**UNITED STATESSECURITIES AND EXCHANGE COMMISSIONWASHINGTON, 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  March 31, 2007.**                                                                                                                                                                                                                                                         |
|------------|------------|-------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
| ** ** | ** ** | ** **                                                                                                                                                                                                                                                                                                                                                                                            |
| **o**      | ** ** | **Transition report pursuant to Section 13 or 15  (d) of the Exchange Act for the Transition Period from                          to                        .** |

 

**No.0-17077**

**(CommissionFile Number)**

**PENNSWOODS BANCORP, INC.**

(Exact name ofRegistrant as specified in its charter)

| **PENNSYLVANIA**                 | ** ** | **23-2226454**       |
|----------------------------------|------------|----------------------|
| (State or other  jurisdiction of |       | (I.R.S. Employer     |
| incorporation or  organization)  |       | Identification  No.) |

 

| **300 Market Street, Williamsport, Pennsylvania** | ** ** | **17701-0967** |
|---------------------------------------------------|------------|----------------|
| (Address of  principal executive offices)         |       | (Zip Code)     |

 

**(570) 322-1111**

Registrant’stelephone number, including area code

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

YES  x                    NO  o

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

               Large accelerated filer  ̈               Acceleratedfiler x               Non-acceleratedfiler o

 

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

YES  o                    NO  x

On May 1, 2007 there were3,891,951 shares of the Registrant’s common stock outstanding.

 

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

 

2

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**Part I.  FINANCIAL INFORMATION**

**Item 1.  Financial Statements**

PENNS WOODS BANCORP, INC.

CONSOLIDATED BALANCESHEET

(UNAUDITED)
| ** **                                                                                          | ** ** | **March 31,** | ** ** | **December 31,** | ** ** |
|-----------------------------------------------------------------------------------------------------|------------|--------------------|------------|-----------------------|------------|
| **(In Thousands, Except Share Data)**                                           | ** ** | **2007**           | ** ** | **2006**              | ** ** |
|                                                                                                |       |               |       |                  |       |
| ASSETS                                                                                              |       |               |       |                  |       |
| Noninterest-bearing  balances                                                                       |       | $                  | 13,237     |                  | $          | 15,348 |   |
| Interest-bearing  deposits in other financial institutions                                          |       | 18                 |       | 25                    |       |
| Total cash and  cash equivalents                                                                    |       | 13,255             |       | 15,373                |       |
|                                                                                                |       |               |       |                  |       |
| Investment securities,  available for sale, at fair value                                           |       | 184,063            |       | 185,200               |       |
| Investment securities  held to maturity (fair value of $287 and $286)                               |       | 284                |       | 283                   |       |
| Loans held for sale                                                                                 |       | 2,996              |       | 3,716                 |       |
| Loans                                                                                               |       | 357,574            |       | 360,384               |       |
| Less: Allowance for  loan losses                                                                    |       | 4,201              |       | 4,185                 |       |
| Loans, net                                                                                          |       | 353,373            |       | 356,199               |       |
| Premises and equipment,  net                                                                        |       | 6,742              |       | 6,737                 |       |
| Accrued interest  receivable                                                                        |       | 2,832              |       | 2,939                 |       |
| Bank-owned life  insurance                                                                          |       | 11,786             |       | 11,346                |       |
| Investment in limited  partnerships                                                                 |       | 4,808              |       | 4,950                 |       |
| Goodwill                                                                                            |       | 3,032              |       | 3,032                 |       |
| Other assets                                                                                        |       | 3,420              |       | 2,510                 |       |
| TOTAL ASSETS                                                                                        |       | $                  | 586,591    |                  | $          | 592,285 |   |
|                                                                                                |       |               |       |                  |       |
| LIABILITIES                                                                                         |       |               |       |                  |       |
| Interest-bearing  deposits                                                                          |       | $                  | 313,921    |                  | $          | 322,031 |   |
| Noninterest-bearing  deposits                                                                       |       | 70,928             |       | 73,160                |       |
| Total deposits                                                                                      |       | 384,849            |       | 395,191               |       |
|                                                                                                |       |               |       |                  |       |
| Short-term borrowings                                                                               |       | 41,173             |       | 34,697                |       |
| Long-term borrowings,  Federal Home Loan Bank (FHLB)                                                |       | 81,378             |       | 82,878                |       |
| Accrued interest  payable                                                                           |       | 1,372              |       | 1,532                 |       |
| Other liabilities                                                                                   |       | 3,637              |       | 3,393                 |       |
| TOTAL LIABILITIES                                                                                   |       | 512,409            |       | 517,691               |       |
|                                                                                                |       |               |       |                  |       |
| SHAREHOLDERS’ EQUITY                                                                           |       |               |       |                  |       |
| Common stock, par value  $8.33, 10,000,000 shares authorized; 4,004,516 and 4,003,514 shares issued |       | 33,371             |       | 33,362                |       |
| Additional paid-in  capital                                                                         |       | 17,832             |       | 17,810                |       |
| Retained earnings                                                                                   |       | 26,350             |       | 25,783                |       |
| Accumulated other  comprehensive income (loss):                                                     |       |               |       |                  |       |
| Net unrealized  gain on available for sale securities                                               |       | 1,486              |       | 2,139                 |       |
| Defined benefit  plan                                                                               |       | (579               | )          | (579                  | )          |
| Less: Treasury stock at  cost, 112,802 and 102,772 shares                                           |       | (4,278             | )          | (3,921                | )          |
| TOTAL SHAREHOLDERS’  EQUITY                                                                    |       | 74,182             |       | 74,594                |       |
| TOTAL LIABILITIES AND SHAREHOLDERS’ EQUITY                                                     |       | $                  | 586,591    |                  | $          | 592,285 |   |

 

See accompanying notes tothe unaudited consolidated financial statements.

3

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PENNS WOODS BANCORP, INC.

CONSOLIDATED STATEMENT OFINCOME 

(UNAUDITED)
| ** **                                                         | ** ** | **Three Months Ended** | ** ** |
|--------------------------------------------------------------------|------------|----------------------------------|------------|
| ** **                                                         | ** ** | **March 31,**               | ** ** |
| **(In Thousands, Except Per Share Data)** | ** ** | **2007**                         | ** ** | **2006** | ** ** |
|                                                               |       |                             |       |   |   |
| INTEREST AND  DIVIDEND INCOME                                      |       |                             |       |   |   |
| Loans including  fees                                              |       | $                                | 6,423      |   | $ | 5,809 |   |
| Investment  Securities:                                            |       |                             |       |   |   |
| Taxable                                                            |       | 823                              |       | 923 |   |
| Tax-exempt                                                         |       | 1,111                            |       | 989 |   |
| Dividend and other interest income                                 |       | 322                              |       | 301 |   |
| TOTAL INTEREST  AND DIVIDEND INCOME                                |       | 8,679                            |       | 8,022 |   |
|                                                               |       |                             |       |   |   |
| INTEREST EXPENSE                                                   |       |                             |       |   |   |
| Deposits                                                           |       | 2,512                            |       | 1,837 |   |
| Short-term  borrowings                                             |       | 505                              |       | 406 |   |
| Long-term  borrowings, FHLB                                        |       | 922                              |       | 946 |   |
| TOTAL INTEREST  EXPENSE                                            |       | 3,939                            |       | 3,189 |   |
|                                                               |       |                             |       |   |   |
| NET INTEREST  INCOME                                               |       | 4,740                            |       | 4,833 |   |
|                                                               |       |                             |       |   |   |
| PROVISION FOR  LOAN LOSSES                                         |       | 40                               |       | 198 |   |
|                                                               |       |                             |       |   |   |
| NET INTEREST  INCOME AFTER PROVISION FOR LOAN LOSSES               |       | 4,700                            |       | 4,635 |   |
|                                                               |       |                             |       |   |   |
| NON-INTEREST  INCOME                                               |       |                             |       |   |   |
| Deposit service  charges                                           |       | 541                              |       | 590 |   |
| Securities  gains, net                                             |       | 326                              |       | 559 |   |
| Bank-owned life  insurance                                         |       | 115                              |       | 88 |   |
| Gain on sale of  loans                                             |       | 138                              |       | 150 |   |
| Insurance  commissions                                             |       | 438                              |       | 560 |   |
| Other                                                              |       | 416                              |       | 390 |   |
| TOTAL  NON-INTEREST INCOME                                         |       | 1,974                            |       | 2,337 |   |
|                                                               |       |                             |       |   |   |
| NON-INTEREST  EXPENSE                                              |       |                             |       |   |   |
| Salaries and  employee benefits                                    |       | 2,281                            |       | 2,232 |   |
| Occupancy, net                                                     |       | 331                              |       | 243 |   |
| Furniture and  equipment                                           |       | 286                              |       | 297 |   |
| Pennsylvania  shares tax                                           |       | 161                              |       | 145 |   |
| Other                                                              |       | 1,069                            |       | 1,034 |   |
| TOTAL  NON-INTEREST EXPENSE                                        |       | 4,128                            |       | 3,951 |   |
|                                                               |       |                             |       |   |   |
| INCOME BEFORE  INCOME TAX PROVISION                                |       | 2,546                            |       | 3,021 |   |
| INCOME TAX  PROVISION                                              |       | 265                              |       | 566 |   |
| NET INCOME                                                         |       | $                                | 2,281      |   | $ | 2,455 |   |
|                                                               |       |                             |       |   |   |
| EARNINGS PER  SHARE - BASIC                                        |       | $                                | 0.59       |   | $ | 0.62 |   |
|                                                               |       |                             |       |   |   |
| EARNINGS PER  SHARE - DILUTED                                      |       | $                                | 0.59       |   | $ | 0.62 |   |
|                                                               |       |                             |       |   |   |
| WEIGHTED AVERAGE  SHARES OUTSTANDING - BASIC                       |       | 3,897,480                        |       | 3,961,287 |   |
|                                                               |       |                             |       |   |   |
| WEIGHTED AVERAGE  SHARES OUTSTANDING - DILUTED                     |       | 3,897,818                        |       | 3,961,772 |   |
|                                                               |       |                             |       |   |   |
| DIVIDENDS PER SHARE                                                |       | $                                | 0.44       |   | $ | 0.42 |   |

 

See accompanying notes tothe unaudited consolidated financial statements.

4

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PENNS WOODS BANCORP, INC.

CONSOLIDATED STATEMENT OFCHANGES IN SHAREHOLDERS’ EQUITY

(UNAUDITED)

 
| ** **                                                                                        | ** ** | **COMMON** | ** ** | **ADDITIONAL** | ** ** | ** **   | ** ** | **ACCUMULATED  OTHER** | ** ** | ** **   | ** ** | **TOTAL**              | ** ** |
|---------------------------------------------------------------------------------------------------|------------|------------|------------|----------------|------------|--------------|------------|------------------------|------------|--------------|------------|------------------------|------------|
| ** **                                                                                        | ** ** | **STOCK**  | ** ** | **PAID-IN**    | ** ** | **RETAINED** | ** ** | **COMPREHENSIVE**      | ** ** | **TREASURY** | ** ** | **SHAREHOLDERS’** | ** ** |
| **(In Thousands Except Per Share Data)**                                 | ** ** | **SHARES** | ** ** | **AMOUNT**     | ** ** | **CAPITAL**  | ** ** | **EARNINGS**           | ** ** | **INCOME**   | ** ** | **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                                                                                        |       |       |       |           |       |         |       | 2,281                  |       |         |       |                   |       | 2,281 |   |
| Net change in  unrealized gain on reclassification adjustment, net of income tax benefit of  $337 |       |       |       |           |       |         |       |                   |       | (653         | )          |                   |       | (653 | ) |
| Total  comprehensive income                                                                       |       |       |       |           |       |         |       |                   |       |         |       |                   |       | 1,628 |   |
| Dividends  declared, ($0.44 per share)                                                            |       |       |       |           |       |         |       | (1,714                 | )          |         |       |                   |       | (1,714 | ) |
| Purchase of  treasury stock (10,030 shares)                                                       |       |       |       |           |       |         |       |                   |       |         |       | (357                   | )          | (357 | ) |
| Stock options  exercised                                                                          |       | 330        |       | 3              |       | 5            |       |                   |       |         |       |                   |       | 8 |   |
| Common shares  issued for employee stock purchase plan                                            |       | 672        |       | 6              |       | 17           |       |                   |       |         |       |                   |       | 23 |   |
| Balance, March 31, 2007                                                                           |       | 4,004,516  |       | $              | 33,371     |         | $          | 17,832                 |       | $            | 26,350     |                   | $          | 907 |   | $ | (4,278 | ) | $ | 74,182 |   |

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

 

See accompanying notes to the unaudited consolidated financialstatements.

PENNS WOODSBANCORP, INC.

CONSOLIDATEDSTATEMENT OF COMPREHENSIVE INCOME

(UNAUDITED**)**

 
| ** **                                                                 | ** ** | **Three Months Ended March 31,** | ** ** |
|----------------------------------------------------------------------------|------------|------------------------------------------------------|------------|
| **(In Thousands)**                                                    | ** ** | **2007**                                             | ** ** | **2006** | ** ** |
|                                                                       |       |                                                 |       |   |   |
| Net Income                                                                 |       | $                                                    | 2,281      |   | $ | 2,455 |   |
| Other  comprehensive (loss) income:                                        |       |                                                 |       |   |   |
| Change in net unrealized gains on available for sale  securities           |       | (664                                                 | )          | 1,189 |   |
| Less: Reclassification adjustment for net gains  included in net income    |       | 326                                                  |       | 559 |   |
| Other  comprehensive (loss) income before tax                              |       | (990                                                 | )          | 630 |   |
| Income tax  (benefit) expense related to other comprehensive (loss) income |       | (337                                                 | )          | 214 |   |
| Other  comprehensive (loss) income, net of tax                             |       | (653                                                 | )          | 416 |   |
| Comprehensive  income                                                      |       | $                                                    | 1,628      |   | $ | 2,871 |   |

 

Seeaccompanying notes to the unaudited consolidated financial statements.

5

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PENNSWOODS BANCORP, INC.

CONSOLIDATED STATEMENT OFCASH FLOWS

(UNAUDITED)

 
| ** **                                                                         | ** ** | **Three Months Ended** | ** ** |
|------------------------------------------------------------------------------------|------------|----------------------------------|------------|
| ** **                                                                         | ** ** | **March 31,**               | ** ** |
| **(In Thousands)**                                                            | ** ** | **2007**                         | ** ** | **2006** | ** ** |
|                                                                               |       |                             |       |   |   |
| OPERATING  ACTIVITIES                                                              |       |                             |       |   |   |
| Net Income                                                                         |       | $                                | 2,281      |   | $ | 2,455 |   |
| Adjustments to reconcile net income to net cash provided  by operating activities: |       |                             |       |   |   |
| Depreciation                                                                       |       | 179                              |       | 176 |   |
| Provision for loan losses                                                          |       | 40                               |       | 198 |   |
| Accretion and amortization of investment security  discounts and premiums          |       | (232                             | )          | (191 | ) |
| Securities gains, net                                                              |       | (326                             | )          | (559 | ) |
| Originations of loans held for sale                                                |       | (5,289                           | )          | (5,735 | ) |
| Proceeds of loans held for sale                                                    |       | 6,147                            |       | 6,505 |   |
| Gain on sale of loans                                                              |       | (138                             | )          | (150 | ) |
| Increases in bank-owned life insurance                                             |       | (440                             | )          | (88 | ) |
| Other, net                                                                         |       | (389                             | )          | 150 |   |
| Net cash provided by operating activities                                          |       | 1,833                            |       | 2,761 |   |
| INVESTING  ACTIVITIES                                                              |       |                             |       |   |   |
| Investment securities available for sale:                                          |       |                             |       |   |   |
| Proceeds from sales                                                                |       | 13,110                           |       | 16,302 |   |
| Proceeds from calls and maturities                                                 |       | 1,769                            |       | 1,744 |   |
| Purchases                                                                          |       | (13,277                          | )          | (16,680 | ) |
| Net decrease (increase) in loans                                                   |       | 2,786                            |       | (7,638 | ) |
| Acquisition of bank premises and equipment                                         |       | (184                             | )          | (298 | ) |
| Proceeds from the sale of foreclosed assets                                        |       | —                           |       | 61 |   |
| Investment in limited partnership                                                  |       | —                           |       | (1,446 | ) |
| Proceeds from redemption of regulatory stock                                       |       | 132                              |       | 430 |   |
| Purchases of regulatory stock                                                      |       | (881                             | )          | (377 | ) |
| Net cash provided by (used) for investing activities                               |       | 3,455                            |       | (7,902 | ) |
| FINANCING  ACTIVITIES                                                              |       |                             |       |   |   |
| Net (decrease) increase in interest-bearing deposits                               |       | (8,110                           | )          | 12,167 |   |
| Net (decrease) increase in noninterest-bearing deposits                            |       | (2,232                           | )          | 2,950 |   |
| Proceeds of long-term borrowings, FHLB                                             |       | 10,000                           |       | — |   |
| Repayment of long-term borrowings, FHLB                                            |       | (11,500                          | )          | (1,600 | ) |
| Net increase (decrease) in short-term borrowings                                   |       | 6,476                            |       | (4,609 | ) |
| Dividends paid                                                                     |       | (1,714                           | )          | (1,666 | ) |
| Issuance of common stock                                                           |       | 23                               |       | — |   |
| Stock options exercised                                                            |       | 8                                |       | — |   |
| Purchase of treasury stock                                                         |       | (357                             | )          | (1,309 | ) |
| Net cash (used) for provided by financing activities                               |       | (7,406                           | )          | 5,933 |   |
| NET (DECREASE)  INCREASE IN CASH AND CASH EQUIVALENTS                              |       | (2,118                           | )          | 792 |   |
| CASH AND CASH  EQUIVALENTS, BEGINNING                                              |       | 15,373                           |       | 14,090 |   |
| CASH AND CASH  EQUIVALENTS, ENDING                                                 |       | $                                | 13,255     |   | $ | 14,882 |   |
|                                                                               |       |                             |       |   |   |
| SUPPLEMENTAL  DISCLOSURES OF CASH FLOW INFORMATION                                 |       |                             |       |   |   |
|                                                                               |       |                             |       |   |   |
| Interest paid                                                                      |       | $                                | 4,099      |   | $ | 3,201 |   |
| Income taxes  paid                                                                 |       | 200                              |       | 500 |   |
| Transfer of  loans to foreclosed real estate                                       |       | —                           |       | 34 |   |

 

See accompanying notes tothe unaudited consolidated financial statements.

6

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# **PENNS WOODS BANCORP, INC. AND SUBSIDIARIESNOTES TOCONSOLIDATED FINANCIAL STATEMENTS**

**(Unaudited)**

# **Note 1. Basis of Presentation**

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

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

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

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

**Note 2. Recent AccountingPronouncements**

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

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

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(offset) accounting. FAS No. 156 also clarifies when an obligation to service financialassets should be separately recognized as a servicing asset or a servicingliability, requires that a separately recognized servicing asset or servicingliability be initially measured at fair value, if practicable, and permits anentity with a separately recognized servicing asset or servicing liability tochoose either of the amortization or fair value methods for subsequentmeasurement.  The provisions of FAS No.156 are effective as of the beginning of the first fiscal year that beginsafter September 15, 2006.   The adoptionof this standard is not expected to have a material effect on the Company’sresults of operations or financial position.

In September2006, the FASB issued FAS No. 157, *Fair Value Measurements*,which provides enhanced guidance for using fair value to measure assets andliabilities. The standard applies whenever other standards require or permitassets or liabilities to be measured at fair value. The Standard does notexpand the use of fair value in any new circumstances. FAS No. 157 iseffective for financial statements issued for fiscal years beginning afterNovember 15, 2007 and interim periods within those fiscal years. Earlyadoption is permitted.  The adoption ofthis standard is not expected to have a material effect on the Company’sresults of operations or financial position.

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

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

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

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

In September 2006, the FASB reached consensus on theguidance provided by Emerging Issues Task Force Issue 06-4 (“EITF 06-4”), *Accounting for Deferred Compensation and Postretirement Benefit Aspectsof Endorsement Split-Dollar Life Insurance Arrangements*.  The guidance is applicable to endorsementsplit-dollar life insurance arrangements, whereby the employer owns andcontrols the insurance policy, that are associated with a postretirementbenefit.  EITF 06-4 requires that for asplit-dollar life insurance arrangement within the scope of the Issue, anemployer should recognize a liability for future benefits in accordance withFAS No. 106 (if, in substance, a postretirement benefit plan exists) orAccounting Principles Board Opinion No. 12 (if the arrangement is, insubstance, an individual deferred compensation contract) based on thesubstantive agreement with the employee. EITF 06-4 is effective for fiscal years beginning after December 15,2007.  The Company is currentlyevaluating the impact the adoption of the EITF will have on the Company’sresults of operations or financial condition.

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

In March 2007, the FASB ratified Emerging IssuesTask Force Issue No. 06-10 (“EITF 06-10”), *Accounting for CollateralAssignment Split-Dollar Life Insurance Agreements*. EITF 06-10provides guidance for determining a liability for the postretirement benefitobligation as well as recognition and measurement of the associated asset onthe basis of the terms of the collateral assignment agreement. EITF 06-10 iseffective for fiscal years beginning after December 15, 2007. The Company iscurrently evaluating the impact the adoption of the EITF will have on theCompany’s results of operations or financial condition.

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**Note 3. Per Share Data**

The following table sets forth the composition ofthe weighted average common shares (denominator) used in the basic and dilutiveper share computation.  There are noconvertible securities which would affect the numerator in calculating basicand diluted earnings per share; therefore, net income as presented on theconsolidated statement of income will be used as the numerator.
| ** **                                                                                                 | ** ** | **Three Months Ended March 31,** | ** ** |
|------------------------------------------------------------------------------------------------------------|------------|------------------------------------------------------|------------|
| ** **                                                                                                 | ** ** | **2007**                                             | ** ** | **2006** | ** ** |
|                                                                                                       |       |                                                 |       |   |   |
| Weighted average  common shares outstanding                                                                |       | 4,003,936                                            |       | 4,002,159 |   |
|                                                                                                       |       |                                                 |       |   |   |
| Average treasury  stock shares                                                                             |       | (106,456                                             | )          | (40,872 | ) |
|                                                                                                       |       |                                                 |       |   |   |
| Weighted average  common shares and common stock equivalents used to calculate basic earnings  per share   |       | 3,897,480                                            |       | 3,961,287 |   |
|                                                                                                       |       |                                                 |       |   |   |
| Additional  common stock equivalents (stock options) used to calculate diluted earnings  per share         |       | 338                                                  |       | 485 |   |
|                                                                                                       |       |                                                 |       |   |   |
| Weighted average common  shares and common stock equivalents used to calculate diluted earnings per  share |       | 3,897,818                                            |       | 3,961,772 |   |

 

Options to purchase 8,276 and 9,002 shares ofcommon stock at the price of $40.29 were outstanding during the three monthsended March 31, 2007 and 2006, respectively, but were not included in thecomputation of diluted earnings per share as they were anti-dilutive due to thestrike price being greater than the market price as of March 31, 2007 and 2006,respectively.

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

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

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Thefollowing sets forth the components of the net periodic benefit cost of thedomestic non-contributory defined benefit plan for the three months ended March31, 2007 and 2006, respectively:
|                                     | ** ** | **Three Months Ended** | ** ** |
|-------------------------------------|------------|----------------------------------|------------|
| ** **                          | ** ** | **March 31,**               | ** ** |
| **(In Thousands)**             | ** ** | **2007**                         | ** ** | **2006** | ** ** |
|                                |       |                             |       |   |   |
| Service cost                        |       | $                                | 117        |   | $ | 117 |   |
| Interest cost                       |       | 121                              |       | 108 |   |
| Expected return  on plan assets     |       | (140                             | )          | (121 | ) |
| Amortization of  transition         |       | (1                               | )          | (1 | ) |
| Amortization of  prior service cost |       | 6                                |       | 6 |   |
| Amortization of  net loss           |       | —                           |       | 6 |   |
| Net periodic cost                   |       | $                                | 103        |   | $ | 115 |   |

 

**Employer Contributions**

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

**Note5.  Off Balance Sheet Risk**

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

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

Outstanding financial instruments with offbalance sheet risk are as follows:
|                               | ** ** | **March 31,** | ** ** | **December 31,** | ** ** |
|-------------------------------|------------|--------------------|------------|-----------------------|------------|
| **(In Thousands)**       | ** ** | **2007**           | ** ** | **2006**              | ** ** |
| Commitments to  extend credit |       | $                  | 58,951     |                  | $          | 61,736 |   |
| Standby letters of  credit    |       | 1,100              |       | 1,033                 |       |
|                               |            |                    |            |                       |            |  |  |

 

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

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

# **Note 7.  Employee Stock Purchase Plan**

Effective April 26, 2006, the Company implemented the Penns WoodsBancorp, Inc. 2006 Employee Stock Purchase Plan (“Plan”).  The Plan is intended to encourage employeeparticipation in the ownership and economic progress of the Company.  The Plan allows for up to 1,000,000 shares tobe purchased by employees.  The purchaseprice of the shares is 95% of market value with an employee eligible topurchase up to the lesser of 15% of base compensation or $12,000 in marketvalue annually.  During the three monthsended March 31, 2007, there were 672 shares issued under the plan.

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

ThisReport contains certain “forward-looking statements” including statements concerningplans, objectives, future events or performance and assumptions and otherstatements which are other than statements of historical fact.  The Company wishes to caution readers thatthe following important factors, among others, may have affected and could inthe future affect the Company’s actual results and could cause the Company’sactual results for subsequent periods to differ materially from those expressedin any forward-looking statement made by or on behalf of the Companyherein:  (i) the effect of changes inlaws and regulations, including federal and state banking laws and regulations,which the Company must comply, and the associated costs of compliance with suchlaws and regulations either currently or in the future as applicable; (ii) theeffect of changes in accounting policies and practices, as may be adopted bythe regulatory agencies as well as by the Financial Accounting Standards Board,or of changes in the Company’s organization, compensation and benefit plans;(iii) the effect on the Company’s competitive position within its market areaof the  increasing consolidation withinthe banking and financial services industries, including the increasedcompetition from larger regional and out-of-state banking organizations as wellas non-bank providers of various financial services; (iv) the effect of changesin interest rates; and (v) the effect of changes in the business cycle anddownturns in the local, regional or national economies.

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

# **EARNINGS SUMMARY**

**Comparisonof the Three Months Ended March 31, 2007 and 2006**

**SummaryResults**

Net income for thethree months ended March 31, 2007 was $2,281,000 compared to $2,455,000 for thesame period of 2006.  Basic and dilutedearnings per share for the three months ended March 31, 2007 were $0.59 ascompared to $0.62 for the three months ended March 31, 2006.  Return on average assets and return onaverage equity were 1.56% and 12.13% for the three months ended March 31, 2007as compared to 1.72% and 13.24% for the corresponding period of 2006.  Net income from core operations for the threemonths ended March 31, 2007 and 2006, excluding after-tax net securities gainsof $215,000 and $369,000, respectively, were $2,066,000 and $2,086,000 or $0.53per share for the periods being compared. (Management uses the non-GAAP measure of net income from core operationsin its analysis of the Company’s performance. This measure, as used by the Company, adjusts net income by significantgains or losses that are unusual in nature. Because certain of these items and their impact on the Company’sperformance are difficult to predict, management believes the presentation offinancial measures excluding the impact of such items provides usefulsupplemental information in evaluating the operating results of the Company’score businesses.  For purposes of thisQuarterly Report on Form 10-Q, net income from core operations means net incomeadjusted to exclude after-tax net securities gains.  These disclosures should not be viewed as asubstitute for net income determined in accordance with GAAP, nor are theynecessarily comparable to non-GAAP performance measures that may be presentedby other companies.)

**InterestIncome**

Interest income for the three months ended March 31, 2007 increased$657,000 to $8,679,000 as compared to $8,022,000 for the same period of2006.  The increase in total interestincome was primarily the result of growth in average loans of $17,717,000 forthe three months ended March 31, 2007 as compared to 2006.  The average loan growth and a 35 basis point(“bp”) increase in loan portfolio yields accounted for $614,000 of the totalinterest income growth.  Over this timeframe, the average balance of investment securities decreased $15,076,000 asthe funds were utilized to assist in funding the loan growth.  The decrease in the average investmentportfolio was offset by an increase of 34 bp in the investment portfolio yieldwhich resulted in total interest income from the investment portfolioincreasing $43,000 to $2,256,000 for the three months ended March 31,2007.  On a taxable equivalent basis, theinterest income from the investment portfolio increased $106,000 as the portfoliowas strategically shifted to a more tax-exempt weighting.  The increase in dividends received is theresult of an increase in the level of dividends from the Federal Home Loan Bankof Pittsburgh (“FHLB”).

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Interest income composition for the three months ended March 31, 2007and 2006 were as follows:

 
| ** **                         | ** ** | **For The Three Months Ended** | ** ** |
|------------------------------------|------------|----------------------------------------------------|------------|
| ** **                         | ** ** | **March 31, 2007**                       | ** ** | **March 31, 2006** | ** ** | **Change** | ** ** |
| **(In Thousands)**            | ** ** | **Amount**                                         | ** ** | **% Total** | ** ** | **Amount** | ** ** | **% Total** | ** ** | **Amount** | ** ** | **%** | ** ** |
| Loans including  fees              |       | $                                                  | 6,423      |   | 74.0 | % | $ | 5,809 |   | 72.4 | % | $ | 614 |   | 10.6 | % |
| Investment  securities:            |       |                                               |       |   |   |   |   |   |   |   |   |   |   |
| Taxable                            |       | 823                                                |       | 9.5 |   | 923 |   | 11.5 |   | (100 | ) | (10.8 | ) |
| Tax-exempt                         |       | 1,111                                              |       | 12.8 |   | 989 |   | 12.3 |   | 122 |   | 12.3 |   |
| Dividend and other interest income |       | 322                                                |       | 3.7 |   | 301 |   | 3.8 |   | 21 |   | 7.0 |   |
| Total interest  income             |       | $                                                  | 8,679      |   | 100.0 | % | $ | 8,022 |   | 100.0 | % | $ | 657 |   | 8.2 | % |

 

**InterestExpense**

Interest expense for the three months ended March 31, 2007 increased$750,000 to $3,939,000 as compared to $3,189,000 for the same period of2006.  The increased expense associatedwith deposits is primarily the result of rate increases for time deposits, whichare comprised of various certificates of deposit (“CD”) accounts, from thethree months ended March 31, 2006 to the corresponding period of 2007.  Factors that led to the rate increasesinclude, but are not limited to, several period prime rate increases,competitive market pricing pressure, and promotional campaigns run inconjunction with the opening of the Montoursville branch and the one yearanniversary celebration of the State College North Atherton Street branch.  The increase in CD interest rates hasexceeded the increase for other deposit accounts.  This has led to a shift of a portion of themoney market and savings deposit portfolios into higher yielding CDs.

Short-term borrowing costs increased as rates paid increased 84 bp as adirect result of the four prime rate increases since the start of 2006 and aminimal increase in the average balance of $1,131,000.  Long-term FHLB borrowing expense decreasedminimally due to a decline in average borrowings of $3,614,000.  The decline was the result of maturities of$11,500,000, with an average rate of 3.77%, during the first three months of2007 offset by the acquisition of $10,000,000, with an average rate of 4.28%.

Interestexpense composition for the three months ended March 31, 2007 and 2006 were asfollows:
| ** **                  | ** ** | **For The Three Months Ended** | ** ** |
|-----------------------------|------------|----------------------------------------------------|------------|
| ** **                  | ** ** | **March 31, 2007**                       | ** ** | **March 31, 2006** | ** ** | **Change** | ** ** |
| **(In Thousands)**     | ** ** | **Amount**                                         | ** ** | **% Total** | ** ** | **Amount** | ** ** | **% Total** | ** ** | **Amount** | ** ** | **%** | ** ** |
| Deposits                    |       | $                                                  | 2,512      |   | 63.8 | % | $ | 1,837 |   | 57.6 | % | $ | 675 |   | 36.7 | % |
| Short-term  borrowings      |       | 505                                                |       | 12.8 |   | 406 |   | 12.7 |   | 99 |   | 24.4 |   |
| Long-term  borrowings, FHLB |       | 922                                                |       | 23.4 |   | 946 |   | 29.7 |   | (24 | ) | (2.5 | ) |
| Total interest  expense     |       | $                                                  | 3,939      |   | 100.0 | % | $ | 3,189 |   | 100.0 | % | $ | 750 |   | 23.5 | % |

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**Net Interest Margin**

The net interest margin (“NIM”) for the three months ended March 31,2007 was 3.95% as compared to 4.08% for the corresponding period of 2006.  The decrease in the NIM was the result of theyield on earning assets increasing 36 bp to 6.87% for the three months endedMarch 31, 2007, as compared to 2006; however, interest bearing liabilitiesincreased 59 bp over the same period. The increase in the yield on earning assets is attributable to growth inthe taxable loan portfolio of $17,614,000 in addition to the yield on taxableloans increasing 36 bp coupled with an increase of 53 bp on the taxable investmentportfolio.  The average loan growth waspredominately comprised of residential and commercial real estate loans.  The yield on total loans increased to 7.27%from 6.92% due to the impact of the Federal Open Market Committee rateincreases enacted over the past year offset by competitive factors. The averagetaxable investment securities portfolio declined by $3,440,000, as the cashflow from the portfolio was utilized to fund the growth in loans. Theinvestment portfolio yield increased to 6.10% from 5.76% primarily from thepreviously noted shift in the portfolio to a portfolio weighting of tax-exemptinvestments.  The average interest ratepaid on deposit accounts increased to 3.25% as compared to 2.52% for the 2006period.  This increase was driven bygrowth in average time deposits of $25,767,000 and an increase in the rate paidon time deposits of 98 bp.  A portion ofthe increase in deposit volume and the average interest yield paid is due toseveral CD promotions during the past year to attract new customers whileretaining existing customers.  Thepromotions were designed to gather deposits that would have maturities of twoyears or less.  In addition, thepromotions served as a catalyst to cross sell other deposit products and toimplement management’s strategy regarding the CD portfolio allocation amongvarious maturities and therefore, reducing the concentration of time depositmaturities within any single month.

The prime rate increased 100 bp to 8.25% at March 31, 2007 from 7.25%at January 1, 2006, as further evidence of the correlation between the Company’sprimary source of borrowed funds, the FHLB, and the primary lending rateindicator used on a national basis. Based on this increase, short-term borrowings realized an increase of 84bp in interest rates for the three months ended March 31, 2007 as compared toMarch 31, 2006.

Following is a schedule of average balances and associated yields forthe three month periods ended March 31, 2007 and 2006:

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| ** **                                       | ** ** | **AVERAGE BALANCES AND INTEREST RATES** | ** ** |
|--------------------------------------------------|------------|-------------------------------------------------------------|------------|
| ** **                                       | ** ** | **Three Months Ended**                            | ** ** | **Three Months Ended** | ** ** |
| ** **                                       | ** ** | **March 31, 2007**                                | ** ** | **March 31, 2006** | ** ** |
| **(In Thousands)**                          | ** ** | **Average Balance**                                    | ** ** | **Interest** | ** ** | **Average Rate** | ** ** | **Average Balance** | ** ** | **Interest** | ** ** | **Average Rate** | ** ** |
|                                             |       |                                                        |       |   |   |   |   |   |   |   |   |   |   |
| Tax-exempt loans                                 |       | $                                                           | 8,266      |   | $ | 127 |   | 6.23 | % | $ | 8,163 |   | $ | 127 |   | 6.31 | % |
| All other loans                                  |       | 352,599                                                     |       | 6,339 |   | 7.29 | % | 334,985 |   | 5,725 |   | 6.93 | % |
| Total loans                                      |       | 360,865                                                     |       | 6,466 |   | 7.27 | % | 343,148 |   | 5,852 |   | 6.92 | % |
|                                             |       |                                                        |       |   |   |   |   |   |   |   |   |   |   |
| Taxable investment  securities                   |       | 82,572                                                      |       | 1,144 |   | 5.54 | % | 97,648 |   | 1,223 |   | 5.01 | % |
| Tax-exempt investment  securities                |       | 102,786                                                     |       | 1,683 |   | 6.55 | % | 91,150 |   | 1,498 |   | 6.57 | % |
| Total securities                                 |       | 185,358                                                     |       | 2,827 |   | 6.10 | % | 188,798 |   | 2,721 |   | 5.76 | % |
|                                             |       |                                                        |       |   |   |   |   |   |   |   |   |   |   |
| Interest bearing  deposits                       |       | 21                                                          |       | 1 |   | 19.31 | % | 12 |   | 1 |   | 33.80 | % |
|                                             |       |                                                        |       |   |   |   |   |   |   |   |   |   |   |
| Total interest-earning assets                    |       | 546,244                                                     |       | 9,294 |   | 6.87 | % | 531,958 |   | 8,574 |   | 6.51 | % |
|                                             |       |                                                        |       |   |   |   |   |   |   |   |   |   |   |
| Other assets                                     |       | 39,842                                                      |       |   |   |   |   | 37,564 |   |   |   |   |   |
|                                             |       |                                                        |       |   |   |   |   |   |   |   |   |   |   |
| Total assets                                     |       | $                                                           | 586,086    |   |   |   |   |   | $ | 569,522 |   |   |   |   |   |
|                                             |       |                                                        |       |   |   |   |   |   |   |   |   |   |   |
| Savings                                          |       | $                                                           | 58,997     |   | 105 |   | 0.72 | % | $ | 62,715 |   | 120 |   | 0.78 | % |
| Super Now deposits                               |       | 44,847                                                      |       | 149 |   | 1.35 | % | 48,163 |   | 150 |   | 1.26 | % |
| Money market deposits                            |       | 23,562                                                      |       | 125 |   | 2.15 | % | 25,124 |   | 115 |   | 1.86 | % |
| Time deposits                                    |       | 185,761                                                     |       | 2,133 |   | 4.66 | % | 159,994 |   | 1,452 |   | 3.68 | % |
| Total deposits                                   |       | 313,167                                                     |       | 2,512 |   | 3.25 | % | 295,996 |   | 1,837 |   | 2.52 | % |
|                                             |       |                                                        |       |   |   |   |   |   |   |   |   |   |   |
| Short-term borrowings                            |       | 42,283                                                      |       | 505 |   | 4.84 | % | 41,152 |   | 406 |   | 4.00 | % |
| Long-term borrowings,  FHLB                      |       | 80,722                                                      |       | 922 |   | 4.63 | % | 84,336 |   | 946 |   | 4.55 | % |
| Total borrowings                                 |       | 123,005                                                     |       | 1,427 |   | 4.70 | % | 125,488 |   | 1,352 |   | 4.37 | % |
|                                             |       |                                                        |       |   |   |   |   |   |   |   |   |   |   |
| Total interest-bearing  liabilities              |       | 436,172                                                     |       | 3,939 |   | 3.66 | % | 421,484 |   | 3,189 |   | 3.07 | % |
|                                             |       |                                                        |       |   |   |   |   |   |   |   |   |   |   |
| Demand deposits                                  |       | 68,222                                                      |       |   |   |   |   | 68,447 |   |   |   |   |   |
| Other liabilities                                |       | 6,459                                                       |       |   |   |   |   | 5,416 |   |   |   |   |   |
| Shareholders’ equity                        |       | 75,233                                                      |       |   |   |   |   | 74,175 |   |   |   |   |   |
| Total liabilities and  shareholders’ equity |       | $                                                           | 586,086    |   |   |   |   |   | $ | 569,522 |   |   |   |   |   |
|                                             |       |                                                        |       |   |   |   |   |   |   |   |   |   |   |
| Interest rate spread                             |       |                                                        |       |   |   | 3.21 | % |   |   |   |   | 3.44 | % |
| Net interest income/margin                       |       |                                                        |       | $ | 5,355 |   | 3.95 | % |   |   | $ | 5,385 |   | 4.08 | % |

 

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

2.               Nonaccrual loans havebeen included with loans for the purpose of analyzing net interest earnings.

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

16

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The followingtable presents the adjustment to convert net interest income to net interestincome on a fully taxable equivalent basis for the three month periods endedMarch 31, 2007 and 2006.
|                                                 | ** ** | **For the Three Months Ended** | ** ** |
|-------------------------------------------------|------------|----------------------------------------------------|------------|
| **(In Thousands)**                         | ** ** | **March 31,**                                 | ** ** |
| ** **                                      | ** ** | **2007**                                           | ** ** | **2006** | ** ** |
|                                            |       |                                               |       |   |   |
| Total interest  income                          |       | $                                                  | 8,679      |   | $ | 8,022 |   |
| Total interest  expense                         |       | 3,939                                              |       | 3,189 |   |
|                                            |       |                                               |       |   |   |
| Net interest  income                            |       | 4,740                                              |       | 4,833 |   |
| Tax equivalent  adjustment                      |       | 615                                                |       | 552 |   |
|                                            |       |                                               |       |   |   |
| Net interest income  (fully taxable equivalent) |       | $                                                  | 5,355      |   | $ | 5,385 |   |

 

# The following table setsforth the respective impact that both volume and rate changes have had on netinterest income on a fully taxable equivalent basis for the three month periodsended March 31, 2007 and 2006:

|                                    | ** ** | **Three Months Ended March 31,** | ** ** |
|------------------------------------|------------|------------------------------------------------------|------------|
| ** **                         | ** ** | **2007 vs 2006**                           | ** ** |
| ** **                         | ** ** | **Increase (Decrease)**                         | ** ** |
| ** **                         | ** ** | **Due to**                                      | ** ** |
| **(In Thousands)**            | ** ** | **Volume**                                           | ** ** | **Rate** | ** ** | **Net** | ** ** |
| Interest income:                   |       |                                                 |       |   |   |   |   |
| Loans,  tax-exempt                 |       | $                                                    | 2          |   | $ | (2 | ) | $ | — |   |
| Loans                              |       | 309                                                  |       | 305 |   | 614 |   |
| Taxable  investment securities     |       | (237                                                 | )          | 158 |   | (79 | ) |
| Tax-exempt  investment securities  |       | 190                                                  |       | (5 | ) | 185 |   |
| Interest bearing  deposits         |       | —                                               |       | — |   | — |   |
| Total interest-earning assets      |       | 264                                                  |       | 456 |   | 720 |   |
|                               |       |                                                 |       |   |   |   |   |
| Interest  expenses:                |       |                                                 |       |   |   |   |   |
| Savings deposits                   |       | (7                                                   | )          | (8 | ) | (15 | ) |
| Super Now  deposits                |       | (20                                                  | )          | 19 |   | (1 | ) |
| Money market  deposits             |       | (6                                                   | )          | 16 |   | 10 |   |
| Time deposits                      |       | 255                                                  |       | 426 |   | 681 |   |
| Short-term  borrowings             |       | 11                                                   |       | 88 |   | 99 |   |
| Long-term  borrowings, FHLB        |       | (42                                                  | )          | 18 |   | (24 | ) |
| Total interest-bearing liabilities |       | 191                                                  |       | 559 |   | 750 |   |
| Change in net interest  income     |       | $                                                    | 73         |   | $ | (103 | ) | $ | (30 | ) |

 

17

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# **Provision for Loan Losses**

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

The allowance iscalculated by applying loss factors to outstanding loans by type, excludingloans for which a specific allowance has been determined.  Loss factors are based on management’s considerationof the nature of the portfolio segments, changes in mix and volume of the loanportfolio, and historical loan loss experience. In addition, management considers industry standards and trends withrespect to non-performing loans and its knowledge and experience with specificlending segments.

Althoughmanagement believes it uses the best information available to make suchdeterminations and that the allowance for loan losses is adequate at March 31,2007, future adjustments could be necessary if circumstances or economicconditions differ substantially from the assumptions used in making the initialdeterminations.  A downturn in the localeconomy, employment, and delays in receiving financial information fromborrowers could result in increased levels of nonperforming assets,charge-offs, loan loss provisions, and reductions in income.  Additionally, as an integral part of theexamination process, bank regulatory agencies periodically review the Bank’sloan loss allowance.  The bankingagencies could require the recognition of additions to the loan loss allowancebased on their judgment of information available to them at the time of theirexamination.

While determiningthe appropriate allowance level, management has attributed the allowance for loan losses to variousportfolio segments; however, the allowance is available for the entireportfolio as needed.

The allowance forloan losses increased from $4,185,000 at December 31, 2006 to $4,201,000 atMarch 31, 2007.  At March 31, 2007, theallowance for loan losses was 1.17% of total loans compared to 1.16% of totalloans at December 31, 2006.  Management’sconclusion is that the allowance for loan losses is adequate to provide for possible losses inherent inthe loan portfolio as of the balance sheet date.

The provision forloan losses totaled $40,000 for the three months ended March 31, 2007,respectively, as compared to $198,000 for the same period in 2006.  The decrease in the provision was the resultof several continuing positive factors, including but not limited to,annualized net charge offs to average loans of 0.03%, nonperforming loans tototal loans of 0.28%, and an allowance for losses to nonperforming loans of412.27%.

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

18

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**Non-interestIncome**

Total non-interest income for the three months ended March 31, 2007compared to the same period in 2006 decreased $363,000 to $1,974,000.  Excluding net security gains, non-interestincome would have decreased $130,000. Deposit service charges declined $49,000 as overdraft protection feesdeclined and customers migrated to new checking accounts having reduced or noservice charges.  Other income increaseddue primarily to revenue generated from increased debit card transactions andcommissions generated by The M Group for securities transactions.

Insurance commissions for the three months ended March 31, 2007decreased $122,000 as compared to the same period in 2006 due to a shift inproduct mix.  Management of The M Groupcontinues to pursue new and build upon current relationships.  The sales call program continues to expand toother financial institutions, which typically results in additional revenue forThe M Group.

Non-interest income composition for the three months ended March 31,2007 and 2006 were as follows:
| ** **                 | ** ** | **For The Three Months Ended** | ** ** |
|----------------------------|------------|----------------------------------------------------|------------|
| ** **                 | ** ** | **March 31, 2007**                       | ** ** | **March 31, 2006** | ** ** | **Change** | ** ** |
| **(In Thousands)**    | ** ** | **Amount**                                         | ** ** | **% Total** | ** ** | **Amount** | ** ** | **% Total** | ** ** | **Amount** | ** ** | **%** | ** ** |
| Deposit service  charges   |       | $                                                  | 541        |   | 27.4 | % | $ | 590 |   | 25.2 | % | $ | (49 | ) | (8.3 | )% |
| Security gains,  net       |       | 326                                                |       | 16.5 |   | 559 |   | 24.0 |   | (233 | ) | (41.7 | ) |
| Bank owned life  insurance |       | 115                                                |       | 5.8 |   | 88 |   | 3.8 |   | 27 |   | 30.7 |   |
| Gain on sale of  loans     |       | 138                                                |       | 7.0 |   | 150 |   | 6.4 |   | (12 | ) | (8.0 | ) |
| Insurance  commissions     |       | 438                                                |       | 22.2 |   | 560 |   | 24.0 |   | (122 | ) | (21.8 | ) |
| Other                      |       | 416                                                |       | 21.1 |   | 390 |   | 16.6 |   | 26 |   | 6.6 |   |
| Total  non-interest income |       | $                                                  | 1,974      |   | 100.0 | % | $ | 2,337 |   | 100.0 | % | $ | (363 | ) | (15.5 | )% |

 

**Non-interestExpense**

Total non-interest expense increased $177,000 from the three monthsended March 31, 2006 compared to the same period of 2007.  The increase in salaries and employeebenefits was attributable to several items including: standard cost of livingwage adjustments for employees, new additions to our staff, and increasedbenefit cost.  Occupancy expenseincreased due to the new branch in Montoursville, which opened in the thirdquarter of 2006, and increased cost of maintenance and property taxes.  Other expenses increased primarily due tonormal anticipated inflationary adjustments to ongoing business operating costsand the amortization related to two low income housing partnerships that beganoperation during the first and fourth quarters of 2006, respectively.

19

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Non-interest expense composition for the three months ended March 31,2007 and 2006 was as follows:

 
| ** **                      | ** ** | **For The Three Months Ended** | ** ** |
|---------------------------------|------------|----------------------------------------------------|------------|
| ** **                      | ** ** | **March 31, 2007**                       | ** ** | **March 31, 2006** | ** ** | **Change** | ** ** |
| **(In Thousands)**         | ** ** | **Amount**                                         | ** ** | **% Total** | ** ** | **Amount** | ** ** | **% Total** | ** ** | **Amount** | ** ** | **%** | ** ** |
| Salaries and employee  benefits |       | $                                                  | 2,281      |   | 55.3 | % | $ | 2,232 |   | 56.4 | % | $ | 49 |   | 2.2 | % |
| Occupancy, net                  |       | 331                                                |       | 8.0 |   | 243 |   | 6.2 |   | 88 |   | 36.2 |   |
| Furniture and  equipment        |       | 286                                                |       | 6.9 |   | 297 |   | 7.5 |   | (11 | ) | (3.7 | ) |
| Pennsylvania  shares tax        |       | 161                                                |       | 3.9 |   | 145 |   | 3.8 |   | 16 |   | 11.0 |   |
| Other                           |       | 1,069                                              |       | 25.9 |   | 1,034 |   | 26.1 |   | 35 |   | 3.4 |   |
| Total  non-interest expense     |       | $                                                  | 4,128      |   | 100.0 | % | $ | 3,951 |   | 100.0 | % | $ | 177 |   | 4.5 | % |

 

**Provisionfor Income Taxes**

Income taxes decreased $301,000 for the three month period ended March31, 2007 compared to the same periods of 2006. The effective tax rates for the three months ended March 31, 2007 and2006 were 10.4% and 18.7%, respectively. The decline in the effective tax rate is consistent with management’srepositioning of the investment portfolio from taxable investment securities totax-exempt investment securities and tax credits related to investments in lowincome housing projects.

# **ASSET/LIABILITY MANAGEMENT**

# **Cash and Cash Equivalents**

Cash and cashequivalents decreased $2,118,000 from $15,373,000 at December 31, 2006,primarily as a result of the following activities during the three months endedMarch  31, 2007:

# **Operating Activities**

The significantcomponents of operating activities are net income and the origination andproceeds of loans held for sale. Activity regarding loans held for sale resulted in sale proceeds, less$138,000 in realized gains, exceeding loan origination disbursements by$720,000 for the period.

**Loans**

Gross loansdecreased $2,810,000 since December 31, 2006 due to the early payoff of  a large commercial loan coupled with increasedcompetition for commercial loans.

20

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The allocation of the loan portfolio, bycategory, as of March 31, 2007 and December 31, 2006 is presented below:

 
| ** **                               | ** ** | **March 31,** | ** ** | **December 31,** | ** ** | **Change** | ** ** |
|------------------------------------------|------------|--------------------|------------|-----------------------|------------|------------|------------|
| **(In Thousands)**                  | ** ** | **2007**           | ** ** | **2006**              | ** ** | **Amount** | ** ** | **%** | ** ** |
| Commercial,  financial, and agricultural |       | $                  | 38,156     |                  | $          | 36,995     |       | $ | 1,161 |   | 3.1 | % |
| Real estate  mortgage:                   |       |               |       |                  |       |       |       |   |   |
| Residential                              |       | 158,006            |       | 158,219               |       | (213       | )          | (0.1 | ) |
| Commercial                               |       | 132,201            |       | 135,404               |       | (3,203     | )          | (2.4 | ) |
| Construction                             |       | 16,636             |       | 16,749                |       | (113       | )          | (0.7 | ) |
| Installment  loans to individuals        |       | 13,550             |       | 14,035                |       | (485       | )          | (3.5 | ) |
| Less: Net  deferred loan fees            |       | 975                |       | 1,018                 |       | (43        | )          | (4.2 | ) |
| Gross loans                              |       | $                  | 357,574    |                  | $          | 360,384    |       | $ | (2,810 | ) | (0.8 | )% |

 

Therecorded investment in loans for which impairment has been recognized inaccordance with Statement of Financial Accounting Standards No. 114, *Accounting by Creditors for Impairment of a Loan*, amountedto $1,209,000 at March 31, 2007, as compared to $574,000 at December 31,2006.  The valuation allowance related toimpaired loans amounted to $73,000 at March 31, 2007 and $42,000 at December31, 2006.  The increase in impaired loansis primarily from a single commercial relationship that accounted for $523,000of the increase, while the increase in valuation allowance is the result of asecond commercial relationship that had a specific collateral weakness.

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

**Investments**

The amortized cost and estimated fair market value of the investmentsecurities portfolio in total has remained constant since December 31,2006.  Over the first three months of2007, the amortized cost of equity securities has increased $591,000, whileU.S. Government and agency securities decreased $399,000.  The position in state and politicalsecurities remained relatively static as the Bank continued its strategy tomaintain call protection, maintain taxable equivalent yields, reduce theeffective federal income tax rate, and invest in communities across theCommonwealth of Pennsylvania and the country.

21

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

 
| ** **                             | ** ** | **March 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 |       | $                            | 54,550     |   | $ | 26 |   | $ | (645 | ) | $ | 53,931 |   |
| State and  political securities        |       | 104,219                      |       | 1,750 |   | (385 | ) | 105,584 |   |
| Other debt  securities                 |       | 2,098                        |       | 36 |   | (11 | ) | 2,123 |   |
| Total debt securities                  |       | 160,867                      |       | 1,812 |   | (1,041 | ) | 161,638 |   |
| Equity  securities                     |       | 20,944                       |       | 2,004 |   | (523 | ) | 22,425 |   |
| Total investment  securities AFS       |       | $                            | 181,811    |   | $ | 3,816 |   | $ | (1,564 | ) | $ | 184,063 |   |
|                                   |       |                         |       |   |   |   |   |   |   |
| Held to maturity  (HTM)                |       |                         |       |   |   |   |   |   |   |
| U.S. Government  and agency securities |       | $                            | 26         |   | $ | 1 |   | $ | — |   | $ | 27 |   |
| Other debt  securities                 |       | 258                          |       | 1 |   | — |   | 259 |   |
| Total investment  securities HTM       |       | $                            | 284        |   | $ | 2 |   | $ | — |   | $ | 286 |   |

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

 

22

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# **Financing Activities**

# **Deposits**

Total deposits decreased 2.6% or $10,342,000 from December 31, 2006 toMarch 31, 2007.  The mix of deposits hasshifted from brokered time deposits at December 31, 2006 to transactionaccounts at March 31, 2007.  The shift isthe result of the Bank replacing maturing brokered time deposits with FHLBshort-term borrowings at or below the cost of replacement brokered deposits.The amount of brokered deposits is continuously monitored and is used tosupplement deposits, not as a primary source of deposits.

# **Deposit balances and their changes for the periodsbeing discussed follow:**

| ** **                | ** ** | **March 31, 2007** | ** ** | **December 31, 2006** | ** ** | **Change** | ** ** |
|---------------------------|------------|------------------------------|------------|---------------------------------|------------|------------|------------|
| **(In Thousands)**   | ** ** | **Amount**                   | ** ** | **% Total**                | ** ** | **Amount** | ** ** | **% Total** | ** ** | **Amount** | ** ** | **%** | ** ** |
| Demand deposits           |       | $                            | 70,928     |                            | 18.4       | %          | $          | 73,160 |   | 18.5 | % | $ | (2,232 | ) | (3.1 | )% |
| NOW accounts              |       | 48,428                       |       | 12.6                            |       | 46,156     |       | 11.7 |   | 2,272 |   | 4.9 |   |
| Money market deposits     |       | 24,124                       |       | 6.3                             |       | 23,137     |       | 5.9 |   | 987 |   | 4.3 |   |
| Savings deposits          |       | 60,495                       |       | 15.7                            |       | 59,289     |       | 15.0 |   | 1,206 |   | 2.0 |   |
| Time deposits             |       | 165,938                      |       | 43.1                            |       | 168,420    |       | 42.6 |   | (2,482 | ) | (1.5 | ) |
| Time deposits -  brokered |       | 14,936                       |       | 3.9                             |       | 25,029     |       | 6.3 |   | (10,093 | ) | (40.3 | ) |
| Total deposits            |       | $                            | 384,849    |                            | 100.0      | %          | $          | 395,191 |   | 100.0 | % | $ | (10,342 | ) | (2.6 | )% |

 

# **Borrowed Funds**

Total borrowedfunds increased 4.2% to $122,551,000 at March 31, 2007 as compared to December31, 2006.  The increase in borrowed fundsis the result of brokered time deposit maturities that occurred since December31, 2006.  FHLB short-term borrowingswere utilized during the first three months of 2007 to replace the fundingvacated by the brokered deposit maturities.  Long-term borrowings declined due to the maturity of three borrowingstotaling $11,500,000 that carried an average rate of 3.77%.  The matured borrowings were replaced with anew FHLB $10,000,000 borrowing that carries a 4.28% rate and matures in 2017.
| ** **                                     | ** ** | **March 31, 2007** | ** ** | **December 31, 2006** | ** ** | **Change** | ** ** |
|------------------------------------------------|------------|------------------------------|------------|---------------------------------|------------|------------|------------|
| **(In Thousands)**                        | ** ** | **Amount**                   | ** ** | **% Total**                | ** ** | **Amount** | ** ** | **% Total** | ** ** | **Amount** | ** ** | **%** | ** ** |
| Short-term borrowings:                         |       |                         |       |                            |       |       |       |   |   |   |   |   |   |
| FHLB repurchase  agreements                    |       | $                            | 25,295     |                            | 20.6       | %          | $          | 18,706 |   | 15.9 | % | $ | 6,589 |   | 35.2 | % |
| Securities sold under  agreement to repurchase |       | 15,878                       |       | 13.0                            |       | 15,991     |       | 13.6 |   | (113 | ) | (0.7 | ) |
| Total short-term  borrowings                   |       | 41,173                       |       | 33.6                            | %          | 34,697     |       | 29.5 | % | 6,476 |   | 18.7 |   |
|                                           |       |                         |       |                            |       |       |       |   |   |   |   |   |   |
| Long-term borrowings,  FHLB                    |       | 81,378                       |       | 66.4                            |       | 82,878     |       | 70.5 |   | (1,500 | ) | (1.8 | ) |
| Total borrowed funds                           |       | $                            | 122,551    |                            | 100.0      | %          | $          | 117,575 |   | 100.0 | % | $ | 4,976 |   | 4.2 | % |

 

# **Capital**

## The adequacy of the Company’s capital is reviewed on an ongoing basiswith reference to the size, composition, and quality of the Company’s resourcesand regulatory guidelines.

23

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## Management seeks to maintain a level of capital sufficient to supportexisting assets and anticipated asset growth, maintain favorable access tocapital markets, and preserve high quality credit ratings.

## Bank holding companies are required to comply with the Federal ReserveBoard’s risk-based capital guidelines. The risk-based capital rules are designed to make regulatory capitalrequirements more sensitive to differences in risk profiles among banks andbank holding companies and to minimize disincentives for holding liquidassets.  Specifically, each is requiredto maintain certain minimum dollar amounts and ratios of Total risk-based, TierI risk-based, and Tier I leverage capital requirements. In addition to thecapital requirements, the Federal Deposit Insurance Corporation ImprovementsAct (FDICIA) established five capital categories ranging from “well capitalized”to “critically undercapitalized.” To be classified as “well capitalized”, Totalrisk-based, Tier I risked-based, and Tier I leverage capital ratios must be atleast 10%, 6%, and5%, respectively.

Capitalratios as of March 31, 2007 and December 31, 2006 were as follows:
| ** **                      | ** ** | **2007**   | ** ** | **2006**  | ** ** |
|---------------------------------|------------|------------|------------|-----------|------------|
| **(In Thousands)**         | ** ** | **Amount** | ** ** | **Ratio** | ** ** | **Amount** | ** ** | **Ratio** | ** ** |
| Total Capital                   |       |       |       |      |       |   |   |   |   |
|  (to Risk-weighted Assets) |       |       |       |      |       |   |   |   |   |
|                            |       |       |       |      |       |   |   |   |   |
| Actual                          |       | $          | 73,626     |      | 19.8       | % | $ | 73,098 |   | 20.5 | % |
| For Capital  Adequacy Purposes  |       | 29,785     |       | 8.0       |       | 28,515 |   | 8.0 |   |
| To Be Well  Capitalized         |       | 37,231     |       | 10.0      |       | 35,643 |   | 10.0 |   |
|                            |       |       |       |      |       |   |   |   |   |
| Tier I Capital                  |       |       |       |      |       |   |   |   |   |
|  (to Risk-weighted Assets) |       |       |       |      |       |   |   |   |   |
|                            |       |       |       |      |       |   |   |   |   |
| Actual                          |       | $          | 68,759     |      | 18.5       | % | $ | 67,869 |   | 19.0 | % |
| For Capital  Adequacy Purposes  |       | 14,893     |       | 4.0       |       | 14,257 |   | 4.0 |   |
| To Be Well  Capitalized         |       | 22,339     |       | 6.0       |       | 21,386 |   | 6.0 |   |
|                            |       |       |       |      |       |   |   |   |   |
| Tier I Capital                  |       |       |       |      |       |   |   |   |   |
|  (to Average Assets)       |       |       |       |      |       |   |   |   |   |
|                            |       |       |       |      |       |   |   |   |   |
| Actual                          |       | $          | 68,759     |      | 11.9       | % | $ | 67,869 |   | 12.0 | % |
| For Capital  Adequacy Purposes  |       | 23,151     |       | 4.0       |       | 22,591 |   | 4.0 |   |
| To Be Well Capitalized          |       | 28,938     |       | 5.0       |       | 28,239 |   | 5.0 |   |

 

24

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# **Liquidity and Interest Rate Sensitivity**

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

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

1.  Net Loans to Total Assets,85% maximum

2.  Net Loans to Total Deposits,100% maximum

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

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

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

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

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

Management monitors and determines the desirable level ofliquidity.  Consideration is given toloan demand, investment opportunities, deposit pricing and growth potential, aswell as the current cost of borrowing funds. The Company has a current borrowing capacity at the FHLB of $224,147,000.  Inaddition to this credit arrangement, the Company has additional lines of creditwith correspondent banks of $27,880,000. Management believes it has sufficientliquidity to satisfy estimated short-term and long-term funding needs.  FHLB borrowings totaled $106,673,000 as ofMarch 31, 2007.

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

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

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

# **Inflation**

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

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

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

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

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**Item 4.  Controls and Procedures**

Ananalysis was performed under the supervision and with the participation of theCompany’s management, including the Chief Executive Officer and the PrincipalFinancial Officer, of the effectiveness of the design and operation of theCompany’s disclosure controls and procedures. Based on that evaluation, theCompany’s Chief Executive Officer and Principal Financial Officer concludedthat the Company’s disclosure controls and procedures were effective as ofMarch 31, 2007.  There were no changes inthe Company’s internal control over financial reporting that occurred duringthe quarter ended March 31, 2007, that have materially affected, or arereasonably likely to materially affect, the Company’s internal control overfinancial reporting.

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

**Item 1.          Legal Proceedings**

None.

**Item 1A.  Risk Factors**

There are no materialchanges to the risk factors set forth in Part I, Item 1A, “Risk Factors,” ofthe Company’s Annual Report on Form 10-K for the year ended December 31,2006.  Please refer to that section fordisclosures regarding the risks and uncertainties related to the Company’sbusiness.

**Item 2.          Unregistered Sales of Equity Securitiesand 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 (January  1-January 31, 2007)   |       | —              |       | —              |       | —                                  |       | 154,600                                             |       |
|                                    |       |                |       |                |       |                                    |       |                                                |       |
| Month#2  (February 1-February 28, 2007) |       | 5,030               |       | $                   | 35.50      |                                    | 5,030      |                                                | 149,570    |   |
|                                    |       |                |       |                |       |                                    |       |                                                |       |
| Month#3 (March 1-March  31, 2007)       |       | 5,000               |       | $                   | 35.60      |                                    | 5,000      |                                                | 144,570    |   |

 

On April 24, 2007,the Board of Directors extended the authorization to repurchase up to 197,000shares, or approximately 5%, of the outstanding shares of the Company for anadditional year to April 25, 2008.  Therepurchase plan was originally for a one year period expiring on April 25,2007.  To date, there have been 52,430shares repurchased under this plan.

During the three monthsended March 31, 2007, there were 10,030 shares of the Company’s common stockrepurchased as part of the previously announced repurchase program.

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**Item 3.          Defaults Upon Senior Securities**

None

**Item 4.          Submission of Matters to a Vote ofSecurity Holders**

None

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

 

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## **SIGNATURES**

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

PENNS WOODS BANCORP, INC.

(Registrant)
| Date:  May 10, 2007 |   | /s/ Ronald A. Walko                                                       |   |
|-------------------------------|--------|---------------------------------------------------------------------------|--------|
|                          |   | Ronald A. Walko, President and Chief Executive  Officer                   |   |
|                          |   |                                                                      |   |
|                          |   |                                                                      |   |
| Date:  May 10, 2007 |   | /s/ Brian L. Knepp                                                        |   |
|                          |   | Brian L. Knepp,  Vice President of Finance (Principal  Financial Officer) |   |

 

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

 

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