
| NET INCREASE IN  CASH AND CASH EQUIVALENTS                                         |       | 792                               |       | 4,718 |   |
| CASH AND CASH  EQUIVALENTS, BEGINNING                                              |       | 14,090                            |       | 12,626 |   |
| CASH AND CASH  EQUIVALENTS, ENDING                                                 |       | $                                 | 14,882     |   | $ | 17,344 |   |
|                                                                               |       |                              |       |   |   |
| SUPPLEMENTAL  DISCLOSURES OF CASH FLOW INFORMATION:                                |       |                              |       |   |   |
|                                                                               |       |                              |       |   |   |
| Interest paid                                                                      |       | $                                 | 3,201      |   | $ | 2,237 |   |
| Income taxes  paid                                                                 |       | 500                               |       | — |   |
| Transfer of  loans to foreclosed assets                                            |       | 34                                |       | 77 |   |

 

See accompanyingnotes to the unaudited consolidated financial statements.

 

7

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**PENNS WOODS BANCORP, INC. ANDSUBSIDIARIES**

**NOTES TO**

**CONSOLIDATED FINANCIAL STATEMENTS**

**(Unaudited)**

 

**Note 1. Basis of Presentation**

 

The consolidated financial statements include the accounts of PennsWoods Bancorp, Inc. (the “Company”) and its wholly-owned subsidiaries WoodsInvestment Company, Inc., Woods Real Estate Development Company, Inc., andJersey Shore State Bank (the “Bank”) and its wholly-owned subsidiary The MGroup, Inc. D/B/A The Comprehensive Financial Group (“The M Group”).  All significant inter-company balances andtransactions have been eliminated in the consolidation.

 

The interim financial statements are unaudited but, in the opinion ofmanagement, reflect all adjustments necessary for the fair presentation ofresults for such periods.  All of thoseadjustments are of a normal, recurring nature. The results of operations for any interim period are not necessarilyindicative of results for the full year. These financial statements should be read in conjunction with financialstatements and notes thereto contained in the Company’s annual report for theyear ended December 31, 2005.

 

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 38 thru 43 of the Annual Report on Form10-K for the year ended December 31, 2005.

 

**Note 2. Recent Accounting Pronouncements**

 

In February 2006, the Financial Accounting Standards Board (“FASB”)issued Statement of Financial Accounting (“FAS”) No. 155, *Accounting for Certain Hybrid Instruments, as anamendment 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 issued FAS 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(offset) accounting.  FAS No. 156 alsoclarifies when an obligation to service financial assets should be separatelyrecognized as a servicing asset or a servicing liability, requires that aseparately recognized servicing asset or servicing liability be initiallymeasured at fair value, if practicable, and permits an entity with a separatelyrecognized servicing asset or servicing

 

8

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liability to choose either of the amortization or fair value methodsfor 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.

 

**Note3. Per Share Data**

 

The following table sets forth the composition of the weighted averagecommon shares (denominator) used in the basic and dilutive per sharecomputation.  There are no convertiblesecurities which would affect the numerator in calculating basic and dilutedearnings per share, therefore, net income as presented on the consolidatedstatement of income will be used as the numerator.

 
| ** **                                                                                                 | ** ** | **Three Months Ended March 31,** | ** ** |
|------------------------------------------------------------------------------------------------------------|------------|----------------------------------|------------|
| ** **                                                                                                 | ** ** | **2006**                         | ** ** | **2005** | ** ** |
|                                                                                                       |       |                             |       |   |   |
| Weighted average  common shares outstanding                                                                |       | 3,975,787                        |       | 3,985,898 |   |
|                                                                                                       |       |                             |       |   |   |
| Average treasury  stock shares                                                                             |       | (40,872                          | )          | (12,372 | ) |
|                                                                                                       |       |                             |       |   |   |
| Weighted average  common shares and common stock equivalents used to calculate basic earnings  per share   |       | 3,934,915                        |       | 3,973,526 |   |
|                                                                                                       |       |                             |       |   |   |
| Additional  common stock equivalents (stock options) used to calculate diluted earnings  per share         |       | 485                              |       | 2,580 |   |
|                                                                                                       |       |                             |       |   |   |
| Weighted average  common shares and common stock equivalents used to calculate diluted earnings  per share |       | 3,935,400                        |       | 3,976,106 |   |

 

Options to purchase 8,999 shares and 10,092 shares of common stock atthe price of $40.29 were outstanding during the three months ended March 31,2006 and 2005, respectively, but were not included in the computation ofdiluted earnings per share as they were anti-dilutive due to the strike pricebeing greater than the market price as of the end of the quarter.

 

**Note 4.  Net Periodic Benefit Cost-Defined BenefitPlans**

 

For a detailed disclosure on the Company’s pension and employeebenefits plans, please refer to Note 11 of the Company’s Consolidated FinancialStatements included in the 2005 Annual Report on Form 10-K.

 

The following sets forth the components of net periodic benefit cost ofthe domestic non-contributory defined benefit plan for the three months endedMarch 31, 2006 and 2005, respectively.

 

9

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| ** **                             | ** ** | **Three Months Ended  March 31,** | ** ** |
|----------------------------------------|------------|-----------------------------------|------------|
| ** **                             | ** ** | **2006**                          | ** ** | **2005** | ** ** |
|                                   |       |                              |       |   |   |
| Service cost                           |       | $                                 | 117        |   | $ | 127 |   |
| Interest cost                          |       | 108                               |       | 112 |   |
| Expected return  on plan assets        |       | (121                              | )          | (95 | ) |
| Amortization of  transition obligation |       | (1                                | )          | (1 | ) |
| Amortization of  prior service cost    |       | 6                                 |       | 6 |   |
| Amortization of  net loss              |       | 6                                 |       | 16 |   |
| Net periodic  cost                     |       | $                                 | 115        |   | $ | 165 |   |

 

**Employer Contributions**

 

The Company previously disclosed in its consolidated financialstatements, included in the 2005 Annual Report on Form 10-K, that it expectedto contribute $500,000 to its defined benefit plan in 2006.  As of March31, 2006, there were no contributions made for the 2006 plan year.  This is the result of the contributions madeduring 2005 being above the required minimum in order to benefit from a currenttax and future financial perspective.  Ineffect, the 2005 contributions eliminated the need for a minimum funding during2006. The Company is evaluating the amount, if any, of funds to contributeduring 2006.

 

**Note 5.  Off Balance Sheet Risk**

 

The Company is aparty to financial instruments with off-balance sheet risk in the normal courseof business to meet the financing needs of its customers.  These financial instruments includecommitments to extend credit and standby letters of credit.  These instruments involve, to varyingdegrees, elements of credit, interest rate, or liquidity risk in excess of theamount recognized in the consolidated balance sheet.  The contract amounts of these instrumentsexpress the extent of involvement the Company has in particular classes offinancial instruments.

 

The Company’sexposure to credit loss from nonperformance by the other party to the financialinstruments for commitments to extend credit and standby letters of credit isrepresented by the contractual amount of these instruments.  The Company uses the same credit policies inmaking commitments and conditional obligations as it does for on-balance sheetinstruments.

 

The Company mayrequire collateral or other security to support financial instruments withoff-balance sheet credit risk.

 

Financialinstruments whose contract amounts represent credit risk are as follows:

 
| ** **                    | ** ** | **March 31,** | ** ** |
|-------------------------------|------------|---------------|------------|
| **(In Thousands)**            | ** ** | **2006**      | ** ** | **2005** | ** ** |
| Commitments to  extend credit |       | $             | 74,106     |   | $ | 41,361 |   |
| Standby letters  of credit    |       | 1,412         |       | 1,705 |   |
|                               |            |               |            |  |  |  |  |

 

10

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**Note 6. Reclassification of Comparative Amounts**

 

Certain comparative amounts for the prior periods have beenreclassified to conform to current period presentations. Such reclassificationshad no effect on net income or shareholders’ equity.

 

**Note 7. Stock Split**

 

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

 

**CAUTIONARY STATEMENT FOR PURPOSES OFTHE PRIVATE SECURITIES LITIGATION REFORM ACT OF 1995**

 

This Report contains certain “forward-lookingstatements” including statements concerning plans, objectives, future events orperformance and assumptions and other statements which are other thanstatements of historical fact.  TheCompany wishes to caution readers that the following important factors, amongothers, may have affected and could in the future affect the Company’s actualresults and could cause the Company’s actual results for subsequent periods todiffer materially from those expressed in any forward-looking statement made byor on behalf of the Company herein:  (i)the effect of changes in laws and regulations, including federal and statebanking laws and regulations, which the Company must comply, and the associatedcosts of compliance with such laws and regulations either currently or in thefuture as applicable; (ii) the effect of changes in accounting policies andpractices, as may be adopted by the regulatory agencies as well as by theFinancial Accounting Standards Board, or of changes in the Company’sorganization, compensation and benefit plans; (iii) the effect on the Company’scompetitive position within its market area 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.

 

11

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

 

**EARNINGS SUMMARY**

 

**Comparison of the Three Months EndedMarch 31, 2006 and 2005**

 

**Summary Results**

 

Net income for the three months ended March 31, 2006 was $2,455,000compared to $2,715,000 for the same period of 2005.  Basic and diluted earnings per share for thethree months ended March 31, 2006 were $0.62 as compared to $0.68 for the threemonths ended March 31, 2005.  Return onaverage assets and return on average equity were 1.72% and 13.24% for the threemonths ended March 31, 2006 as compared to 2.01% and 14.56% for thecorresponding period of 2005.  Net incomefrom core operations for the three months ended March 31, 2006 and 2005,excluding after-tax net securities gains of $369,000 and $403,000,respectively, were $2,086,000 and $2,312,000. (Management uses the non-GAAP measure of net income from core operationsin its analysis of the Company’s performance. This measure, as used by the Company, adjusts net income by significantgains or losses that are unusual in nature. Because certain of these items and their impact on the Company’sperformance are difficult to predict, management believes the presentation offinancial measures excluding the impact of such items provides usefulsupplemental information in evaluating the operating results of the Company’score businesses.  These disclosuresshould not be viewed as a substitute for net income determined in accordancewith GAAP, nor are they necessarily comparable to non-GAAP performance measuresthat may be presented by other companies.)

 

**Interest Income**

 

Interest income for the three months ended March 31, 2006 increased$587,000 to $8,022,000 as compared to $7,435,000 for the same period of2005.  The increase in total interestincome was primarily the result of growth in average loans of $16,301,000 forthe three months ended March 31, 2006 as compared to 2005.  The average loan growth and a 35 basis pointincrease in loan portfolio yields accounted for $525,000 of the total interestincome growth.  Over this time frame theaverage balance of investment securities increased $12,235,000.  The investment portfolio continued to shiftfrom taxable mortgage-backed securities to tax-exempt municipal bonds. Theaverage investment portfolio growth coupled with the shift to tax-exemptmunicipal bonds resulted in interest income from the investment portfolioincreasing $62,000.  On a taxableequivalent basis the interest income from the investment portfolio increased by$268,000.  This shift within theinvestment securities portfolio was strategically designed to ladder cashflows, enhance management’s ability to currently maintain the interest margin,and to allow growth through participation in funding local area communityhousing projects.  The increase individends received is the result of an increase in the level of dividends fromthe Federal Home Loan Bank of Pittsburgh coupled with an emphasis on purchasingstocks consistently having an above average dividend yield.

 

12

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Interest income composition for the three months ended March 31, 2006and 2005 was as follows:

 
| ** **              | ** ** | **For The  Three Months Ended** | ** ** |
|-------------------------|------------|---------------------------------|------------|
| ** **              | ** ** | **March  31, 2006**             | ** ** | **March  31, 2005** | ** ** | **Change** | ** ** |
| **(In  Thousands)**     | ** ** | **Amount**                      | ** ** | **% Total** | ** ** | **Amount** | ** ** | **% Total** | ** ** | **Amount** | ** ** | **%** | ** ** |
| Loans including  fees   |       | $                               | 5,809      |   | 72.4 | % | $ | 5,284 |   | 71.1 | % | $ | 525 |   | 9.9 | % |
| Investment  securities: |       |                            |       |   |   |   |   |   |   |   |   |   |   |
| Taxable                 |       | 923                             |       | 11.5 |   | 1,264 |   | 17.0 |   | (341 | ) | (27.0 | ) |
| Tax-exempt              |       | 989                             |       | 12.3 |   | 589 |   | 7.9 |   | 400 |   | 67.9 |   |
| Dividend                |       | 301                             |       | 3.8 |   | 298 |   | 4.0 |   | 3 |   | 1.0 |   |
| Total interest  income  |       | $                               | 8,022      |   | 100.0 | % | $ | 7,435 |   | 100.0 | % | $ | 587 |   | 7.9 | % |

 

**Interest Expense**

 

Interest expense for the three months ended March 31, 2006 increased$940,000 to $3,189,000 as compared to $2,249,000 for the same period of2005.  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 from thethree months ended March 31, 2005 to the corresponding period of 2006.  Factors that led to the rate increasesinclude, but are not limited to, several period prime rate increases,competitive market pricing pressure, and attracting new deposit customers whileretaining existing accounts.  Theincrease in CD interest rates has exceeded the increase for other depositaccounts.  This has led to a shift of aportion of the money market and savings deposit portfolios into higher yieldingCDs.

 

Short-term borrowing costs increased as a direct result of the primerate increases over the past year and an increase in the average balance of$4,754,000 for the three months ended March 31, 2006 as compared to the sameperiod of 2005.  Long-term FHLB borrowingexpense increased due to $10,000,000 that was borrowed from the FHLB during thesecond quarter of 2005 at a fixed rate of 3.97% for 5 years with a finalmaturity of 10 years.

 

Interest expense composition for the three months ended March 31, 2006and 2005 was as follows:

 
| ** **              | ** ** | **For The  Three Months Ended** | ** ** |
|-------------------------|------------|---------------------------------|------------|
| ** **              | ** ** | **March  31, 2006**             | ** ** | **March  31, 2005** | ** ** | **Change** | ** ** |
| **(In  Thousands)**     | ** ** | **Amount**                      | ** ** | **% Total** | ** ** | **Amount** | ** ** | **% Total** | ** ** | **Amount** | ** ** | **%** | ** ** |
| Deposits                |       | $                               | 1,837      |   | 57.6 | % | $ | 1,194 |   | 53.1 | % | $ | 643 |   | 53.9 | % |
| Short-term  borrowings  |       | 406                             |       | 12.7 |   | 202 |   | 9.0 |   | 204 |   | 101.0 |   |
| Long-term  borrowings   |       | 946                             |       | 29.7 |   | 853 |   | 37.9 |   | 93 |   | 10.9 |   |
| Total interest  expense |       | $                               | 3,189      |   | 100.0 | % | $ | 2,249 |   | 100.0 | % | $ | 940 |   | 41.8 | % |
|                         |            |                                 |            |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |

 

**Net Interest Margin**

 

The net interest margin (“NIM”) for the three months ended March 31,2006 was 4.08% as compared to 4.40% for the corresponding period of 2005.  The decrease in the NIM was the result of theyield on earning assets increasing 30 basis points (“bp”) to 6.51% for thethree months ended March 31, 2006, as compared to 2005, however, interestbearing liabilities increased 76 bp

 

13

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over the same period.  Theincrease in the yield on earning assets is attributable to a change in the mixof earning assets as previously discussed in the Interest Income section ofthis Earnings Summary section.  Theaverage tax-exempt investment securities portfolio grew by $42,871,000, thedirect result of a shift in investment strategy which also resulted in adecline in taxable investment securities of $30,636,000.  The average loan growth of $16,301,000 waspredominately comprised of commercial real estate loans.  The yield on total loans increased to 6.92%from 6.57% due to the impact of the Federal Open Market Committee rateincreases enacted over the past year. The investment portfolio yield increased to 5.77% from 5.56% primarilyfrom the previously noted shift in the portfolio to tax-exempt investments.  The average interest rates paid on depositaccounts increased to 2.52% as compared to 1.72% for the 2005 period.  This increase was driven by growth in timedeposits of $31,026,000 and an increase in the rate paid on time deposits of 96bp.  A portion of the increase in depositvolume and the average interest yield paid is due to several CD promotionsduring the past year to attract new customers while retaining existingcustomers.  The promotions were designedto gather deposits that would have maturities of two years or less.  In addition, the promotions served as acatalyst to implement management’s strategy regarding the CD portfolioallocation among various maturities and therefore, reducing the concentrationof time deposit maturities within any single month.

 

Short-term borrowings realized an increase of 175 bp in interest ratescharged for the three months ended March 31, 2006.  The prime rate increased to 7.75% at March31, 2006 from 5.75% at March 31, 2005, as further evidence of the correlationbetween the Company’s primary source of borrowed funds, the FHLB, and theprimary lending rate indicator used on a national basis.

 

Following is a schedule of average balances and associated yields forthe three month periods ended March 31, 2006 and 2005:

 

14

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| ** **                                       | ** ** | **AVERAGE BALANCES AND INTEREST RATES** | ** ** |
|--------------------------------------------------|------------|-------------------------------------------------------------|------------|
| ** **                                       | ** ** | **Three Months Ended**                            | ** ** | **Three Months Ended** | ** ** |
| ** **                                       | ** ** | **March 31, 2006**                                | ** ** | **March 31, 2005** | ** ** |
| **(In Thousands)**                          | ** ** | **Average Balance**                                    | ** ** | **Interest** | ** ** | **Average Rate** | ** ** | **Average Balance** | ** ** | **Interest** | ** ** | **Average Rate** | ** ** |
|                                             |       |                                                        |       |   |   |   |   |   |   |   |   |   |   |
| Tax-exempt loans                                 |       | $                                                           | 8,163      |   | $ | 127 |   | 6.31 | % | $ | 1,421 |   | $ | 21 |   | 5.99 | % |
| All other loans                                  |       | 334,985                                                     |       | 5,725 |   | 6.93 | % | 325,426 |   | 5,270 |   | 6.57 | % |
| Total loans                                      |       | 343,148                                                     |       | 5,852 |   | 6.92 | % | 326,847 |   | 5,291 |   | 6.57 | % |
|                                             |       |                                                        |       |   |   |   |   |   |   |   |   |   |   |
| Taxable  investment securities                   |       | 97,648                                                      |       | 1,224 |   | 5.01 | % | 128,284 |   | 1,562 |   | 4.87 | % |
| Tax-exempt  investment securities                |       | 91,150                                                      |       | 1,498 |   | 6.58 | % | 48,279 |   | 892 |   | 7.39 | % |
| Total securities                                 |       | 188,798                                                     |       | 2,722 |   | 5.77 | % | 176,563 |   | 2,454 |   | 5.56 | % |
|                                             |       |                                                        |       |   |   |   |   |   |   |   |   |   |   |
| Total  interest-earning assets                   |       | 531,946                                                     |       | 8,574 |   | 6.51 | % | 503,410 |   | 7,745 |   | 6.21 | % |
|                                             |       |                                                        |       |   |   |   |   |   |   |   |   |   |   |
| Other assets                                     |       | 37,576                                                      |       |   |   |   |   | 37,715 |   |   |   |   |   |
|                                             |       |                                                        |       |   |   |   |   |   |   |   |   |   |   |
| Total assets                                     |       | $                                                           | 569,522    |   |   |   |   |   | $ | 541,125 |   |   |   |   |   |
|                                             |       |                                                        |       |   |   |   |   |   |   |   |   |   |   |
| Savings                                          |       | $                                                           | 62,715     |   | 120 |   | 0.78 | % | $ | 66,930 |   | 131 |   | 0.79 | % |
| Super Now  deposits                              |       | 48,163                                                      |       | 150 |   | 1.26 | % | 53,505 |   | 107 |   | 0.81 | % |
| Money market  deposits                           |       | 25,124                                                      |       | 115 |   | 1.86 | % | 32,560 |   | 91 |   | 1.13 | % |
| Time deposits                                    |       | 159,994                                                     |       | 1,452 |   | 3.68 | % | 128,968 |   | 865 |   | 2.72 | % |
| Total deposits                                   |       | 295,996                                                     |       | 1,837 |   | 2.52 | % | 281,963 |   | 1,194 |   | 1.72 | % |
|                                             |       |                                                        |       |   |   |   |   |   |   |   |   |   |   |
| Short-term  borrowings                           |       | 41,152                                                      |       | 406 |   | 4.00 | % | 36,398 |   | 202 |   | 2.25 | % |
| Long-term  borrowings                            |       | 84,336                                                      |       | 946 |   | 4.55 | % | 75,754 |   | 853 |   | 4.57 | % |
| Total borrowings                                 |       | 125,488                                                     |       | 1,352 |   | 4.37 | % | 112,152 |   | 1,055 |   | 3.82 | % |
|                                             |       |                                                        |       |   |   |   |   |   |   |   |   |   |   |
| Total interest  bearing liabilities              |       | 421,484                                                     |       | 3,189 |   | 3.07 | % | 394,115 |   | 2,249 |   | 2.31 | % |
|                                             |       |                                                        |       |   |   |   |   |   |   |   |   |   |   |
| Demand deposits                                  |       | 68,447                                                      |       |   |   |   |   | 68,205 |   |   |   |   |   |
| Other  liabilities                               |       | 5,416                                                       |       |   |   |   |   | 4,200 |   |   |   |   |   |
| Shareholders’  equity                       |       | 74,175                                                      |       |   |   |   |   | 74,605 |   |   |   |   |   |
| Total  liabilities and shareholders’ equity |       | $                                                           | 569,522    |   |   |   |   |   | $ | 541,125 |   |   |   |   |   |
|                                             |       |                                                        |       |   |   |   |   |   |   |   |   |   |   |
| Interest rate  spread                            |       |                                                        |       |   |   | 3.44 | % |   |   |   |   | 3.90 | % |
| Net interest  income/margin                      |       |                                                        |       | $ | 5,385 |   | 4.08 | % |   |   | $ | 5,496 |   | 4.40 | % |
|                                             |       |                                                        |       |   |   |   |   |   |   |   |   |   |   |

 

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

2.     Nonaccrualloans have been included with loans for the purpose of analyzing net interestearnings.

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

 

15

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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 month periods endedMarch 31, 2006 and 2005.

 
| ** **                                      | ** ** | **For the Three Months Ended** | ** ** |
|-------------------------------------------------|------------|----------------------------------------------------|------------|
| ** **                                      | ** ** | **March 31,**                                 | ** ** |
| **(In Thousands)**                         | ** ** | **2006**                                           | ** ** | **2005** | ** ** |
|                                            |       |                                               |       |   |   |
| Total interest  income                          |       | $                                                  | 8,022      |   | $ | 7,435 |   |
| Total interest  expense                         |       | 3,189                                              |       | 2,249 |   |
|                                            |       |                                               |       |   |   |
| Net interest  income                            |       | 4,833                                              |       | 5,186 |   |
| Tax equivalent  adjustment                      |       | 552                                                |       | 310 |   |
|                                            |       |                                               |       |   |   |
| Net interest  income (fully taxable equivalent) |       | $                                                  | 5,385      |   | $ | 5,496 |   |

 

The following table sets forth the respective impact that both volumeand rate changes have had on net interest income and the net interest marginfor the three month periods ended March 31, 2006 and 2005:

 
| ** **                          | ** ** | **Three Months Ended March 31,** | ** ** |
|-------------------------------------|------------|------------------------------------------------------|------------|
| ** **                          | ** ** | **2006 vs 2005**                           | ** ** |
| ** **                          | ** ** | **Increase (Decrease)**                         | ** ** |
| ** **                          | ** ** | **Due to**                                      | ** ** |
| **(In Thousands)**             | ** ** | **Volume**                                           | ** ** | **Rate** | ** ** | **Net** | ** ** |
| Interest income:                    |       |                                                 |       |   |   |   |   |
| Loans,  tax-exempt                  |       | $                                                    | 105        |   | $ | 1 |   | $ | 106 |   |
| Loans                               |       | 145                                                  |       | 310 |   | 455 |   |
| Taxable  investment securities      |       | (383                                                 | )          | 45 |   | (338 | ) |
| Tax-exempt  investment securities   |       | 714                                                  |       | (108 | ) | 606 |   |
| Total  interest-earning assets      |       | 581                                                  |       | 248 |   | 829 |   |
|                                |       |                                                 |       |   |   |   |   |
| Interest  expenses:                 |       |                                                 |       |   |   |   |   |
| Savings deposits                    |       | (8                                                   | )          | (3 | ) | (11 | ) |
| Super Now  deposits                 |       | (12                                                  | )          | 55 |   | 43 |   |
| Money market  deposits              |       | (25                                                  | )          | 49 |   | 24 |   |
| Time deposits                       |       | 50                                                   |       | 537 |   | 587 |   |
| Short-term  borrowings              |       | 22                                                   |       | 182 |   | 204 |   |
| Long-term  borrowings               |       | 96                                                   |       | (3 | ) | 93 |   |
| Total  interest-bearing liabilities |       | 123                                                  |       | 817 |   | 940 |   |
| Change in net  interest income      |       | $                                                    | 458        |   | $ | (569 | ) | $ | (111 | ) |

 

**Provision for Loan Losses**

 

The provision for loan losses is based upon management’s quarterlyreview of the loan portfolio.  Thepurpose of the review is to assess loan quality, identify impaired loans,analyze delinquencies, ascertain loan growth, evaluate potential charge-offsand recoveries, and assess general economic conditions in the marketsserved.  An external independent loanreview is also

 

16

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performed annually for the Bank. Management remains committed to an aggressive program of problem loanidentification and resolution.

 

The allowance is calculated by applying loss factors to outstandingloans by type, excluding loans for which a specific allowance has beendetermined.  Loss factors are based onmanagement’s consideration of the nature of the portfolio segments, changes inmix and volume of the loan portfolio, and historical loan loss experience.  In addition, management considers industrystandards and trends with respect to non-performing loans and its knowledge andexperience with specific lending segments.

 

Although management believes it uses the best information available tomake such determinations and that the allowance for loan losses is adequate atMarch 31, 2006, future adjustments could be necessary if circumstances oreconomic conditions differ substantially from the assumptions used in makingthe initial determinations.  A downturnin the local economy, employment, and delays in receiving financial informationfrom borrowers could result in increased levels of nonperforming assets andcharge-offs, increased loan loss provisions, and reductions in income.  Additionally, as an integral part of theexamination process, bank regulatory agencies periodically review the Bank’sloan loss allowance.  The bankingagencies could require the recognition of additions to the loan loss allowancebased on their judgment of information available to them at the time of theirexamination.

 

While determining the appropriate allowance level management hasattributed the allowance for loan losses to various portfolio segments; however,the allowance is available for the entire portfolio as needed.

 

The allowance for loan losses increased from $3,679,000 at December 31,2005 to $3,834,000 at March 31, 2006.  AtMarch 31, 2006, the allowance for loan losses was 1.11% of total loans comparedto 1.09% of total loans at December 31, 2005. Management’s conclusion is that the allowance for loan losses isadequate to provide for possible losses inherent in the loan portfolio as ofthe balance sheet date.

 

The provision for loan losses totaled $198,000 for the three monthsended March 31, 2006 as compared to $180,000 for the same period in 2005.  The increase was the result of gross loangrowth of $22,872,000, primarily in commercial real estate loans, from April 1,2005 to March 31, 2006.

 

An overall increase of $164,000, or 27.24%, was experienced innon-performing loans (non-accrual and 90 days past due) from December 31, 2005to $766,000 at March 31, 2006.

 

Based upon this analysis, as well as the others noted above, seniormanagement has concluded that the allowance for loan losses remains at a leveladequate to provide for probable losses inherent in its loan portfolio.

 

17

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**Non-interest Income**

 

Total non-interest income for the quarter ended March 31, 2006 comparedto the same period in 2005 increased $30,000 to $2,337,000.  Excluding net security gains, the increasefrom period to period was $82,000. Deposit service charges increased due to the implementation of BounceProtection during May 2005.  This productprovides overdraft protection up to a predetermined amount to non-commercialcustomers for a per event fee which resulted in an approximate $141,000increase in overdraft charges over the 2005 period.  Gain on the sale of loans from secondarymarket originations decreased due to a decline in volumes.

 

Insurance commissions decreased due to a reduction in the overall commissionsearned from the underwriter that The M Group receives on each insurancecontract written.  The management of TheM Group continued to gather new and build upon current relationships during thefirst quarter of 2006, however, the sales cycle for insurance and investmentproducts can take typically from six months to one year or more to complete.The sales call program continues to expand to other financial institutions, andresults in shared revenue with The M Group.

 

Other income increased due primarily to increased revenue generatedfrom the customer usage of debit cards, title insurance income, and the feesrecognized related to the origination of secondary market residential loans.

 

Non-interest income composition for the three months ended March 31,2006 and 2005 was as follows:

 
| ** **                 | ** ** | **For The Three Months Ended** | ** ** |
|----------------------------|------------|----------------------------------------------------|------------|
| ** **                 | ** ** | **March 31, 2006**                       | ** ** | **March 31, 2005** | ** ** | **Change** | ** ** |
| **(In Thousands)**    | ** ** | **Amount**                                         | ** ** | **% Total** | ** ** | **Amount** | ** ** | **% Total** | ** ** | **Amount** | ** ** | **%** | ** ** |
| Deposit service  charges   |       | $                                                  | 590        |   | 25.2 | % | $ | 455 |   | 19.7 | % | $ | 135 |   | 29.7 | % |
| Net security  gains        |       | 559                                                |       | 23.9 |   | 611 |   | 26.5 |   | (52 | ) | (8.5 | ) |
| Bank owned life  insurance |       | 88                                                 |       | 3.8 |   | 94 |   | 4.1 |   | (6 | ) | (6.4 | ) |
| Gain on sale of  loans     |       | 150                                                |       | 6.4 |   | 190 |   | 8.2 |   | (40 | ) | (21.1 | ) |
| Insurance  commissions     |       | 560                                                |       | 24.0 |   | 643 |   | 27.9 |   | (83 | ) | (12.9 | ) |
| Other income               |       | 390                                                |       | 16.7 |   | 314 |   | 13.6 |   | 76 |   | 24.2 |   |
| Total  non-interest income |       | $                                                  | 2,337      |   | 100.0 | % | $ | 2,307 |   | 100.0 | % | $ | 30 |   | 1.3 | % |

 

**Non-interest Expenses**

 

Total non-interest expenses increased $356,000 from the three monthsended March 31, 2005 as 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, increased healthinsurance cost, and adjustments for the projected annual bonus period estimatesfor 2006.  Furniture and equipmentexpenses increased due to the previously mentioned new branch in State Collegeand increased cost of maintenance contracts. The decrease in occupancy expenses was attributable to a reduction inleasehold improvements amortization and facilities maintenance coverageamounts.   Other expenses increasedprimarily due to normal anticipated inflationary adjustments to ongoingbusiness operating costs and the Company’s share of operating results incurredthrough a limited partnership arrangement which was initiated during the fourthquarter of 2005 for the purposes of funding the construction of affordablehousing in the Company’s primary market area.

 

18

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Non-interest expense composition for the three months ended March 31,2006 and 2005 was as follows:

 
| ** **                        | ** ** | **For The Three Months Ended** | ** ** |
|-----------------------------------|------------|----------------------------------------------------|------------|
| ** **                        | ** ** | **March 31, 2006**                       | ** ** | **March 31, 2005** | ** ** | **Change** | ** ** |
| **(In Thousands)**           | ** ** | **Amount**                                         | ** ** | **% Total** | ** ** | **Amount** | ** ** | **% Total** | ** ** | **Amount** | ** ** | **%** | ** ** |
| Salaries and  employee benefits   |       | $                                                  | 2,232      |   | 56.4 | % | $ | 1,994 |   | 55.5 | % | $ | 238 |   | 11.9 | % |
| Occupancy  expense, net           |       | 243                                                |       | 6.2 |   | 291 |   | 8.1 |   | (48 | ) | (16.5 | ) |
| Furniture and  equipment expenses |       | 297                                                |       | 7.5 |   | 221 |   | 6.1 |   | 76 |   | 34.4 |   |
| Pennsylvania  shares tax          |       | 145                                                |       | 3.7 |   | 139 |   | 3.9 |   | 6 |   | 4.3 |   |
| Other expense                     |       | 1,034                                              |       | 26.2 |   | 950 |   | 26.4 |   | 84 |   | 8.8 |   |
| Total  non-interest expense       |       | $                                                  | 3,951      |   | 100.0 | % | $ | 3,595 |   | 100.0 | % | $ | 356 |   | 9.9 | % |

 

**Provision for Income Taxes**

 

Income taxes decreased $437,000 for the three month period ended March31, 2006 compared to the same period of 2005. The effective tax rates for the three months ended March 31, 2006 and2005 were 18.7% and 27.0%, respectively. 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 an investment in alow income housing project.

 

**ASSET/LIABILITY MANAGEMENT**

 

Cash and cash equivalents increased $792,000 from $14,090,000 atDecember 31, 2005, and are the results of the following activities which haveoccurred during the three months ended March 31, 2006:

 

**Operating Activities**

 

The significant components of operating activities are net income andthe origination and proceeds of loans held for sale.  Cash provided by net income, as adjusted forloans held for sale activity, amounted to $1,991,000.  Activity regarding loans held for saleresulted in sale proceeds, less $150,000 in realized gains, exceeding loanorigination disbursements by $620,000 for the period.

 

**Loans**

 

Gross loans increased $7,574,000 since December 31, 2005 as commercialreal estate mortgages increased 5.0% or $6,393,000.  The growth in commercial real estatemortgages is part of the Company’s strategy to originate high quality, wellsecured commercial loans and was driven by the origination of several large loans.  Residential real estate mortgages increased$1,348,000 with a portion of the increase related to the active marketing of anew home equity line of credit product during the first quarter of 2006.

 

19

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The allocation of the loan portfolio, by category, as of March 31, 2006and December 31, 2005 is presented below:

 
| ** **                        | ** ** | **March 31,** | ** ** | **December 31** | ** ** | **Change** | ** ** |
|-----------------------------------|------------|--------------------|------------|----------------------|------------|------------|------------|
| **(In Thousands)**           | ** ** | **2006**           | ** ** | **2005**             | ** ** | **Amount** | ** ** | **%** | ** ** |
| Commercial and  agricultural      |       | $                  | 34,252     |                 | $          | 34,407     |       | $ | (155 | ) | (0.5 | )% |
| Real estate  mortgage:            |       |               |       |                 |       |       |       |   |   |
| Residential                       |       | 151,348            |       | 150,000              |       | 1,348      |       | 0.9 |   |
| Commercial                        |       | 133,524            |       | 127,131              |       | 6,393      |       | 5.0 |   |
| Construction                      |       | 10,715             |       | 10,681               |       | 34         |       | 0.3 |   |
| Installment  loans to individuals |       | 17,226             |       | 17,281               |       | (55        | )          | (0.3 | ) |
| Less: Net  deferred loan fees     |       | 1,053              |       | 1,062                |       | (9         | )          | (0.8 | ) |
| Gross loans                       |       | $                  | 346,012    |                 | $          | 338,438    |       | $ | 7,574 |   | 2.2 | % |

 

The recorded investment in loans for which impairment has beenrecognized in accordance with Statement of Financial Accounting Standards No.114, *Accounting by Creditors for Impairmentof a Loan*, was comprised of only three loans totaling $302,000. Theloans identified as impaired were collateral-dependent, and consideredwell secured, with no valuation allowance necessary due to the collateralposition.

 

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

 

**Investments**

 

The amortized cost and fair market value of the investment securitiesportfolio in total has remained steady since December 31, 2005.  Over the first three months of 2006, theamortized cost of state and political securities has increased $1,768,000,while U.S. Government and agency securities decreased $2,323,000.  This shift is the result of a repositioningof the security portfolio that began during 2005.  The shift from taxable to tax exempt bonds hasbeen undertaken as a strategy to build call protection, maintain the taxableequivalent yield, reduce the effective federal income tax rate, and to investin communities across the Commonwealth of Pennsylvania and the country.

 

The amortized cost of investment securities and their approximate fairvalues are as follows:

 

20

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| ** **                             | ** ** | **March 31, 2006** | ** ** |
|----------------------------------------|------------|------------------------------|------------|
| ** **                             | ** ** | ** **                   | ** ** | **Gross** | ** ** | **Gross** | ** ** | ** ** | ** ** |
| ** **                             | ** ** | **Amortized**                | ** ** | **Unrealized** | ** ** | **Unrealized** | ** ** | **Fair** | ** ** |
| **(In Thousands)**                | ** ** | **Cost**                     | ** ** | **Gains** | ** ** | **Losses** | ** ** | **Value** | ** ** |
| Available for  Sale (AFS)              |       |                         |       |   |   |   |   |   |   |
| U.S. Government  and agency securities |       | $                            | 63,173     |   | $ | 8 |   | $ | (2,258 | ) | $ | 60,923 |   |
| State and  political securities        |       | 95,537                       |       | 1,870 |   | (797 | ) | 96,610 |   |
| Other debt  securities                 |       | 1,825                        |       | 16 |   | (21 | ) | 1,820 |   |
| Total debt  securities                 |       | 160,535                      |       | 1,894 |   | (3,076 | ) | 159,353 |   |
| Equity  securities                     |       | 24,972                       |       | 3,310 |   | (210 | ) | 28,072 |   |
| Total Investment  Securities AFS       |       | $                            | 185,507    |   | $ | 5,204 |   | $ | (3,286 | ) | $ | 187,425 |   |
|                                   |       |                         |       |   |   |   |   |   |   |
| Held to Maturity  (HTM)                |       |                         |       |   |   |   |   |   |   |
| U.S. Government  and agency securities |       | $                            | 28         |   | $ | 2 |   | $ | — |   | $ | 30 |   |
| Other debt  securities                 |       | 252                          |       | 2 |   | — |   | 254 |   |
| Total Investment  Securities HTM       |       | $                            | 280        |   | $ | 4 |   | $ | — |   | $ | 284 |   |
|                                        |            |                              |            |  |  |  |  |  |  |  |  |  |  |  |  |  |  |

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

 

**Financing Activities**

** **

**Deposits**

** **

Total deposits increased 4.3% or $15,117,000 from December 31, 2005 asboth interest and noninterest bearing deposit categories increased from December31, 2005 to March 31, 2006.  The mix ofdeposits has remained constant from December 31, 2005 to March 31, 2006 withdemand deposits holding steady at 20.2% of total deposits.  During the second half of 2005 the Bank beganutilizing brokered deposits (time deposits) to supplement the funding of loan

 

21

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originations and investment purchases. These time deposits are generally for a term of either four or thirteenweeks presently with interest rates at or below the cost of alternative fundingsources, such as short term borrowing instruments from the FHLB.  The amount of brokered deposits iscontinuously monitored and is used to supplement deposits, not as a primarysource of deposits.

 

Deposit balances and their changes for the periods being discussedfollow:

 
| ** **                | ** ** | **March 31, 2006** | ** ** | **December 31, 2005** | ** ** | **Change** | ** ** |
|---------------------------|------------|------------------------------|------------|---------------------------------|------------|------------|------------|
| **(In Thousands)**   | ** ** | **Amount**                   | ** ** | **% Total**                | ** ** | **Amount** | ** ** | **% Total** | ** ** | **Amount** | ** ** | **%** | ** ** |
| Demand deposits           |       | $                            | 74,329     |                            | 20.2       | %          | $          | 71,379 |   | 20.2 | % | $ | 2,950 |   | 4.1 | % |
| NOW Accounts              |       | 50,957                       |       | 13.9                            |       | 48,678     |       | 13.8 |   | 2,279 |   | 4.7 |   |
| Insured MMDA              |       | 24,658                       |       | 6.7                             |       | 24,446     |       | 6.9 |   | 212 |   | 0.9 |   |
| Savings deposits          |       | 64,260                       |       | 17.5                            |       | 61,906     |       | 17.6 |   | 2,354 |   | 3.8 |   |
| Time deposits             |       | 139,739                      |       | 38.0                            |       | 137,373    |       | 39.0 |   | 2,366 |   | 1.7 |   |
| Time deposits -  brokered |       | 13,703                       |       | 3.7                             |       | 8,747      |       | 2.5 |   | 4,956 |   | 56.7 |   |
| Total deposits            |       | $                            | 367,646    |                            | 100.0      | %          | $          | 352,529 |   | 100.0 | % | $ | 15,117 |   | 4.3 | % |

 

**Borrowed Funds**

 

Total borrowed funds decreased 4.5% to $132,272,000 at March 31, 2006as compared to December 31, 2005. Short-term borrowings were replaced with brokered time deposits withmore favorable interest rates to the Company at this time.  FHLB short-term borrowings were utilizedduring the first three months of 2006; however, there were no such borrowingsoutstanding at March 31, 2006.  Long-term borrowings declined due to a maturity of $1,600,000 thatcarried a fixed rate of 2.67%.

 
| ** **                                     | ** ** | **March 31,** | ** ** | **December 31,** | ** ** |
|------------------------------------------------|------------|--------------------|------------|-----------------------|------------|
| **(In Thousands)**                        | ** ** | **2006**           | ** ** | **2005**              | ** ** |
| Short-term  borrowings:                        |       |               |       |                  |       |
| FHLB repurchase  agreements                    |       | $                  | 35,045     |                  | $          | 1,740 |   |
| Short-term  borrowings, FHLB                   |       | —             |       | 37,000                |       |
| Securities sold  under agreement to repurchase |       | 14,349             |       | 15,263                |       |
| Total short-term  borrowings                   |       | 49,394             |       | 54,003                |       |
|                                           |       |               |       |                  |       |
| Long-term  borrowings, FHLB                    |       | 82,878             |       | 84,478                |       |
| Total borrowed  funds                          |       | $                  | 132,272    |                  | $          | 138,481 |   |

 

**Capital**

 

The adequacy of the Company’s capital is reviewed on an ongoing basiswith reference to the size, composition and quality of the Company’s resourcesand regulatory guidelines.  Managementseeks to 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 comply with the Federal ReserveBoard’s risk-based capital guidelines. The risk-based capital rules are designed to make regulatory capital

 

22

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requirements more sensitive to differences in risk profiles among banksand bank holding companies and to minimize disincentives for holding liquid assets.  Specifically, each is required to maintaincertain minimum dollar amounts and ratios of Total risk-based, Tier Irisk-based, and Tier I leverage capital requirements. In addition to thecapital requirements, the Federal Deposit Insurance Corporation ImprovementsAct (FDICIA) established five capital categories ranging from “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.

 

Capital ratios as of March 31, 2006 and 2005 were as follows:

 
| ** **                                | ** ** | **2006**   | ** ** | **2005**  | ** ** |
|-------------------------------------------|------------|------------|------------|-----------|------------|
| **(In Thousands)**                   | ** ** | **Amount** | ** ** | **Ratio** | ** ** | **Amount** | ** ** | **Ratio** | ** ** |
| Total Capital  (to Risk-weighted Assets)  |       |       |       |      |       |   |   |   |   |
|                                      |       |       |       |      |       |   |   |   |   |
| Actual                                    |       | $          | 73,098     |      | 20.5       | % | $ | 72,991 |   | 22.0 | % |
| For Capital  Adequacy Purposes            |       | 28,515     |       | 8.0       |       | 26,523 |   | 8.0 |   |
| To Be Well  Capitalized                   |       | 35,643     |       | 10.0      |       | 33,154 |   | 10.0 |   |
|                                      |       |       |       |      |       |   |   |   |   |
| Tier I Capital  (to Risk-weighted Assets) |       |       |       |      |       |   |   |   |   |
|                                      |       |       |       |      |       |   |   |   |   |
| Actual                                    |       | $          | 67,869     |      | 19.0       | % | $ | 67,809 |   | 20.5 | % |
| For Capital  Adequacy Purposes            |       | 14,257     |       | 4.0       |       | 13,261 |   | 4.0 |   |
| To Be Well  Capitalized                   |       | 21,386     |       | 6.0       |       | 19,892 |   | 6.0 |   |
|                                      |       |       |       |      |       |   |   |   |   |
| Tier I Capital  (to Average Assets)       |       |       |       |      |       |   |   |   |   |
|                                      |       |       |       |      |       |   |   |   |   |
| Actual                                    |       | $          | 67,869     |      | 12.0       | % | $ | 67,809 |   | 12.8 | % |
| For Capital  Adequacy Purposes            |       | 22,591     |       | 4.0       |       | 21,231 |   | 4.0 |   |
| To Be Well  Capitalized                   |       | 28,239     |       | 5.0       |       | 26,538 |   | 5.0 |   |

 

**Liquidity and Interest RateSensitivity**

 

The asset/liability committee addresses the liquidity needs of theCompany to see that sufficient funds are available to meet credit demands anddeposit withdrawals as well as to the placement of available funds in theinvestment portfolio.  In assessingliquidity requirements, equal consideration is given to the current position aswell as the future outlook.

 

The following liquidity measures are monitored for compliance withinthe limits cited.

 

1.  Net Loans to TotalAssets,  100% maximum

2.  Net Loans to Total Deposits,100% maximum

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

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

 

23

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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, loancommitments, and expenses.   In order tocontrol cash flow, the Bank estimates future flows of cash from deposits, loanpayments, and investment security payments. The primary sources of funds are deposits, principal and interestpayments on loans and investment securities, as well as Federal Home Loan Bankborrowings.  Funds generated are usedprincipally to fund loans and purchase investment securities.  Management believes the Bank has adequateresources to meet its normal funding requirements.

 

Management monitors the Company’s liquidity on both a long andshort-term basis, thereby providing management necessary information to reactto current balance sheet trends.  Cashflow needs are 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 Federal Home LoanBank of $213,869,000.  In addition tothis credit arrangement, the Company has additional lines of credit withcorrespondent banks of $25,500,000. Management believes that it has sufficientliquidity to satisfy estimated short-term and long-term funding needs.  Federal Home Loan Bank borrowings totaled$117,923,000 as of March 31, 2006.

 

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.  Successful asset/liabilitymanagement results in a balance sheet structure which can cope effectively withmarket rate fluctuations. The matching process is affected by segmenting bothassets and liabilities into future time periods (usually 12 months, or less)based upon when repricing can be effected. Repriceable assets are subtracted from repriceable liabilities, for aspecific time period to determine the “gap”, or difference. Once known, the gapis managed based on predictions about future market interest rates.  Intentional mismatching, or gapping, canenhance net interest income if market rates move as predicted.  However, if market rates behave in a mannercontrary to predictions, net interest

 

24

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income will suffer.  Gaps,therefore, contain an element of risk and must be prudently managed.  In addition to gap management, the Companyhas an asset/liability management policy which incorporates a market value atrisk calculation which is used to determine the effects of interest ratemovements on shareholders’ equity and a simulation analysis to monitor theeffects of interest rate changes 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 period ended December 31, 2005.

 

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

 

**Inflation**

 

The asset and liability structure of a financial institution isprimarily monetary in nature.  Therefore,interest rates rather than inflation have a more significant impact on theCompany’s performance.  Interest ratesare not always affected in the same direction or magnitude as prices of othergoods and services, but are reflective of fiscal policy initiatives or economicfactors which are not measured by a price index.

 

In reference to the attached financial statements, all adjustments areof a normal recurring nature pursuant to Rule 10-01 (b) (8) of Regulation S-X.

 

**Item3.  Quantitative and QualitativeDisclosure About Market Risk**

 

Market risk for the Company is comprised primarily from 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 Company’s SEC 10-K for the period ended December31, 2005.  Additional information anddetails are provided in the Liquidity and Interest Rate Sensitivity section ofItem 2. Management’s Discussion and Analysis of Financial Condition and Resultsof Operations.

 

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

 

**Item4.  Controls and Procedures**

 

An analysis was performed under the supervision and with theparticipation of the Company’s management, including the Chief ExecutiveOfficer and the Principal Financial Officer, of the effectiveness of the designand operation of the Company’s disclosure controls and procedures. Based onthat evaluation, the Company’s Chief Executive Officer and Principal FinancialOfficer concluded that the Company’s disclosure controls and procedures wereeffective as of March 31,

 

25

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2006. During the quarter ended March 31, 2006, the Company strengthenedthe review process associated with the preparation of the Statement of CashFlows.  There were no other changes inthe Company’s internal control over financial reporting that occurred duringthe quarter ended March 31, 2006, that have materially affected, or arereasonably likely to materially affect, the Company’s internal control overfinancial reporting.

 

**PartII.  OTHER INFORMATION**

 

**Item1.****          LegalProceedings**

 

None.

 

**Item 1A.****         Risk Factors**

 

There are no material changes to the risk factors set forth in Part I,Item 1A, “Risk Factors,” of the Company’s Annual Report on Form 10-K for theyear ended December 31, 2005. Please refer to that section for disclosures regarding the risks anduncertainties related to the Company’s business.

 

**Item2.****          UnregisteredSales of Equity Securities and Use of Proceeds**

 

During the three months ended March 31, 2006 there were 34,000 sharesof the Company’s common stock repurchased as part of a previously announcedrepurchase program.

 
| **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(January  1-January 31, 2006)    |       | 15,000                                              |       | $                                                         | 38.75      |                                                                                                 | 15,000     |                                                                                                                             | 20,693     |   |
| Month#2  (February 1-February 28, 2006) |       | —                                              |       | —                                                    |       | —                                                                                               |       | —                                                                                                                           |       |
| Month#3 (March  1,- March 31, 2006)     |       | 19,000                                              |       | 38.33                                                     |       | 19,000                                                                                               |       | 1,693                                                                                                                            |       |
|                                         |            |                                                     |            |                                                           |            |                                                                                                      |            |                                                                                                                                  |            |  |

 

**Item3.****          DefaultsUpon Senior Securities**

 

None

 

**Item4.****          Submissionof Matters to a Vote of Security Holders**

 

None

 

26

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**Item 5.****          OtherInformation**

 

On April 25, 2006 the Board of Directors authorized the repurchase ofapproximately 5% of the outstanding shares of the Registrant.  The repurchase plan is for a one year periodand allows for the repurchase of 197,000 shares of the 3,941,787 sharesoutstanding.

 

**Item6. ****        Exhibits**

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

 

## **SIGNATURES**

 

Pursuant to the requirements of the Securities Exchange Act of 1934,the Registrant has duly caused this report to be signed on its behalf by theundersigned thereunto duly authorized.

 
|                           | PENNS WOODS BANCORP, INC.                                                |
|--------------------------------|--------------------------------------------------------------------------|
|                           | (Registrant)                                                             |
|                           |
|                           |
| Date:   May 9,  2006 | /s/ Ronald A. Walko                                                      |   |
|                           | Ronald A. Walko, President and Chief Executive  Officer                  |
|                           |                                                                     |
|                           |                                                                     |
| Date:   May 9,  2006 | /s/ Brian L. Knepp                                                       |   |
|                           | Brian L. Knepp, Vice President of Finance (Principal  Financial Officer) |
|                                |                                                                          |  |  |  |

 

27

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**EXHIBITINDEX**

 
| 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 Accounting Officer |
| Exhibit 32(i)  |   | Section 1350 Certification of Chief Executive  Officer                       |
| Exhibit 32(ii) |   | Section 1350 Certification of Principal Accounting  Officer                  |

 

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