** **

**UNITED STATES**

**SECURITIES AND EXCHANGE COMMISSION**

**WASHINGTON, D.C.  20549**

 

**FORM 10-Q**

 

| **x** | **Quarterly  Report pursuant to Section 13 or 15 (d) of the Securities Exchange  Act of 1934** |
|-------|----------------------------------------------------------------------------------------------------------|

 

**for the Quarterly Period Ended March 31, 2009.**

 

| **o** | **Transition  report pursuant to Section 13 or 15 (d) of the Exchange Act** |
|-------|---------------------------------------------------------------------------------------|

 

**for theTransition Period from                              to                               .**

 

**No. 0-17077**

**(Commission File Number)**

** **

**PENNS WOODS BANCORP, INC.**

(Exact name of Registrant as specified in its charter)

 

| **PENNSYLVANIA**                                                     | ** ** | **23-2226454**      |
|----------------------------------------------------------------------|------------|---------------------|
| (State or other jurisdiction of                                      |       | (I.R.S. Employer    |
| incorporation or organization)                                       |       | Identification No.) |
|                                                                 |       |                |
| **300 Market Street,  P.O. Box 967 Williamsport, Pennsylvania** | ** ** | **17703-0967**      |
| (Address of principal executive offices)                             |       | (Zip Code)          |

 

**(570) 322-1111**

Registrant’s telephone number, including area code

 

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

 

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

 

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

 

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

 

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

 

OnMay 1, 2009 there were 3,832,572 shares of the Registrant’s common stockoutstanding.

 

 

 

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**PENNSWOODS BANCORP, INC.**

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

 
| ** **                                                                                                                            | ** ** |                                                                                            | **Page  Number** |
|---------------------------------------------------------------------------------------------------------------------------------------|------------|-------------------------------------------------------------------------------------------------|------------------|
|                                                                                                                                  |       |                                                                                            |             |
| **Part I**                                                                                                                       | ** ** | **Financial  Information**                                                                      | ** **       |
| ** **                                                                                                                            | ** ** | ** **                                                                                      | ** **       |
| **Item 1.**                                                                                                                           | ** ** | **Financial  Statements**                                                                       | ** **       |
| ** **                                                                                                                            | ** ** | ** **                                                                                      | ** **       |
| Consolidated  Balance Sheet (unaudited) as of March 31, 2009 and December 31,  2008                                         | 3          |
|                                                                                                                                  |       |                                                                                            |             |
| Consolidated Statement  of Income (unaudited) for the Three Months ended March 31, 2009 and 2008                                 | 4          |
|                                                                                                                                  |       |                                                                                            |             |
| Consolidated  Statement of Changes in Shareholders’ Equity (unaudited) for the Three Months  ended  March 31, 2009 and 2008 | 5          |
|                                                                                                                                  |       |                                                                                            |             |
| Consolidated Statement  of Comprehensive Income (unaudited) for the Three Months ended March 31,  2009 and 2008                  | 5          |
|                                                                                                                                  |       |                                                                                            |             |
| Consolidated Statement  of Cash Flows (unaudited) for the Three Months ended March 31, 2009 and  2008                            | 6          |
|                                                                                                                                  |       |                                                                                            |             |
| Notes to Consolidated  Financial Statements (unaudited)                                                                               | 7          |
|                                                                                                                                  |       |                                                                                            |             |
| **Item 2.**                                                                                                                           | ** ** | **Management’s  Discussion and Analysis of Financial Condition and Results of Operations** | **14**           |
| **Item 3.**                                                                                                                           | ** ** | **Quantitative and  Qualitative Disclosures About Market Risk**                                 | **29**           |
| **Item 4.**                                                                                                                           | ** ** | **Controls and  Procedures**                                                                    | **29**           |
| ** **                                                                                                                            | ** ** | ** **                                                                                      | ** **       |
| **Part II**                                                                                                                      | ** ** | **Other  Information**                                                                          | ** **       |
| ** **                                                                                                                            | ** ** | ** **                                                                                      | ** **       |
| **Item  1.**                                                                                                                          | ** ** | **Legal  Proceedings**                                                                          | 30               |
| **Item  1A.**                                                                                                                         | ** ** | **Risk  Factors**                                                                               | 30               |
| **Item  2.**                                                                                                                          | ** ** | **Unregistered  Sales of Equity Securities and Use of Proceeds**                                | 30               |
| **Item  3.**                                                                                                                          | ** ** | **Defaults  Upon Senior Securities**                                                            | 30               |
| **Item  4.**                                                                                                                          | ** ** | **Submission  of Matters to a Vote of Security Holders**                                        | 30               |
| **Item  5.**                                                                                                                          | ** ** | **Other  Information**                                                                          | 30               |
| **Item  6.**                                                                                                                          | ** ** | **Exhibits**                                                                                    | 31               |
| **Signatures**                                                                                                                        |       | 32                                                                                              |
| **Exhibit Index  and Exhibits**                                                                                                  | 33         |
|                                                                                                                                       |            |                                                                                                 |                  |  |

 

2

----

 

**Part I.  FINANCIAL INFORMATION**

 

**Item 1.  Financial Statements**

PENNS WOODSBANCORP, INC.

CONSOLIDATEDBALANCE SHEET

(UNAUDITED)

 
| ** **                                                                                           | ** ** | **March 31,** | ** ** | **December 31,** | ** ** |
|------------------------------------------------------------------------------------------------------|------------|--------------------|------------|-----------------------|------------|
| **(In Thousands, Except Share Data)**                                            | ** ** | **2009**           | ** ** | **2008**              | ** ** |
|                                                                                                 |       |               |       |                  |       |
| ASSETS                                                                                               |       |               |       |                  |       |
| Noninterest-bearing  balances                                                                        |       | $                  | 12,886     |                  | $          | 16,563 |   |
| Interest-bearing  deposits in other financial institutions                                           |       | 23                 |       | 18                    |       |
| Total cash and  cash equivalents                                                                     |       | 12,909             |       | 16,581                |       |
|                                                                                                 |       |               |       |                  |       |
| Investment  securities, available for sale, at fair value                                            |       | 201,651            |       | 208,251               |       |
| Investment  securities held to maturity (fair value of $111 and $136)                                |       | 110                |       | 135                   |       |
| Loans held for  sale                                                                                 |       | 2,514              |       | 3,622                 |       |
| Loans                                                                                                |       | 387,192            |       | 381,478               |       |
| Less: Allowance  for loan losses                                                                     |       | 4,441              |       | 4,356                 |       |
| Loans, net                                                                                           |       | 382,751            |       | 377,122               |       |
| Premises and  equipment, net                                                                         |       | 7,733              |       | 7,865                 |       |
| Accrued interest  receivable                                                                         |       | 3,370              |       | 3,614                 |       |
| Bank-owned life  insurance                                                                           |       | 14,750             |       | 14,546                |       |
| Investment in  limited partnerships                                                                  |       | 5,286              |       | 4,727                 |       |
| Goodwill                                                                                             |       | 3,032              |       | 3,032                 |       |
| Deferred tax  asset                                                                                  |       | 12,614             |       | 10,879                |       |
| Other assets                                                                                         |       | 2,892              |       | 2,429                 |       |
| TOTAL ASSETS                                                                                         |       | $                  | 649,612    |                  | $          | 652,803 |   |
|                                                                                                 |       |               |       |                  |       |
| LIABILITIES                                                                                          |       |               |       |                  |       |
| Interest-bearing  deposits                                                                           |       | $                  | 376,844    |                  | $          | 345,333 |   |
| Noninterest-bearing  deposits                                                                        |       | 71,963             |       | 76,035                |       |
| Total deposits                                                                                       |       | 448,807            |       | 421,368               |       |
|                                                                                                 |       |               |       |                  |       |
| Short-term  borrowings                                                                               |       | 45,268             |       | 73,946                |       |
| Long-term  borrowings, Federal Home Loan Bank (FHLB)                                                 |       | 86,778             |       | 86,778                |       |
| Accrued interest  payable                                                                            |       | 1,193              |       | 1,317                 |       |
| Other  liabilities                                                                                   |       | 8,982              |       | 8,367                 |       |
| TOTAL  LIABILITIES                                                                                   |       | 591,028            |       | 591,776               |       |
|                                                                                                 |       |               |       |                  |       |
| SHAREHOLDERS’  EQUITY                                                                           |       |               |       |                  |       |
| Common stock,  par value $8.33, 10,000,000 shares authorized; 4,011,251 and 4,010,528 shares  issued |       | 33,427             |       | 33,421                |       |
| Additional  paid-in capital                                                                          |       | 17,970             |       | 17,959                |       |
| Retained  earnings                                                                                   |       | 27,254             |       | 28,177                |       |
| Accumulated  other comprehensive loss:                                                               |       |               |       |                  |       |
| Net unrealized  loss on available for sale securities                                                |       | (10,023            | )          | (8,486                | )          |
| Defined benefit  plan                                                                                |       | (3,780             | )          | (3,780                | )          |
| Less:  Treasury stock at cost, 179,028 and 179,028  shares                                      |       | (6,264             | )          | (6,264                | )          |
| TOTAL  SHAREHOLDERS’ EQUITY                                                                     |       | 58,584             |       | 61,027                |       |
| TOTAL  LIABILITIES AND SHAREHOLDERS’ EQUITY                                                     |       | $                  | 649,612    |                  | $          | 652,803 |   |

 

See accompanyingnotes to the unaudited consolidated financial statements.

 

3

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PENNS WOODSBANCORP, INC.

CONSOLIDATEDSTATEMENT OF INCOME

(UNAUDITED)

 
| ** **                                                         | ** ** | **Three Months Ended  March 31,** | ** ** |
|--------------------------------------------------------------------|------------|--------------------------------------------------|------------|
| **(In Thousands, Except Per Share Data)** | ** ** | **2009**                                         | ** ** | **2008** | ** ** |
|                                                               |       |                                             |       |   |   |
| INTEREST AND  DIVIDEND INCOME                                      |       |                                             |       |   |   |
| Loans including  fees                                              |       | $                                                | 6,219      |   | $ | 6,380 |   |
| Investment  Securities:                                            |       |                                             |       |   |   |
| Taxable                                                            |       | 1,363                                            |       | 1,190 |   |
| Tax-exempt                                                         |       | 1,246                                            |       | 1,226 |   |
| Dividend and  other interest income                                |       | 89                                               |       | 252 |   |
| TOTAL INTEREST  AND DIVIDEND INCOME                                |       | 8,917                                            |       | 9,048 |   |
|                                                               |       |                                             |       |   |   |
| INTEREST EXPENSE                                                   |       |                                             |       |   |   |
| Deposits                                                           |       | 2,005                                            |       | 2,541 |   |
| Short-term  borrowings                                             |       | 158                                              |       | 429 |   |
| Long-term  borrowings, FHLB                                        |       | 917                                              |       | 1,197 |   |
| TOTAL INTEREST  EXPENSE                                            |       | 3,080                                            |       | 4,167 |   |
|                                                               |       |                                             |       |   |   |
| NET INTEREST  INCOME                                               |       | 5,837                                            |       | 4,881 |   |
|                                                               |       |                                             |       |   |   |
| PROVISION FOR  LOAN LOSSES                                         |       | 126                                              |       | 60 |   |
|                                                               |       |                                             |       |   |   |
| NET INTEREST  INCOME AFTER PROVISION FOR LOAN LOSSES               |       | 5,711                                            |       | 4,821 |   |
|                                                               |       |                                             |       |   |   |
| NON-INTEREST  INCOME                                               |       |                                             |       |   |   |
| Service charges                                                    |       | 525                                              |       | 570 |   |
| Securities  (losses) gains, net                                    |       | (2,369                                           | )          | 38 |   |
| Bank-owned life  insurance                                         |       | 162                                              |       | 155 |   |
| Gain on sale of  loans                                             |       | 118                                              |       | 152 |   |
| Insurance  commissions                                             |       | 354                                              |       | 580 |   |
| Other                                                              |       | 434                                              |       | 419 |   |
| TOTAL  NON-INTEREST INCOME                                         |       | (776                                             | )          | 1,914 |   |
|                                                               |       |                                             |       |   |   |
| NON-INTEREST  EXPENSE                                              |       |                                             |       |   |   |
| Salaries and  employee benefits                                    |       | 2,482                                            |       | 2,451 |   |
| Occupancy, net                                                     |       | 339                                              |       | 338 |   |
| Furniture and  equipment                                           |       | 307                                              |       | 285 |   |
| Pennsylvania  shares tax                                           |       | 171                                              |       | 105 |   |
| Amortization of  investment in limited partnerships                |       | 142                                              |       | 178 |   |
| Other                                                              |       | 1,204                                            |       | 1,088 |   |
| TOTAL  NON-INTEREST EXPENSE                                        |       | 4,645                                            |       | 4,445 |   |
|                                                               |       |                                             |       |   |   |
| INCOME BEFORE  INCOME TAX (BENEFIT) PROVISION                      |       | 290                                              |       | 2,290 |   |
| INCOME TAX  (BENEFIT) PROVISION                                    |       | (549                                             | )          | 159 |   |
| NET INCOME                                                         |       | $                                                | 839        |   | $ | 2,131 |   |
|                                                               |       |                                             |       |   |   |
| EARNINGS PER  SHARE - BASIC                                        |       | $                                                | 0.22       |   | $ | 0.55 |   |
|                                                               |       |                                             |       |   |   |
| EARNINGS PER  SHARE - DILUTED                                      |       | $                                                | 0.22       |   | $ | 0.55 |   |
|                                                               |       |                                             |       |   |   |
| WEIGHTED AVERAGE  SHARES OUTSTANDING - BASIC                       |       | 3,831,747                                        |       | 3,874,741 |   |
|                                                               |       |                                             |       |   |   |
| WEIGHTED AVERAGE  SHARES OUTSTANDING - DILUTED                     |       | 3,831,747                                        |       | 3,874,931 |   |
|                                                               |       |                                             |       |   |   |
| DIVIDENDS PER  SHARE                                               |       | $                                                | 0.46       |   | $ | 0.46 |   |

 

See accompanyingnotes to the unaudited consolidated financial statements.

 

4

----

 

PENNS WOODSBANCORP, INC.

CONSOLIDATEDSTATEMENT OF CHANGES IN SHAREHOLDERS’ EQUITY

(UNAUDITED)

 
| ** **                                                         | ** ** | ** ** | ** ** | ** **     | ** ** | ** **   | ** ** | ** **        | ** ** | **ACCUMULATED** | ** ** | ** **             | ** ** | ** ** | ** ** |
|--------------------------------------------------------------------|------------|------------|------------|----------------|------------|--------------|------------|-------------------|------------|-----------------|------------|------------------------|------------|------------|------------|
| ** **                                                         | ** ** | **COMMON** | ** ** | **ADDITIONAL** | ** ** | ** **   | ** ** | **OTHER**         | ** ** | ** **      | ** ** | **TOTAL**              | ** ** |
| ** **                                                         | ** ** | **STOCK**  | ** ** | **PAID-IN**    | ** ** | **RETAINED** | ** ** | **COMPREHENSIVE** | ** ** | **TREASURY**    | ** ** | **SHAREHOLDERS’** | ** ** |
| **(In Thousands, Except Per Share Data)** | ** ** | **SHARES** | ** ** | **AMOUNT**     | ** ** | **CAPITAL**  | ** ** | **EARNINGS**      | ** ** | **LOSS**        | ** ** | **STOCK**              | ** ** | **EQUITY** | ** ** |
| Balance,  December 31, 2008                                   |       | 4,010,528  |       | $              | 33,421     |         | $          | 17,959            |       | $               | 28,177     |                   | $          | (12,266    | )          | $ | (6,264 | ) | $ | 61,027 |   |
|                                                               |       |       |       |           |       |         |       |              |       |            |       |                   |       |       |       |
| Comprehensive  loss:                                               |       |       |       |           |       |         |       |              |       |            |       |                   |       |       |       |
| Net income                                                         |       |       |       |           |       |         |       | 839               |       |            |       |                   |       | 839        |       |
| Other  comprehensive loss                                          |       |       |       |           |       |         |       |              |       | (1,537          | )          |                   |       | (1,537     | )          |
| Dividends declared  ($0.46 per share)                              |       |       |       |           |       |         |       | (1,762            | )          |            |       |                   |       | (1,762     | )          |
| Common shares  issued for employee stock purchase plan             |       | 723        |       | 6              |       | 11           |       |              |       |            |       |                   |       | 17         |       |
| Balance,  March 31, 2009                                      |       | 4,011,251  |       | $              | 33,427     |         | $          | 17,970            |       | $               | 27,254     |                   | $          | (13,803    | )          | $ | (6,264 | ) | $ | 58,584 |   |

 
| ** **                                                             | ** ** | ** ** | ** ** | ** **     | ** ** | ** **   | ** ** | ** **        | ** ** | **ACCUMULATED** | ** ** | ** **             | ** ** | ** ** | ** ** |
|------------------------------------------------------------------------|------------|------------|------------|----------------|------------|--------------|------------|-------------------|------------|-----------------|------------|------------------------|------------|------------|------------|
| ** **                                                             | ** ** | **COMMON** | ** ** | **ADDITIONAL** | ** ** | ** **   | ** ** | **OTHER**         | ** ** | ** **      | ** ** | **TOTAL**              | ** ** |
| ** **                                                             | ** ** | **STOCK**  | ** ** | **PAID-IN**    | ** ** | **RETAINED** | ** ** | **COMPREHENSIVE** | ** ** | **TREASURY**    | ** ** | **SHAREHOLDERS’** | ** ** |
| **(In Thousands, Except Per Share Data)**     | ** ** | **SHARES** | ** ** | **AMOUNT**     | ** ** | **CAPITAL**  | ** ** | **EARNINGS**      | ** ** | **LOSS**        | ** ** | **STOCK**              | ** ** | **EQUITY** | ** ** |
| Balance,  December 31, 2007                                       |       | 4,006,934  |       | $              | 33,391     |         | $          | 17,888            |       | $               | 27,707     |                   | $          | (3,534     | )          | $ | (4,893 | ) | $ | 70,559 |   |
|                                                                   |       |       |       |           |       |         |       |              |       |            |       |                   |       |       |       |
| Cumulative effect  of change in accounting for postretirement benefits |       |       |       |           |       |         |       | (437              | )          |            |       |                   |       | (437       | )          |
| Comprehensive  income:                                                 |       |       |       |           |       |         |       |              |       |            |       |                   |       |       |       |
| Net income                                                             |       |       |       |           |       |         |       | 2,131             |       |            |       |                   |       | 2,131      |       |
| Other  comprehensive loss                                              |       |       |       |           |       |         |       |              |       | (1,207          | )          |                   |       | (1,207     | )          |
| Dividends  declared, ($0.46 per share)                                 |       |       |       |           |       |         |       | (1,781            | )          |            |       |                   |       | (1,781     | )          |
| Common shares  issued for employee stock purchase plan                 |       | 718        |       | 6              |       | 16           |       |              |       |            |       |                   |       | 22         |       |
| Purchase of  treasury stock (4,297 shares)                             |       |       |       |           |       |         |       |              |       |            |       | (133                   | )          | (133       | )          |
| Balance,  March 31, 2008                                          |       | 4,007,652  |       | $              | 33,397     |         | $          | 17,904            |       | $               | 27,620     |                   | $          | (4,741     | )          | $ | (5,026 | ) | $ | 69,154 |   |

 

PENNS WOODSBANCORP, INC.

CONSOLIDATEDSTATEMENT OF COMPREHENSIVE INCOME

(UNAUDITED)

 
| ** **                                                                       | ** ** | **Three Months Ended March 31,** | ** ** |
|----------------------------------------------------------------------------------|------------|------------------------------------------------------|------------|
| **(In Thousands)**                                                          | ** ** | **2009**                                             | ** ** | **2008** | ** ** |
|                                                                             |       |                                                 |       |   |   |   |   |   |   |
| Net Income                                                                       |       |                                                 |       | $ | 839 |   |   |   | $ | 2,131 |   |
| Other  comprehensive loss:                                                       |       |                                                 |       |   |   |   |   |   |   |
| Change in net  unrealized losses on available for sale securities                |       | (4,697                                               | )          |   |   | (1,791 | ) |   |   |
| Less:  Reclassification adjustment for net (losses) gains included in net income |       | (2,369                                               | )          |   |   | 38 |   |   |   |
| Other  comprehensive loss before tax benefit                                     |       |                                                 |       | (2,328 | ) |   |   | (1,829 | ) |
| Income tax  benefit related to other comprehensive loss                          |       |                                                 |       | (791 | ) |   |   | (622 | ) |
| Other  comprehensive loss, net of tax                                            |       |                                                 |       | (1,537 | ) |   |   | (1,207 | ) |
| Comprehensive  (loss) income                                                     |       |                                                 |       | $ | (698 | ) |   |   | $ | 924 |   |

 

See accompanyingnotes to the unaudited consolidated financial statements.

 

5

----

 

PENNS WOODSBANCORP, INC.

CONSOLIDATEDSTATEMENT OF CASH FLOWS

(UNAUDITED)

 
| ** **                                                                         | ** ** | **Three Months Ended  March 31,** | ** ** |
|------------------------------------------------------------------------------------|------------|--------------------------------------------------|------------|
| **(In Thousands)**                                                            | ** ** | **2009**                                         | ** ** | **2008** | ** ** |
|                                                                               |       |                                             |       |   |   |
| OPERATING  ACTIVITIES                                                              |       |                                             |       |   |   |
| Net Income                                                                         |       | $                                                | 839        |   | $ | 2,131 |   |
| Adjustments to  reconcile net income to net cash provided by operating activities: |       |                                             |       |   |   |
| Depreciation and  amortization                                                     |       | 181                                              |       | 157 |   |
| Provision for  loan losses                                                         |       | 126                                              |       | 60 |   |
| Accretion and  amortization of investment security discounts and premiums          |       | (23                                              | )          | (284 | ) |
| Securities  losses (gains), net                                                    |       | 2,369                                            |       | (38 | ) |
| Originations of  loans held for sale                                               |       | (3,797                                           | )          | (6,400 | ) |
| Proceeds of loans  held for sale                                                   |       | 5,023                                            |       | 7,512 |   |
| Gain on sale of  loans                                                             |       | (118                                             | )          | (152 | ) |
| Increases in  bank-owned life insurance                                            |       | (162                                             | )          | (155 | ) |
| Other, net                                                                         |       | (398                                             | )          | (702 | ) |
| Net cash  provided by operating activities                                         |       | 4,040                                            |       | 2,129 |   |
| INVESTING  ACTIVITIES                                                              |       |                                             |       |   |   |
| Investment securities  available for sale:                                         |       |                                             |       |   |   |
| Proceeds from  sales                                                               |       | 17                                               |       | 17,737 |   |
| Proceeds from  calls and maturities                                                |       | 2,178                                            |       | 1,887 |   |
| Purchases                                                                          |       | (100                                             | )          | (23,912 | ) |
| Investment  securities held to maturity:                                           |       |                                             |       |   |   |
| Proceeds from  calls and maturities                                                |       | 25                                               |       | — |   |
| Net (increase)  decrease in loans                                                  |       | (5,886                                           | )          | 2,833 |   |
| Acquisition of  bank premises and equipment                                        |       | (49                                              | )          | (764 | ) |
| Proceeds from  the sale of foreclosed assets                                       |       | —                                           |       | 11 |   |
| Purchase of  bank-owned life insurance                                             |       | (42                                              | )          | (679 | ) |
| Investment in  limited partnership                                                 |       | (701                                             | )          | — |   |
| Proceeds from  redemption of regulatory stock                                      |       | —                                           |       | 1,161 |   |
| Purchases of  regulatory stock                                                     |       | (170                                             | )          | (1,446 | ) |
| Net cash used  for investing activities                                            |       | (4,728                                           | )          | (3,172 | ) |
| FINANCING  ACTIVITIES                                                              |       |                                             |       |   |   |
| Net increase in  interest-bearing deposits                                         |       | 31,511                                           |       | 10,112 |   |
| Net decrease in  noninterest-bearing deposits                                      |       | (4,072                                           | )          | (3,009 | ) |
| Repayment of  long-term borrowings, FHLB                                           |       | —                                           |       | (9,600 | ) |
| Net (decrease)  increase in short-term borrowings                                  |       | (28,678                                          | )          | 6,451 |   |
| Dividends paid                                                                     |       | (1,762                                           | )          | (1,781 | ) |
| Issuance of  common stock                                                          |       | 17                                               |       | 22 |   |
| Purchase of  treasury stock                                                        |       | —                                           |       | (133 | ) |
| Net cash (used  for) provided by financing activities                              |       | (2,984                                           | )          | 2,062 |   |
| NET (DECREASE)  INCREASE IN CASH AND CASH EQUIVALENTS                              |       | (3,672                                           | )          | 1,019 |   |
| CASH AND CASH  EQUIVALENTS, BEGINNING                                              |       | 16,581                                           |       | 15,433 |   |
| CASH AND CASH  EQUIVALENTS, ENDING                                                 |       | $                                                | 12,909     |   | $ | 16,452 |   |
|                                                                               |       |                                             |       |   |   |
| SUPPLEMENTAL  DISCLOSURES OF CASH FLOW INFORMATION                                 |       |                                             |       |   |   |
|                                                                               |       |                                             |       |   |   |
| Interest paid                                                                      |       | $                                                | 3,204      |   | $ | 4,285 |   |
| Income taxes  paid                                                                 |       | 150                                              |       | 150 |   |

 

See accompanyingnotes to the unaudited consolidated financial statements.

 

6

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# ** **

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

**NOTES TO**

**CONSOLIDATED FINANCIAL STATEMENTS**

**(Unaudited)**

 

# **Note 1.  Basis of Presentation**

# ** **

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

# ** **

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

 

Theaccounting policies followed in the presentation of interim financial resultsare the same as those followed on an annual basis.  These policies arepresented on pages 38 through 44 of the Annual Report on Form 10-Kfor the year ended December 31, 2008.

 

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

 

**Note 2. RecentAccounting Pronouncements**

** **

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

 

7

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

 

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

 

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

 

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

 

**Note 3. Per Share Data**

 

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

 

8

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| ** **                                                                                                | ** ** | **Three Months Ended March 31,** | ** ** |
|-----------------------------------------------------------------------------------------------------------|------------|------------------------------------------------------|------------|
| ** **                                                                                                | ** ** | **2009**                                             | ** ** | **2008** | ** ** |
|                                                                                                      |       |                                                 |       |   |   |
| Weighted average  common shares issued                                                                    |       | 4,010,775                                            |       | 4,007,176 |   |
|                                                                                                      |       |                                                 |       |   |   |
| Average treasury  stock shares                                                                            |       | (179,028                                             | )          | (132,435 | ) |
|                                                                                                      |       |                                                 |       |   |   |
| Weighted average  common shares andcommon stock equivalents used to calculate basic  earnings per share   |       | 3,831,747                                            |       | 3,874,741 |   |
|                                                                                                      |       |                                                 |       |   |   |
| Additional  common stock equivalents(stock options) used to calculate diluted earnings  per share         |       | —                                               |       | 190 |   |
|                                                                                                      |       |                                                 |       |   |   |
| Weighted average  common shares andcommon stock equivalents used to calculate diluted  earnings per share |       | 3,831,747                                            |       | 3,874,931 |   |

 

Options to purchase 1,980 shares of common stock wereoutstanding during the three months ended March 31, 2009 but were notincluded in the computation of diluted earnings per share as they wereanti-dilutive due to the strike prices range of $24.72 to $31.82 being greaterthan the average market price of $24.62 for the three months ended March 31,2009.  Options to purchase 8,273 sharesof common stock were outstanding during the three months ended March 31,2008 but were not included in the computation of diluted earnings per share asthey were anti-dilutive due to the strike price being greater than the averagemarket price for the three months ended March 31, 2008.

 

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

 

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

 

The following sets forth the components of the netperiodic benefit cost of the domestic non-contributory defined benefit plan forthe three months ended March 31, 2009 and 2008, respectively:

 

9

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| ** **                             | ** ** | **Three Months Ended  March 31,** | ** ** |
|----------------------------------------|------------|--------------------------------------------------|------------|
| **(In Thousands)**                | ** ** | **2009**                                         | ** ** | **2008** | ** ** |
|                                   |       |                                             |       |   |   |
| Service cost                           |       | $                                                | 136        |   | $ | 137 |   |
| Interest cost                          |       | 170                                              |       | 152 |   |
| Expected return  on plan assets        |       | (127                                             | )          | (157 | ) |
| Amortization of  transition obligation |       | (1                                               | )          | (1 | ) |
| Amortization of  prior service cost    |       | 6                                                |       | 6 |   |
| Amortization of  net loss              |       | 85                                               |       | 14 |   |
| Net periodic  cost                     |       | $                                                | 269        |   | $ | 151 |   |

 

**Employer Contributions**

** **

The Company previously disclosed in its consolidatedfinancial statements, included in the Annual Report on Form 10-K for theyear ended December 31, 2008, that it expected to contribute a minimum of$325,000 to its defined benefit plan in 2009.  As of March 31, 2009,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.

 

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

 
| ** **                    | ** ** | **March 31,** | ** ** | **December 31,** | ** ** |
|-------------------------------|------------|--------------------|------------|-----------------------|------------|
| **(In Thousands)**       | ** ** | **2009**           | ** ** | **2008**              | ** ** |
| Commitments to  extend credit |       | $                  | 84,833     |                  | $          | 85,871 |   |
| Standby letters  of credit    |       | 883                |       | 841                   |       |
|                               |            |                    |            |                       |            |  |  |

 

10

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# ** **

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

# ** **

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

# ** **

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

# ** **

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

 

# **Note 7.  Employee Stock PurchasePlan**

# ** **

EffectiveApril 26, 2006, the Company implemented the Penns Woods Bancorp, Inc.2006 Employee Stock Purchase Plan (“Plan”). The Plan is intended to encourageemployee participation in the ownership and economic progress of the Company.The Plan allows for up to 1,000,000 shares to be purchased by employees.  The purchase price of the shares is 95% ofmarket value with an employee eligible to purchase up to the lesser of 15% ofbase compensation or $12,000 in market value annually.  During the three months ended March 31,2009 and 2008, there were 723 and 718 shares issued under the plan,respectively.

 

# **Note 8.  Fair Value Measurements**

# ** **

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

 

11

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

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

 

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

 
| ** **                                 | ** ** | **March 31, 2009** | ** ** |
|--------------------------------------------|------------|------------------------------|------------|
| **(In Thousands)**                    | ** ** | **Level I**             | ** ** | **Level II** | ** ** | **Level III** | ** ** | **Total** | ** ** |
| Assets Measured  on a Recurring Basis:     |       |                         |       |   |   |   |   |   |   |
| Investment  Securities, available-for-sale |       | $                            | 11,339     |   | $ | 190,312 |   | $ | — |   | $ | 201,651 |   |
|                                            |            |                              |            |  |  |  |  |  |  |  |  |  |  |

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

 

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

 
| ** **                                 | ** ** | **March 31, 2009** | ** ** |
|--------------------------------------------|------------|------------------------------|------------|
| **(In Thousands)**                    | ** ** | **Level I**             | ** ** | **Level II** | ** ** | **Level III** | ** ** | **Total** | ** ** |
| Assets Measured  on a Non-recurring Basis: |       |                         |       |   |   |   |   |   |   |
| Impaired Loans                             |       | $                            | —     |   | $ | 6,001 |   | $ | — |   | $ | 6,001 |   |
|                                            |            |                              |            |  |  |  |  |  |  |  |  |  |  |

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

 

12

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**CAUTIONARYSTATEMENT FOR PURPOSES OF THE PRIVATE**

**SECURITIESLITIGATION REFORM ACT OF 1995**

 

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

 

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

 

13

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

 

# **EARNINGS SUMMARY**

# ** **

**Comparisonof the Three Months Ended March 31, 2009 and 2008**

 

**SummaryResults**

 

Netincome for the three months ended March 31, 2009 was $839,000 compared to$2,131,000 for the same period of 2008 as after-tax securities losses increased$1,589,000 (from a gain of $25,000 to a loss of $1,564,000).  Included within the change in after-taxsecurities losses was an other than temporary impairment charge relating tocertain equity securities held in the investment portfolio of $2,333,000. Basicand diluted earnings per share for the three months ended March 31, 2009were $0.22 compared to $0.55 for the three months ended March 31,2008.  Return on average assets andreturn on average equity were 0.52% and 5.64% for the three months ended March 31,2009 compared to 1.36% and 12.01% for the corresponding period of 2008.  Net income from core operations (“operatingearnings”) increased 14.1% to $2,403,000 for the three months ended March 31,2009 compared to $2,106,000 for the same period of 2008.  Operating earnings per share for the threemonths ended March 31, 2009 increased 16.7% to $0.63 basic and dilutivecompared to $0.54 basic and dilutive for the three months ended March 31,2008.

 

(Management uses thenon-GAAP measure of net income from core operations in its analysis of theCompany’s performance.  This measure, asused by the Company, adjusts net income by excluding significant gains orlosses 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 netincome adjusted to exclude after-tax net securities gains or losses.  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.)

 

**InterestAnd Dividend Income**

 

Interestand dividend income for the three months ended March 31, 2009 decreased$131,000 to $8,917,000 compared to $9,048,000 for the same period of 2008.  The decrease in interest income was theresult of a decline in loan interest of $161,000 offset by an increase ininvestment securities income of $30,000. The decline in loan interest is the result of the low interest rateenvironment that has existed over the past year.  This has caused the interest rate of newloans to be at a lower rate, resulting in a 56 basis point (“bp”) decline inloan portfolio yield.  Dividend incomedecreased as a direct result of the current status of the economy that hascaused many of the equity holdings in our portfolio to decrease theirdividend.  In addition, the Federal 

 

14

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HomeLoan Bank of Pittsburgh (“FHLB”) has suspended payment of dividends on sharesof its common stock, which has resulted in a decrease of approximately $75,000in dividend income.  Offsetting thedecreased dividend income was an increase in taxable investment securitiesincome of $173,000.  On a taxableequivalent basis, the decline in total interest income was limited to$73,000.  Average loan portfolio growthof $27,202,000 limited the impact of the decline in loan portfolio yield.  In addition, the investment portfolio yieldincreased 43 bp resulting in increased taxable equivalent income of $41,000.

 

Interestand dividend income composition for the three months ended March 31, 2009and 2008 was as follows:

 
| ** **                          | ** ** | **For The Three Months Ended** | ** ** |
|-------------------------------------|------------|----------------------------------------------------|------------|
| ** **                          | ** ** | **March 31, 2009**                       | ** ** | **March 31, 2008** | ** ** | **Change** | ** ** |
| **(In Thousands)**             | ** ** | **Amount**                                         | ** ** | **% Total** | ** ** | **Amount** | ** ** | **% Total** | ** ** | **Amount** | ** ** | **%** | ** ** |
| Loans including  fees               |       | $                                                  | 6,219      |   | 69.7 | % | $ | 6,380 |   | 70.5 | % | $ | (161 | ) | (2.5 | )% |
| Investment  securities:             |       |                                               |       |   |   |   |   |   |   |   |   |   |   |
| Taxable                             |       | 1,363                                              |       | 15.3 |   | 1,190 |   | 13.2 |   | 173 |   | 14.5 |   |
| Tax-exempt                          |       | 1,246                                              |       | 14.0 |   | 1,226 |   | 13.5 |   | 20 |   | 1.6 |   |
| Dividend and  other interest income |       | 89                                                 |       | 1.0 |   | 252 |   | 2.8 |   | (163 | ) | (64.7 | ) |
| Total interest  and dividend income |       | $                                                  | 8,917      |   | 100.0 | % | $ | 9,048 |   | 100.0 | % | $ | (131 | ) | (1.4 | )% |

 

**InterestExpense**

 

Interestexpense for the three months ended March 31, 2009 decreased $1,087,000 to$3,080,000 compared to $4,167,000 for the same period of 2008.  The decreased expense of $536,000 associatedwith deposits is primarily the result of a reduction of 138 bp in rate paid ontime deposits.  Factors that led to therate decreases include, but are not limited to, Federal Open Market Committee (“FOMC”)interest rate actions and campaigns conducted by the Company during the pasttwo years to attract 12 month or shorter maturity CDs resulting in an increasedrepricing frequency.  Short-termborrowings interest expense decreased $271,000 as the increase in averagebalance of $10,374,000 was countered by a decrease in the rate paid of 231 bpdue to the FOMC rate actions and overall decline in the treasury securitymarket.  Long-term borrowing interestexpense decreased $280,000 as the average balance of such borrowings decreased$18,756,000, while the average rate decreased 26 bp to 4.23%.  The change in average balance and rate isreflective of $29,600,000 in long-term borrowing maturities during the first halfof 2008 at an average rate of 4.77% offset by the acquisition of $10,000,000 inlong-term borrowings at a rate of 3.18% during the third quarter of 2008.

 

Interestexpense composition for the three months ended March 31, 2009 and 2008 wasas follows:

 

15

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| ** **                  | ** ** | **For The Three Months Ended** | ** ** |
|-----------------------------|------------|----------------------------------------------------|------------|
| ** **                  | ** ** | **March 31, 2009**                       | ** ** | **March 31, 2008** | ** ** | **Change** | ** ** |
| **(In Thousands)**     | ** ** | **Amount**                                         | ** ** | **% Total** | ** ** | **Amount** | ** ** | **% Total** | ** ** | **Amount** | ** ** | **%** | ** ** |
| Deposits                    |       | $                                                  | 2,005      |   | 65.1 | % | $ | 2,541 |   | 61.0 | % | $ | (536 | ) | (21.1 | )% |
| Short-term  borrowings      |       | 158                                                |       | 5.1 |   | 429 |   | 10.3 |   | (271 | ) | (63.2 | ) |
| Long-term  borrowings, FHLB |       | 917                                                |       | 29.8 |   | 1,197 |   | 28.7 |   | (280 | ) | (23.4 | ) |
| Total interest  expense     |       | $                                                  | 3,080      |   | 100.0 | % | $ | 4,167 |   | 100.0 | % | $ | (1,087 | ) | (26.1 | )% |

 

**Net Interest Margin**

** **

Thenet interest margin (“NIM”) for the three months ended March 31, 2009 was4.47% compared to 3.87% for the corresponding period of 2008.  The increase in the NIM was driven by a 105bp decline in the rate paid on interest bearing liabilities that more thancompensated for a 19 bp decline in the yield on earning assets.  The decrease in earning asset yield is due tothe impact on the loan portfolio of the current low rate environment offset inpart by an increase in yield for the investment portfolio.  The increase in the investment portfolioyield was driven by a strategic initiative to increase tax equivalent netinterest income by purchasing tax-exempt and taxable municipal bonds inanticipation of the decreasing rate environment that has continued to date.  The decrease in the cost of interest bearingliabilities to 2.45% from 3.50% was driven primarily by a reduction in the ratepaid on time deposits of 138 bp and total borrowings of 121 bp.  The reduction in the rate paid on time depositswas the result of a shortening of the time deposit portfolio that has resultedin an increasing repricing frequency during this period of decreasing rates.

 

Thefollowing is a schedule of average balances and associated yields for the threemonths ended March 31, 2009 and 2008:

 

16

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| ** **                                       | ** ** | **AVERAGE  BALANCES AND INTEREST RATES**                   | ** ** |
|--------------------------------------------------|------------|------------------------------------------------------------|------------|
| ** **                                       | ** ** | **Three Months Ended  March 31, 2009** | ** ** | **Three Months Ended  March 31, 2008** | ** ** |
| **(In Thousands)**                               | ** ** | **Average Balance**                                   | ** ** | **Interest** | ** ** | **Average Rate** | ** ** | **Average Balance** | ** ** | **Interest** | ** ** | **Average Rate** | ** ** |
| Assets:                                          |       |                                                       |       |   |   |   |   |   |   |   |   |   |   |
| Tax-exempt loans                                 |       | $                                                          | 16,052     |   | $ | 265 |   | 6.70 | % | $ | 8,013 |   | $ | 126 |   | 6.32 | % |
| All other loans                                  |       | 373,878                                                    |       | 6,044 |   | 6.56 | % | 354,715 |   | 6,297 |   | 7.14 | % |
| Total loans                                      |       | 389,930                                                    |       | 6,309 |   | 6.56 | % | 362,728 |   | 6,423 |   | 7.12 | % |
|                                             |       |                                                       |       |   |   |   |   |   |   |   |   |   |   |
| Taxable  investment securities                   |       | 101,890                                                    |       | 1,452 |   | 5.70 | % | 100,730 |   | 1,442 |   | 5.73 | % |
| Tax-exempt  investment securities                |       | 101,654                                                    |       | 1,888 |   | 7.43 | % | 114,590 |   | 1,857 |   | 6.48 | % |
| Total securities                                 |       | 203,544                                                    |       | 3,340 |   | 6.56 | % | 215,320 |   | 3,299 |   | 6.13 | % |
|                                             |       |                                                       |       |   |   |   |   |   |   |   |   |   |   |
| Interest bearing  deposits                       |       | 23                                                         |       | — |   | 0.00 | % | 38 |   | — |   | 0.00 | % |
|                                             |       |                                                       |       |   |   |   |   |   |   |   |   |   |   |
| Total  interest-earning assets                   |       | 593,497                                                    |       | 9,649 |   | 6.56 | % | 578,086 |   | 9,722 |   | 6.75 | % |
|                                             |       |                                                       |       |   |   |   |   |   |   |   |   |   |   |
| Other assets                                     |       | 55,256                                                     |       |   |   |   |   | 48,692 |   |   |   |   |   |
|                                             |       |                                                       |       |   |   |   |   |   |   |   |   |   |   |
| Total assets                                     |       | $                                                          | 648,753    |   |   |   |   |   | $ | 626,778 |   |   |   |   |   |
|                                             |       |                                                       |       |   |   |   |   |   |   |   |   |   |   |
| Liabilities:                                     |       |                                                       |       |   |   |   |   |   |   |   |   |   |   |
| Savings                                          |       | $                                                          | 59,642     |   | 78 |   | 0.53 | % | $ | 58,561 |   | 109 |   | 0.75 | % |
| Super Now  deposits                              |       | 53,890                                                     |       | 129 |   | 0.97 | % | 46,367 |   | 155 |   | 1.34 | % |
| Money market  deposits                           |       | 41,276                                                     |       | 212 |   | 2.08 | % | 23,324 |   | 127 |   | 2.18 | % |
| Time deposits                                    |       | 205,110                                                    |       | 1,586 |   | 3.14 | % | 190,927 |   | 2,150 |   | 4.52 | % |
| Total deposits                                   |       | 359,918                                                    |       | 2,005 |   | 2.26 | % | 319,179 |   | 2,541 |   | 3.20 | % |
|                                             |       |                                                       |       |   |   |   |   |   |   |   |   |   |   |
| Short-term  borrowings                           |       | 61,487                                                     |       | 158 |   | 1.03 | % | 51,113 |   | 429 |   | 3.34 | % |
| Long-term  borrowings, FHLB                      |       | 86,778                                                     |       | 917 |   | 4.23 | % | 105,534 |   | 1,197 |   | 4.49 | % |
| Total borrowings                                 |       | 148,265                                                    |       | 1,075 |   | 2.90 | % | 156,647 |   | 1,626 |   | 4.11 | % |
|                                             |       |                                                       |       |   |   |   |   |   |   |   |   |   |   |
| Total  interest-bearing liabilities              |       | 508,183                                                    |       | 3,080 |   | 2.45 | % | 475,826 |   | 4,167 |   | 3.50 | % |
|                                             |       |                                                       |       |   |   |   |   |   |   |   |   |   |   |
| Demand deposits                                  |       | 71,321                                                     |       |   |   |   |   | 70,243 |   |   |   |   |   |
| Other  liabilities                               |       | 9,760                                                      |       |   |   |   |   | 9,726 |   |   |   |   |   |
| Shareholders’  equity                       |       | 59,489                                                     |       |   |   |   |   | 70,983 |   |   |   |   |   |
| Total  liabilities and shareholders’ equity |       | $                                                          | 648,753    |   |   |   |   |   | $ | 626,778 |   |   |   |   |   |
|                                             |       |                                                       |       |   |   |   |   |   |   |   |   |   |   |
| Interest rate  spread                            |       |                                                       |       |   |   | 4.12 | % |   |   |   |   | 3.25 | % |
|                                             |       |                                                       |       |   |   |   |   |   |   |   |   |   |   |
| Net interest  income/margin                      |       |                                                       |       | $ | 6,569 |   | 4.47 | % |   |   | $ | 5,555 |   | 3.87 | % |

 

1.               Information on this table has beencalculated using average daily balance sheets to obtain average balances.

2.               Nonaccrual loans have been included withloans for the purpose of analyzing net interest earnings.

3.               Income and rates on a fully taxableequivalent basis include an adjustment for the difference between annual incomefrom tax-exempt obligations and the taxable equivalent of such income at thestandard 34% tax rate.

 

17

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# ** **

# **The following table presents theadjustment to convert net interest income to net interest income on a fullytaxable equivalent basis for the three months ended March 31, 2009 and2008.**

# ** **

| ** **                                      | ** ** | **For the Three Months Ended********March 31,** | ** ** |
|-------------------------------------------------|------------|--------------------------------------------------------------------------|------------|
| **(In Thousands)**                         | ** ** | **2009**                                                                 | ** ** | **2008** | ** ** |
|                                            |       |                                                                     |       |   |   |
| Total interest  income                          |       | $                                                                        | 8,917      |   | $ | 9,048 |   |
| Total interest  expense                         |       | 3,080                                                                    |       | 4,167 |   |
|                                            |       |                                                                     |       |   |   |
| Net interest  income                            |       | 5,837                                                                    |       | 4,881 |   |
| Tax equivalent  adjustment                      |       | 732                                                                      |       | 674 |   |
|                                            |       |                                                                     |       |   |   |
| Net interest  income (fully taxable equivalent) |       | $                                                                        | 6,569      |   | $ | 5,555 |   |

# ** **

# **The following table sets forth therespective impact that both volume and rate changes have had on net interestincome on a fully taxable equivalent basis for the three month periods ended March 31,2009 and 2008:**

 

18

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| ** **                          | ** ** | **Three Months Ended March 31,**                          | ** ** |
|-------------------------------------|------------|-------------------------------------------------------------------------------|------------|
| ** **                          | ** ** | **2009 vs 2008********Increase (Decrease)********Due to** | ** ** |
| **(In Thousands)**             | ** ** | **Volume**                                                                    | ** ** | **Rate** | ** ** | **Net** | ** ** |
| Interest income:                    |       |                                                                          |       |   |   |   |   |
| Loans,  tax-exempt                  |       | $                                                                             | 131        |   | $ | 8 |   | $ | 139 |   |
| Loans                               |       | 453                                                                           |       | (706 | ) | (253 | ) |
| Taxable  investment securities      |       | 17                                                                            |       | (7 | ) | 10 |   |
| Tax-exempt  investment securities   |       | (223                                                                          | )          | 254 |   | 31 |   |
| Interest bearing  deposits          |       | —                                                                        |       | — |   | — |   |
| Total  interest-earning assets      |       | 378                                                                           |       | (451 | ) | (73 | ) |
|                                |       |                                                                          |       |   |   |   |   |
| Interest  expense:                  |       |                                                                          |       |   |   |   |   |
| Savings deposits                    |       | 2                                                                             |       | (33 | ) | (31 | ) |
| Super Now deposits                  |       | 33                                                                            |       | (59 | ) | (26 | ) |
| Money market  deposits              |       | 90                                                                            |       | (5 | ) | 85 |   |
| Time deposits                       |       | 178                                                                           |       | (742 | ) | (564 | ) |
| Short-term  borrowings              |       | 106                                                                           |       | (377 | ) | (271 | ) |
| Long-term  borrowings, FHLB         |       | (211                                                                          | )          | (69 | ) | (280 | ) |
| Total  interest-bearing liabilities |       | 198                                                                           |       | (1,285 | ) | (1,087 | ) |
| Change in net  interest income      |       | $                                                                             | 180        |   | $ | 834 |   | $ | 1,014 |   |

# ** **

# **Provision for LoanLosses**

# ** **

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

 

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

 

Although managementbelieves it uses the best information available to make such determinations andthat the allowance for loan losses is adequate at March 31, 2009, futureadjustments could be necessary if circumstances or economic conditions differsubstantially from the assumptions used in making the initialdeterminations.  A downturn in the localeconomy, 

 

19

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increased unemployment,and delays in receiving financial information from borrowers could result inincreased levels of nonperforming assets, charge-offs, loan loss provisions,and reductions in income.  Additionally,as an integral part of the examination process, bank regulatory agenciesperiodically review the Bank’s loan loss allowance.  The banking agencies could require therecognition of additions to the loan loss allowance based on their judgment ofinformation available to them at the time of their examination.

 

While determining theappropriate allowance level, management has attributed the allowance for loanlosses to various portfolio segments; however, the allowance is available forthe entire portfolio as needed.

 

The allowance for loanlosses increased from $4,356,000 at December 31, 2008 to $4,441,000 at March 31,2009.  At March 31, 2009 and December 31,2008, the allowance for loan losses to total loans was 1.15% and 1.14%,respectively.

 

The provision for loanlosses totaled $126,000 for the three months ended March 31, 2009,compared to $60,000 for the same period in 2008.  The amount of the increase in the provisionwas the result of several factors, including but not limited to, an increase ingross loans of $5,714,000 since December 31, 2008, a ratio of annualizednet charge offs to average loans of 0.04% for the three months ended March 31,2009, a ratio of nonperforming loans to total loans of 0.59%, and a ratio ofthe allowance for loan losses to nonperforming loans of 195.72% at March 31,2009.

 

**Non-interestIncome**

** **

Totalnon-interest income for the three months ended March 31, 2009 compared tothe same period in 2008 decreased $2,690,000 to $(776,000) due to a $2,407,000decrease in net securities gains and losses realized when comparing the threemonth periods ended March 31, 2009 and 2008.  Excluding net securities gains and losses,non-interest income for the first quarter of 2009 would have decreased $283,000as compared to the 2008 period.  Depositservice charges decreased $45,000 as overdraft fee income declined $33,000 inaddition to customers migrating to no service charge checking accounts thatwere introduced as part of a customer acquisition and retention program.  Gain on sale of loans decreased $34,000 dueprimarily from a change in product mix which has resulted in a greaterpercentage of the fee collected being categorized as other income.  Other income increased due to increasedrevenue from electronic card (debit/credit) usage and fees from the sale ofloans into the secondary market, which countered losses realized from the saleof other real estate owned.

 

Insurancecommissions for the three months ended March 31, 2009 decreased $226,000compared to the same period in 2008 due to a softening market and shift inproduct mix.  Management of The M Groupcontinues to pursue new and build upon current relationships.  The sales call program continues to expand toother financial institutions, which results in additional revenue for The MGroup if another sales outlet is added. However, the addition of another sales outlet for The M Group can takeup to a year or more to be completed.

 

20

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Non-interestincome composition for the three months ended March 31, 2009 and 2008 wasas follows:

 
| ** **                      | ** ** | **For The Three Months Ended** | ** ** |
|---------------------------------|------------|----------------------------------------------------|------------|
| ** **                      | ** ** | **March 31, 2009**                       | ** ** | **March 31, 2008** | ** ** | **Change** | ** ** |
| **(In Thousands)**         | ** ** | **Amount**                                         | ** ** | **% Total** | ** ** | **Amount** | ** ** | **% Total** | ** ** | **Amount** | ** ** | **%** | ** ** |
| Deposit service  charges        |       | $                                                  | 525        |   | (67.7 | )% | $ | 570 |   | 29.8 | % | $ | (45 | ) | (7.9 | )% |
| Securities  (losses) gains, net |       | (2,369                                             | )          | 305.3 |   | 38 |   | 2.0 |   | (2,407 | ) | (6,334.2 | ) |
| Bank owned life  insurance      |       | 162                                                |       | (20.9 | ) | 155 |   | 8.1 |   | 7 |   | 4.5 |   |
| Gain on sale of  loans          |       | 118                                                |       | (15.2 | ) | 152 |   | 7.9 |   | (34 | ) | (22.4 | ) |
| Insurance  commissions          |       | 354                                                |       | (45.6 | ) | 580 |   | 30.3 |   | (226 | ) | (39.0 | ) |
| Other                           |       | 434                                                |       | (55.9 | ) | 419 |   | 21.9 |   | 15 |   | 3.6 |   |
| Total  non-interest income      |       | $                                                  | (776       | ) | 100.0 | % | $ | 1,914 |   | 100.0 | % | $ | (2,690 | ) | (140.5 | )% |

 

**Non-interestExpense**

** **

Totalnon-interest expense increased $200,000 for the three months ended March 31,2009 compared to the same period of 2008. The increase in salaries and employee benefits was attributable toseveral items including standard cost of living wage adjustments for employees,increased pension expense, and other benefit costs.  Pennsylvania shares tax increased $66,000 dueto the utilization of Pennsylvania Enterprise Zone tax credits from a lowincome housing partnership during 2008. Other expenses increased primarily due to normal anticipatedinflationary adjustments to ongoing business operating costs.

 

Non-interestexpense composition for the three months ended March 31, 2009 and 2008 wasas follows:

 
| ** **                                          | ** ** | **For The Three Months Ended** | ** ** |
|-----------------------------------------------------|------------|----------------------------------------------------|------------|
| ** **                                          | ** ** | **March 31, 2009**                       | ** ** | **March 31, 2008** | ** ** | **Change** | ** ** |
| **(In Thousands)**                             | ** ** | **Amount**                                         | ** ** | **% Total** | ** ** | **Amount** | ** ** | **% Total** | ** ** | **Amount** | ** ** | **%** | ** ** |
| Salaries and  employee benefits                     |       | $                                                  | 2,482      |   | 53.4 | % | $ | 2,451 |   | 55.1 | % | $ | 31 |   | 1.3 | % |
| Occupancy, net                                      |       | 339                                                |       | 7.3 |   | 338 |   | 7.6 |   | 1 |   | 0.3 |   |
| Furniture and  equipment                            |       | 307                                                |       | 6.6 |   | 285 |   | 6.4 |   | 22 |   | 7.7 |   |
| Pennsylvania  shares tax                            |       | 171                                                |       | 3.7 |   | 105 |   | 2.4 |   | 66 |   | 62.9 |   |
| Amortization of  investment in limited partnerships |       | 142                                                |       | 3.1 |   | 177 |   | 4.0 |   | (35 | ) | (19.8 | ) |
| Other                                               |       | 1,204                                              |       | 25.9 |   | 1,089 |   | 24.5 |   | 115 |   | 10.6 |   |
| Total  non-interest expense                         |       | $                                                  | 4,645      |   | 100.0 | % | $ | 4,445 |   | 100.0 | % | $ | 200 |   | 4.5 | % |

 

**Provisionfor Income Taxes**

** **

Incometaxes decreased $708,000 for the three months ended March 31, 2009compared to the same period of 2008.  Thedecrease, due to net securities losses of $2,369,000, resulted in a tax benefitof $549,000 for the three months ended March 31, 2009.  Excluding the impact of the net securitiesgains and losses, the effective tax rate for the three months ended March 31,2009 was 9.63% as compared to 6.48% for the same period of 2008.  The Company currently is in a deferred taxasset position due to the low income housing tax credits earned both currentlyand previously.  Management has reviewedthe deferred tax asset and has determined that the asset 

 

21

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willbe utilized within the appropriate carry forward period and therefore does notrequire a valuation allowance.

 

# **ASSET/LIABILITYMANAGEMENT**

# ** **

# **Cash and CashEquivalents**

# ** **

Cash and cash equivalentsdecreased $3,672,000 from $16,581,000 at December 31, 2008 to $12,909,000at March 31, 2009 primarily as a result of the following activities duringthe three months ended March 31, 2009:

 

# **Loans Held forSale**

# ** **

Activity regarding loansheld for sale resulted in sale proceeds exceeding loan originations, less$118,000 in realized gains, by $1,108,000 for the three months ended March 31,2009.

 

**Loans**

** **

Gross loans increased $5,714,000since December 31, 2008 due to the increase of commercial related loans,while non-commercial loans remained relatively constant.

 

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

 
| ** **                              | ** ** | **March 31, 2009** | ** ** | **December 31, 2008** | ** ** | **Change** | ** ** |
|-----------------------------------------|------------|------------------------------|------------|---------------------------------|------------|------------|------------|
| **(In Thousands)**                 | ** ** | **Amount**                   | ** ** | **% Total**                | ** ** | **Amount** | ** ** | **% Total** | ** ** | **Amount** | ** ** | **%** | ** ** |
| Commercial,  financial and agricultural |       | $                            | 43,606     |                            | 11.3       | %          | $          | 40,602 |   | 10.6 | % | $ | 3,004 |   | 7.4 | % |
| Real estate  mortgage:                  |       |                         |       |                            |       |       |       |   |   |   |   |   |   |
| Residential                             |       | 177,637                      |       | 45.9                            |       | 177,406    |       | 46.5 |   | 231 |   | 0.1 |   |
| Commercial                              |       | 139,255                      |       | 36.0                            |       | 136,158    |       | 35.7 |   | 3,097 |   | 2.3 |   |
| Construction                            |       | 15,897                       |       | 4.1                             |       | 15,838     |       | 4.2 |   | 59 |   | 0.4 |   |
| Installment  loans to individuals       |       | 11,806                       |       | 3.0                             |       | 12,487     |       | 3.3 |   | (681 | ) | (5.5 | ) |
| Less: Net deferred  loan fees           |       | 1,009                        |       | (0.3                            | )          | 1,013      |       | (0.3 | ) | (4 | ) | (0.4 | ) |
| Gross loans                             |       | $                            | 387,192    |                            | 100.0      | %          | $          | 381,478 |   | 100.0 | % | $ | 5,714 |   | 1.5 | % |

 

The recorded investment in loans for which impairment has beenrecognized in accordance with Statement of Financial Accounting Standards No. 114,*Accounting by Creditors for Impairment of a Loan*,amounted to $6,743,000 at March 31, 2009, compared to $5,042,000 at December 31,2008.  The valuation allowance related toimpaired loans amounted to $742,000 at March 31, 2009 and $166,000 at December 31,2008.  The increase in impaired loans andvaluation allowance is from a few commercial relationships.

 

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

 

22

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effective interest rate, except that all collateral-dependent loans aremeasured for impairment based on the fair value of the collateral.

 

**Investments**

 

Theestimated fair value of the investment securities portfolio at March 31,2009 has decreased $6,625,000 since December 31, 2008.  The change is due to a reduction in agencysecurities caused by normal principal payments, an increase in unrealizedlosses for state and political securities, and an equity securities impairmentcharge.  The increased level ofunrealized losses within the bond portfolio was the result of changes in theyield curve and a virtual freeze of trading in the municipal market, not creditquality, as the credit quality of the portfolio remains sound.

 

Theequity portfolio continues to feel the effects of the economic turbulence thatis affecting the financial sector.  Thissector of the portfolio, as of March 31, 2009, held $3,103,000 inunrealized losses on an amortized cost basis of $14,263,000.  The amount of the declines has caused severalof our equity holdings to be deemed other than temporarily impaired resultingin a write down in value of these holdings of $2,333,000 for the three monthsended March 31, 2009.  Certainpositions may be liquidated, in whole or part, through the balance of 2009 sothat the losses can be carried back for tax purposes and offset against gainsthat have been recognized over the past several years.

 

23

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

 
| ** **                            | ** ** | **March 31, 2009** | ** ** |
|---------------------------------------|------------|------------------------------|------------|
| **(In Thousands)**               | ** ** | **Amortized********Cost**    | ** ** | **Gross********Unrealized********Gains** | ** ** | **Gross  Unrealized********Losses** | ** ** | **Estimated********Fair********Value** | ** ** |
| Available for  sale (AFS)             |       |                         |       |   |   |   |   |   |   |
| U.S. Government  and agencysecurities |       | $                            | 43,909     |   | $ | 1,645 |   | $ | — |   | $ | 45,554 |   |
| State and  political securities       |       | 142,655                      |       | 270 |   | (12,014 | ) | 130,911 |   |
| Other debt  securities                |       | 16,010                       |       | 92 |   | (2,255 | ) | 13,847 |   |
| Total debt  securities                |       | 202,574                      |       | 2,007 |   | (14,269 | ) | 190,312 |   |
| Equity  securities                    |       | 14,263                       |       | 179 |   | (3,103 | ) | 11,339 |   |
| Total investment  securities AFS      |       | $                            | 216,837    |   | $ | 2,186 |   | $ | (17,372 | ) | $ | 201,651 |   |
|                                  |       |                         |       |   |   |   |   |   |   |
| Held to maturity  (HTM)               |       |                         |       |   |   |   |   |   |   |
| U.S. Government  and agencysecurities |       | $                            | 10         |   | $ | 1 |   | $ | — |   | $ | 11 |   |
| Other debt securities                 |       | 100                          |       | — |   | — |   | 100 |   |
| Total investment  securities HTM      |       | $                            | 110        |   | $ | 1 |   | $ | — |   | $ | 111 |   |

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

 

24

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# ** **

# **Financing Activities**

# ** **

# **Deposits**

# ** **

Totaldeposits increased 6.5% or $27,439,000 from December 31, 2008 to March 31,2009.  The growth was led by a 40.8% or$14,628,000 increase in money market deposits from December 31, 2008 to March 31,2009.  The increase in core deposits(deposits less time deposits) of 6.5% or $14,647,000 has provided relationshipdriven funding for the loan portfolio, while also reducing the utilization ofFHLB borrowings.  The increase indeposits is the result of a deposit gathering program coupled with customerscoming back to their hometown bank in the wake of the economic turbulence.

 

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

# ** **

| ** **              | ** ** | **March 31, 2009** | ** ** | **December 31, 2008** | ** ** | **Change** | ** ** |
|-------------------------|------------|------------------------------|------------|---------------------------------|------------|------------|------------|
| **(In Thousands)** | ** ** | **Amount**                   | ** ** | **% Total**                | ** ** | **Amount** | ** ** | **% Total** | ** ** | **Amount** | ** ** | **%** | ** ** |
| Demand deposits         |       | $                            | 71,963     |                            | 16.0       | %          | $          | 76,035 |   | 18.0 | % | $ | (4,072 | ) | (5.4 | )% |
| NOW accounts            |       | 55,816                       |       | 12.4                            |       | 53,821     |       | 12.8 |   | 1,995 |   | 3.7 |   |
| Money market  deposits  |       | 50,476                       |       | 11.3                            |       | 35,848     |       | 8.5 |   | 14,628 |   | 40.8 |   |
| Savings deposits        |       | 60,764                       |       | 13.5                            |       | 58,668     |       | 13.9 |   | 2,096 |   | 3.6 |   |
| Time deposits           |       | 209,788                      |       | 46.8                            |       | 196,996    |       | 46.8 |   | 12,792 |   | 6.5 |   |
| Total deposits          |       | $                            | 448,807    |                            | 100.0      | %          | $          | 421,368 |   | 100.0 | % | $ | 27,439 |   | 6.5 | % |

# ** **

# **Borrowed Funds**

# ** **

Total borrowed fundsdecreased 17.8% or $28,678,000 to $132,046,000 at March 31, 2009 comparedto $160,724,000 at December 31, 2008. The decrease in borrowed funds is primarily the result of growth indeposits as part of the previously discussed deposit gathering campaigns thatwere utilized to provide loan portfolio funding and to reduce the level oftotal borrowings.  Short-term FHLBborrowings were utilized in addition to FHLB repurchase agreements as theirstructure allowed for a reduction in interest expense, while also reducingshort-term exposure to interest rate changes.

 
| ** **                                     | ** ** | **March 31, 2009** | ** ** | **December 31, 2008** | ** ** | **Change** | ** ** |
|------------------------------------------------|------------|------------------------------|------------|---------------------------------|------------|------------|------------|
| **(In Thousands)**                        | ** ** | **Amount**                   | ** ** | **% Total**                | ** ** | **Amount** | ** ** | **% Total** | ** ** | **Amount** | ** ** | **%** | ** ** |
| Short-term  borrowings:                        |       |                         |       |                            |       |       |       |   |   |   |   |   |   |
| FHLB repurchase  agreements                    |       | $                            | 24,320     |                            | 18.4       | %          | $          | 61,013 |   | 38.0 | % | $ | (36,693 | ) | (60.1 | )% |
| Securities sold  under agreement to repurchase |       | 10,948                       |       | 8.3                             |       | 12,933     |       | 8.0 |   | (1,985 | ) | (15.3 | ) |
| Short-term  borrowings, FHLB                   |       | 10,000                       |       | 7.6                             |       | —     |       | — |   | 10,000 |   | 100.0 |   |
| Total short-term  borrowings                   |       | 45,268                       |       | 34.3                            | %          | 73,946     |       | 46.0 | % | (28,678 | ) | (38.8 | ) |
|                                           |       |                         |       |                            |       |       |       |   |   |   |   |   |   |
| Long-term  borrowings, FHLB                    |       | 86,778                       |       | 65.7                            |       | 86,778     |       | 54.0 |   | — |   | — |   |
| Total borrowed funds                           |       | $                            | 132,046    |                            | 100.0      | %          | $          | 160,724 |   | 100.0 | % | $ | (28,678 | ) | (17.8 | )% |

 

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# ** **

# **Capital**

# ** **

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

##  

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

##  

TheEmergency Economic Stabilization Act of 2008 provides authority to the UnitedStates Department of the Treasury (“Treasury”) to, among other things, purchaseup to $700 billion of mortgages, mortgage-backed securities, and certain otherfinancial instruments from financial institutions.   Pursuant to this authority, Treasuryimplemented a number of programs, including the Troubled Assets Relief CapitalPurchase Program.  The Company evaluatedparticipation in the Capital Purchase Program, pursuant to which Treasurypurchased preferred stock and common stock purchase warrants from qualifyinginstitutions that applied for funds, and determined that the Company would notparticipate in the Program due primarily to the fact that the Company did notrequire additional capital because its capital ratios remained well above theminimum levels required for well capitalized status under applicable bankingregulations.  The FDIC has also initiateda Temporary Liquidity Guarantee Program (“TLGP”) that provides a guarantee forcertain new senior unsecured debt issued by a participating institution by June 30,2009 (or October 31, 2009 in certain cases) and a temporary guarantee ofdeposits held in noninterest-bearing transaction accounts at a participatinginstitution.  Participating institutionsthat issue senior unsecured debt covered by the TLGP will generally pay apremium of 50 to 100 bps per year (depending on maturity) on the principalamount of securities covered by the guarantee and a fee of 10 bps on amounts innoninterest-bearing transaction accounts in excess of $250,000.  The Company did not opt out of coverage bythe TLGP, but has not at this time issued any new senior unsecured debt thatwould be covered by the debt guarantee portion of the TLGP.

 

26

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

 
| ** **                               | ** ** | **2009**   | ** ** | **2008**  | ** ** |
|------------------------------------------|------------|------------|------------|-----------|------------|
| **(In Thousands)**                  | ** ** | **Amount** | ** ** | **Ratio** | ** ** | **Amount** | ** ** | **Ratio** | ** ** |
| Total Capital(to  Risk-weighted Assets)  |       |       |       |      |       |   |   |   |   |
|                                     |       |       |       |      |       |   |   |   |   |
| Actual                                   |       | $          | 64,374     |      | 15.3       | % | $ | 66,891 |   | 16.0 | % |
| For Capital  Adequacy Purposes           |       | 33,612     |       | 8.0       |       | 33,410 |   | 8.0 |   |
| To Be Well  Capitalized                  |       | 42,016     |       | 10.0      |       | 41,763 |   | 10.0 |   |
|                                     |       |       |       |      |       |   |   |   |   |
| Tier I Capital(to  Risk-weighted Assets) |       |       |       |      |       |   |   |   |   |
|                                     |       |       |       |      |       |   |   |   |   |
| Actual                                   |       | $          | 59,933     |      | 14.3       | % | $ | 62,540 |   | 15.0 | % |
| For Capital  Adequacy Purposes           |       | 16,806     |       | 4.0       |       | 16,705 |   | 4.0 |   |
| To Be Well  Capitalized                  |       | 25,209     |       | 6.0       |       | 25,058 |   | 6.0 |   |
|                                     |       |       |       |      |       |   |   |   |   |
| Tier I Capital(to Average Assets)        |       |       |       |      |       |   |   |   |   |
|                                     |       |       |       |      |       |   |   |   |   |
| Actual                                   |       | $          | 59,933     |      | 9.2        | % | $ | 62,540 |   | 9.7 | % |
| For Capital  Adequacy Purposes           |       | 26,059     |       | 4.0       |       | 25,773 |   | 4.0 |   |
| To Be Well  Capitalized                  |       | 32,574     |       | 5.0       |       | 32,216 |   | 5.0 |   |

# ** **

# **Liquidity andInterest Rate Sensitivity**

# ** **

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

##  

The following liquidity measuresare monitored for compliance within the limits cited:

 

1.  Net Loans to Total Assets, 85% maximum

2.  Net Loans to Total Deposits, 100% maximum

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

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

 

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

 

27

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andbusiness opportunities as they arise. The objective of interest rate sensitivity management is to increase netinterest income by managing interest sensitive assets and liabilities in such away that they can be repriced in response to changes in market interest rates.

 

TheBank, like other financial institutions, must have sufficient funds availableto meet its liquidity needs for deposit withdrawals, loan commitments andoriginations, and expenses.  In order tocontrol cash flow, the Bank estimates future cash flows from deposits, loanpayments, and investment security payments. The primary sources of funds are deposits, principal and interestpayments on loans and investment securities, FHLB borrowings, and brokereddeposits.  Management believes the Bankhas adequate resources to meet its normal funding requirements.

 

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

 

Managementmonitors and determines the desirable level of liquidity.  Consideration is given to loan demand,investment opportunities, deposit pricing and growth potential, as well as thecurrent cost of borrowing funds.  TheCompany has a current borrowing capacity at the FHLB of $213,644,000.  In addition to this credit arrangement, theCompany has additional lines of credit with correspondent banks of $13,596,000.Management believes it has sufficient liquidity to satisfy estimated short-termand long-term funding needs.  FHLB borrowings totaled $121,098as of March 31, 2009.

 

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

 

28

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Therehave been no substantial changes in the Company’s gap analyses or simulationanalyses compared to the information provided in the Company’s Form 10-Kfor the year ended December 31, 2008.

 

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

 

# **Inflation**

# ** **

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

 

**Item 3.  Quantitative and Qualitative DisclosuresAbout Market Risk**

 

Marketrisk for the Company is comprised primarily of interest rate risk exposure andliquidity risk.  Interest rate risk andliquidity risk management is performed at the Bank level as well as the Companylevel.  The Company’s interest ratesensitivity is monitored by management through selected interest rate riskmeasures produced by an independent third party.  There have been no substantial changes in theCompany’s gap analyses or simulation analyses compared to the informationprovided in the Annual Report on Form 10-K for the period ended December 31,2008.  Additional information and detailsare provided in the “Liquidity and Interest Rate Sensitivity” section of “Item2. Management’s Discussion and Analysis of Financial Condition and Results ofOperations.”

 

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

 

**Item 4.  Controls and Procedures**

 

An analysis was performed under the supervision and with theparticipation of the Company’s management, including the Chief ExecutiveOfficer and the Chief Financial Officer, of the effectiveness of the design andoperation of the Company’s disclosure controls and procedures. Based on thatevaluation, the Company’s Chief Executive Officer and Chief Financial Officerconcluded that the Company’s disclosure controls and procedures were effectiveas of March 31, 2009.  There were nochanges in the Company’s internal control over financial reporting thatoccurred during the quarter ended March 31, 2009, that have materiallyaffected, or are reasonably likely to materially affect, the Company’s internalcontrol over financial reporting.

 

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### ** **

### **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,”of the Company’s Annual Report on Form 10-K for the year ended December 31,2008.  Please refer to that section fordisclosures regarding the risks and uncertainties related to the Company’sbusiness.

 

**Item 2.          Unregistered Sales of EquitySecurities and Use of Proceeds**

** **
| ** **                                         | ** ** | **Total**           | ** ** | **Average**         | ** ** | **Total Number of**           | ** ** | **Maximum Number (or**                    | ** ** |
|----------------------------------------------------|------------|---------------------|------------|---------------------|------------|-----------------------------------------|------------|-----------------------------------------------------|------------|
| ** **                                         | ** ** | **Number of**  | ** ** | **Price Paid** | ** ** | **Shares (or Units)**         | ** ** | **Approximate Dollar Value)**             | ** ** |
| ** **                                         | ** ** | **Shares (or** | ** ** | **per Share**  | ** ** | **Purchased as Part of** | ** ** | **of Shares (or Units) that**   | ** ** |
| ** **                                         | ** ** | **Units)**          | ** ** | **(or Units)** | ** ** | **Publicly Announced**             | ** ** | **May Yet Be Purchased**             | ** ** |
| **Period**                                         | ** ** | **Purchased**       | ** ** | **Purchased**       | ** ** | **Plans or Programs**         | ** ** | **Under the Plans or Programs** | ** ** |
|                                               |       |                |       |                |       |                                    |       |                                                |       |
| Month #1  (January 1-January 31, 2009)   |       | —              |       | —              |       | —                                  |       | —                                              |       |
|                                               |       |                |       |                |       |                                    |       |                                                |       |
| Month #2  (February 1-February 28, 2009) |       | —              |       | —              |       | —                                  |       | —                                              |       |
|                                               |       |                |       |                |       |                                    |       |                                                |       |
| Month #3  (March 1-March 31, 2009)       |       | —              |       | —              |       | —                                  |       | —                                              |       |

 

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

 

**Item 3.          Defaults Upon Senior Securities**

 

None

 

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

 

### **None**

### ** **

### **Item 5.          OtherInformation**

### ** **

None

 

30

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**Item 6.          Exhibits**

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

 

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##  

## **SIGNATURES**

##  

Pursuant to the requirementsof the Securities Exchange Act of 1934, the Registrant has duly caused thisreport to be signed on its behalf by the undersigned thereunto duly authorized.

 
|                    | PENNS WOODS  BANCORP, INC.                              |
|-------------------------|---------------------------------------------------------|
|                    | (Registrant)                                            |
|                    |                                                    |
|                    |                                                    |
| Date: May 11, 2009 | /s/ Ronald A. Walko                                     |
|                    | Ronald A. Walko,  President and Chief Executive Officer |
|                    |                                                    |
|                    |                                                    |
| Date: May 11, 2009 | /s/ Brian L. Knepp                                      |
|                    | Brian L. Knepp, Chief  Financial Officer                |

 

32

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**EXHIBITINDEX**

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

 

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