Tableof Contents

 

 

 

**UNITEDSTATES**

**SECURITIESAND EXCHANGE COMMISSION**

**WASHINGTON, D.C.  20549**

 

**FORM 10-Q**

 
| **x**      | ** ** | **Quarterly Report pursuant to Section 13 or  15 (d) of the Securities Exchange Act   of 1934 for the Quarterly Period Ended June 30, 2008.**                                                                                                                                                                                                                                                                                                                                          |
|------------|------------|-------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
| ** ** | ** ** | ** **                                                                                                                                                                                                                                                                                                                                                                                                                                                                                            |
| **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)**

 

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

 

**(570) 322-1111**

Registrant’s telephonenumber, including area code

 

Indicate by check mark whether the registrant (1) has filed allreports required to be filed by Section 13 or 15(d) of the SecuritiesExchange Act of 1934 during the preceding 12 months (or for such shorter periodthat the registrant was required to file such reports), and (2) has beensubject to such filing requirements for the past 90 days.

 
|   | YES x | NO o |
|--------|-------|------|

 

Indicate by check markwhether the registrant is a large accelerated filer, an accelerated filer, anon-accelerated filer, or a smaller reporting company. See definitions of“large accelerated filer,” “accelerated filer,” and “smaller reporting company”in Rule 12b-2 of the Exchange Act. (Check one):

 

| Large accelerated filer  o                     |   | Accelerated filer x          |
|------------------------------------------------|--------|-----------------------------------|
|                                           |   |                              |
| Non-accelerated filer o                        |   | Smaller reporting  company o |
| (Do not check if a  smaller reporting company) |   |                              |

 

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

 
|   | YES o | NO x |
|--------|-------|------|

 

On July 28, 2008 there were 3,859,015 shares of the Registrant’scommon stock outstanding.

 

 

 

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** **

**PENNS WOODS BANCORP, INC.**

 

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

 
| ** **                                                                                                                        | ** **                                                                                      | **Page**   |
|-----------------------------------------------------------------------------------------------------------------------------------|-------------------------------------------------------------------------------------------------|------------|
| ** **                                                                                                                        | ** **                                                                                      | **Number** |
|                                                                                                                              |                                                                                            |       |   |
| **Part I**                                                                                                                   | **Financial Information**                                                                       | ** ** | ** ** |
| ** **                                                                                                                        | ** **                                                                                      | ** ** | ** ** |
| **Item 1.**                                                                                                                       | **Financial Statements**                                                                        | ** ** | ** ** |
| ** **                                                                                                                        | ** **                                                                                      | ** ** | ** ** |
| Consolidated  Balance Sheet (unaudited) as of June 30, 2008 and December 31, 2007                                       |                                                                                            | 3          |
|                                                                                                                              |                                                                                            |       |   |
| Consolidated  Statement of Income (unaudited) for the Three and Six Months ended  June 30, 2008 and 2007                     |                                                                                            | 4          |
|                                                                                                                              |                                                                                            |       |   |
| Consolidated  Statement of Changes in Shareholders’ Equity (unaudited) for the Six Months  ended June 30, 2008 and 2007 |                                                                                            | 5          |
|                                                                                                                              |                                                                                            |       |   |
| Consolidated  Statement of Comprehensive Income (unaudited) for the Three and Six Months  ended June 30, 2008 and 2007       |                                                                                            | 5          |
|                                                                                                                              |                                                                                            |       |   |
| Consolidated  Statement of Cash Flows (unaudited) for the Six Months ended June 30,  2008 and 2007                           |                                                                                            | 6          |
|                                                                                                                              |                                                                                            |       |   |
| Notes to  Consolidated Financial Statements (unaudited)                                                                           |                                                                                            | 7          |
|                                                                                                                              |                                                                                            |       |   |
| **Item 2.**                                                                                                                       | **Management’s  Discussion and Analysis of Financial Condition and Results of Operations** | ** ** | **15** |
| **Item 3.**                                                                                                                       | **Quantitative  and Qualitative Disclosures About Market Risk**                                 | ** ** | **32** |
| **Item 4.**                                                                                                                       | **Controls and  Procedures**                                                                    | ** ** | **32** |
| ** **                                                                                                                        | ** **                                                                                      | ** ** | ** ** |
| **Part II**                                                                                                                  | **Other Information**                                                                           | ** ** | ** ** |
| ** **                                                                                                                        | ** **                                                                                      | ** ** | ** ** |
| **Item 1.**                                                                                                                       | **Legal Proceedings**                                                                           |       | 33 |
| **Item 1A.**                                                                                                                      | **Risk Factors**                                                                                |       | 33 |
| **Item 2.**                                                                                                                       | **Unregistered  Sales of Equity Securities and Use of Proceeds**                                |       | 33 |
| **Item 3.**                                                                                                                       | **Defaults Upon  Senior Securities**                                                            |       | 33 |
| **Item 4.**                                                                                                                       | **Submission of  Matters to a Vote of Security Holders**                                        |       | 33 |
| **Item 5.**                                                                                                                       | **Other Information**                                                                           |       | 34 |
| **Item 6.**                                                                                                                       | **Exhibits**                                                                                    |       | 34 |
| **Signatures**                                                                                                                    |                                                                                            |       | 35 |
| **Exhibit Index  and Exhibits**                                                                                              |                                                                                            | 36         |

 

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** **

**Part I.  FINANCIALINFORMATION**

 

**Item 1.  Financial Statements**

 

PENNSWOODS BANCORP, INC.

CONSOLIDATED BALANCE SHEET

(UNAUDITED)

 
| ** **                                                                                           | ** ** | **June 30,** | ** ** | **December 31,** | ** ** |
|------------------------------------------------------------------------------------------------------|------------|-------------------|------------|-----------------------|------------|
| **(In Thousands, Except Share Data)**                                            | ** ** | **2008**          | ** ** | **2007**              | ** ** |
|                                                                                                 |       |              |       |                  |       |
| ASSETS                                                                                               |       |              |       |                  |       |
| Noninterest-bearing  balances                                                                        |       | $                 | 17,193     |                  | $          | 15,417 |   |
| Interest-bearing  deposits in other financial institutions                                           |       | 16                |       | 16                    |       |
| Total cash and  cash equivalents                                                                     |       | 17,209            |       | 15,433                |       |
|                                                                                                 |       |              |       |                  |       |
| Investment  securities, available for sale, at fair value                                            |       | 209,284           |       | 214,455               |       |
| Investment  securities held to maturity (fair value of $161 and $279)                                |       | 160               |       | 277                   |       |
| Loans held for  sale                                                                                 |       | 3,590             |       | 4,214                 |       |
| Loans                                                                                                |       | 365,955           |       | 360,478               |       |
| Less: Allowance  for loan losses                                                                     |       | 4,207             |       | 4,130                 |       |
| Loans, net                                                                                           |       | 361,748           |       | 356,348               |       |
| Premises and  equipment, net                                                                         |       | 7,449             |       | 6,774                 |       |
| Accrued interest  receivable                                                                         |       | 3,322             |       | 3,343                 |       |
| Bank-owned life  insurance                                                                           |       | 13,319            |       | 12,375                |       |
| Investment in  limited partnerships                                                                  |       | 5,083             |       | 5,439                 |       |
| Goodwill                                                                                             |       | 3,032             |       | 3,032                 |       |
| Other assets                                                                                         |       | 10,308            |       | 6,448                 |       |
| TOTAL ASSETS                                                                                         |       | $                 | 634,504    |                  | $          | 628,138 |   |
|                                                                                                 |       |              |       |                  |       |
| LIABILITIES                                                                                          |       |              |       |                  |       |
| Interest-bearing  deposits                                                                           |       | $                 | 358,013    |                  | $          | 314,351 |   |
| Noninterest-bearing  deposits                                                                        |       | 79,908            |       | 74,671                |       |
| Total deposits                                                                                       |       | 437,921           |       | 389,022               |       |
|                                                                                                 |       |              |       |                  |       |
| Short-term  borrowings                                                                               |       | 48,081            |       | 55,315                |       |
| Long-term  borrowings, Federal Home Loan Bank (FHLB)                                                 |       | 76,778            |       | 106,378               |       |
| Accrued interest  payable                                                                            |       | 1,463             |       | 1,744                 |       |
| Other  liabilities                                                                                   |       | 5,739             |       | 5,120                 |       |
| TOTAL  LIABILITIES                                                                                   |       | 569,982           |       | 557,579               |       |
|                                                                                                 |       |              |       |                  |       |
| SHAREHOLDERS'  EQUITY                                                                                |       |              |       |                  |       |
| Common stock,  par value $8.33, 10,000,000 shares authorized; 4,008,833 and 4,006,934 shares  issued |       | 33,407            |       | 33,391                |       |
| Additional  paid-in capital                                                                          |       | 17,930            |       | 17,888                |       |
| Retained  earnings                                                                                   |       | 27,898            |       | 27,707                |       |
| Accumulated  other comprehensive loss:                                                               |       |              |       |                  |       |
| Net unrealized  loss on available for sale securities                                                |       | (7,860            | )          | (2,159                | )          |
| Defined benefit  plan                                                                                |       | (1,375            | )          | (1,375                | )          |
| Less: Treasury  stock at cost, 149,818 and 131,302 shares                                            |       | (5,478            | )          | (4,893                | )          |
| TOTAL  SHAREHOLDERS' EQUITY                                                                          |       | 64,522            |       | 70,559                |       |
| TOTAL  LIABILITIES AND SHAREHOLDERS' EQUITY                                                          |       | $                 | 634,504    |                  | $          | 628,138 |   |

 

See accompanying notes tothe unaudited consolidated financial statements.

 

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PENNS WOODS BANCORP, INC.

CONSOLIDATEDSTATEMENT OF INCOME

(UNAUDITED)

 
| ** **                                                         | ** ** | **Three Months Ended** | ** ** | **Six Months Ended** | ** ** |
|--------------------------------------------------------------------|------------|----------------------------------|------------|--------------------------------|------------|
| ** **                                                         | ** ** | **June 30,**                | ** ** | **June 30,**              | ** ** |
| **(In Thousands, Except Per Share Data)** | ** ** | **2008**                         | ** ** | **2007**                       | ** ** | **2008** | ** ** | **2007** | ** ** |
|                                                               |       |                             |       |                           |       |   |   |   |   |
| INTEREST AND  DIVIDEND INCOME                                      |       |                             |       |                           |       |   |   |   |   |
| Loans including  fees                                              |       | $                                | 6,246      |                           | $          | 6,516 |   | $ | 12,625 |   | $ | 12,939 |   |
| Investment  Securities:                                            |       |                             |       |                           |       |   |   |   |   |
| Taxable                                                            |       | 1,276                            |       | 924                            |       | 2,466 |   | 1,747 |   |
| Tax-exempt                                                         |       | 1,210                            |       | 1,052                          |       | 2,436 |   | 2,163 |   |
| Dividend and  other interest income                                |       | 204                              |       | 301                            |       | 457 |   | 623 |   |
| TOTAL INTEREST  AND DIVIDEND INCOME                                |       | 8,936                            |       | 8,793                          |       | 17,984 |   | 17,472 |   |
|                                                               |       |                             |       |                           |       |   |   |   |   |
| INTEREST EXPENSE                                                   |       |                             |       |                           |       |   |   |   |   |
| Deposits                                                           |       | 2,551                            |       | 2,868                          |       | 5,092 |   | 5,380 |   |
| Short-term  borrowings                                             |       | 257                              |       | 227                            |       | 686 |   | 732 |   |
| Long-term  borrowings, FHLB                                        |       | 972                              |       | 904                            |       | 2,169 |   | 1,826 |   |
| TOTAL INTEREST  EXPENSE                                            |       | 3,780                            |       | 3,999                          |       | 7,947 |   | 7,938 |   |
|                                                               |       |                             |       |                           |       |   |   |   |   |
| NET INTEREST  INCOME                                               |       | 5,156                            |       | 4,794                          |       | 10,037 |   | 9,534 |   |
|                                                               |       |                             |       |                           |       |   |   |   |   |
| PROVISION FOR  LOAN LOSSES                                         |       | 60                               |       | 10                             |       | 120 |   | 50 |   |
|                                                               |       |                             |       |                           |       |   |   |   |   |
| NET INTEREST  INCOME AFTER PROVISION FOR LOAN LOSSES               |       | 5,096                            |       | 4,784                          |       | 9,917 |   | 9,484 |   |
|                                                               |       |                             |       |                           |       |   |   |   |   |
| NON-INTEREST  INCOME                                               |       |                             |       |                           |       |   |   |   |   |
| Service charges                                                    |       | 540                              |       | 567                            |       | 1,110 |   | 1,108 |   |
| Securities  (losses) gains, net                                    |       | (251                             | )          | 293                            |       | (213 | ) | 619 |   |
| Bank-owned life  insurance                                         |       | 91                               |       | 86                             |       | 246 |   | 201 |   |
| Gain on sale of  loans                                             |       | 212                              |       | 234                            |       | 364 |   | 372 |   |
| Insurance  commissions                                             |       | 486                              |       | 550                            |       | 1,066 |   | 988 |   |
| Other                                                              |       | 543                              |       | 456                            |       | 962 |   | 872 |   |
| TOTAL  NON-INTEREST INCOME                                         |       | 1,621                            |       | 2,186                          |       | 3,535 |   | 4,160 |   |
|                                                               |       |                             |       |                           |       |   |   |   |   |
| NON-INTEREST  EXPENSE                                              |       |                             |       |                           |       |   |   |   |   |
| Salaries and  employee benefits                                    |       | 2,469                            |       | 2,301                          |       | 4,920 |   | 4,582 |   |
| Occupancy, net                                                     |       | 314                              |       | 337                            |       | 652 |   | 668 |   |
| Furniture and  equipment                                           |       | 287                              |       | 297                            |       | 572 |   | 583 |   |
| Pennsylvania  shares tax                                           |       | 105                              |       | 161                            |       | 210 |   | 322 |   |
| Amortization of  investment in limited partnerships                |       | 178                              |       | 142                            |       | 356 |   | 283 |   |
| Other                                                              |       | 1,158                            |       | 1,102                          |       | 2,246 |   | 2,030 |   |
| TOTAL  NON-INTEREST EXPENSE                                        |       | 4,511                            |       | 4,340                          |       | 8,956 |   | 8,468 |   |
|                                                               |       |                             |       |                           |       |   |   |   |   |
| INCOME BEFORE  INCOME TAX PROVISION                                |       | 2,206                            |       | 2,630                          |       | 4,496 |   | 5,176 |   |
| INCOME TAX  PROVISION                                              |       | 149                              |       | 295                            |       | 308 |   | 560 |   |
| NET INCOME                                                         |       | $                                | 2,057      |                           | $          | 2,335 |   | $ | 4,188 |   | $ | 4,616 |   |
|                                                               |       |                             |       |                           |       |   |   |   |   |
| EARNINGS PER  SHARE - BASIC                                        |       | $                                | 0.53       |                           | $          | 0.60 |   | $ | 1.08 |   | $ | 1.19 |   |
|                                                               |       |                             |       |                           |       |   |   |   |   |
| EARNINGS PER  SHARE - DILUTED                                      |       | $                                | 0.53       |                           | $          | 0.60 |   | $ | 1.08 |   | $ | 1.19 |   |
|                                                               |       |                             |       |                           |       |   |   |   |   |
| WEIGHTED AVERAGE  SHARES OUTSTANDING - BASIC                       |       | 3,865,977                        |       | 3,889,139                      |       | 3,870,359 |   | 3,893,286 |   |
|                                                               |       |                             |       |                           |       |   |   |   |   |
| WEIGHTED AVERAGE  SHARES OUTSTANDING - DILUTED                     |       | 3,866,115                        |       | 3,889,401                      |       | 3,870,523 |   | 3,893,586 |   |
|                                                               |       |                             |       |                           |       |   |   |   |   |
| DIVIDENDS PER  SHARE                                               |       | $                                | 0.46       |                           | $          | 0.44 |   | $ | 0.92 |   | $ | 0.88 |   |

 

See accompanying notes tothe unaudited consolidated financial statements.

 

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PENNSWOODS BANCORP, INC.

CONSOLIDATED STATEMENT OF CHANGES IN SHAREHOLDERS’ EQUITY

(UNAUDITED)

 
| ** **                                                                                                                   | ** ** | ** ** | ** ** | ** **     | ** ** | ** **   | ** ** | ** **        | ** ** | **ACCUMULATED**        | ** ** | ** **             | ** ** | ** ** | ** ** |
|------------------------------------------------------------------------------------------------------------------------------|------------|------------|------------|----------------|------------|--------------|------------|-------------------|------------|------------------------|------------|------------------------|------------|------------|------------|
| ** **                                                                                                                   | ** ** | **COMMON** | ** ** | **ADDITIONAL** | ** ** | ** **   | ** ** | **OTHER**         | ** ** | ** **             | ** ** | **TOTAL**              | ** ** |
| ** **                                                                                                                   | ** ** | **STOCK**  | ** ** | **PAID-IN**    | ** ** | **RETAINED** | ** ** | **COMPREHENSIVE** | ** ** | **TREASURY**           | ** ** | **SHAREHOLDERS’** | ** ** |
| **(In Thousands Except Per Share Data)**                                                            | ** ** | **SHARES** | ** ** | **AMOUNT**     | ** ** | **CAPITAL**  | ** ** | **EARNINGS**      | ** ** | **INCOME (LOSS)** | ** ** | **STOCK**              | ** ** | **EQUITY** | ** ** |
| Balance, December  31, 2007                                                                                                  |       | 4,006,934  |       | $              | 33,391     |         | $          | 17,888            |       | $                      | 27,707     |                   | $          | (3,534     | )          | $ | (4,893 | ) | $ | 70,559 |   |
|                                                                                                                         |       |       |       |           |       |         |       |              |       |                   |       |                   |       |       |       |
| Comprehensive  Income:                                                                                                       |       |       |       |           |       |         |       |              |       |                   |       |                   |       |       |       |
| Net income                                                                                                                   |       |       |       |           |       |         |       | 4,188             |       |                   |       |                   |       | 4,188      |       |
| Unrealized loss  on investments available for sale, net of reclassification adjustment, net of  income tax benefit of $2,938 |       |       |       |           |       |         |       |              |       | (5,701                 | )          |                   |       | (5,701     | )          |
| Total  comprehensive loss                                                                                                    |       |       |       |           |       |         |       |              |       |                   |       |                   |       | (1,513     | )          |
| Dividends  declared, ($0.92 per share)                                                                                       |       |       |       |           |       |         |       | (3,560            | )          |                   |       |                   |       | (3,560     | )          |
| Purchase of  treasury stock (18,516 shares)                                                                                  |       |       |       |           |       |         |       |              |       |                   |       | (585                   | )          | (585       | )          |
| Cumulative effect  of change in accounting for postretirement benefits                                                       |       |       |       |           |       |         |       | (437              | )          |                   |       |                   |       | (437       | )          |
| Stock options  exercised                                                                                                     |       | 330        |       | 3              |       | 8            |       |              |       |                   |       |                   |       | 11         |       |
| Common shares  issued for employee stock purchase plan                                                                       |       | 1,569      |       | 13             |       | 34           |       |              |       |                   |       |                   |       | 47         |       |
| Balance, June 30,  2008                                                                                                      |       | 4,008,833  |       | $              | 33,407     |         | $          | 17,930            |       | $                      | 27,898     |                   | $          | (9,235     | )          | $ | (5,478 | ) | $ | 64,522 |   |

 
| ** **                                                                                                                   | ** ** | ** ** | ** ** | ** **     | ** ** | ** **   | ** ** | ** **        | ** ** | **ACCUMULATED**        | ** ** | ** **             | ** ** | ** ** | ** ** |
|------------------------------------------------------------------------------------------------------------------------------|------------|------------|------------|----------------|------------|--------------|------------|-------------------|------------|------------------------|------------|------------------------|------------|------------|------------|
| ** **                                                                                                                   | ** ** | **COMMON** | ** ** | **ADDITIONAL** | ** ** | ** **   | ** ** | **OTHER**         | ** ** | ** **             | ** ** | **TOTAL**              | ** ** |
| ** **                                                                                                                   | ** ** | **STOCK**  | ** ** | **PAID-IN**    | ** ** | **RETAINED** | ** ** | **COMPREHENSIVE** | ** ** | **TREASURY**           | ** ** | **SHAREHOLDERS’** | ** ** |
| **(In Thousands Except Per Share Data)**                                                            | ** ** | **SHARES** | ** ** | **AMOUNT**     | ** ** | **CAPITAL**  | ** ** | **EARNINGS**      | ** ** | **INCOME (LOSS)** | ** ** | **STOCK**              | ** ** | **EQUITY** | ** ** |
| Balance, December  31, 2006                                                                                                  |       | 4,003,514  |       | $              | 33,362     |         | $          | 17,810            |       | $                      | 25,783     |                   | $          | 1,560      |       | $ | (3,921 | ) | $ | 74,594 |   |
|                                                                                                                         |       |       |       |           |       |         |       |              |       |                   |       |                   |       |       |       |
| Comprehensive  Income:                                                                                                       |       |       |       |           |       |         |       |              |       |                   |       |                   |       |       |       |
| Net income                                                                                                                   |       |       |       |           |       |         |       | 4,616             |       |                   |       |                   |       | 4,616      |       |
| Unrealized loss  on investments available for sale, net of reclassification adjustment, net of  income tax benefit of $2,882 |       |       |       |           |       |         |       |              |       | (5,594                 | )          |                   |       | (5,594     | )          |
| Total  comprehensive loss                                                                                                    |       |       |       |           |       |         |       |              |       |                   |       |                   |       | (978       | )          |
| Dividends  declared, ($0.88 per share)                                                                                       |       |       |       |           |       |         |       | (3,425            | )          |                   |       |                   |       | (3,425     | )          |
| Purchase of  treasury stock (15,030 shares)                                                                                  |       |       |       |           |       |         |       |              |       |                   |       | (529                   | )          | (529       | )          |
| Stock options  exercised                                                                                                     |       | 330        |       | 3              |       | 5            |       |              |       |                   |       |                   |       | 8          |       |
| Common shares  issued for employee stock purchase plan                                                                       |       | 1,498      |       | 13             |       | 37           |       |              |       |                   |       |                   |       | 50         |       |
| Balance, June 30,  2007                                                                                                      |       | 4,005,342  |       | $              | 33,378     |         | $          | 17,852            |       | $                      | 26,974     |                   | $          | (4,034     | )          | $ | (4,450 | ) | $ | 69,720 |   |

 

PENNSWOODS BANCORP, INC.

CONSOLIDATED STATEMENT OF COMPREHENSIVE INCOME

(UNAUDITED)

 
| ** **                                                                      | ** ** | **Three Months Ended June 30,** | ** ** | **Six Months Ended June 30,** | ** ** |
|---------------------------------------------------------------------------------|------------|-----------------------------------------------------|------------|---------------------------------------------------|------------|
| **(In Thousands)**                                                              | ** ** | **2008**                                            | ** ** | **2007**                                          | ** ** | **2008** | ** ** | **2007** | ** ** |
|                                                                            |       |                                                |       |                                              |       |   |   |   |   |   |   |   |   |   |   |   |   |
| Net Income                                                                      |       |                                                |       | $                                                 | 2,057      |   |   |   | $ | 2,335 |   |   |   | $ | 4,188 |   |   |   | $ | 4,616 |   |
| Other  comprehensive loss:                                                      |       |                                                |       |                                              |       |   |   |   |   |   |   |   |   |   |   |   |   |
| Change in net  unrealized losses on available for sale securities               |       | (7,061                                              | )          |                                              |       | (7,194 | ) |   |   | (8,852 | ) |   |   | (7,857 | ) |   |   |
| Less:  Reclassification adjustment for net (losses)gains included in net income |       | (251                                                | )          |                                              |       | 293 |   |   |   | (213 | ) |   |   | 619 |   |   |   |
| Other  comprehensive loss before tax                                            |       |                                                |       | (6,810                                            | )          |   |   | (7,487 | ) |   |   | (8,639 | ) |   |   | (8,476 | ) |
| Income tax  benefit related to other comprehensive loss                         |       |                                                |       | (2,315                                            | )          |   |   | (2,546 | ) |   |   | (2,938 | ) |   |   | (2,882 | ) |
| Other  comprehensive loss, net of tax                                           |       |                                                |       | (4,495                                            | )          |   |   | (4,941 | ) |   |   | (5,701 | ) |   |   | (5,594 | ) |
| Comprehensive  loss                                                             |       |                                                |       | $                                                 | (2,438     | ) |   |   | $ | (2,606 | ) |   |   | $ | (1,513 | ) |   |   | $ | (978 | ) |

 

See accompanying notes to the unaudited consolidatedfinancial statements.

 

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PENNSWOODS BANCORP, INC.

CONSOLIDATED STATEMENT OF CASH FLOWS

(UNAUDITED)

 
| ** **                                                                         | ** ** | **Six Months Ended** | ** ** |
|------------------------------------------------------------------------------------|------------|--------------------------------|------------|
| ** **                                                                         | ** ** | **June 30,**              | ** ** |
| **(In Thousands)**                                                            | ** ** | **2008**                       | ** ** | **2007** | ** ** |
|                                                                               |       |                           |       |   |   |
| OPERATING  ACTIVITIES                                                              |       |                           |       |   |   |
| Net Income                                                                         |       | $                              | 4,188      |   | $ | 4,616 |   |
| Adjustments to  reconcile net income to net cash provided by operating activities: |       |                           |       |   |   |
| Depreciation and  amortization                                                     |       | 323                            |       | 366 |   |
| Provision for  loan losses                                                         |       | 120                            |       | 50 |   |
| Accretion and  amortization of investment security discounts and premiums          |       | (636                           | )          | (479 | ) |
| Securities  losses (gains), net                                                    |       | 213                            |       | (619 | ) |
| Originations of  loans held for sale                                               |       | (16,137                        | )          | (19,875 | ) |
| Proceeds of  loans held for sale                                                   |       | 17,125                         |       | 18,618 |   |
| Gain on sale of  loans                                                             |       | (364                           | )          | (372 | ) |
| Increases in  bank-owned life insurance                                            |       | (246                           | )          | (201 | ) |
| Other, net                                                                         |       | (1,465                         | )          | 207 |   |
| Net cash  provided by operating activities                                         |       | 3,121                          |       | 2,311 |   |
| INVESTING  ACTIVITIES                                                              |       |                           |       |   |   |
| Investment  securities available for sale:                                         |       |                           |       |   |   |
| Proceeds from  sales                                                               |       | 36,098                         |       | 39,212 |   |
| Proceeds from  calls and maturities                                                |       | 5,139                          |       | 3,165 |   |
| Purchases                                                                          |       | (45,132                        | )          | (46,179 | ) |
| Investment  securities held to maturity:                                           |       |                           |       |   |   |
| Proceeds from  calls and maturities                                                |       | 154                            |       | 11 |   |
| Net (increase)  decrease in loans                                                  |       | (5,520                         | )          | 4,136 |   |
| Acquisition of  bank premises and equipment                                        |       | (998                           | )          | (593 | ) |
| Proceeds from  the sale of foreclosed assets                                       |       | 70                             |       | 66 |   |
| Purchase of  bank-owned life insurance                                             |       | (698                           | )          | (602 | ) |
| Proceeds from  redemption of regulatory stock                                      |       | 3,560                          |       | 2,550 |   |
| Purchases of  regulatory stock                                                     |       | (1,996                         | )          | (2,097 | ) |
| Net cash used  for investing activities                                            |       | (9,323                         | )          | (331 | ) |
| FINANCING  ACTIVITIES                                                              |       |                           |       |   |   |
| Net increase in  interest-bearing deposits                                         |       | 43,662                         |       | 13,872 |   |
| Net increase  (decrease) in noninterest-bearing deposits                           |       | 5,237                          |       | (3,160 | ) |
| Proceeds of  long-term borrowings, FHLB                                            |       | —                         |       | 10,000 |   |
| Repayment of  long-term borrowings, FHLB                                           |       | (29,600                        | )          | (16,500 | ) |
| Net decrease in  short-term borrowings                                             |       | (7,234                         | )          | (6,338 | ) |
| Dividends paid                                                                     |       | (3,560                         | )          | (3,425 | ) |
| Issuance of  common stock                                                          |       | 47                             |       | 50 |   |
| Stock options  exercised                                                           |       | 11                             |       | 8 |   |
| Purchase of  treasury stock                                                        |       | (585                           | )          | (529 | ) |
| Net cash  provided by (used for) financing activities                              |       | 7,978                          |       | (6,022 | ) |
| NET INCREASE  (DECREASE) IN CASH AND CASH EQUIVALENTS                              |       | 1,776                          |       | (4,042 | ) |
| CASH AND CASH  EQUIVALENTS, BEGINNING                                              |       | 15,433                         |       | 15,373 |   |
| CASH AND CASH  EQUIVALENTS, ENDING                                                 |       | $                              | 17,209     |   | $ | 11,331 |   |
|                                                                               |       |                           |       |   |   |
| SUPPLEMENTAL  DISCLOSURES OF CASH FLOW INFORMATION                                 |       |                           |       |   |   |
|                                                                               |       |                           |       |   |   |
| Interest paid                                                                      |       | $                              | 8,228      |   | $ | 7,823 |   |
| Income taxes  paid                                                                 |       | 1,075                          |       | 1,185 |   |

 

See accompanying notes tothe unaudited consolidated financial statements.

 

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

**NOTES TO**

**CONSOLIDATEDFINANCIAL STATEMENTS**

**(Unaudited)**

 

# **Note 1.  Basis of Presentation**

# ** **

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

# ** **

The interim financial statements are unaudited but, in the opinion ofmanagement, reflect all adjustments necessary for the fair presentation ofresults for such periods.  The results ofoperations for any interim period are not necessarily indicative of results forthe full year.  These financialstatements should be read in conjunction with financial statements and notesthereto contained in the Company’s Annual Report on Form 10-K for the yearended December 31, 2007.

 

The accounting policies followed in thepresentation of interim financial results are the same as those followed on anannual basis.  These policies are presented on pages 41 through 47 ofthe Annual Report on Form 10-K for the year ended December 31, 2007.

 

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

 

**Note 2. RecentAccounting Pronouncements**

 

In December 2007, the FASB issued FAS No. 141 (revised 2007),Business Combinations (“FAS 141(R)”), which establishes principles andrequirements for how an acquirer recognizes and measures in its financialstatements the identifiable assets acquired, the liabilities assumed, and anynoncontrolling interest in an acquiree, including the recognition andmeasurement of goodwill acquired in a business combination.  FAS No. 141(R) iseffective for fiscal years beginning on or after December 15, 2008. Earlier adoption is prohibited.  The adoption of this standard is not expected to have a material effecton the Company’s results of operations or financial position.

 

In September 2006, the FASB issued FAS No. 157,Fair Value Measurements, which provides enhanced guidance for using fair valueto measure assets and liabilities.  Thestandard applies whenever other standards require or permit assets orliabilities to be measured at fair value. The Standard does not expand the use of fair value in any newcircumstances.  FAS No. 157 iseffective for financial statements issued for fiscal years beginning after November 15,2007 and interim periods within those fiscal years.  In February 2008, the FASB issued StaffPosition No. 157-1, Application of FASB Statement No. 157 to FASBStatement No. 13 and Other 

 

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Accounting Pronouncements That Address Fair ValueMeasurements for Purposes of Lease Classification or**Measurementunder Statement 13, which removed leasing transactions accounted for under FAS No. 13and related guidance from the scope of FAS No. 157*.*  Also in February 2008, the FASB issuedStaff Position No.157-2, Partial Deferral of the Effective Date of Statement157, which deferred the effective date of FAS No. 157 for all nonfinancialassets and nonfinancial liabilities to fiscal years beginning after November 15,2008.  On January 1, 2008, theCompany adopted FAS No. 157 which did not have a material effect on theCompany’s results of operations or financial position, see Note 8.

 

In February 2007, theFASB issued FAS No. 159, The Fair Value Option for Financial Assets andFinancial Liabilities – Including an amendment of FASB Statement No. 115,which provides all entities with an option to report selected financial assetsand liabilities at fair value. The objective of the FAS No. 159 is toimprove financial reporting by providing entities with the opportunity tomitigate volatility in earnings caused by measuring related assets andliabilities differently without having to apply the complex provisions of hedgeaccounting.  FAS No. 159 iseffective as of the beginning of an entity’s first fiscal year beginning after November 15,2007.  Early adoption is permitted as ofthe beginning of a fiscal year that begins on or before November 15, 2007provided the entity also elects to apply the provisions of FAS No. 157,Fair Value Measurements.  On January 31,2008, the Company adopted FAS No. 159 which did not have a material effecton the Company’s results of operations or financial position.

 

In December 2007, theFASB issued FAS No. 160, Noncontrolling Interests in ConsolidatedFinancial Statements — an amendment of ARB No. 51.  FAS No. 160 amends ARB No. 51 toestablish accounting and reporting standards for the noncontrolling interest ina subsidiary and for the deconsolidation of a subsidiary.  It clarifiesthat a noncontrolling interest in a subsidiary, which is sometimes referred toas minority interest, is an ownership interest in the consolidated entity thatshould be reported as equity in the consolidated financial statements. Among other requirements, this statement requires consolidated net income to bereported at amounts that include the amounts attributable to both the parentand the noncontrolling interest.  It also requires disclosure, on the faceof the consolidated income statement, of the amounts of consolidated net incomeattributable to the parent and to the noncontrolling interest.   FAS No. 160is effective for fiscal years beginning on or after December 15,2008.  Earlier adoption isprohibited.  The adoption of this standard is not expected to have amaterial effect on the Company’s results of operations or financial position.

 

In September 2006, the FASB reached consensus on the guidanceprovided by Emerging Issues Task Force Issue 06-4 (“EITF 06-4”), Accounting forDeferred Compensation and Postretirement Benefit Aspects of EndorsementSplit-Dollar Life Insurance Arrangements. The guidance is applicable to endorsement split-dollar life insurancearrangements, whereby the employer owns and controls the insurance policy, thatare associated with a postretirement benefit. EITF 06-4 requires that for a split-dollar life insurance arrangementwithin the scope of the Issue, an employer should recognize a liability forfuture benefits in accordance with FAS No. 106 (if, in substance, apostretirement benefit plan exists) or Accounting Principles Board Opinion No. 12(if the arrangement is, in substance, an individual deferred compensationcontract) based on the substantive agreement with the employee.  EITF 06-4 is effective for fiscal yearsbeginning after December 15, 2007. On January 1, 2008, the Company adopted 

 

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EITF 06-04 which resulted in an adjustment to retained earnings and anassociated liability in the amount of $437,000.

 

In March 2007, the FASB ratified Emerging Issues Task Force Issue No. 06-10(“EITF 06-10”), Accounting for Collateral Assignment Split-Dollar LifeInsurance Agreements. EITF 06-10 provides guidance for determining a liabilityfor the postretirement benefit obligation as well as recognition andmeasurement of the associated asset on the basis of the terms of the collateralassignment agreement. EITF 06-10 is effective for fiscal years beginning after December 15,2007. On January 1, 2008, the Company adopted EITF 06-10 which did nothave a material effect on the Company’s results of operations or financialposition.

 

In June 2007, the FASB ratified Emerging Issues Task Force Issue No. 06-11(“EITF 06-11”), Accounting for Income Tax Benefits of Dividends on Share-BasedPayment Awards.  EITF 06-11 applies toshare-based payment arrangements with dividend protection features that entitleemployees to receive (a) dividends on equity-classified nonvested shares, (b) dividendequivalents on equity-classified nonvested share units, or (c) paymentsequal to the dividends paid on the underlying shares while an equity-classifiedshare option is outstanding, when those dividends or dividend equivalents arecharged to retained earnings under FAS No. 123R, Share-Based Payment, andresult in an income tax deduction for the employer. A consensus was reachedthat a realized income tax benefit from dividends or dividend equivalents thatare charged to retained earnings and are paid to employees forequity-classified nonvested equity shares, nonvested equity share units, andoutstanding equity share options should be recognized as an increase inadditional paid-in capital.  EITF 06-11is effective for fiscal years beginning after December 15, 2007, andinterim periods within those fiscal years. On January 1, 2008, the Company adopted EITF 06-11 which did nothave a material effect on the Company’s results of operations or financial position.

 

In March 2008, the FASB issued FAS No. 161, Disclosures aboutDerivative Instruments and Hedging Activities, to require enhanced disclosuresabout derivative instruments and hedging activities. The new standard hasrevised financial reporting for derivative instruments and hedging activitiesby requiring more transparency about how and why an entity uses derivativeinstruments, how derivative instruments and related hedged items are accountedfor under FAS No. 133, Accounting for Derivative Instruments and HedgingActivities; and how derivative instruments and related hedged items affect anentity’s financial position, financial performance, and cash flows.  FAS No. 161 requires disclosure of thefair values of derivative instruments and their gains and losses in a tabularformat. It also requires entities to provide more information about theirliquidity by requiring disclosure of derivative features that are creditrisk-related. Further, it requires cross-referencing within footnotes to enablefinancial statement users to locate important information about derivativeinstruments.  FAS No. 161 is effective for financialstatements issued for fiscal years and interim periods beginning after November 15,2008, with early application encourage. The adoption of this standard is not expected to have a material effecton the Company’s results of operations or financial position.

 

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In May 2008, the FASB issued FAS No. 162, TheHierarchy of Generally Accepted Accounting Principles. FAS No. 162identifies the sources of accounting principles and the framework for selectingthe principles used in the preparation of financial statements ofnongovernmental entities that are presented in conformity with generallyaccepted accounting principles (the GAAP hierarchy). FAS No. 162 willbecome effective 60 days following the SEC’s approval of the PublicCompany Accounting Oversight Board amendments to AU Section 411, TheMeaning of Present Fairly in Conformity With Generally Accepted AccountingPrinciples. The Company does not expect the adoption of FAS No. 162 tohave a material effect on its results of operations and financial position.

 

In April 2008, the FASB issued FASB Staff Position No. 142-3,Determination of the Useful Life of Intangible Assets (“FSP 142-3”). FSP 142-3amends the factors that should be considered in developing assumptions aboutrenewal or extension used in estimating the useful life of a recognizedintangible asset under FAS No. 142, Goodwill and Other Intangible Assets.This standard is intended to improve the consistency between the useful life ofa recognized intangible asset under FAS No. 142 and the period of expectedcash flows used to measure the fair value of the asset under FAS No. 141R andother GAAP. FSP 142-3 is effective for financial statements issued for fiscalyears beginning after December 15, 2008. The measurement provisions ofthis standard will apply only to intangible assets of the Company acquiredafter the effective date.

 

In June 2008, the FASB issued FASB Staff Position (FSP) No. EITF03-6-1, Determining Whether Instruments Granted in Share-Based PaymentTransactions Are Participating Securities, to clarify that instruments grantedin share-based payment transactions can be participating securities prior tothe requisite service having been rendered. A basic principle of the FSP is that unvested share-based payment awardsthat contain nonforfeitable rights to dividends or dividend equivalents(whether paid or unpaid) are participating securities and are to be included inthe computation of EPS pursuant to the two-class method.  The provisions of this FSP are effective forfinancial statements issued for fiscal years beginning after December 15,2008, and interim periods within those years. All prior-period EPS datapresented (including interim financial statements, summaries of earnings, andselected financial data) are required to be adjusted retrospectively to conformwith the provisions of the FSP.  The adoption of this FSP is not expected tohave a material effect on the Company’s results of operations or financialposition.

 

**Note 3. Per Share Data**

 

The following tablesets forth the composition of the weighted average common shares (denominator)used in the basic and dilutive per share computation.  There are no convertible securities whichwould affect the numerator in calculating basic and diluted earnings per share;therefore, net income as presented on the consolidated statement of income willbe used as the numerator.

 

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| ** **                                                                                                 | ** ** | **Three Months Ended June 30,** | ** ** | **Six Months Ended June 30,** | ** ** |
|------------------------------------------------------------------------------------------------------------|------------|-----------------------------------------------------|------------|---------------------------------------------------|------------|
| ** **                                                                                                 | ** ** | **2008**                                            | ** ** | **2007**                                          | ** ** | **2008** | ** ** | **2007** | ** ** |
|                                                                                                       |       |                                                |       |                                              |       |   |   |   |   |
| Weighted average  common shares outstanding                                                                |       | 4,008,030                                           |       | 4,004,798                                         |       | 4,007,603 |   | 4,004,369 |   |
|                                                                                                       |       |                                                |       |                                              |       |   |   |   |   |
| Average treasury  stock shares                                                                             |       | (142,053                                            | )          | (115,659                                          | )          | (137,244 | ) | (111,083 | ) |
|                                                                                                       |       |                                                |       |                                              |       |   |   |   |   |
| Weighted average  common shares and common  stock equivalents used to calculate basic earnings per share   |       | 3,865,977                                           |       | 3,889,139                                         |       | 3,870,359 |   | 3,893,286 |   |
|                                                                                                       |       |                                                |       |                                              |       |   |   |   |   |
| Additional  common stock equivalents(stock options) used to calculate diluted earnings per share           |       | 138                                                 |       | 262                                               |       | 164 |   | 300 |   |
|                                                                                                       |       |                                                |       |                                              |       |   |   |   |   |
| Weighted average  common shares and common  stock equivalents used to calculate diluted earnings per share |       | 3,866,115                                           |       | 3,889,401                                         |       | 3,870,523 |   | 3,893,586 |   |

 

Options to purchase8,273 and 9,923 shares of common stock during the three and six months ended June 30,2008 were outstanding but were not included in the computation of dilutedearnings per share as they were anti-dilutive due to the strike prices of$40.29 and $31.82 being greater than the market price of $31.25 at June 30,2008.  Options to purchase 8,276 and9,002 shares of common stock during the three and six months ended June 30,2007 were outstanding but were not included in the computation of dilutedearnings per share as they were anti-dilutive due to the strike price of $40.29being greater than the market price of $34.24 at June 30, 2007.

 

**Note 4.****  Net Periodic Benefit Cost-DefinedBenefit Plans**

 

For a detailed disclosure on the Company’s pension andemployee benefits plans, please refer to Note 11 of the Company’s ConsolidatedFinancial Statements included in the Annual Report on Form 10-K for theyear ended December 31, 2007.

 

The following sets forth the components of the net periodicbenefit cost of the domestic non-contributory defined benefit plan for thethree and six months ended June 30, 2008 and 2007, respectively:

 

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| ** **                             | ** ** | **Three Months Ended** | ** ** | **Six Months Ended** | ** ** |
|----------------------------------------|------------|----------------------------------|------------|--------------------------------|------------|
| ** **                             | ** ** | **June 30,**                | ** ** | **June 30,**              | ** ** |
| **(In Thousands)**                | ** ** | **2008**                         | ** ** | **2007**                       | ** ** | **2008** | ** ** | **2007** | ** ** |
|                                   |       |                             |       |                           |       |   |   |   |   |
| Service cost                           |       | $                                | 136        |                           | $          | 117 |   | $ | 273 |   | $ | 233 |   |
| Interest cost                          |       | 152                              |       | 121                            |       | 304 |   | 243 |   |
| Expected return  on plan assets        |       | (163                             | )          | (140                           | )          | (320 | ) | (281 | ) |
| Amortization of  transition obligation |       | —                           |       | (1                             | )          | (1 | ) | (1 | ) |
| Amortization of  prior service cost    |       | 7                                |       | 6                              |       | 13 |   | 13 |   |
| Amortization of  net loss              |       | 14                               |       | —                         |       | 28 |   | — |   |
| Net periodic  cost                     |       | $                                | 146        |                           | $          | 103 |   | $ | 297 |   | $ | 207 |   |

 

**EmployerContributions**

** **

The Company previously disclosed in its consolidatedfinancial statements, included in the Annual Report on Form 10-K for theyear ended December 31, 2007, that it expected to contribute $450,000 toits defined benefit plan in 2008.  As of June 30, 2008, acontribution in the amount of $500,000 was made for the 2007 plan year with noadditional contributions anticipated during 2008.

 

**Note 5.  Off Balance Sheet Risk**

 

The Company is a party to financial instrumentswith off-balance sheet risk in the normal course of business to meet thefinancing needs of its customers.  Thesefinancial instruments are primarily comprised of commitments to extend creditand standby letters of credit.  Theseinstruments involve, to varying degrees, elements of credit, interest rate, orliquidity risk in excess of the amount recognized in the consolidated balancesheet.  The contract amounts of theseinstruments express the extent of involvement the Company has in particularclasses of financial instruments.

 

The Company’s exposure to credit loss from nonperformanceby the other party to the financial instruments for commitments to extendcredit and standby letters of credit is represented by the contractual amountof these instruments.  The Company usesthe same credit policies in making commitments and conditional obligations asit does for on-balance sheet instruments. The Company may require collateral or other security to supportfinancial instruments with off-balance sheet credit risk.

 

Outstanding financial instruments with offbalance sheet risk are as follows:

 
| ** **                    | ** ** | **June 30,** | ** ** | **December 31,** | ** ** |
|-------------------------------|------------|-------------------|------------|-----------------------|------------|
| **(In Thousands)**       | ** ** | **2008**          | ** ** | **2007**              | ** ** |
| Commitments to  extend credit |       | $                 | 74,746     |                  | $          | 74,349 |   |
| Standby letters  of credit    |       | 928               |       | 974                   |       |
|                               |            |                   |            |                       |            |  |  |

 

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

# ** **

Certain comparative amounts for the prior period havebeen reclassified to conform to current period presentations. Suchreclassifications had no effect on net income or shareholders’ equity.

 

# **Note 7.  Employee Stock PurchasePlan**

# ** **

The Company issues shares under the PennsWoods Bancorp, Inc. 2006 Employee Stock Purchase Plan (“Plan”) which isintended to encourage employee participation in the ownership and economicprogress of the Company.  The Plan allowsfor up to 1,000,000 shares to be purchased by employees.  The purchase price of the shares is 95% ofmarket value with an employee eligible to purchase up to the lesser of 15% ofbase compensation or $12,000 in market value annually.  During the six months ended June 30,2008 and 2007, there were 1,569 and 1,498 shares issued under the plan,respectively.

 

# **Note 8.  Fair Value Measurements**

# ** **

Effective January 1, 2008, the Companyadopted FAS 157, which, among other things, requires enhanced disclosures aboutassets and liabilities carried at fair value. FAS 157 establishes a hierarchaldisclosure framework associated with the level of pricing observabilityutilized in measuring assets and liabilities at fair value. The three broadlevels defined by FAS 157 hierarchy are as follows:

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

 

The following table presents the assets andliabilities reported on the consolidated statements of financial condition attheir fair value as of June 30, 2008 by level within the fair valuehierarchy. As required by FAS 157, financial assets and liabilities areclassified in their entirety based on the lowest level of input that issignificant to the fair value measurement.

 
| ** **                                 | ** ** | **June 30, 2008** | ** ** |
|--------------------------------------------|------------|-----------------------------|------------|
| **(In Thousands)**                    | ** ** | **Level I**            | ** ** | **Level II** | ** ** | **Level III** | ** ** | **Total** | ** ** |
|                                       |       |                        |       |   |   |   |   |   |   |
| Assets:                                    |       |                        |       |   |   |   |   |   |   |
| Investment  Securities, available-for-sale |       | $                           | —     |   | $ | 209,284 |   | $ | — |   | $ | 209,284 |   |
|                                            |            |                             |            |  |  |  |  |  |  |  |  |  |  |

 

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**CAUTIONARY STATEMENT FOR PURPOSESOF THE PRIVATE**

**SECURITIES LITIGATION REFORM ACTOF 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) theeffect of changes in laws and regulations, including federal and state bankinglaws and regulations, with 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 policiesand practices, as may be adopted by the regulatory agencies as well as by theFinancial Accounting Standards Board, or of changes in the Company’sorganization, compensation and benefit plans; (iii) the effect on theCompany’s competitive position within its market area of the increasingconsolidation within the banking and financial services industries, includingthe increased competition from larger regional and out-of-state bankingorganizations as well as non-bank providers of various financial services; (iv) theeffect of changes in interest rates; and (v) the effect of changes in thebusiness cycle and downturns in the local, regional or national economies.

 

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

 

# **EARNINGS SUMMARY**

# ** **

**Comparison of the Three and SixMonths Ended June 30, 2008 and 2007**

 

**Summary Results**

 

Net income for the three months ended June 30,2008 was $2,057,000 compared to $2,335,000 for the same period of 2007 asafter-tax securities gains decreased $359,000 (from $193,000 to a loss of$166,000).  The decrease in securitygains is the result of a write down in value of certain equity holdings thathave been deemed other than temporarily impaired. Basic and diluted earningsper share for the three months ended June 30, 2008 were $0.53 compared to$0.60 for the three months ended June 30, 2007.  Return on average assets and return onaverage equity were 1.30% and 11.73% for the three months ended June 30,2008 compared to 1.58% and 12.57% for the corresponding period of 2007.  Net income from core operations (“operatingearnings”) increased 3.8% to $2,223,000 for the three months ended June 30,2008 compared to $2,142,000 for the same period of 2007  Operating earnings per share for the threemonths ended June 30, 2008 increased to $0.58 basic and $0.57 dilutive comparedto $0.55 basic and dilutive for the three months ended June 30, 2007.

 

The six months ended June 30, 2008 generated net income of$4,188,000 compared to $4,616,000 for the same period of 2007 due to a declinein after-tax securities gains of $550,000 (from $409,000 to a loss of$141,000). Earnings per share, basic and diluted, for the six months ended June 30,2008 were $1.08 as compared to $1.19 for the comparable period of 2007.  Return on average assets and return onaverage equity were 1.33% and 11.87% for the six months ended June 30,2007 as compared to 1.57% and 12.35% for the corresponding period of 2007. Operating earnings increased 2.9% to $4,329,000 for the six months endedJune 30, 2008 compared to $4,207,000 for the comparable period of 2007resulting in basic and dilutive operating earnings per share of $1.12 and $1.08for the six month periods ended June 30, 2008 and 2007, respectively.

 

(Management uses the non-GAAP measure of net income from coreoperations in its analysis of the Company’s performance.  This measure, as used by the Company, adjustsnet income by significant gains or losses that are unusual in nature.  Because certain of these items and their impacton the Company’s performance are difficult to predict, management believes thepresentation of financial measures excluding the impact of such items providesuseful supplemental information in evaluating the operating results of theCompany’s core businesses.  For purposesof this Quarterly Report on Form 10-Q, net income from core operationsmeans net income adjusted to exclude after-tax net securities gains orlosses.  These disclosures should not beviewed as a substitute for net income determined in accordance with GAAP, norare they necessarily comparable to non-GAAP performance measures that may bepresented by other companies.)

 

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**Interest And Dividend Income**

 

Interest and dividend income for the threemonths ended June 30, 2008 increased $143,000 to $8,936,000 compared to$8,793,000 for the same period of 2007. The increase in interest income was primarily the result of growth inaverage taxable investment securities of $21,967,000 offset by an 18 basispoint (“bp”) decrease in the related security yields for the three months endedJune 30, 2008 over the same period of 2007.  The combination of taxable investmentsecurity growth and slight yield decrease resulted in a $352,000 increase intaxable interest income. Over the same time frame, the average balance oftax-exempt investment securities increased $8,267,000 with the portfolio yieldincreasing 40 bp resulting in a $158,000 increase in tax-exempt interestincome.  On a taxable equivalent basis,the interest income from the investment portfolio increased $510,000 due to theinvestment portfolio being strategically shifted toward tax-exemptinstruments.  The decrease in dividendsreceived is the result of a decrease in equity investments coupled with ageneral decline in the dividends per share received from the equityholdings.  Interest and fee income fromthe loan portfolio decreased $270,000 as the actions of the FOMC served as the foundationfor the 48 bp decline in loan portfolio yield.

 

During the six months ended June 30,2008, interest and dividend income was $17,984,000, an increase of $512,000over the same period in 2007.  Thereasons for the 2.9% growth in interest income for the six month period areidentical to those for the three month period ending June 30, 2008discussed above.  The growth in averageloans of $4,256,000 coupled with a 28 bp decrease in the loan portfolio yielddue to the decreasing prime rate resulted in a decrease of $314,000 in loaninterest and fee income.   Averageinvestment securities and interest bearing deposit income increased $826,000due to an increase in average balance of $29,493,000 and a 6 bp increase inyield.  The increase in yield was due toan increase in yield on tax-exempt securities as portfolio cash flow wasreinvested into higher yielding bonds over the past year.  The asset allocation between loans and theinvestment portfolio composition resulted in taxable equivalent interest incomeincreasing $659,000 for the six months ended June 30, 2008 compared to thesame period of 2007.

 

Interest and dividend income composition forthe three and six months ended June 30, 2008 and 2007 was as follows:

 

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| ** **                          | ** ** | **For The Three Months Ended** | ** ** |
|-------------------------------------|------------|----------------------------------------------------|------------|
| ** **                          | ** ** | **June 30, 2008**                        | ** ** | **June 30, 2007** | ** ** | **Change** | ** ** |
| **(In Thousands)**             | ** ** | **Amount**                                         | ** ** | **% Total** | ** ** | **Amount** | ** ** | **% Total** | ** ** | **Amount** | ** ** | **%** | ** ** |
| Loans including  fees               |       | $                                                  | 6,246      |   | 69.9 | % | $ | 6,516 |   | 74.1 | % | $ | (270 | ) | (4.1 | )% |
| Investment  securities:             |       |                                               |       |   |   |   |   |   |   |   |   |   |   |
| Taxable                             |       | 1,276                                              |       | 14.3 |   | 924 |   | 10.5 |   | 352 |   | 38.1 |   |
| Tax-exempt                          |       | 1,210                                              |       | 13.5 |   | 1,052 |   | 12.0 |   | 158 |   | 15.0 |   |
| Dividend and  other interest income |       | 204                                                |       | 2.3 |   | 301 |   | 3.4 |   | (97 | ) | (32.2 | ) |
| Total interest  and dividend income |       | $                                                  | 8,936      |   | 100.0 | % | $ | 8,793 |   | 100.0 | % | $ | 143 |   | 1.6 | % |
|                                |       |                                               |       |   |   |   |   |   |   |   |   |   |   |
| ** **                          | ** ** | **For The Six Months Ended**   | ** ** |
| ** **                          | ** ** | **June 30, 2008**                        | ** ** | **June 30, 2007** | ** ** | **Change** | ** ** |
| **(In Thousands)**             | ** ** | **Amount**                                         | ** ** | **% Total** | ** ** | **Amount** | ** ** | **% Total** | ** ** | **Amount** | ** ** | **%** | ** ** |
| Loans including  fees               |       | $                                                  | 12,625     |   | 70.2 | % | $ | 12,939 |   | 74.0 | % | $ | (314 | ) | (2.4 | )% |
| Investment  securities:             |       |                                               |       |   |   |   |   |   |   |   |   |   |   |
| Taxable                             |       | 2,466                                              |       | 13.7 |   | 1,747 |   | 10.0 |   | 719 |   | 41.2 |   |
| Tax-exempt                          |       | 2,436                                              |       | 13.6 |   | 2,163 |   | 12.4 |   | 273 |   | 12.6 |   |
| Dividend and  other interest income |       | 457                                                |       | 2.5 |   | 623 |   | 3.6 |   | (166 | ) | (26.6 | ) |
| Total interest  and dividend income |       | $                                                  | 17,984     |   | 100.0 | % | $ | 17,472 |   | 100.0 | % | $ | 512 |   | 2.9 | % |

 

**Interest Expense**

 

Interest expense for the three months ended June 30,2008 decreased $219,000 to $3,780,000 compared to $3,999,000 for the same period of 2007.  The decreased expense associated withdeposits is primarily the result of a reduction in rate paid of 77 bp on timedeposits.  Factors that led to the ratedecreases include, but are not limited to, Federal Open Market Committee (“FOMC”)actions over the past year, campaigns conducted to attract 8 to 12 monthmaturity CDs that have resulted in an increased repricing frequency, anddecreased average utilization of $9,000,000 in brokered CDs.  Short-term borrowings interest expenseincreased $30,000 as the increase in average balance of $19,080,000 countered adecrease in the rate paid of 164 bp due to the FOMC rate actions over the pastyear.  Long-term borrowings interestexpense increased $68,000 as the average balance of such borrowings increased$7,818,000 for the three months ended June 30, 2008 compared to the sameperiod of 2007, while the average rate decreased 22 bp to 4.43% for the 2008period.

 

Interest expense for the six months ended June 30,2008 remained stable at $7,947,000 compared to $7,938,000 for the same periodof 2007.  Interest on deposits decreased$288,000 due to the reasons noted in the above three month analysis.  Borrowing costs increased primarily due tothe addition of $30,000,000 in borrowings during the latter portion of 2007 aspart of a program to increase net interest income through the purchase of fixedrate investment securities.

 

Interest expense composition for the threeand six months ended June 30, 2008 and 2007 was as follows:

 

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| ** **                  | ** ** | **For The Three Months Ended** | ** ** |
|-----------------------------|------------|----------------------------------------------------|------------|
| ** **                  | ** ** | **June 30, 2008**                        | ** ** | **June 30, 2007** | ** ** | **Change** | ** ** |
| **(In Thousands)**     | ** ** | **Amount**                                         | ** ** | **% Total** | ** ** | **Amount** | ** ** | **% Total** | ** ** | **Amount** | ** ** | **%** | ** ** |
| Deposits                    |       | $                                                  | 2,551      |   | 67.5 | % | $ | 2,868 |   | 71.7 | % | $ | (317 | ) | (11.1 | )% |
| Short-term  borrowings      |       | 257                                                |       | 6.8 |   | 227 |   | 5.7 |   | 30 |   | 13.2 |   |
| Long-term  borrowings, FHLB |       | 972                                                |       | 25.7 |   | 904 |   | 22.6 |   | 68 |   | 7.5 |   |
| Total interest  expense     |       | $                                                  | 3,780      |   | 100.0 | % | $ | 3,999 |   | 100.0 | % | $ | (219 | ) | (5.5 | )% |

 
| ** **                  | ** ** | **For The Six Months Ended** | ** ** |
|-----------------------------|------------|--------------------------------------------------|------------|
| ** **                  | ** ** | **June 30, 2008**                      | ** ** | **June 30, 2007** | ** ** | **Change** | ** ** |
| **(In Thousands)**     | ** ** | **Amount**                                       | ** ** | **%**** Total** | ** ** | **Amount** | ** ** | **% Total** | ** ** | **Amount** | ** ** | **%** | ** ** |
| Deposits                    |       | $                                                | 5,092      |   | 64.1 | % | $ | 5,380 |   | 67.8 | % | $ | (288 | ) | (5.4 | )% |
| Short-term  borrowings      |       | 686                                              |       | 8.6 |   | 732 |   | 9.2 |   | (46 | ) | (6.3 | ) |
| Long-term  borrowings, FHLB |       | 2,169                                            |       | 27.3 |   | 1,826 |   | 23.0 |   | 343 |   | 18.8 |   |
| Total interest  expense     |       | $                                                | 7,947      |   | 100.0 | % | $ | 7,938 |   | 100.0 | % | $ | 9 |   | 0.1 | % |

 

**Net Interest Margin**

** **

The net interest margin (“NIM”) for the threemonths ended June 30, 2008 was 4.01% compared to 3.95% for thecorresponding period of 2007.  Theincrease in the NIM was driven by a 53 bp decline in the rate paid on interestbearing liabilities that more than compensated for a 30 bp decline in the yieldon earning assets.  The decrease inearning asset yield is due to the impact on the loan portfolio of the FOMC ratedecreases over the past year coupled with the investment portfolio growth thatoccurred during the second half of 2007. Despite this investment growth being accretive to earnings, return onaverage assets, and return on average equity, it lowered the net interestmargin due to the spread between the yield on assets purchased and theassociated funding cost being less than historical levels.  The growth in the investment portfolio wasdriven by a strategic initiative in the second half of 2007 to increase taxequivalent net interest income by purchasing fixed rate instruments inanticipation of the decreasing rate environment that is continuing into 2008.  The decrease in the cost of interest bearingliabilities to 3.12% from 3.65% was driven primarily by a reduction in the ratepaid on time deposits of 77 bp.  Thereduction was the result of a shortening of the time deposit portfolio initiatedin the early stages of 2007 that has resulted in an increasing repricingfrequency during this period of decreasing rates.

 

The NIM for the six months ended June 30,2008 and 2007 was 3.95%.  The impact ofthe items mentioned in the three month discussion also applies to for the sixmonth period.  A 44 bp decline in therate paid on time deposits served as the foundation for a 27 `bp decline inrate paid on deposits, while the FOMC actions steered the yield on earningassets and cost of borrowings.

 

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Following is a schedule of average balancesand associated yields for the three and six month periods ended June 30,2008 and 2007:

 
| ** **                                       | ** ** | **AVERAGE BALANCES AND INTEREST RATES** | ** ** |
|--------------------------------------------------|------------|-----------------------------------------|------------|
| ** **                                       | ** ** | **Three Months Ended**        | ** ** | **Three Months Ended** | ** ** |
| ** **                                       | ** ** | **June 30, 2008**             | ** ** | **June 30, 2007** | ** ** |
| **(In Thousands)**                          | ** ** | **Average Balance**                | ** ** | **Interest** | ** ** | **Average Rate** | ** ** | **Average Balance** | ** ** | **Interest** | ** ** | **Average Rate** | ** ** |
| Assets:                                          |       |                                    |       |   |   |   |   |   |   |   |   |   |   |
| Tax-exempt loans                                 |       | $                                       | 8,506      |   | $ | 135 |   | 6.31 | % | $ | 7,819 |   | $ | 120 |   | 6.16 | % |
| All other loans                                  |       | 358,980                                 |       | 6,157 |   | 6.82 | % | 353,019 |   | 6,437 |   | 7.31 | % |
| Total loans                                      |       | 367,486                                 |       | 6,292 |   | 6.81 | % | 360,838 |   | 6,557 |   | 7.29 | % |
|                                             |       |                                    |       |   |   |   |   |   |   |   |   |   |   |
| Taxable  investment securities                   |       | 105,295                                 |       | 1,480 |   | 5.62 | % | 83,328 |   | 1,209 |   | 5.80 | % |
| Tax-exempt  investment securities                |       | 108,670                                 |       | 1,833 |   | 6.75 | % | 100,403 |   | 1,594 |   | 6.35 | % |
| Total securities                                 |       | 213,965                                 |       | 3,313 |   | 6.19 | % | 183,731 |   | 2,803 |   | 6.10 | % |
|                                             |       |                                    |       |   |   |   |   |   |   |   |   |   |   |
| Interest bearing  deposits                       |       | 34                                      |       | — |   | 0.00 | % | 1,230 |   | 16 |   | 5.22 | % |
|                                             |       |                                    |       |   |   |   |   |   |   |   |   |   |   |
| Total  interest-earning assets                   |       | 581,485                                 |       | 9,605 |   | 6.58 | % | 545,799 |   | 9,376 |   | 6.88 | % |
|                                             |       |                                    |       |   |   |   |   |   |   |   |   |   |   |
| Other assets                                     |       | 50,186                                  |       |   |   |   |   | 43,594 |   |   |   |   |   |
|                                             |       |                                    |       |   |   |   |   |   |   |   |   |   |   |
| Total assets                                     |       | $                                       | 631,671    |   |   |   |   |   | $ | 589,393 |   |   |   |   |   |
|                                             |       |                                    |       |   |   |   |   |   |   |   |   |   |   |
| Liabilities:                                     |       |                                    |       |   |   |   |   |   |   |   |   |   |   |
| Savings                                          |       | $                                       | 61,197     |   | 115 |   | 0.75 | % | $ | 59,906 |   | 110 |   | 0.74 | % |
| Super Now  deposits                              |       | 54,327                                  |       | 183 |   | 1.34 | % | 47,531 |   | 153 |   | 1.29 | % |
| Money market  deposits                           |       | 26,803                                  |       | 146 |   | 2.17 | % | 26,346 |   | 158 |   | 2.41 | % |
| Time deposits                                    |       | 209,539                                 |       | 2,107 |   | 4.00 | % | 205,554 |   | 2,447 |   | 4.77 | % |
| Total deposits                                   |       | 351,866                                 |       | 2,551 |   | 2.88 | % | 339,337 |   | 2,868 |   | 3.39 | % |
|                                             |       |                                    |       |   |   |   |   |   |   |   |   |   |   |
| Short-term  borrowings                           |       | 41,319                                  |       | 257 |   | 2.45 | % | 22,239 |   | 227 |   | 4.09 | % |
| Long-term  borrowings, FHLB                      |       | 85,789                                  |       | 972 |   | 4.43 | % | 77,971 |   | 904 |   | 4.65 | % |
| Total borrowings                                 |       | 127,108                                 |       | 1,229 |   | 3.79 | % | 100,210 |   | 1,131 |   | 4.53 | % |
|                                             |       |                                    |       |   |   |   |   |   |   |   |   |   |   |
| Total  interest-bearing liabilities              |       | 478,974                                 |       | 3,780 |   | 3.12 | % | 439,547 |   | 3,999 |   | 3.65 | % |
|                                             |       |                                    |       |   |   |   |   |   |   |   |   |   |   |
| Demand deposits                                  |       | 73,485                                  |       |   |   |   |   | 68,677 |   |   |   |   |   |
| Other liabilities                                |       | 9,095                                   |       |   |   |   |   | 6,888 |   |   |   |   |   |
| Shareholders’  equity                       |       | 70,117                                  |       |   |   |   |   | 74,281 |   |   |   |   |   |
| Total  liabilities and shareholders’ equity |       | $                                       | 631,671    |   |   |   |   |   | $ | 589,393 |   |   |   |   |   |
|                                             |       |                                    |       |   |   |   |   |   |   |   |   |   |   |
| Interest rate  spread                            |       |                                    |       |   |   | 3.46 | % |   |   |   |   | 3.23 | % |
| Net interest  income/margin                      |       |                                    |       | $ | 5,825 |   | 4.01 | % |   |   | $ | 5,377 |   | 3.95 | % |

 

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

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

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

 

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| ** **                          | ** ** | **AVERAGE BALANCES AND INTEREST RATES** | ** ** |
|-------------------------------------|------------|-----------------------------------------|------------|
| ** **                          | ** ** | **Six Months Ended**          | ** ** | **Six Months Ended** | ** ** |
| ** **                          | ** ** | **June 30, 2008**             | ** ** | **June 30, 2007** | ** ** |
| **(In Thousands)**             | ** ** | **Average Balance**                | ** ** | **Interest** | ** ** | **Average Rate** | ** ** | **Average Balance** | ** ** | **Interest** | ** ** | **Average Rate** | ** ** |
| Assets:                             |       |                                    |       |   |   |   |   |   |   |   |   |   |   |
| Tax-exempt loans                    |       | $                                       | 8,277      |   | $ | 262 |   | 6.37 | % | $ | 8,022 |   | $ | 247 |   | 6.21 | % |
| All other loans                     |       | 356,830                                 |       | 12,453 |   | 7.02 | % | 352,829 |   | 12,776 |   | 7.30 | % |
| Total loans                         |       | 365,107                                 |       | 12,715 |   | 7.00 | % | 360,851 |   | 13,023 |   | 7.28 | % |
|                                |       |                                    |       |   |   |   |   |   |   |   |   |   |   |
| Taxable  securities                 |       | 103,013                                 |       | 2,923 |   | 5.68 | % | 82,952 |   | 2,353 |   | 5.67 | % |
| Tax-exempt  securities              |       | 111,630                                 |       | 3,691 |   | 6.61 | % | 101,588 |   | 3,277 |   | 6.45 | % |
| Total securities                    |       | 214,643                                 |       | 6,614 |   | 6.16 | % | 184,540 |   | 5,630 |   | 6.10 | % |
|                                |       |                                    |       |   |   |   |   |   |   |   |   |   |   |
| Interest bearing  deposits          |       | 19                                      |       | — |   | 0.00 | % | 629 |   | 17 |   | 5.45 | % |
|                                |       |                                    |       |   |   |   |   |   |   |   |   |   |   |
| Total  interest-earning assets      |       | 579,769                                 |       | 19,329 |   | 6.69 | % | 546,020 |   | 18,670 |   | 6.88 | % |
|                                |       |                                    |       |   |   |   |   |   |   |   |   |   |   |
| Other assets                        |       | 49,325                                  |       |   |   |   |   | 41,723 |   |   |   |   |   |
| Total assets                        |       | $                                       | 629,094    |   |   |   |   |   | $ | 587,743 |   |   |   |   |   |
|                                |       |                                    |       |   |   |   |   |   |   |   |   |   |   |
| Liabilities:                        |       |                                    |       |   |   |   |   |   |   |   |   |   |   |
| Savings                             |       | $                                       | 59,880     |   | 224 |   | 0.75 | % | $ | 59,454 |   | 215 |   | 0.73 | % |
| Super Now  deposits                 |       | 50,347                                  |       | 338 |   | 1.35 | % | 46,196 |   | 302 |   | 1.32 | % |
| Money market  deposits              |       | 25,064                                  |       | 273 |   | 2.19 | % | 24,962 |   | 283 |   | 2.29 | % |
| Time deposits                       |       | 200,233                                 |       | 4,257 |   | 4.28 | % | 195,712 |   | 4,580 |   | 4.72 | % |
| Total Deposits                      |       | 335,524                                 |       | 5,092 |   | 3.05 | % | 326,324 |   | 5,380 |   | 3.32 | % |
|                                |       |                                    |       |   |   |   |   |   |   |   |   |   |   |
| Short-term  borrowings              |       | 46,216                                  |       | 686 |   | 2.95 | % | 32,206 |   | 732 |   | 4.58 | % |
| Other borrowings                    |       | 95,661                                  |       | 2,169 |   | 4.48 | % | 79,339 |   | 1,826 |   | 4.64 | % |
| Total borrowings                    |       | 141,877                                 |       | 2,855 |   | 3.99 | % | 111,545 |   | 2,558 |   | 4.62 | % |
|                                |       |                                    |       |   |   |   |   |   |   |   |   |   |   |
| Total  interest-bearing liabilities |       | 477,401                                 |       | 7,947 |   | 3.33 | % | 437,869 |   | 7,938 |   | 3.66 | % |
|                                |       |                                    |       |   |   |   |   |   |   |   |   |   |   |
| Demand deposits                     |       | 71,864                                  |       |   |   |   |   | 68,446 |   |   |   |   |   |
| Other  liabilities                  |       | 9,280                                   |       |   |   |   |   | 6,673 |   |   |   |   |   |
| Shareholders’  equity          |       | 70,459                                  |       |   |   |   |   | 74,755 |   |   |   |   |   |
|                                |       | $                                       | 629,004    |   |   |   |   |   | $ | 587,743 |   |   |   |   |   |
| Interest rate  spread               |       |                                    |       |   |   | 3.36 | % |   |   |   |   | 3.22 | % |
| Net interest  income/margin         |       |                                    |       | $ | 11,382 |   | 3.95 | % |   |   | $ | 10,732 |   | 3.95 | % |

 

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

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

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

 

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# **The following table presents theadjustment to convert net interest income to net interest income on a fullytaxable equivalent basis for the three and six month periods ended June 30,2008 and 2007.**

# ** **

| ** **                                      | ** ** | **For the Three Months Ended** | ** ** | **For the Six Months Ended** | ** ** |
|-------------------------------------------------|------------|----------------------------------------------------|------------|--------------------------------------------------|------------|
| ** **                                      | ** ** | **June 30,**                                  | ** ** | **June 30,**                                | ** ** |
| **(In Thousands)**                         | ** ** | **2008**                                           | ** ** | **2007**                                         | ** ** | **2008** | ** ** | **2007** | ** ** |
|                                            |       |                                               |       |                                             |       |   |   |   |   |
| Total interest  income                          |       | $                                                  | 8,936      |                                             | $          | 8,793 |   | $ | 17,984 |   | $ | 17,472 |   |
| Total interest  expense                         |       | 3,780                                              |       | 3,999                                            |       | 7,947 |   | 7,938 |   |
|                                            |       |                                               |       |                                             |       |   |   |   |   |
| Net interest  income                            |       | 5,156                                              |       | 4,794                                            |       | 10,037 |   | 9,534 |   |
| Tax equivalent  adjustment                      |       | 669                                                |       | 583                                              |       | 1,345 |   | 1,198 |   |
|                                            |       |                                               |       |                                             |       |   |   |   |   |
| Net interest  income (fully taxable equivalent) |       | $                                                  | 5,825      |                                             | $          | 5,377 |   | $ | 11,382 |   | $ | 10,732 |   |

# ** **

# **The following table sets forth therespective impact that both volume and rate changes have had on net interestincome on a fully taxable equivalent basis for the three and six month periodsended June 30, 2008 and 2007:**

# ** **

| ** **                          | ** ** | **Three Months Ended June 30,** | ** ** | **Six Months Ended June 30,** | ** ** |
|-------------------------------------|------------|-----------------------------------------------------|------------|---------------------------------------------------|------------|
| ** **                          | ** ** | **2008 vs 2007**                          | ** ** | **2008 vs 2007**                        | ** ** |
| ** **                          | ** ** | **Increase (Decrease)**                        | ** ** | **Increase (Decrease)**                      | ** ** |
| ** **                          | ** ** | **Due to**                                     | ** ** | **Due to**                                   | ** ** |
| **(In Thousands)**             | ** ** | **Volume**                                          | ** ** | **Rate**                                          | ** ** | **Net** | ** ** | **Volume** | ** ** | **Rate** | ** ** | **Net** | ** ** |
| Interest income:                    |       |                                                |       |                                              |       |   |   |   |   |   |   |   |   |
| Loans,  tax-exempt                  |       | $                                                   | 11         |                                              | $          | 4 |   | $ | 15 |   | $ | 12 |   | $ | 3 |   | $ | 15 |   |
| Loans                               |       | 117                                                 |       | (397                                              | )          | (280 | ) | 150 |   | (473 | ) | (323 | ) |
| Taxable  investment securities      |       | 310                                                 |       | (39                                               | )          | 271 |   | 569 |   | 1 |   | 570 |   |
| Tax-exempt  investment securities   |       | 166                                                 |       | 73                                                |       | 239 |   | 335 |   | 79 |   | 414 |   |
| Interest bearing  deposits          |       | (16                                                 | )          | —                                            |       | (16 | ) | (17 | ) | — |   | (17 | ) |
| Total  interest-earning assets      |       | 588                                                 |       | (359                                              | )          | 229 |   | 1,049 |   | (390 | ) | 659 |   |
|                                |       |                                                |       |                                              |       |   |   |   |   |   |   |   |   |
| Interest  expense:                  |       |                                                |       |                                              |       |   |   |   |   |   |   |   |   |
| Savings deposits                    |       | 3                                                   |       | 2                                                 |       | 5 |   | 2 |   | 7 |   | 9 |   |
| Super Now  deposits                 |       | 25                                                  |       | 5                                                 |       | 30 |   | 30 |   | 6 |   | 36 |   |
| Money market  deposits              |       | 3                                                   |       | (15                                               | )          | (12 | ) | 1 |   | (11 | ) | (10 | ) |
| Time deposits                       |       | 48                                                  |       | (388                                              | )          | (340 | ) | 107 |   | (430 | ) | (323 | ) |
| Short-term  borrowings              |       | 145                                                 |       | (115                                              | )          | 30 |   | 262 |   | (308 | ) | (46 | ) |
| Long-term  borrowings, FHLB         |       | 105                                                 |       | (37                                               | )          | 68 |   | 403 |   | (60 | ) | 343 |   |
| Total  interest-bearing liabilities |       | 329                                                 |       | (548                                              | )          | (219 | ) | 805 |   | (796 | ) | 9 |   |
| Change in net  interest income      |       | $                                                   | 259        |                                              | $          | 189 |   | $ | 448 |   | $ | 244 |   | $ | 406 |   | $ | 650 |   |

# ** **

# **Provision for LoanLosses**

# ** **

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

 

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performed annuallyfor the Bank.  Management remainscommitted to an aggressive program of problem loan identification andresolution.

 

The allowance for loan losses is determined by applying loss factors tooutstanding loans by type, excluding loans for which a specific allowance hasbeen determined.  Loss factors are basedon management’s consideration of the nature of the portfolio segments, changesin mix and volume of the loan portfolio, and historical loan lossexperience.  In addition, managementconsiders industry standards and trends with respect to non-performing loansand its knowledge and experience 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 at June 30,2008, future adjustments could be necessary if circumstances or economicconditions differ substantially from the assumptions used in making the initialdeterminations.  A downturn in the localeconomy, employment, and delays in receiving financial information fromborrowers could result in increased levels of nonperforming assets,charge-offs, loan loss provisions, and reductions in income.  Additionally, as an integral part of theexamination process, bank regulatory agencies periodically review the Bank’sloan loss allowance.  The bankingagencies could require the recognition of additions to the loan loss allowancebased on their judgment of information available to them at the time of theirexamination.

 

While 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 $4,130,000 at December 31,2007 to $4,207,000 at June 30, 2008. At June 30, 2008 and December 31, 2007, the allowance for loanlosses was 1.15%.  Management’sconclusion is that the allowance for loan losses is adequate to provide for possible losses inherent inthe loan portfolio as of the balance sheet date.

 

The provision for loan losses totaled $60,000 and $120,000 for thethree and six months ended June 30, 2008, as compared to $10,000 and$50,000 for the same periods in 2007. The size of the increase in the provision was the result of severalcontinuing positive factors, including but not limited to, an increase in grossloans of $5,477,000 since December 31, 2007, a ratio of annualized netcharge offs to average loans of 0.01%, a ratio of nonperforming loans to totalloans of 0.25%, and a ratio of the allowance for loan losses to nonperformingloans of 462.82% at June 30, 2008.

 

**Non-interest Income**

 

Total non-interest income for the threemonths ended June 30, 2008 compared to the same period in 2007 decreased$565,000 to $1,621,000 due to a $544,000 decrease in net securities gains andlosses realized when comparing the three month periods ended June 30, 2008and 2007.  Excluding net securities gainsand losses, non-interest income for the second quarter of 2008 would havedecreased $21,000 as compared to the 2007 period.  Deposit service charges decreased $27,000 ascustomers migrated to no service charge checking accounts that were 

 

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introduced as part of a customer obtainmentand retention program.  Earnings on bankowned life insurance increased $5,000 as a result of increased holdings as of June 30,2008 as compared to the 2007 period.

 

Insurance commissions for the three monthsended June 30, 2008 decreased $64,000 compared to the same period in 2007 due to a shift in product mix.  Management of The M Group continues to pursuenew and build upon current relationships. The sales call program continues to expand to other financialinstitutions, which results in additional revenue for The M Group.  However, the addition of another sales outletfor The M Group can take up to a year or more to be completed.

 

Total non-interest income for the six monthsended June 30, 2008 compared to the same period in 2007 decreased$625,000.  Excluding net securitiesgains, non-interest income would have increased $207,000 as compared to the2007 period.   The increase innon-interest income for the six month period is the result of the same itemsnoted in the three month discussion.

 

Non-interest income composition for the threeand six months ended June 30, 2008 and 2007 was as follows:

 
| ** **                      | ** ** | **For The Three Months Ended** | ** ** |
|---------------------------------|------------|----------------------------------------------------|------------|
| ** **                      | ** ** | **June 30, 2008**                        | ** ** | **June 30, 2007** | ** ** | **Change** | ** ** |
| **(In Thousands)**         | ** ** | **Amount**                                         | ** ** | **% Total** | ** ** | **Amount** | ** ** | **% Total** | ** ** | **Amount** | ** ** | **%** | ** ** |
| Deposit service  charges        |       | $                                                  | 540        |   | 33.3 | % | $ | 567 |   | 25.9 | % | $ | (27 | ) | (4.8 | )% |
| Securities  (losses) gains, net |       | (251                                               | )          | (15.5 | ) | 293 |   | 13.4 |   | (544 | ) | (185.7 | ) |
| Bank owned life  insurance      |       | 91                                                 |       | 5.6 |   | 86 |   | 3.9 |   | 5 |   | 5.8 |   |
| Gain on sale of  loans          |       | 212                                                |       | 13.1 |   | 234 |   | 10.7 |   | (22 | ) | (9.4 | ) |
| Insurance  commissions          |       | 486                                                |       | 30.0 |   | 550 |   | 25.2 |   | (64 | ) | (11.6 | ) |
| Other                           |       | 543                                                |       | 33.5 |   | 456 |   | 20.9 |   | 87 |   | 19.0 |   |
| Total  non-interest income      |       | $                                                  | 1,621      |   | 100.0 | % | $ | 2,186 |   | 100.0 | % | $ | (565 | ) | (25.8 | )% |

 
| ** **                      | ** ** | **For The Six Months Ended** | ** ** |
|---------------------------------|------------|--------------------------------------------------|------------|
| ** **                      | ** ** | **June 30, 2008**                      | ** ** | **June 30, 2007** | ** ** | **Change** | ** ** |
| **(In Thousands)**         | ** ** | **Amount**                                       | ** ** | **% Total** | ** ** | **Amount** | ** ** | **% Total** | ** ** | **Amount** | ** ** | **%** | ** ** |
| Deposit service  charges        |       | $                                                | 1,110      |   | 31.4 | % | $ | 1,108 |   | 26.6 | % | $ | 2 |   | 0.2 | % |
| Securities  (losses) gains, net |       | (213                                             | )          | (6.0 | ) | 619 |   | 14.9 |   | (832 | ) | (134.4 | ) |
| Bank owned life  insurance      |       | 246                                              |       | 7.0 |   | 201 |   | 4.8 |   | 45 |   | 22.4 |   |
| Gain on sale of  loans          |       | 364                                              |       | 10.3 |   | 372 |   | 8.9 |   | (8 | ) | (2.2 | ) |
| Insurance  commissions          |       | 1,066                                            |       | 30.1 |   | 988 |   | 23.8 |   | 78 |   | 7.9 |   |
| Other                           |       | 962                                              |       | 27.2 |   | 872 |   | 21.0 |   | 90 |   | 10.3 |   |
| Total  non-interest income      |       | $                                                | 3,535      |   | 100.0 | % | $ | 4,160 |   | 100.0 | % | $ | (625 | ) | (15.0 | )% |

 

**Non-interest Expense**

 

Total non-interest expense increased $171,000for the three months ended June 30, 2008 compared to the same period of2007.  The increase in salaries andemployee benefits was attributable to several items including standard cost ofliving wage adjustments for employees, 

 

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increased pension expense, and other benefitcosts.  Occupancy expense decreased dueto decreased cost of utilities, maintenance and property taxes. Pennsylvaniashares tax decreased $56,000 due to the use of Pennsylvania Enterprise Zone taxcredits from a low income housing partnership committed to during 2007.  Other expenses increased primarily due tonormal anticipated inflationary adjustments to ongoing business operating costsand the amortization related to the before mentioned low income housing.

 

Total non-interest expenses increased$488,000 for the six months ended June 30, 2008  compared to the same period of 2007.  As noted above in the three month discussion,normal increases in general business expenses and the amortization of a lowincome housing partnership, impacted the level of non-interest expenses.

 

Non-interest expense composition for thethree and six months ended June 30, 2008 and 2007 was as follows:

 
|                                                |   | **For The Three Months Ended** |   |
|-----------------------------------------------------|--------|----------------------------------------------------|--------|
|                                                |   | **June 30, 2008**                        |   | **June 30, 2007** |   | **Change** |   |
| **(In Thousands)**                             |   | **Amount**                                         |   | **% Total** |   | **Amount** |   | **% Total** |   | **Amount** |   | **%** |   |
| Salaries and  employee benefits                     |   | $                                                  | 2,469  |   | 54.7 | % | $ | 2,301 |   | 53.0 | % | $ | 168 |   | 7.3 | % |
| Occupancy, net                                      |   | 314                                                |   | 7.0 |   | 337 |   | 7.8 |   | (23 | ) | (6.8 | ) |
| Furniture and  equipment                            |   | 287                                                |   | 6.4 |   | 297 |   | 6.8 |   | (10 | ) | (3.4 | ) |
| Pennsylvania  shares tax                            |   | 105                                                |   | 2.3 |   | 161 |   | 3.7 |   | (56 | ) | (34.8 | ) |
| Amortization of  investment in limited partnerships |   | 178                                                |   | 3.9 |   | 142 |   | 3.3 |   | 36 |   | 25.4 |   |
| Other                                               |   | 1,158                                              |   | 25.7 |   | 1,102 |   | 25.4 |   | 56 |   | 5.1 |   |
| Total  non-interest expense                         |   | $                                                  | 4,511  |   | 100.0 | % | $ | 4,340 |   | 100.0 | % | $ | 171 |   | 3.9 | % |

 
|                                                |   | **For The Six Months Ended** |   |
|-----------------------------------------------------|--------|--------------------------------------------------|--------|
|                                                |   | **June 30, 2008**                      |   | **June 30, 2007** |   | **Change** |   |
| **(In Thousands)**                             |   | **Amount**                                       |   | **%**** Total** |   | **Amount** |   | **% Total** |   | **Amount** |   | **%** |   |
| Salaries and  employee benefits                     |   | $                                                | 4,920  |   | 54.9 | % | $ | 4,582 |   | 54.1 | % | $ | 338 |   | 7.4 | % |
| Occupancy, net                                      |   | 652                                              |   | 7.3 |   | 668 |   | 7.9 |   | (16 | ) | (2.4 | ) |
| Furniture and  equipment                            |   | 572                                              |   | 6.4 |   | 583 |   | 6.9 |   | (11 | ) | (1.9 | ) |
| Pennsylvania  shares tax                            |   | 210                                              |   | 2.3 |   | 322 |   | 3.8 |   | (112 | ) | (34.8 | ) |
| Amortization of  investment in limited partnerships |   | 356                                              |   | 4.0 |   | 283 |   | 3.3 |   | 73 |   | 25.8 |   |
| Other                                               |   | 2,246                                            |   | 25.1 |   | 2,030 |   | 24.0 |   | 216 |   | 10.6 |   |
| Total  non-interest expense                         |   | $                                                | 8,956  |   | 100.0 | % | $ | 8,468 |   | 100.0 | % | $ | 488 |   | 5.8 | % |

 

**Provision for Income Taxes**

 

Income taxes decreased $146,000 and $252,000for the three and six month periods ended June 30, 2008 compared to thesame period of 2007.  The effective taxrate for the three and six months ended June 30, 2008 was 6.75% and 6.85%as compared to 11.22% and 10.82% for the same periods of 2007.  The decline in the effective tax rate isconsistent with management’s repositioning of the investment portfolio fromtaxable investment securities to tax-exempt investment securities, and theelimination of the allowance for loan loss recapture.  The current effective tax rate has resulted ina deferred tax asset due to the low income housing tax credits.  Management has reviewed the deferred taxasset and has determined that the asset will be 

 

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utilized within the appropriate carry forwardperiod and therefore does not require a valuation allowance.

 

# **ASSET/LIABILITYMANAGEMENT**

# ** **

# **Cash and CashEquivalents**

# ** **

Cash and cash equivalents increased $1,776,000 from$15,433,000 at December 31, 2007 to $17,209,000 at June 30, 2008primarily as a result of the following activities during the six months ended June 30,2008:

 

# **Loans Held forSale**

# ** **

Activity regarding loans held for sale resulted insale proceeds exceeding loan originations, less $364,000 in realized gains, by$624,000 for the six months ended June 30, 2008.

 

**Loans**

 

Gross loans increased $5,477,000 since December 31,2007 due to the increase of residential mortgages coupled with increasedcompetition for commercial loans and a softening of the market.

 

Theallocation of the loan portfolio, by category, as of June 30, 2008 and December 31,2007 is presented below:

 
| ** **                              | ** ** | **June 30,** | ** ** | **December 31,** | ** ** | **Change** | ** ** |
|-----------------------------------------|------------|-------------------|------------|-----------------------|------------|------------|------------|
| **(In Thousands)**                 | ** ** | **2008**          | ** ** | **2007**              | ** ** | **Amount** | ** ** | **%** | ** ** |
| Commercial, financial  and agricultural |       | $                 | 36,266     |                  | $          | 35,739     |       | $ | 527 |   | 1.5 | % |
| Real estate  mortgage:                  |       |              |       |                  |       |       |       |   |   |
| Residential                             |       | 171,552           |       | 163,268               |       | 8,284      |       | 5.1 |   |
| Commercial                              |       | 129,498           |       | 132,943               |       | (3,445     | )          | (2.6 | ) |
| Construction                            |       | 16,650            |       | 16,152                |       | 498        |       | 3.1 |   |
| Installment loans  to individuals       |       | 12,948            |       | 13,317                |       | (369       | )          | (2.8 | ) |
| Less: Net  deferred loan fees           |       | 959               |       | 941                   |       | 18         |       | 1.9 |   |
| Gross loans                             |       | $                 | 365,955    |                  | $          | 360,478    |       | $ | 5,477 |   | 1.5 | % |

 

Therecorded investment in loans for which impairment has been recognized inaccordance with Statement of Financial Accounting Standards No. 114, *Accounting by Creditors for Impairment of a Loan*, amountedto $4,473,000 at June 30, 2008, compared to $1,477,000 at December 31,2007.  The valuation allowance related toimpaired loans amounted to $49,000 at June 30, 2008 and $102,000 at December 31,2007.  The increase in impaired loans isfrom a few commercial relationships, while the decrease in valuation allowanceis the result of the charge off of a commercial relationship that had aspecific collateral weakness.

 

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Aloan is considered impaired, based on current information and events, if it isprobable that the Bank will be unable to collect the scheduled payments ofprincipal or interest when due according to the contractual terms of the loanagreement. The measurement of impaired loans is generally based on the presentvalue of expected future cash flows discounted at the historical effectiveinterest rate, except that all collateral-dependent loans are measured forimpairment based on the fair value of the collateral.

 

**Investments**

 

The estimated fair value of the investmentsecurities portfolio in total at June 30, 2008 has decreased $5,289,000since December 31, 2007, while the amortized cost increased$3,351,000.  The majority of the changesin value occurred within the agency securities and state and municipal segmentsof the portfolio.  The amortized cost positionin state and political securities increased $19,922,000 as the Bank continuedits strategy to build call protection, maintain taxable equivalent yields,reduce the effective federal income tax rate, and invest in communities acrossthe Commonwealth of Pennsylvania and the country.  Over the same time period, the above strategyresulted in the amortized cost position of U.S. Government and agencysecurities to decrease by $15,713,000. The increased level of unrealized losseswithin the bond portfolio, which offset the increase in amortized cost, was theresult of changes in the yield curve, not credit quality, as the credit qualityof the portfolio remains sound.

 

The equity portfolio continues to feel theeffects of the economic turbulence that is effecting the financial sector.  This sector of the portfolio, as of June 30,2008, held $4,930,000 in unrealized losses on an amortized cost basis of$18,573,000.  The amount of the declineshas caused several of our equity holdings to be deemed other than temporarilyimpaired resulting in a write down in value of these holdings of $366,000 and$574,000 for the three and six months ended June 30, 2008.  Certain positions may be liquidated, in wholeor part, through the balance of 2008 so that the losses can be carried back fortax purposes and offset against gains that have been recognized over the pastseveral years.

 

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The amortized cost ofinvestment securities and their estimated fair values are as follows:

 
| ** **                             | ** ** | **June 30, 2008** | ** ** |
|----------------------------------------|------------|-----------------------------|------------|
| ** **                             | ** ** | ** **                  | ** ** | **Gross** | ** ** | **Gross** | ** ** | **Estimated** | ** ** |
| ** **                             | ** ** | **Amortized**               | ** ** | **Unrealized** | ** ** | **Unrealized** | ** ** | **Fair** | ** ** |
| **(In Thousands)**                | ** ** | **Cost**                    | ** ** | **Gains** | ** ** | **Losses** | ** ** | **Value** | ** ** |
| Available  for sale (AFS)              |       |                        |       |   |   |   |   |   |   |
| U.S.  Government and agency securities |       | $                           | 46,669     |   | $ | 95 |   | $ | (215 | ) | $ | 46,549 |   |
| State  and political securities        |       | 139,573                     |       | 263 |   | (6,459 | ) | 133,377 |   |
| Other  debt securities                 |       | 16,379                      |       | 15 |   | (926 | ) | 15,468 |   |
| Total  debt securities                 |       | 202,621                     |       | 373 |   | (7,600 | ) | 195,394 |   |
| Equity  securities                     |       | 18,573                      |       | 247 |   | (4,930 | ) | 13,890 |   |
| Total  investment securities AFS       |       | $                           | 221,194    |   | $ | 620 |   | $ | (12,530 | ) | $ | 209,284 |   |
|                                   |       |                        |       |   |   |   |   |   |   |
| Held  to maturity (HTM)                |       |                        |       |   |   |   |   |   |   |
| U.S.  Government and agency securities |       | $                           | 11         |   | $ | — |   | $ | — |   | $ | 11 |   |
| Other  debt securities                 |       | 149                         |       | 1 |   | — |   | 150 |   |
| Total  investment securities HTM       |       | $                           | 160        |   | $ | 1 |   | $ | — |   | $ | 161 |   |

 
| ** **                             | ** ** | **December 31, 2007** | ** ** |
|----------------------------------------|------------|-----------------------|------------|
| ** **                             | ** ** | ** **            | ** ** | **Gross** | ** ** | **Gross** | ** ** | **Estimated** | ** ** |
| ** **                             | ** ** | **Amortized**         | ** ** | **Unrealized** | ** ** | **Unrealized** | ** ** | **Fair** | ** ** |
| **(In  Thousands)**                    | ** ** | **Cost**              | ** ** | **Gains** | ** ** | **Losses** | ** ** | **Value** | ** ** |
| Available  for sale (AFS)              |       |                  |       |   |   |   |   |   |   |
| U.S.  Government and agency securities |       | $                     | 62,382     |   | $ | 522 |   | $ | — |   | $ | 62,904 |   |
| State  and political securities        |       | 119,651               |       | 581 |   | (2,417 | ) | 117,815 |   |
| Other  debt securities                 |       | 15,917                |       | 290 |   | (440 | ) | 15,767 |   |
| Total  debt securities                 |       | 197,950               |       | 1,393 |   | (2,857 | ) | 196,486 |   |
| Equity  securities                     |       | 19,776                |       | 496 |   | (2,303 | ) | 17,969 |   |
| Total  investment securities AFS       |       | $                     | 217,726    |   | $ | 1,889 |   | $ | (5,160 | ) | $ | 214,455 |   |
|                                   |       |                  |       |   |   |   |   |   |   |
| Held  to maturity (HTM)                |       |                  |       |   |   |   |   |   |   |
| U.S.  Government and agency securities |       | $                     | 14         |   | $ | 1 |   | $ | — |   | $ | 15 |   |
| Other  debt securities                 |       | 263                   |       | 1 |   | — |   | 264 |   |
| Total  investment securities HTM       |       | $                     | 277        |   | $ | 2 |   | $ | — |   | $ | 279 |   |

 

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# **Financing Activities**

# ** **

# **Deposits**

# ** **

Totaldeposits increased 12.6% or $48,899,000 from December 31, 2007 to June 30,2008.  The growth was led by a 37.2% or$7,831,000 increase in money market accounts coupled with growth in timedeposits of 17.8% or $31,561,000 from December 31, 2007 to June 30,2008.  In addition, demand deposits haveincreased 7.0% or $5,237,000 with NOW and savings accounts increasing$8,155,000 in aggregate.  The increasesin all core deposit categories have allowed for a 44.0% reduction in thebalance of brokered time deposits due to the ability to attract market areadeposits at more favorable terms through the first six months of 2008.

 

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

# ** **

| ** **                | ** ** | **June 30, 2008** | ** ** | **December 31, 2007** | ** ** | **Change** | ** ** |
|---------------------------|------------|-----------------------------|------------|---------------------------------|------------|------------|------------|
| **(In Thousands)**   | ** ** | **Amount**                  | ** ** | **% Total**                | ** ** | **Amount** | ** ** | **% Total** | ** ** | **Amount** | ** ** | **%** | ** ** |
| Demand  deposits          |       | $                           | 79,908     |                            | 18.2       | %          | $          | 74,671 |   | 19.2 | % | $ | 5,237 |   | 7.0 | % |
| NOW  accounts             |       | 52,948                      |       | 12.1                            |       | 50,883     |       | 13.1 |   | 2,065 |   | 4.1 |   |
| Money  market deposits    |       | 28,860                      |       | 6.6                             |       | 21,029     |       | 5.4 |   | 7,831 |   | 37.2 |   |
| Savings  deposits         |       | 62,847                      |       | 14.4                            |       | 56,757     |       | 14.6 |   | 6,090 |   | 10.7 |   |
| Time  deposits            |       | 208,412                     |       | 47.6                            |       | 176,851    |       | 45.4 |   | 31,561 |   | 17.8 |   |
| Time  deposits - brokered |       | 4,946                       |       | 1.1                             |       | 8,831      |       | 2.3 |   | (3,885 | ) | (44.0 | ) |
| Total  deposits           |       | $                           | 437,921    |                            | 100.0      | %          | $          | 389,022 |   | 100.0 | % | $ | 48,899 |   | 12.6 | % |

 

# **Borrowed Funds**

# ** **

Total borrowed funds decreased22.8% to $124,859,000 at June 30, 2008 as compared to $161,693,000 at December 31,2007.  The decrease in borrowed funds isprimarily the result of the previously discussed deposit gathering campaignsthat were utilized to provide funds to reduce the level of higher costshort-term borrowings and to assist in replacing long-term borrowingmaturities.  Long-term borrowingsdecreased $29,600,000 since December 31, 2007 due to the maturity ofseveral borrowings that carried rates between 3.14% and 5.56%.

 
| ** **                                     | ** ** | **June 30, 2008** | ** ** | **December 31, 2007** | ** ** | **Change** | ** ** |
|------------------------------------------------|------------|-----------------------------|------------|---------------------------------|------------|------------|------------|
| **(In Thousands)**                        | ** ** | **Amount**                  | ** ** | **% Total**                | ** ** | **Amount** | ** ** | **% Total** | ** ** | **Amount** | ** ** | **%** | ** ** |
| Short-term  borrowings:                        |       |                        |       |                            |       |       |       |   |   |   |   |   |   |
| FHLB  repurchase agreements                    |       | $                           | 31,819     |                            | 25.5       | %          | $          | 38,160 |   | 23.6 | % | $ | (6,341 | ) | (16.6 | )% |
| Short-term  borrowings, FHLB                   |       | —                      |       | —                          |       | —     |       | — |   | — |   | — |   |
| Securities  sold under agreement to repurchase |       | 16,262                      |       | 13.0                            |       | 17,155     |       | 10.6 |   | (893 | ) | (5.2 | ) |
| Total  short-term borrowings                   |       | 48,081                      |       | 38.5                            | %          | 55,315     |       | 34.2 | % | (7,234 | ) | (13.1 | ) |
|                                           |       |                        |       |                            |       |       |       |   |   |   |   |   |   |
| Long-term  borrowings, FHLB                    |       | 76,778                      |       | 61.5                            |       | 106,378    |       | 65.8 |   | (29,600 | ) | (27.8 | ) |
| Total  borrowed funds                          |       | $                           | 124,859    |                            | 100.0      | %          | $          | 161,693 |   | 100.0 | % | $ | (36,834 | ) | (22.8 | )% |

 

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# **Capital**

# ** **

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

##  

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

 

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Capitalratios as of June 30, 2008 and December 31, 2007 were as follows:

 
| ** **                     | ** ** | **2008**   | ** ** | **2007**  | ** ** |
|--------------------------------|------------|------------|------------|-----------|------------|
| **(In Thousands)**        | ** ** | **Amount** | ** ** | **Ratio** | ** ** | **Amount** | ** ** | **Ratio** | ** ** |
| Total  Capital                 |       |       |       |      |       |   |   |   |   |
| (to  Risk-weighted Assets)     |       |       |       |      |       |   |   |   |   |
|                           |       |       |       |      |       |   |   |   |   |
| Actual                         |       | $          | 66,597     |      | 16.5       | % | $ | 70,381 |   | 18.0 | % |
| For  Capital Adequacy Purposes |       | 32,342     |       | 8.0       |       | 31,280 |   | 8.0 |   |
| To  Be Well Capitalized        |       | 40,428     |       | 10.0      |       | 39,100 |   | 10.0 |   |
|                           |       |       |       |      |       |   |   |   |   |
| Tier  I Capital                |       |       |       |      |       |   |   |   |   |
| (to  Risk-weighted Assets)     |       |       |       |      |       |   |   |   |   |
|                           |       |       |       |      |       |   |   |   |   |
| Actual                         |       | $          | 62,390     |      | 15.4       | % | $ | 66,251 |   | 16.9 | % |
| For  Capital Adequacy Purposes |       | 16,171     |       | 4.0       |       | 15,640 |   | 4.0 |   |
| To  Be Well Capitalized        |       | 24,257     |       | 6.0       |       | 23,460 |   | 6.0 |   |
|                           |       |       |       |      |       |   |   |   |   |
| Tier  I Capital                |       |       |       |      |       |   |   |   |   |
| (to  Average Assets)           |       |       |       |      |       |   |   |   |   |
|                           |       |       |       |      |       |   |   |   |   |
| Actual                         |       | $          | 62,390     |      | 10.0       | % | $ | 66,251 |   | 10.8 | % |
| For  Capital Adequacy Purposes |       | 25,054     |       | 4.0       |       | 24,664 |   | 4.0 |   |
| To  Be Well Capitalized        |       | 31,317     |       | 5.0       |       | 30,830 |   | 5.0 |   |

 

# **Liquidityand Interest Rate Sensitivity**

# ** **

## The asset/liabilitycommittee addresses the liquidity needs of the Company to ensure thatsufficient funds are available to meet credit demands and deposit withdrawalsas well as to the placement of available funds in the investmentportfolio.  In assessing liquidityrequirements, equal consideration is given to the current position as well asthe future outlook.

##  

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

 

1.  Net Loans to Total Assets, 85% maximum

2.  Net Loans to Total Deposits, 100% maximum

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

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

 

Fundamentalobjectives of the Company’s asset/liability management process are to maintainadequate liquidity while minimizing interest rate risk.  The maintenance of adequate liquidity 

 

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providesthe Company with the ability to meet its financial obligations to depositors,loan customers, and shareholders. Additionally, it provides funds for normal operating expenditures andbusiness opportunities as they arise. The objective of interest rate sensitivity management is to increase netinterest income by managing interest sensitive assets and liabilities in such away that they can be repriced in response to changes in market interest rates.

 

TheBank, like other financial institutions, must have sufficient funds availableto meet its liquidity needs for deposit withdrawals, loan commitments andoriginations, and expenses.  In order tocontrol cash flow, the Bank estimates future flows of cash from deposits, loan payments,and investment security payments.  Theprimary sources of funds are deposits, principal and interest payments on loansand investment securities, FHLB borrowings, and brokered deposits.  Management believes the Bank has adequateresources to meet its normal funding requirements.

 

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

 

Managementmonitors and determines the desirable level of liquidity.  Consideration is given to loan demand,investment opportunities, deposit pricing and growth potential, as well as thecurrent cost of borrowing funds.  TheCompany has a current borrowing capacity at the FHLB of $202,644,000.  Inaddition to this credit arrangement, the Company has additional lines of creditwith correspondent banks of $28,876,000. Management believes it has sufficientliquidity to satisfy estimated short-term and long-term funding needs.  FHLB borrowings totaled $108,597,000 as of June 30,2008.

 

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

 

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Therehave been no substantial changes in the Company’s gap analyses or simulationanalyses compared to the information provided in the Company’s Form 10-Kfor the year ended December 31, 2007.

 

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

 

# **Inflation**

# ** **

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

 

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

 

Marketrisk for the Company is comprised primarily of interest rate risk exposure andliquidity risk.  Interest rate risk andliquidity risk management is performed at the Bank level as well as the Companylevel.  The Company’s interest ratesensitivity is monitored by management through selected interest rate riskmeasures produced by an independent third party.  There have been no substantial changes in theCompany’s gap analyses or simulation analyses compared to the informationprovided in the Annual Report on Form 10-K for the period ended December 31,2007.  Additional information and detailsare provided in the “Liquidity and Interest Rate Sensitivity” section of “Item2. Management’s Discussion and Analysis of Financial Condition and Results ofOperations.”

 

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

 

**Item 4.  Controls and Procedures**

 

An analysis was performed under the supervision and with theparticipation of the Company’s management, including the Chief ExecutiveOfficer and the 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 June 30, 2008. There were no changes in the Company’s internal control over financialreporting that occurred during the quarter ended June 30, 2008, that havematerially affected, or are reasonably likely to materially affect, the Company’sinternal control over financial reporting.

 

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

### ** **

**Item 1.****                                   LegalProceedings**

 

None.

 

**Item 1A.  Risk Factors**

 

There are no materialchanges to the risk factors set forth in Part I, Item 1A, “Risk Factors,”of the Company’s Annual Report on Form 10-K for the year ended December 31,2007.  Please refer to that section fordisclosures regarding the risks and uncertainties related to the Company’sbusiness.

 

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

 
| ** **                            | ** ** | **Total**           | ** ** | **Average**         | ** ** | **Total Number of**           | ** ** | **Maximum Number (or**                    | ** ** |
|---------------------------------------|------------|---------------------|------------|---------------------|------------|-----------------------------------------|------------|-----------------------------------------------------|------------|
| ** **                            | ** ** | **Number of**  | ** ** | **Price Paid** | ** ** | **Shares (or Units)**         | ** ** | **Approximate Dollar Value)**             | ** ** |
| ** **                            | ** ** | **Shares (or** | ** ** | **per Share**  | ** ** | **Purchased as Part of** | ** ** | **of Shares (or Units) that**   | ** ** |
| ** **                            | ** ** | **Units)**          | ** ** | **(or Units)** | ** ** | **Publicly Announced**             | ** ** | **May Yet Be Purchased**             | ** ** |
| **Period**                            | ** ** | **Purchased**       | ** ** | **Purchased**       | ** ** | **Plans or Programs**         | ** ** | **Under the Plans or Programs** | ** ** |
|                                  |       |                |       |                |       |                                    |       |                                                |       |
| Month  #1 (April 1 - April  30, 2008) |       | 4,569               |       | $                   | 32.44      |                                    | 4,569      |                                                | 117,204    |   |
|                                  |       |                |       |                |       |                                    |       |                                                |       |
| Month  #2 (May 1 - May  31, 2008)     |       | 5,000               |       | 32.16               |       | 5,000                                   |       | 112,204                                             |       |
|                                  |       |                |       |                |       |                                    |       |                                                |       |
| Month  #3 (June 1 - June  30, 2008)   |       | 4,650               |       | 30.55               |       | 4,650                                   |       | 107,554                                             |       |
|                                       |            |                     |            |                     |            |                                         |            |                                                     |            |  |

 

On April 22, 2008,the Board of Directors extended the authorization to repurchase up to 197,000shares, or approximately 5%, of the outstanding shares of the Company for anadditional year to April 30, 2009. The repurchase plan was originally for a one year period expiring on April 25,2007.  To date, there have been 89,446shares repurchased under this plan.

 

**Item 3.****                                   DefaultsUpon Senior Securities**

 

None

 

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

 

Penns Woods Bancorp, Inc.’sannual meeting of the shareholders was held on April 30, 2008.  The results of the items voted on are listedbelow:

 

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| **Issue Description** | ** ** | **For**                                      | ** ** | **Withhold** | ** ** |
|----------------------------|------------|----------------------------------------------|------------|--------------|------------|
| 1.                         |       | Election of Directors  for a Three Year Term |       |         |       |   |   |
|                       |       |                                         |       |         |       |   |   |
|                       |       | H.  Thomas Davis, Jr.                        |       | 3,001,180    |       | 71,853 |   |
|                       |       | James  M. Furey, II                          |       | 3,003,586    |       | 69,447 |   |
|                       |       | D.  Michael Hawbaker                         |       | 3,003,000    |       | 70,033 |   |

 
| **Issue  Description** | ** ** | **For**                                                 | ** ** | **Against** | ** ** | **Abstain** | ** ** |
|------------------------|------------|---------------------------------------------------------|------------|-------------|------------|-------------|------------|
| 2.                     |       | Ratification of S.R.  Snodgrass, A.C., Certified Public |       |        |       |        |       |   |   |
|                   |       | Accountants as  independent auditors                    |       | 3,026,116   |       | 24,019      |       | 22,898 |   |

### ** **

### **Item 5.**                                   Other Information

### ** **

None

 

**Item 6.****                                  ****Exhibits**

 
| (3)  | (i)  | Articles  of Incorporation of the Registrant, as presently in effect (incorporated by  reference to Exhibit 3(i) of the Registrant’s Annual Report on  Form 10-K for the year ended December 31, 2007). |
|------|------|----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
| (3)  | (ii) | Bylaws  of the Registrant’s as presently in effect (incorporated by reference to  Exhibit 3(ii) of the Registrant’s Current Report on Form 8-K  filed June 17, 2005).                              |
| (31) | (i)  | Rule 13a-14(a)/Rule 15d-14(a) Certification  of Chief Executive Officer.                                                                                                                                          |
| (31) | (ii) | Rule 13a-14(a)/Rule 15d-14(a) Certification  of Principal Financial Officer.                                                                                                                                      |
| (32) | (i)  | Section 1350  Certification of Chief Executive Officer.                                                                                                                                                                     |
| (32) | (ii) | Section 1350  Certification of Principal Financial Officer.                                                                                                                                                                 |

 

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## **SIGNATURES**

##  

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

 
|   |                | PENNS WOODS BANCORP,  INC.                                               |
|--------|---------------------|--------------------------------------------------------------------------|
|   |                | (Registrant)                                                             |
|   |                |                                                                     |
|   |                |                                                                     |
| Date:  | August 5, 2008 | /s/ Ronald A. Walko                                                      |
|   |                | Ronald A. Walko,  President and Chief Executive Officer                  |
|   |                |                                                                     |
|   |                |                                                                     |
| Date:  | August 5, 2008 | /s/ Brian L. Knepp                                                       |
|   |                | Brian L. Knepp, Chief  Financial Officer (Principal   Financial Officer) |

 

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**EXHIBIT INDEX**

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

 

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