**UNITEDSTATES**

**SECURITIESAND EXCHANGE COMMISSION**

**WASHINGTON,D.C. 20549**

 

**FORM 10-Q**

 
| **x**      | ** ** | **Quarterly Report pursuant to  Section 13 or 15 (d) of the Securities Exchange**                                                                                                                                                                                                                                                                                                         |
|------------|------------|-------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
|       |       | **Act of 1934**                                                                                                                                                                                                                                                                                                                                                                           |
|       |       | ** **                                                                                                                                                                                                                                                                                                                                                                                |
|       |       | **for the Quarterly Period Ended  September 30, 2007.**                                                                                                                                                                                                                                                                                                                                   |
|       |       |                                                                                                                                                                                                                                                                                                                                                                                      |
| **o**      | ** ** | **Transition report pursuant to  Section 13 or 15 (d) of the Exchange Act**                                                                                                                                                                                                                                                                                                               |
| ** ** | ** ** | ** **                                                                                                                                                                                                                                                                                                                                                                                |
|       |       | **for the Transition Period from                               to                             .** |

 

**No.0-17077**

**(CommissionFile Number)**

 

**PENNSWOODS BANCORP, INC.**

(Exact name ofRegistrant as specified in its charter)

 

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

 

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

 

**(570)322-1111**

Registrant’stelephone number, including area code

 

Indicate by check markwhether the registrant (1) has filed all reports required to be filed bySection 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding12 months (or for such shorter period that registrant was required to file suchreports), and (2) has been subject to such filing requirements for the past 90days.

YES x        NO   o

 

Indicateby check mark whether the registrant is a large accelerated filer, anaccelerated filer, or a non-accelerated filer. See definition of “acceleratedfiler and large accelerated filer” in Rule 12b-2 of the Exchange Act. (Checkone):

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

 

Indicate by check markwhether the registrant is a shell company (as defined in Rule 12b-2 of theExchange Act).

YES o              NOx

 

On November 1, 2007 therewere 3,877,534 shares of the Registrant’s common stock outstanding.

 

 

----

 

**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 September 30, 2007 and December 31, 2006                                             |       | 3                                                                                               |
|                                                                                                                               |       |                                                                                            |       |       |
| Consolidated Statement of Income  (unaudited) for the Three and Nine Months ended September 30, 2007 and 2006                      |       | 4                                                                                               |
|                                                                                                                               |       |                                                                                            |       |       |
| Consolidated Statement of  Changes in Shareholders’ Equity (unaudited) for the Nine Months ended  September 30, 2007 and 2006 |       | 5                                                                                               |
|                                                                                                                               |       |                                                                                            |       |       |
| Consolidated Statement of  Comprehensive Income (unaudited) for the Three and Nine Months ended  September 30, 2007 and 2006       |       | 5                                                                                               |
|                                                                                                                               |       |                                                                                            |       |       |
| Consolidated Statement of  Cash Flows (unaudited) for the Nine Months ended September 30, 2007 and 2006                            |       | 6                                                                                               |
|                                                                                                                               |       |                                                                                            |       |       |
| Notes to Consolidated  Financial Statements (unaudited)                                                                            |       | 7                                                                                               |
|                                                                                                                               |       |                                                                                            |       |       |
| **Item 2.**                                                                                                                        | ** ** | **Management’s  Discussion and Analysis of Financial Condition and Results of Operations** | ** ** | **13**     |
| **Item 3.**                                                                                                                        | ** ** | **Quantitative  and Qualitative Disclosures About Market Risk**                                 | ** ** | **31**     |
| **Item 4.**                                                                                                                        | ** ** | **Controls and  Procedures**                                                                    | ** ** | **31**     |
| ** **                                                                                                                         | ** ** | ** **                                                                                      | ** ** | ** ** |
| **Part II**                                                                                                                        | ** ** | **Other Information**                                                                           | ** ** | ** ** |
| ** **                                                                                                                         | ** ** | ** **                                                                                      | ** ** | ** ** |
| **Item 1.**                                                                                                                        | ** ** | **Legal Proceedings**                                                                           |       | 32         |
| **Item 1A.**                                                                                                                       | ** ** | **Risk Factors**                                                                                |       | 32         |
| **Item 2.**                                                                                                                        | ** ** | **Unregistered  Sales of Equity Securities and Use of Proceeds**                                |       | 32         |
| **Item 3.**                                                                                                                        | ** ** | **Defaults  Upon Senior Securities**                                                            |       | 32         |
| **Item 4.**                                                                                                                        | ** ** | **Submission  of Matters to a Vote of Security Holders**                                        |       | 32         |
| **Item 5.**                                                                                                                        | ** ** | **Other Information**                                                                           |       | 32         |
| **Item 6.**                                                                                                                        | ** ** | **Exhibits**                                                                                    |       | 33         |
| **Signatures**                                                                                                                     |       | 34                                                                                              |
| **Exhibit Index and Exhibits**                                                                                                     |       | 35                                                                                              |

 

2

----

 

**Part I. FINANCIAL INFORMATION**

 

**Item 1. Financial Statements**

PENNS WOODSBANCORP, INC.

CONSOLIDATED BALANCE SHEET

(UNAUDITED)

** **
| ** **                                                                                           | ** ** | **September 30,** | ** ** | **December 31,** | ** ** |
|------------------------------------------------------------------------------------------------------|------------|------------------------|------------|-----------------------|------------|
| **(In Thousands, Except Share Data)**                                            | ** ** | **2007**               | ** ** | **2006**              | ** ** |
|                                                                                                 |       |                   |       |                  |       |
| ASSETS                                                                                               |       |                   |       |                  |       |
| Noninterest-bearing  balances                                                                        |       | $                      | 13,228     |                  | $          | 15,348 |   |
| Interest-bearing  deposits in other financial institutions                                           |       | 15                     |       | 25                    |       |
| Total cash and  cash equivalents                                                                     |       | 13,243                 |       | 15,373                |       |
|                                                                                                 |       |                   |       |                  |       |
| Investment  securities, available for sale, at fair value                                            |       | 204,758                |       | 185,200               |       |
| Investment  securities held to maturity (fair value of $278 and $286)                                |       | 276                    |       | 283                   |       |
| Loans held for  sale                                                                                 |       | 6,503                  |       | 3,716                 |       |
| Loans                                                                                                |       | 357,715                |       | 360,384               |       |
| Less: Allowance  for loan losses                                                                     |       | 4,092                  |       | 4,185                 |       |
| Loans, net                                                                                           |       | 353,623                |       | 356,199               |       |
| Premises and  equipment, net                                                                         |       | 6,841                  |       | 6,737                 |       |
| Accrued interest  receivable                                                                         |       | 3,274                  |       | 2,939                 |       |
| Bank-owned life  insurance                                                                           |       | 12,275                 |       | 11,346                |       |
| Investment in  limited partnerships                                                                  |       | 4,447                  |       | 4,950                 |       |
| Goodwill                                                                                             |       | 3,032                  |       | 3,032                 |       |
| Other assets                                                                                         |       | 5,057                  |       | 2,510                 |       |
| TOTAL ASSETS                                                                                         |       | $                      | 613,329    |                  | $          | 592,285 |   |
|                                                                                                 |       |                   |       |                  |       |
| LIABILITIES                                                                                          |       |                   |       |                  |       |
| Interest-bearing  deposits                                                                           |       | $                      | 331,864    |                  | $          | 322,031 |   |
| Noninterest-bearing  deposits                                                                        |       | 72,990                 |       | 73,160                |       |
| Total deposits                                                                                       |       | 404,854                |       | 395,191               |       |
|                                                                                                 |       |                   |       |                  |       |
| Short-term  borrowings                                                                               |       | 44,793                 |       | 34,697                |       |
| Long-term  borrowings, Federal Home Loan Bank (FHLB)                                                 |       | 86,378                 |       | 82,878                |       |
| Accrued interest  payable                                                                            |       | 1,838                  |       | 1,532                 |       |
| Other  liabilities                                                                                   |       | 3,914                  |       | 3,393                 |       |
| TOTAL  LIABILITIES                                                                                   |       | 541,777                |       | 517,691               |       |
|                                                                                                 |       |                   |       |                  |       |
| SHAREHOLDERS’  EQUITY                                                                           |       |                   |       |                  |       |
| Common stock,  par value $8.33, 10,000,000 shares authorized; 4,006,084 and 4,003,514 shares  issued |       | 33,384                 |       | 33,362                |       |
| Additional  paid-in capital                                                                          |       | 17,869                 |       | 17,810                |       |
| Retained  earnings                                                                                   |       | 27,552                 |       | 25,783                |       |
| Accumulated  other comprehensive income (loss):                                                      |       |                   |       |                  |       |
| Net unrealized  (loss) gain on available for sale securities                                         |       | (1,861                 | )          | 2,139                 |       |
| Defined benefit  plan                                                                                |       | (579                   | )          | (579                  | )          |
| Less: Treasury  stock at cost, 128,802 and 102,772 shares                                            |       | (4,813                 | )          | (3,921                | )          |
| TOTAL  SHAREHOLDERS’ EQUITY                                                                     |       | 71,552                 |       | 74,594                |       |
| TOTAL  LIABILITIES AND SHAREHOLDERS’ EQUITY                                                     |       | $                      | 613,329    |                  | $          | 592,285 |   |

 

See accompanyingnotes to the unaudited consolidated financial statements.

 

3

----

 

PENNS WOODS BANCORP, INC.

CONSOLIDATED STATEMENT OF INCOME

(UNAUDITED)

 
| ** **                                                         | ** ** | **Three Months Ended** | ** ** | **Nine Months Ended** | ** ** |
|--------------------------------------------------------------------|------------|----------------------------------|------------|---------------------------------|------------|
| ** **                                                         | ** ** | **September 30,**           | ** ** | **September 30,**          | ** ** |
| **(In Thousands, Except Per Share Data)** | ** ** | **2007**                         | ** ** | **2006**                        | ** ** | **2007** | ** ** | **2006** | ** ** |
|                                                               |       |                             |       |                            |       |   |   |   |   |
| INTEREST AND  DIVIDEND INCOME                                      |       |                             |       |                            |       |   |   |   |   |
| Loans including  fees                                              |       | $                                | 6,621      |                            | $          | 6,355 |   | $ | 19,560 |   | $ | 18,250 |   |
| Investment  Securities:                                            |       |                             |       |                            |       |   |   |   |   |
| Taxable                                                            |       | 964                              |       | 874                             |       | 2,711 |   | 2,691 |   |
| Tax-exempt                                                         |       | 1,108                            |       | 1,004                           |       | 3,271 |   | 2,993 |   |
| Dividend and  other interest income                                |       | 284                              |       | 314                             |       | 907 |   | 982 |   |
| TOTAL INTEREST  AND DIVIDEND INCOME                                |       | 8,977                            |       | 8,547                           |       | 26,449 |   | 24,916 |   |
|                                                               |       |                             |       |                            |       |   |   |   |   |
| INTEREST EXPENSE                                                   |       |                             |       |                            |       |   |   |   |   |
| Deposits                                                           |       | 2,835                            |       | 2,447                           |       | 8,215 |   | 6,252 |   |
| Short-term  borrowings                                             |       | 368                              |       | 306                             |       | 1,100 |   | 1,221 |   |
| Long-term  borrowings, FHLB                                        |       | 909                              |       | 954                             |       | 2,735 |   | 2,844 |   |
| TOTAL INTEREST  EXPENSE                                            |       | 4,112                            |       | 3,707                           |       | 12,050 |   | 10,317 |   |
|                                                               |       |                             |       |                            |       |   |   |   |   |
| NET INTEREST  INCOME                                               |       | 4,865                            |       | 4,840                           |       | 14,399 |   | 14,599 |   |
|                                                               |       |                             |       |                            |       |   |   |   |   |
| PROVISION FOR  LOAN LOSSES                                         |       | 10                               |       | 89                              |       | 60 |   | 485 |   |
|                                                               |       |                             |       |                            |       |   |   |   |   |
| NET INTEREST  INCOME AFTER PROVISION FOR LOAN LOSSES               |       | 4,855                            |       | 4,751                           |       | 14,339 |   | 14,114 |   |
|                                                               |       |                             |       |                            |       |   |   |   |   |
| NON-INTEREST  INCOME                                               |       |                             |       |                            |       |   |   |   |   |
| Deposit service  charges                                           |       | 546                              |       | 596                             |       | 1,654 |   | 1,773 |   |
| Securities  gains, net                                             |       | ––                     |       | 561                             |       | 619 |   | 1,385 |   |
| Bank-owned life  insurance                                         |       | 109                              |       | 94                              |       | 310 |   | 272 |   |
| Gain on sale of  loans                                             |       | 282                              |       | 264                             |       | 654 |   | 624 |   |
| Insurance  commissions                                             |       | 625                              |       | 502                             |       | 1,613 |   | 1,732 |   |
| Other                                                              |       | 444                              |       | 370                             |       | 1,316 |   | 1,154 |   |
| TOTAL  NON-INTEREST INCOME                                         |       | 2,006                            |       | 2,387                           |       | 6,166 |   | 6,940 |   |
|                                                               |       |                             |       |                            |       |   |   |   |   |
| NON-INTEREST  EXPENSE                                              |       |                             |       |                            |       |   |   |   |   |
| Salaries and  employee benefits                                    |       | 2,330                            |       | 2,174                           |       | 6,912 |   | 6,620 |   |
| Occupancy, net                                                     |       | 319                              |       | 308                             |       | 987 |   | 826 |   |
| Furniture and  equipment                                           |       | 267                              |       | 309                             |       | 850 |   | 894 |   |
| Pennsylvania  shares tax                                           |       | 160                              |       | 151                             |       | 482 |   | 447 |   |
| Other                                                              |       | 1,354                            |       | 1,172                           |       | 3,667 |   | 3,356 |   |
| TOTAL  NON-INTEREST EXPENSE                                        |       | 4,430                            |       | 4,114                           |       | 12,898 |   | 12,143 |   |
|                                                               |       |                             |       |                            |       |   |   |   |   |
| INCOME BEFORE  INCOME TAX PROVISION                                |       | 2,431                            |       | 3,024                           |       | 7,607 |   | 8,911 |   |
| INCOME TAX  PROVISION                                              |       | 109                              |       | 560                             |       | 669 |   | 1,558 |   |
| NET INCOME                                                         |       | $                                | 2,322      |                            | $          | 2,464 |   | $ | 6,938 |   | $ | 7,353 |   |
|                                                               |       |                             |       |                            |       |   |   |   |   |
| EARNINGS PER  SHARE - BASIC                                        |       | $                                | 0.60       |                            | $          | 0.63 |   | $ | 1.78 |   | $ | 1.87 |   |
|                                                               |       |                             |       |                            |       |   |   |   |   |
| EARNINGS PER  SHARE - DILUTED                                      |       | $                                | 0.60       |                            | $          | 0.63 |   | $ | 1.78 |   | $ | 1.87 |   |
|                                                               |       |                             |       |                            |       |   |   |   |   |
| WEIGHTED AVERAGE  SHARES OUTSTANDING - BASIC                       |       | 3,881,488                        |       | 3,927,261                       |       | 3,889,310 |   | 3,942,533 |   |
|                                                               |       |                             |       |                            |       |   |   |   |   |
| WEIGHTED AVERAGE  SHARES OUTSTANDING - DILUTED                     |       | 3,881,676                        |       | 3,927,740                       |       | 3,889,573 |   | 3,943,016 |   |
|                                                               |       |                             |       |                            |       |   |   |   |   |
| DIVIDENDS PER  SHARE                                               |       | $                                | 0.45       |                            | $          | 0.44 |   | $ | 1.33 |   | $ | 1.29 |   |

 

See accompanyingnotes to the unaudited consolidated financial statements.

 

4

----

 

PENNS WOODSBANCORP, INC.

CONSOLIDATED STATEMENT OF CHANGES IN SHAREHOLDERS'EQUITY

(UNAUDITED)

 
| ** **                                                                                                                   | ** ** | ** ** | ** ** | ** **     | ** ** | ** **   | ** ** | ** **        | ** ** | **ACCUMULATED**        | ** ** | ** **             | ** ** | ** ** | ** ** |
|------------------------------------------------------------------------------------------------------------------------------|------------|------------|------------|----------------|------------|--------------|------------|-------------------|------------|------------------------|------------|------------------------|------------|------------|------------|
| ** **                                                                                                                   | ** ** | **COMMON** | ** ** | **ADDITIONAL** | ** ** | ** **   | ** ** | **OTHER**         | ** ** | ** **             | ** ** | **TOTAL**              | ** ** |
| ** **                                                                                                                   | ** ** | **STOCK**  | ** ** | **PAID-IN**    | ** ** | **RETAINED** | ** ** | **COMPREHENSIVE** | ** ** | **TREASURY**           | ** ** | **SHAREHOLDERS’** | ** ** |
| **(In Thousands Except Per Share Data)**                                                            | ** ** | **SHARES** | ** ** | **AMOUNT**     | ** ** | **CAPITAL**  | ** ** | **EARNINGS**      | ** ** | **INCOME (LOSS)** | ** ** | **STOCK**              | ** ** | **EQUITY** | ** ** |
| Balance, December  31, 2006                                                                                                  |       | 4,003,514  |       | $              | 33,362     |         | $          | 17,810            |       | $                      | 25,783     |                   | $          | 1,560      |       | $ | (3,921 | ) | $ | 74,594 |   |
|                                                                                                                         |       |       |       |           |       |         |       |              |       |                   |       |                   |       |       |       |
| Comprehensive  Income:                                                                                                       |       |       |       |           |       |         |       |              |       |                   |       |                   |       |       |       |
| Net income                                                                                                                   |       |       |       |           |       |         |       | 6,938             |       |                   |       |                   |       | 6,938      |       |
| Unrealized loss  on investments available for sale, net of reclassification adjustment, net of  income tax benefit of $2,061 |       |       |       |           |       |         |       |              |       | (4,000                 | )          |                   |       | (4,000     | )          |
| Total  comprehensive income                                                                                                  |       |       |       |           |       |         |       |              |       |                   |       |                   |       | 2,938      |       |
| Dividends  declared, ($1.33 per share)                                                                                       |       |       |       |           |       |         |       | (5,169            | )          |                   |       |                   |       | (5,169     | )          |
| Purchase of  treasury stock (26,030 shares)                                                                                  |       |       |       |           |       |         |       |              |       |                   |       | (892                   | )          | (892       | )          |
| Stock options  exercised                                                                                                     |       | 330        |       | 3              |       | 5            |       |              |       |                   |       |                   |       | 8          |       |
| Common shares  issued for employee stock purchase plan                                                                       |       | 2,240      |       | 19             |       | 54           |       |              |       |                   |       |                   |       | 73         |       |
| Balance,  Septamber 30, 2007                                                                                                 |       | 4,006,084  |       | $              | 33,384     |         | $          | 17,869            |       | $                      | 27,552     |                   | $          | (2,440     | )          | $ | (4,813 | ) | $ | 71,552 |   |

 
| ** **                                                                                                         | ** ** | ** ** | ** ** | ** **     | ** ** | ** **   | ** ** | ** **        | ** ** | **ACCUMULATED** | ** ** | ** **             | ** ** | ** ** | ** ** |
|--------------------------------------------------------------------------------------------------------------------|------------|------------|------------|----------------|------------|--------------|------------|-------------------|------------|-----------------|------------|------------------------|------------|------------|------------|
| ** **                                                                                                         | ** ** | **COMMON** | ** ** | **ADDITIONAL** | ** ** | ** **   | ** ** | **OTHER**         | ** ** | ** **      | ** ** | **TOTAL**              | ** ** |
| ** **                                                                                                         | ** ** | **STOCK**  | ** ** | **PAID-IN**    | ** ** | **RETAINED** | ** ** | **COMPREHENSIVE** | ** ** | **TREASURY**    | ** ** | **SHAREHOLDERS’** | ** ** |
| **(In Thousands Except Per Share Data)**                                                  | ** ** | **SHARES** | ** ** | **AMOUNT**     | ** ** | **CAPITAL**  | ** ** | **EARNINGS**      | ** ** | **INCOME**      | ** ** | **STOCK**              | ** ** | **EQUITY** | ** ** |
| Balance, December  31, 2005                                                                                        |       | 4,002,159  |       | $              | 33,351     |         | $          | 17,772            |       | $               | 22,938     |                   | $          | 850        |       | $ | (992 | ) | $ | 73,919 |   |
|                                                                                                               |       |       |       |           |       |         |       |              |       |            |       |                   |       |       |       |
| Comprehensive  Income:                                                                                             |       |       |       |           |       |         |       |              |       |            |       |                   |       |       |       |
| Net income                                                                                                         |       |       |       |           |       |         |       | 7,353             |       |            |       |                   |       | 7,353      |       |
| Unrealized gain  on investments available for sale, net of reclassification adjustment, net of  income tax of $424 |       |       |       |           |       |         |       |              |       | 824             |       |                   |       | 824        |       |
| Total  comprehensive income                                                                                        |       |       |       |           |       |         |       |              |       |            |       |                   |       | 8,177      |       |
| Dividends  declared, ($1.29 per share)                                                                             |       |       |       |           |       |         |       | (5,083            | )          |            |       |                   |       | (5,083     | )          |
| Purchase of  treasury stock (60,000 shares)                                                                        |       |       |       |           |       |         |       |              |       |            |       | (2,303                 | )          | (2,303     | )          |
| Common shares  issued for employee stock purchase plan                                                             |       | 421        |       | 3              |       | 12           |       |              |       |            |       |                   |       | 15         |       |
| Balance,  September 30, 2006                                                                                       |       | 4,002,580  |       | $              | 33,354     |         | $          | 17,784            |       | $               | 25,208     |                   | $          | 1,674      |       | $ | (3,295 | ) | $ | 74,725 |   |

 

See accompanyingnotes to the unaudited consolidated financial statements.

 

PENNS WOODSBANCORP, INC.

CONSOLIDATED STATEMENT OF COMPREHENSIVE INCOME

(UNAUDITED)

 
|                                                                       |   | **Three Months Ended September 30,** |   | **Nine Months Ended September 30,** | ** ** |
|----------------------------------------------------------------------------|--------|----------------------------------------------------------|--------|---------------------------------------------------------|------------|
| **(In Thousands)**                                                    |   | **2007**                                                 |   | **2006**                                                |       | **2007** |   | **2006** | ** ** |
|                                                                       |   |                                                     |   |                                                    |       |   |   |   |   |   |   |   |   |   | ** ** |   | ** ** |
| Net Income                                                                 |   |                                                     |   |                                                    |       |   |   |   |   |   |   |   |   |   | ** ** |   | ** ** |
| Other  comprehensive (loss) income:                                        |   |                                                     |   | $                                                       | 2,322      |   |   |   | $ | 2,464 |   |   |   | $ | 6,938 |   |   | ** ** | $ | 7,353 | ** ** |
| Change in net  unrealized gains (losses) on available for sale securities  |   | 2,415                                                    |   |                                                    |       | 5,026 |   |   |   | (5,442 | ) |   |   | 2,633 |   |   |   |
| Less: Reclassification  adjustment for net gains included in net income    |   | ––                                             |   |                                                    |       | 561 |   |   |   | 619 |   |   |   | 1,385 |   |   |   |
| Other  comprehensive income (loss) before tax                              |   |                                                     |   | 2,415                                                   |       |   |   | 4,465 |   |   |   | (6,061 | ) |   |   | 1,248 |   |
| Income tax  expense (benefit) related to other comprehensive income (loss) |   |                                                     |   | 821                                                     |       |   |   | 1,518 |   |   |   | (2,061 | ) |   |   | 424 |   |
| Other  comprehensive income (loss), net of tax                             |   |                                                     |   | 1,594                                                   |       |   |   | 2,947 |   |   |   | (4,000 | ) |   |   | 824 |   |
| Comprehensive  income                                                      |   |                                                     |   | $                                                       | 3,916      |   |   |   | $ | 5,411 |   |   |   | $ | 2,938 |   |   |   | $ | 8,177 |   |

 

See accompanyingnotes to the unaudited consolidated financial statements.

 

5

----

 

PENNS WOODSBANCORP, INC.

CONSOLIDATED STATEMENT OF CASH FLOWS

(UNAUDITED)

 
| ** **                                                                         | ** ** | **Nine Months Ended** | ** ** |
|------------------------------------------------------------------------------------|------------|---------------------------------|------------|
| ** **                                                                         | ** ** | **September 30,**          | ** ** |
| **(In Thousands)**                                                            | ** ** | **2007**                        | ** ** | **2006** | ** ** |
|                                                                               |       |                            |       |   |   |
| OPERATING  ACTIVITIES                                                              |       |                            |       |   |   |
| Net Income                                                                         |       | $                               | 6,938      |   | $ | 7,353 |   |
| Adjustments to  reconcile net income to net cash provided by operating activities: |       |                            |       |   |   |
| Depreciation                                                                       |       | 523                             |       | 549 |   |
| Provision for  loan losses                                                         |       | 60                              |       | 485 |   |
| Accretion and  amortization of investment security discounts and premiums          |       | (738                            | )          | (575 | ) |
| Securities  gains, net                                                             |       | (619                            | )          | (1,385 | ) |
| Originations of  loans held for sale                                               |       | (33,903                         | )          | (28,031 | ) |
| Proceeds of  loans held for sale                                                   |       | 31,770                          |       | 27,454 |   |
| Gain on sale of  loans                                                             |       | (654                            | )          | (624 | ) |
| Earnings on  bank-owned life insurance                                             |       | (310                            | )          | (272 | ) |
| Other, net                                                                         |       | 303                             |       | 132 |   |
| Net cash  provided by operating activities                                         |       | 3,370                           |       | 5,086 |   |
| INVESTING  ACTIVITIES                                                              |       |                            |       |   |   |
| Investment  securities available for sale:                                         |       |                            |       |   |   |
| Proceeds from  sales                                                               |       | 39,226                          |       | 35,879 |   |
| Proceeds from  calls and maturities                                                |       | 4,290                           |       | 5,445 |   |
| Purchases                                                                          |       | (67,067                         | )          | (31,938 | ) |
| Investment  securities held to maturity:                                           |       |                            |       |   |   |
| Proceeds from  calls and maturities                                                |       | 11                              |       | 25 |   |
| Purchases                                                                          |       | ––                    |       | (25 | ) |
| Net decrease  (increase) in loans                                                  |       | 2,516                           |       | (18,288 | ) |
| Acquisition of  bank premises and equipment                                        |       | (627                            | )          | (767 | ) |
| Proceeds from  the sale of foreclosed assets                                       |       | 66                              |       | 83 |   |
| Purchase of  bank-owned life insurance                                             |       | (619                            | )          | (212 | ) |
| Investment in  limited partnership                                                 |       | ––                    |       | (1,535 | ) |
| Proceeds from  redemption of regulatory stock                                      |       | 3,045                           |       | 3,177 |   |
| Purchases of  regulatory stock                                                     |       | (3,620                          | )          | (2,034 | ) |
| Net cash used  for investing activities                                            |       | (22,779                         | )          | (10,190 | ) |
| FINANCING  ACTIVITIES                                                              |       |                            |       |   |   |
| Net increase in  interest-bearing deposits                                         |       | 9,833                           |       | 51,160 |   |
| Net decrease in  noninterest-bearing deposits                                      |       | (170                            | )          | (1,730 | ) |
| Proceeds of  long-term borrowings, FHLB                                            |       | 20,000                          |       | –– |   |
| Repayment of  long-term borrowings, FHLB                                           |       | (16,500                         | )          | (1,600 | ) |
| Net increase  (decrease) in short-term borrowings                                  |       | 10,096                          |       | (35,977 | ) |
| Dividends paid                                                                     |       | (5,169                          | )          | (5,083 | ) |
| Issuance of  common stock                                                          |       | 73                              |       | 15 |   |
| Stock options  exercised                                                           |       | 8                               |       | –– |   |
| Purchase of  treasury stock                                                        |       | (892                            | )          | (2,303 | ) |
| Net cash  provided by financing activities                                         |       | 17,279                          |       | 4,482 |   |
| NET DECREASE IN  CASH AND CASH EQUIVALENTS                                         |       | (2,130                          | )          | (622 | ) |
| CASH AND CASH  EQUIVALENTS, BEGINNING                                              |       | 15,373                          |       | 14,090 |   |
| CASH AND CASH  EQUIVALENTS, ENDING                                                 |       | $                               | 13,243     |   | $ | 13,468 |   |
|                                                                               |       |                            |       |   |   |
| SUPPLEMENTAL  DISCLOSURES OF CASH FLOW INFORMATION                                 |       |                            |       |   |   |
|                                                                               |       |                            |       |   |   |
| Interest paid                                                                      |       | $                               | 11,744     |   | $ | 9,915 |   |
| Income taxes  paid                                                                 |       | 1,185                           |       | 2,075 |   |
| Transfer of  loans to foreclosed real estate                                       |       | ––                    |       | 51 |   |

 

See accompanying notes to the unaudited consolidated financialstatements.

 

6

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

**NOTES TOCONSOLIDATED FINANCIAL STATEMENTS**

**(Unaudited)**

 

# **Note1.   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., Woods RealEstate Development Company, Inc., and Jersey Shore State Bank (the “Bank”) andits wholly-owned subsidiary The M Group, Inc. D/B/A The Comprehensive FinancialGroup (“The M Group”). All significant inter-company balances and transactionshave been eliminated in the consolidation.**

# ** **

The interim financialstatements are unaudited but, in the opinion of management, reflect alladjustments necessary for the fair presentation of results for such periods. Allof those adjustments are of a normal, recurring nature. The results ofoperations for any interim period are not necessarily indicative of results forthe full year. These financial statements should be read in conjunction withfinancial statements and notes thereto contained in the Company’s Annual Reporton Form 10-K for the year ended December 31, 2006.

 

Theaccounting policies followed in the presentation of interim financial resultsare the same as those followed on an annual basis.  These policies arepresented on pages 40 thru 46 of the Annual Report on Form 10-K for the yearended December 31, 2006.

 

In reference to the attachedfinancial statements, all adjustments are of a normal recurring nature pursuantto Rule 10-01 (b) (8) of Regulation S-X.

 

**Note 2.   RecentAccounting Pronouncements**

** **

InFebruary 2006, the Financial Accounting Standards Board (“FASB”) issuedStatement of Financial Accounting Standards (“FAS”) No. 155, *Accounting for Certain Hybrid Instruments, as an amendment of FASBStatements No. 133 and 140*. FAS No. 155 allows financial instrumentsthat have embedded derivatives to be accounted for as a whole (eliminating theneed to bifurcate the derivative from its host) if the holder elects to accountfor the whole instrument on a fair value basis. This statement is effective forall financial instruments acquired or issued after the beginning of an entity’sfirst fiscal year that begins after September 15, 2006. The adoption of thisstandard is not expected to have a material effect on the Company’s results ofoperations or financial position.

 

InMarch 2006, the FASB issued FAS No. 156, *Accounting for Servicingof Financial Assets*. This Statement, which is an amendment to FASNo. 140, will simplify the accounting for servicing assets and liabilities,such as those common with mortgage securitization activities. Specifically, FASNo. 156 addresses the recognition and measurement of separately recognizedservicing assets and liabilities and provides an approach to simplify effortsto obtain hedge-like (offset) accounting. FAS No. 156 also clarifies when anobligation to service financial assets

 

7

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shouldbe separately recognized as a servicing asset or a servicing liability,requires that a separately recognized servicing asset or servicing liability beinitially measured at fair value, if practicable, and permits an entity with aseparately recognized servicing asset or servicing liability to choose eitherof the amortization or fair value methods for subsequent measurement. Theprovisions of FAS No. 156 are effective as of the beginning of the first fiscalyear that begins after September 15, 2006. The adoption of this standard is notexpected to have a material effect on the Company’s results of operations orfinancial position.

 

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

 

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

 

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

 

InJune 2006, the FASB issued FASB Interpretation No. 48 (“FIN 48”), *Accounting for Uncertainty in Income Taxes*. FIN 48 is aninterpretation of FAS No. 109, *Accounting for IncomeTaxes*, and it seeks to reduce the diversity in practice associatedwith certain aspects of measurement and recognition in accounting for incometaxes. In addition, FIN No. 48 requires expanded disclosure with respect to theuncertainty in income taxes and is effective for fiscal

 

8

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yearsbeginning after December 15, 2006. The adoption of this standard is notexpected to have a material effect on the Company’s results of operations orfinancial position.

 

InSeptember 2006, the FASB reached consensus on the guidance provided by EmergingIssues Task Force Issue 06-4 (“EITF 06-4”), *Accounting for DeferredCompensation and Postretirement Benefit Aspects of Endorsement Split-DollarLife Insurance Arrangements*. The guidance is applicable to endorsementsplit-dollar life insurance arrangements, whereby the employer owns andcontrols the insurance policy, that are associated with a postretirementbenefit. EITF 06-4 requires that for a split-dollar life insurance arrangementwithin the scope of the Issue, an employer should recognize a liability forfuture benefits in accordance with FAS No. 106 (if, in substance, apostretirement benefit plan exists) or Accounting Principles Board Opinion No.12 (if the arrangement is, in substance, an individual deferred compensationcontract) based on the substantive agreement with the employee. EITF 06-4 iseffective for fiscal years beginning after December 15, 2007. The Company iscurrently evaluating the impact the adoption of the EITF will have on the Company’sresults of operations or financial condition.

 

InSeptember 2006, the FASB reached consensus on the guidance provided by EmergingIssues Task Force Issue 06-5 (“EITF 06-5”), *Accounting for Purchasesof Life Insurance—Determining the Amount That Could Be Realized in Accordancewith FASB Technical Bulletin No. 85-4, Accounting for Purchases of LifeInsurance*. EITF 06-5 states that a policyholder should consider anyadditional amounts included in the contractual terms of the insurance policyother than the cash surrender value in determining the amount that could berealized under the insurance contract. EITF 06-5 also states that apolicyholder should determine the amount that could be realized under the lifeinsurance contract assuming the surrender of an individual-life byindividual-life policy (or certificate by certificate in a group policy). EITF06-5 is effective for fiscal years beginning after December 15, 2006. TheCompany is currently evaluating the impact the adoption of the standard willhave on the Company’s results of operations or financial condition.

 

InMarch 2007, the FASB ratified Emerging Issues Task Force Issue No. 06-10 (“EITF06-10”), *Accounting for Collateral Assignment Split-DollarLife Insurance Agreements*. EITF 06-10 provides guidance fordetermining a liability for the postretirement benefit obligation as well asrecognition and measurement of the associated asset on the basis of the termsof the collateral assignment agreement. EITF 06-10 is effective for fiscalyears beginning after December 15, 2007. The Company is currently evaluatingthe impact the adoption of the EITF will have on the Company’s results ofoperations or financial condition.

 

InJune 2007, the FASB ratified Emerging Issues Task Force Issue No. 06-11 (“EITF06-11”), *Accounting for Income Tax Benefits of Dividends onShare-Based Payment Awards*. EITF 06-11 applies to share-basedpayment arrangements with dividend protection features that entitle employeesto receive (a) dividends on equity-classified nonvested shares, (b) dividendequivalents on equity-classified nonvested share units, or (c) payments equalto the dividends paid on the underlying shares while an equity-classified shareoption is outstanding, when those dividends or dividend equivalents are chargedto retained earnings under FAS No. 123R, *Share-Based Payment*,and result in an income tax deduction for the employer. A consensus was

 

9

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reachedthat a realized income tax benefit from dividends or dividend equivalents thatare charged to retained earnings and are paid to employees forequity-classified nonvested equity shares, nonvested equity share units, andoutstanding equity share options should be recognized as an increase inadditional paid-in capital. EITF 06-11 is effective for fiscal years beginningafter December 15, 2007, and interim periods within those fiscal years. Theimpact of the adoption of the EITF will not have an impact on the Company’sfinancial condition.

 

**Note 3. Per Share Data**

 

The following table sets forth the composition of theweighted average common shares (denominator) used in the basic and dilutive pershare computation. There are no convertible securities which would affect thenumerator in calculating basic and diluted earnings per share; therefore, netincome as presented on the consolidated statement of income will be used as thenumerator.

 
| ** **                                                                                                  | ** ** | **Three Months Ended September 30,** | ** ** | **Nine Months Ended September 30,** | ** ** |
|-------------------------------------------------------------------------------------------------------------|------------|----------------------------------------------------------|------------|---------------------------------------------------------|------------|
| ** **                                                                                                  | ** ** | **2007**                                                 | ** ** | **2006**                                                | ** ** | **2007** | ** ** | **2006** | ** ** |
|                                                                                                        |       |                                                     |       |                                                    |       |   |   |   |   |
| Weighted average  common shares outstanding                                                                 |       | 4,005,583                                                |       | 4,002,340                                               |       | 4,004,778 |   | 4,002,220 |   |
|                                                                                                        |       |                                                     |       |                                                    |       |   |   |   |   |
| Average treasury  stock shares                                                                              |       | (124,095                                                 | )          | (75,079                                                 | )          | (115,468 | ) | (59,687 | ) |
|                                                                                                        |       |                                                     |       |                                                    |       |   |   |   |   |
| Weighted average  common shares and common  stock equivalents used to calculate  basic earnings per share   |       | 3,881,488                                                |       | 3,927,261                                               |       | 3,889,310 |   | 3,942,533 |   |
|                                                                                                        |       |                                                     |       |                                                    |       |   |   |   |   |
| Additional  common stock equivalents(stock options) used to calculatediluted earnings per share             |       | 188                                                      |       | 479                                                     |       | 263 |   | 483 |   |
|                                                                                                        |       |                                                     |       |                                                    |       |   |   |   |   |
| Weighted average  common shares and common  stock equivalents used to  calculate diluted earnings per share |       | 3,881,676                                                |       | 3,927,740                                               |       | 3,889,573 |   | 3,943,016 |   |

 

Options to purchase 8,276 and 9,002 shares of commonstock at the price of $40.29 were outstanding during the three and nine monthsended September 30, 2007 and 2006, respectively, but were not included in thecomputation of diluted earnings per share as they were anti-dilutive due to thestrike price being greater than the market price as of September 30, 2007 and2006, respectively.

 

**Note 4.  ****Net Periodic 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 the yearended December 31, 2006.

 

The following sets forth the components of the netperiodic benefit cost of the domestic non-contributory defined benefit plan forthe three and nine months ended September 30, 2007 and 2006, respectively:

 

10

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| ** **                          | ** ** | **Three Months Ended** | ** ** | **Nine Months Ended** | ** ** |
|-------------------------------------|------------|----------------------------------|------------|---------------------------------|------------|
| ** **                          | ** ** | **September 30,**           | ** ** | **September 30,**          | ** ** |
| **(In Thousands)**             | ** ** | **2007**                         | ** ** | **2006**                        | ** ** | **2007** | ** ** | **2006** | ** ** |
|                                |       |                             |       |                            |       |   |   |   |   |
| Service cost                        |       | $                                | 117        |                            | $          | 117 |   | $ | 350 |   | $ | 350 |   |
| Interest cost                       |       | 121                              |       | 108                             |       | 364 |   | 325 |   |
| Expected return  on plan assets     |       | (140                             | )          | (121                            | )          | (421 | ) | (364 | ) |
| Amortization of  transition         |       | (1                               | )          | (1                              | )          | (2 | ) | (2 | ) |
| Amortization of  prior service cost |       | 6                                |       | 6                               |       | 19 |   | 19 |   |
| Amortization of  net loss           |       | —                           |       | 6                               |       | — |   | 17 |   |
| Net periodic  cost                  |       | $                                | 103        |                            | $          | 115 |   | $ | 310 |   | $ | 345 |   |

 

**Employer Contributions**

** **

The Company previously disclosed in its consolidatedfinancial statements, included in the Annual Report on Form 10-K for the yearended December 31, 2006, that it expected to contribute $500,000 to its definedbenefit plan in 2007.  As of September 30, 2007, a contribution in theamount of $580,000 was made for the 2006 plan year with no additionalcontributions anticipated.

 

**Note 5.   Off Balance Sheet Risk**

 

The Company is a party to financial instruments withoff-balance sheet risk in the normal course of business to meet the financingneeds of its customers. These financial instruments are primarily comprised ofcommitments to extend credit and standby letters of credit. These instrumentsinvolve, to varying degrees, elements of credit, interest rate, or liquidityrisk in excess of the amount recognized in the consolidated balance sheet. Thecontract amounts of these instruments express the extent of involvement theCompany has in particular classes 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 creditpolicies in making commitments and conditional obligations as it does foron-balance sheet instruments. The Company may require collateral or othersecurity to support financial instruments with off-balance sheet credit risk.

 

Outstanding financial instruments with off balance sheetrisk are as follows:

 

| ** **                    | ** ** | **September 30,** | ** ** | **December 31,** | ** ** |
|-------------------------------|------------|------------------------|------------|-----------------------|------------|
| **(In Thousands)**       | ** ** | **2007**               | ** ** | **2006**              | ** ** |
| Commitments to  extend credit |       | $                      | 71,588     |                  | $          | 61,736 |   |
| Standby letters  of credit    |       | 1,345                  |       | 1,033                 |       |
|                               |            |                        |            |                       |            |  |  |

 

11

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# **Note6.   Reclassification of ComparativeAmounts**

# ** **

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.   EmployeeStock Purchase Plan**

# ** **

EffectiveApril 26, 2006, the Company implemented the Penns Woods Bancorp, Inc. 2006Employee Stock Purchase Plan (“Plan”). The Plan is intended to encourageemployee participation in the ownership and economic progress of the Company. ThePlan allows for up to 1,000,000 shares to be purchased by employees. Thepurchase price of the shares is 95% of market value with an employee eligibleto purchase up to the lesser of 15% of base compensation or $12,000 in marketvalue annually. During the nine months ended September 30, 2007 and 2006, therewere 2,240 and 421 shares issued under the plan, respectively.

 

**CAUTIONARY STATEMENT FOR PURPOSESOF THE PRIVATE**

**SECURITIES LITIGATION REFORM ACTOF 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 tocaution readers that the following important factors, among others, may haveaffected and could in the future affect the Company’s actual results and couldcause the Company’s actual results for subsequent periods to differ materiallyfrom those expressed in any forward-looking statement made by or on behalf ofthe Company herein:  (i) the effect ofchanges in 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 and practices, asmay be adopted by the regulatory agencies as well as by the FinancialAccounting Standards Board, or of changes in the Company’s organization,compensation and benefit plans; (iii) the effect on the Company’s competitiveposition within its market area of the increasing consolidation within the banking and financial servicesindustries, including the increased competition from larger regional andout-of-state banking organizations as well as non-bank providers of variousfinancial services; (iv) the effect of changes in interest rates; and (v) theeffect of changes in the business cycle and downturns in the local, regional ornational economies.

 

12

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**Item 2.    Management’s Discussionand Analysis of Financial Condition and Results of Operation**

 

# **EARNINGSSUMMARY**

# ** **

**Comparisonof the Three and Nine Months Ended September 30, 2007 and 2006**

 

**SummaryResults**

 

Netincome for the three months ended September 30, 2007 was $2,322,000 compared to$2,464,000 for the same period of 2006. Basic and diluted earnings per sharefor the three months ended September 30, 2007 were $0.60 as compared to $0.63for the three months ended September 30, 2006. Return on average assets andreturn on average equity were 1.57% and 13.21% for the three months endedSeptember 30, 2007 as compared to 1.71% and 13.41% for the corresponding periodof 2006. Net income from core operations (“operating earnings”) for the threemonths ended September 30, 2007 and 2006, which excludes net after-taxsecurities gains of $370,000 for the 2006 period, increased $228,000 to$2,322,000 for the three months ended September 30, 2007 as compared to$2,094,000 for the same period of 2006. Operating earnings per share for thethree months ended September 30, 2007 increased 13.2% or $0.07 to $0.60 basicand dilutive as compared to the three months ended September 30, 2006. Operatingearnings per share for the three months ended September 30, 2007 represent a$0.05 basic and dilutive increase from the previous three month period as coreearnings continued to build upon the $0.02 increase from the first to secondquarters of 2007.

 

The nine months endedSeptember 30, 2007 generated net income of $6,938,000 compared to $7,353,000for the same period of 2006. Earnings per share, basic and diluted, for thenine months ended September 30, 2007 were $1.78 as compared to $1.87 for thecomparable period of 2006. Return on average assets and return on averageequity were 1.57% and 12.63% for the nine months ended September 30, 2007 ascompared to 1.71% and 13.20% for the corresponding period of 2006. Operating earnings for the nine monthsended September 30, 2007 and 2006, which excludes net after-tax securitiesgains of $409,000 and $914,000, respectively, increased $90,000 to $6,529,000for the 2007 period compared to $6,439,000 for the 2006 period. Operatingearnings per share, basic and dilutive, increased 3.1% to $1.68 for the ninemonths ended September 30, 2007 as compared to $1.63 for the comparable periodof 2006.

 

(Management uses thenon-GAAP measure of net income from core operations in its analysis of theCompany’s performance. This measure, as used by the Company, adjusts net incomeby significant gains or losses that are unusual in nature. Because certain ofthese items and their impact on the Company’s performance are difficult topredict, management believes the presentation of financial measures excludingthe impact of such items provides useful supplemental information in evaluatingthe operating results of the Company’s core businesses. For purposes of thisQuarterly Report on Form 10-Q, net income from core operations means net incomeadjusted to exclude after-tax net securities gains. These disclosures shouldnot be viewed as a substitute for net income determined in accordance withGAAP, nor are they necessarily comparable to non-GAAP performance measures thatmay be presented by other companies.)

 

13

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**InterestIncome**

 

Interestincome for the three months ended September 30, 2007 increased $430,000 to$8,977,000 as compared to $8,547,000 for the same period of 2006. The increasein interest income was primarily the result of growth in average loans of$5,736,000 coupled with an 18 basis point (“bp”) increase in loan portfolioyields for the three months ended September 30, 2007 over the same period of2006. Over the same time frame, the average balance of investment securitiesand interest bearing deposits increased $5,693,000 with the portfolio yieldincreasing 28 bp resulting in a $164,000 increase in interest income. On ataxable equivalent basis, the interest income from the investment portfolio andinterest bearing deposits increased $218,000 due to the investment portfoliobeing strategically shifted toward tax-exempt instruments. The decrease individends received is the result of a decrease in equity investments.

 

Duringthe nine months ended September 30, 2007, interest income was $26,449,000, anincrease of $1,533,000 over the same period in 2006. The reasons for the 6.2%growth in interest income for the nine month period are identical to those forthe three month period ending September 30, 2007 discussed above. The growth inaverage loans of $11,727,000 coupled with a 26 bp increase in the loanportfolio yield resulted in an increase of $1,310,000 in loan interest and feeincome. Average investment securities and interest bearing deposits remainedstable, however, interest income increased $223,000 due to a 24 bp increase inyield. The increase in yield was due to an increase in yield on taxablesecurities as portfolio cash flow was reinvested into higher yielding bondsover the past year. The asset allocation between loans and the investmentportfolio composition resulted in taxable equivalent interest income increasing$1,673,000 for the nine months ended September 30, 2007 as compared to the sameperiod of 2006.

 

Interestincome composition for the three and nine months ended September 30, 2007 and2006 was as follows:

 

14

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| ** **                          | ** ** | **For The Three Months Ended** | ** ** |
|-------------------------------------|------------|----------------------------------------------------|------------|
| ** **                          | ** ** | **September 30, 2007**                   | ** ** | **September 30, 2006** | ** ** | **Change** | ** ** |
| **(In Thousands)**             | ** ** | **Amount**                                         | ** ** | **% Total** | ** ** | **Amount** | ** ** | **% Total** | ** ** | **Amount** | ** ** | **%** | ** ** |
| Loans including  fees               |       | $                                                  | 6,621      |   | 73.8 | % | $ | 6,355 |   | 74.4 | % | $ | 266 |   | 4.2 | % |
| Investment  securities:             |       |                                               |       |   |   |   |   |   |   |   |   |   |   |
| Taxable                             |       | 964                                                |       | 10.7 |   | 874 |   | 10.2 |   | 90 |   | 10.3 |   |
| Tax-exempt                          |       | 1,108                                              |       | 12.3 |   | 1,004 |   | 11.7 |   | 104 |   | 10.4 |   |
| Dividend and  other interest income |       | 284                                                |       | 3.2 |   | 314 |   | 3.7 |   | (30 | ) | (9.6 | ) |
| Total interest  income              |       | $                                                  | 8,977      |   | 100.0 | % | $ | 8,547 |   | 100.0 | % | $ | 430 |   | 5.0 | % |

 
| ** **                          | ** ** | **For The Nine Months Ended** | ** ** |
|-------------------------------------|------------|---------------------------------------------------|------------|
| ** **                          | ** ** | **September 30, 2007**                  | ** ** | **September 30, 2006** | ** ** | **Change** | ** ** |
| **(In Thousands)**             | ** ** | **Amount**                                        | ** ** | **% Total** | ** ** | **Amount** | ** ** | **% Total** | ** ** | **Amount** | ** ** | **%** | ** ** |
| Loans including  fees               |       | $                                                 | 19,560     |   | 74.0 | % | $ | 18,250 |   | 73.3 | % | $ | 1,310 |   | 7.2 | % |
| Investment  securities:             |       |                                              |       |   |   |   |   |   |   |   |   |   |   |
| Taxable                             |       | 2,711                                             |       | 10.2 |   | 2,691 |   | 10.8 |   | 20 |   | 0.7 |   |
| Tax-exempt                          |       | 3,271                                             |       | 12.4 |   | 2,993 |   | 12.0 |   | 278 |   | 9.3 |   |
| Dividend and  other interest income |       | 907                                               |       | 3.4 |   | 982 |   | 3.9 |   | (75 | ) | (7.6 | ) |
| Total interest  income              |       | $                                                 | 26,449     |   | 100.0 | % | $ | 24,916 |   | 100.0 | % | $ | 1,533 |   | 6.2 | % |

 

**InterestExpense**

 

Interestexpense for the three months ended September 30, 2007 increased $405,000 to$4,112,000 as compared to $3,707,000 for the same period of 2006. The increasedexpense associated with deposits is primarily the result of rate increases fortime deposits, which are comprised of various certificates of deposit (“CD”)accounts, from the three months ended September 30, 2006 to the correspondingperiod of 2007. Factors that led to the rate increases include, but are notlimited to, competitive market pricing pressure and campaigns conducted toattract 8 to 12 month maturity CDs that provide greater funding flexibility.The increase in CD interest rates has exceeded the increase for other depositaccounts. This has led to a shift of a portion of the money market and savingsdeposit portfolios into higher yielding CDs. Borrowing interest expense on FHLBadvances and customer repurchase accounts increased $17,000 as rates paidincreased 4 bp, while the average balance of borrowed funds remained constant.

 

Interestexpense for the nine months ended September 30, 2007 increased $1,733,000 to$12,050,000 from $10,317,000 for the comparable period of 2006. Interest ondeposits accounted for $1,963,000 of the increase due to the reasons noted inthe above three month analysis. Borrowing costs declined primarily due to thepreviously noted CD campaigns that allowed for average FHLB advances to bereduced for the nine months ended September 30, 2007 as compared to the sameperiod of 2006.

 

Interestexpense composition for the three and nine months ended September 30, 2007 and2006 was as follows:

 

15

----

 
| ** **                  | ** ** | **For The Three Months Ended** | ** ** |
|-----------------------------|------------|----------------------------------------------------|------------|
| ** **                  | ** ** | **September 30, 2007**                   | ** ** | **September 30, 2006** | ** ** | **Change** | ** ** |
| **(In Thousands)**     | ** ** | **Amount**                                         | ** ** | **% Total** | ** ** | **Amount** | ** ** | **% Total** | ** ** | **Amount** | ** ** | **%** | ** ** |
| Deposits                    |       | $                                                  | 2,835      |   | 68.9 | % | $ | 2,447 |   | 66.0 | % | $ | 388 |   | 15.9 | % |
| Short-term  borrowings      |       | 368                                                |       | 9.0 |   | 306 |   | 8.3 |   | 62 |   | 20.3 |   |
| Long-term  borrowings, FHLB |       | 909                                                |       | 22.1 |   | 954 |   | 25.7 |   | (45 | ) | (4.7 | ) |
| Total interest  expense     |       | $                                                  | 4,112      |   | 100.0 | % | $ | 3,707 |   | 100.0 | % | $ | 405 |   | 10.9 | % |

 
| ** **                  | ** ** | **For The Nine Months Ended**    | ** ** |
|-----------------------------|------------|----------------------------------|------------|
| ** **                  | ** ** | **September 30, 2007** | ** ** | **September 30, 2006** | ** ** | **Change** | ** ** |
| **(In Thousands)**     | ** ** | **Amount**                       | ** ** | **% Total** | ** ** | **Amount** | ** ** | **% Total** | ** ** | **Amount** | ** ** | **%** | ** ** |
| Deposits                    |       | $                                | 8,215      |   | 68.2 | % | $ | 6,252 |   | 60.6 | % | $ | 1,963 |   | 31.4 | % |
| Short-term  borrowings      |       | 1,100                            |       | 9.1 |   | 1,221 |   | 11.8 |   | (121 | ) | (9.9 | ) |
| Long-term  borrowings, FHLB |       | 2,735                            |       | 22.7 |   | 2,844 |   | 27.6 |   | (109 | ) | (3.8 | ) |
| Total interest  expense     |       | $                                | 12,050     |   | 100.0 | % | $ | 10,317 |   | 100.0 | % | $ | 1,733 |   | 16.8 | % |

 

**Net Interest Margin**

** **

Thenet interest margin (“NIM”) for the three months ended September 30, 2007 was3.98% as compared to 4.00% for the corresponding period of 2006 and increasedslightly from 3.95% for the three months ended June 30, 2007. The decrease inthe NIM for the three months ended September 30, 2007 compared to the sameperiod in 2006 was due to the cost of interest bearing liabilities continuingto increase at a rate greater than the increase in the yield on earning assetsas has been the trend over the past twelve months. The negative impact of thedisparity between the asset yield increases and the liability rate increases,however, declined for the three months ended September 30, 2007 as compared tothe same period of 2006. Average loan growth of $5,736,000 and a shift in theinvestment portfolio toward tax-exempt bonds paved the way for the increase inyield on earning assets of 21 bp for the three month period ended September2007 as compared to 2006. The average investment securities portfolio increasedby $6,088,000, as the tax-exempt segment increased to $95,383,000 at September30, 2007 as compared to $91,234,000 at September 30, 2006. The growth intax-exempt bonds was part of the Company’s tax strategy and was strategicallyundertaken to provide the cash flow and yield desired from the portfolio as awhole. The increase in the cost of interest bearing liabilities to 3.67% from3.42% was driven primarily by the cost of time deposits increasing 48 bp forthe three months ended September 30, 2007 as compared to the previous year,while the average balance of time deposits increased $17,503,000. The increasein cost of time deposits was impacted by the Federal Open Market Committee rateincreases during 2006 of 100 bp, utilization of brokered deposits, and ourstrategic decision to gather time deposits as part of marketing campaignsassociated with a branch opening and branch anniversaries in 2006 and 2007

 

TheNIM for the nine months ended September 30, 2007 was 3.96% as compared to 4.06%for the corresponding period of 2006. The decrease in the NIM was the result ofthe previously mentioned growth and change in mix of the earnings assets offsetby increased rates paid on interest bearing liabilities and growth in theaverage CD portfolio of $29,282,000.

 

16

----

 

Followingis a schedule of average balances and associated yields for the three and ninemonth periods ended September 30, 2007 and 2006:

 
| ** **                                       | ** ** | **AVERAGE BALANCES AND INTEREST RATES** | ** ** |
|--------------------------------------------------|------------|-------------------------------------------------------------|------------|
| ** **                                       | ** ** | **Three Months Ended**                            | ** ** | **Three Months Ended** | ** ** |
| ** **                                       | ** ** | **September 30, 2007**                            | ** ** | **September 30, 2006** | ** ** |
| **(In Thousands)**                          | ** ** | **Average Balance**                                    | ** ** | **Interest** | ** ** | **Average Rate** | ** ** | **Average Balance** | ** ** | **Interest** | ** ** | **Average Rate** | ** ** |
| Assets:                                          |       |                                                        |       |   |   |   |   |   |   |   |   |   |   |
| Tax-exempt loans                                 |       | $                                                           | 7,652      |   | $ | 118 |   | 6.12 | % | $ | 8,275 |   | $ | 127 |   | 6.09 | % |
| All other loans                                  |       | 354,032                                                     |       | 6,543 |   | 7.33 | % | 347,673 |   | 6,271 |   | 7.16 | % |
| Total loans                                      |       | 361,684                                                     |       | 6,661 |   | 7.31 | % | 355,948 |   | 6,398 |   | 7.13 | % |
|                                             |       |                                                        |       |   |   |   |   |   |   |   |   |   |   |
| Taxable  investment securities                   |       | 91,788                                                      |       | 1,247 |   | 5.43 | % | 89,849 |   | 1,181 |   | 5.26 | % |
| Tax-exempt  investment securities                |       | 95,383                                                      |       | 1,679 |   | 7.04 | % | 91,234 |   | 1,521 |   | 6.67 | % |
| Total securities                                 |       | 187,171                                                     |       | 2,926 |   | 6.25 | % | 181,083 |   | 2,702 |   | 5.97 | % |
|                                             |       |                                                        |       |   |   |   |   |   |   |   |   |   |   |
| Interest bearing  deposits                       |       | 40                                                          |       | 1 |   | 9.92 | % | 435 |   | 7 |   | 6.38 | % |
|                                             |       |                                                        |       |   |   |   |   |   |   |   |   |   |   |
| Total  interest-earning assets                   |       | 548,895                                                     |       | 9,588 |   | 6.95 | % | 537,466 |   | 9,107 |   | 6.74 | % |
|                                             |       |                                                        |       |   |   |   |   |   |   |   |   |   |   |
| Other assets                                     |       | 43,706                                                      |       |   |   |   |   | 42,042 |   |   |   |   |   |
|                                             |       |                                                        |       |   |   |   |   |   |   |   |   |   |   |
| Total assets                                     |       | $                                                           | 592,601    |   |   |   |   |   | $ | 579,508 |   |   |   |   |   |
|                                             |       |                                                        |       |   |   |   |   |   |   |   |   |   |   |
| Liabilities:                                     |       |                                                        |       |   |   |   |   |   |   |   |   |   |   |
| Savings                                          |       | $                                                           | 60,262     |   | 114 |   | 0.75 | % | $ | 63,081 |   | 142 |   | 0.89 | % |
| Super Now  deposits                              |       | 46,531                                                      |       | 153 |   | 1.30 | % | 47,071 |   | 170 |   | 1.43 | % |
| Money market  deposits                           |       | 23,183                                                      |       | 131 |   | 2.24 | % | 23,300 |   | 131 |   | 2.23 | % |
| Time deposits                                    |       | 203,690                                                     |       | 2,437 |   | 4.75 | % | 186,187 |   | 2,004 |   | 4.27 | % |
| Total deposits                                   |       | 333,666                                                     |       | 2,835 |   | 3.37 | % | 319,639 |   | 2,447 |   | 3.04 | % |
|                                             |       |                                                        |       |   |   |   |   |   |   |   |   |   |   |
| Short-term  borrowings                           |       | 32,910                                                      |       | 368 |   | 4.44 | % | 27,255 |   | 306 |   | 4.45 | % |
| Long-term  borrowings, FHLB                      |       | 77,791                                                      |       | 909 |   | 4.64 | % | 82,878 |   | 954 |   | 4.57 | % |
| Total borrowings                                 |       | 110,701                                                     |       | 1,277 |   | 4.58 | % | 110,133 |   | 1,260 |   | 4.54 | % |
|                                             |       |                                                        |       |   |   |   |   |   |   |   |   |   |   |
| Total  interest-bearing liabilities              |       | 444,367                                                     |       | 4,112 |   | 3.67 | % | 429,772 |   | 3,707 |   | 3.42 | % |
|                                             |       |                                                        |       |   |   |   |   |   |   |   |   |   |   |
| Demand deposits                                  |       | 70,689                                                      |       |   |   |   |   | 69,660 |   |   |   |   |   |
| Other  liabilities                               |       | 7,249                                                       |       |   |   |   |   | 6,596 |   |   |   |   |   |
| Shareholders’  equity                       |       | 70,296                                                      |       |   |   |   |   | 73,480 |   |   |   |   |   |
| Total  liabilities and shareholders’ equity |       | $                                                           | 592,601    |   |   |   |   |   | $ | 579,508 |   |   |   |   |   |
|                                             |       |                                                        |       |   |   |   |   |   |   |   |   |   |   |
| Interest rate  spread                            |       |                                                        |       |   |   | 3.28 | % |   |   |   |   | 3.32 | % |
| Net interest  income/margin                      |       |                                                        |       | $ | 5,476 |   | 3.98 | % |   |   | $ | 5,400 |   | 4.00 | % |

 

----

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

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

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

 

17

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| ** **                          | ** ** | **AVERAGE BALANCES AND INTEREST RATES** | ** ** |
|-------------------------------------|------------|-------------------------------------------------------------|------------|
| ** **                          | ** ** | **Nine Months Ended**                             | ** ** | **Nine Months Ended** | ** ** |
| ** **                          | ** ** | **September 30, 2007**                            | ** ** | **September 30, 2006** | ** ** |
| **(In Thousands)**             | ** ** | **Average Balance**                                    | ** ** | **Interest** | ** ** | **Average Rate** | ** ** | **Average Balance** | ** ** | **Interest** | ** ** | **Average Rate** | ** ** |
| Assets:                             |       |                                                        |       |   |   |   |   |   |   |   |   |   |   |
| Tax-exempt loans                    |       | $                                                           | 7,913      |   | $ | 365 |   | 6.17 | % | $ | 8,155 |   | $ | 377 |   | 6.18 | % |
| All other loans                     |       | 353,219                                                     |       | 19,320 |   | 7.31 | % | 341,250 |   | 18,001 |   | 7.05 | % |
| Total loans                         |       | 361,132                                                     |       | 19,685 |   | 7.29 | % | 349,405 |   | 18,378 |   | 7.03 | % |
|                                |       |                                                        |       |   |   |   |   |   |   |   |   |   |   |
| Taxable  securities                 |       | 85,930                                                      |       | 3,600 |   | 5.59 | % | 93,848 |   | 3,664 |   | 5.21 | % |
| Tax-exempt  securities              |       | 99,497                                                      |       | 4,956 |   | 6.64 | % | 90,972 |   | 4,535 |   | 6.65 | % |
| Total securities                    |       | 185,427                                                     |       | 8,556 |   | 6.15 | % | 184,820 |   | 8,199 |   | 5.91 | % |
|                                |       |                                                        |       |   |   |   |   |   |   |   |   |   |   |
| Interest bearing  deposits          |       | 431                                                         |       | 18 |   | 5.58 | % | 161 |   | 9 |   | 7.47 | % |
|                                |       |                                                        |       |   |   |   |   |   |   |   |   |   |   |
| Total  interest-earning assets      |       | 546,990                                                     |       | 28,259 |   | 6.90 | % | 534,386 |   | 26,586 |   | 6.65 | % |
|                                |       |                                                        |       |   |   |   |   |   |   |   |   |   |   |
| Other assets                        |       | 42,390                                                      |       |   |   |   |   | 39,747 |   |   |   |   |   |
|                                |       |                                                        |       |   |   |   |   |   |   |   |   |   |   |
| Total assets                        |       | $                                                           | 589,380    |   |   |   |   |   | $ | 574,133 |   |   |   |   |   |
|                                |       |                                                        |       |   |   |   |   |   |   |   |   |   |   |
| Liabilities:                        |       |                                                        |       |   |   |   |   |   |   |   |   |   |   |
| Savings                             |       | $                                                           | 59,726     |   | 329 |   | 0.74 | % | $ | 63,150 |   | 398 |   | 0.84 | % |
| Super Now  deposits                 |       | 46,309                                                      |       | 455 |   | 1.31 | % | 47,835 |   | 488 |   | 1.36 | % |
| Money market  deposits              |       | 24,362                                                      |       | 414 |   | 2.27 | % | 24,190 |   | 367 |   | 2.03 | % |
| Time deposits                       |       | 198,401                                                     |       | 7,017 |   | 4.73 | % | 169,119 |   | 4,999 |   | 3.95 | % |
| Total Deposits                      |       | 328,798                                                     |       | 8,215 |   | 3.34 | % | 304,294 |   | 6,252 |   | 2.75 | % |
|                                |       |                                                        |       |   |   |   |   |   |   |   |   |   |   |
| Short-term  borrowings              |       | 32,443                                                      |       | 1,100 |   | 4.53 | % | 37,761 |   | 1,221 |   | 4.32 | % |
| Other borrowings                    |       | 78,818                                                      |       | 2,735 |   | 4.64 | % | 83,359 |   | 2,844 |   | 4.56 | % |
| Total borrowings                    |       | 111,261                                                     |       | 3,835 |   | 4.61 | % | 121,120 |   | 4,065 |   | 4.49 | % |
|                                |       |                                                        |       |   |   |   |   |   |   |   |   |   |   |
| Total  interest-bearing liabilities |       | 440,059                                                     |       | 12,050 |   | 3.66 | % | 425,414 |   | 10,317 |   | 3.24 | % |
|                                |       |                                                        |       |   |   |   |   |   |   |   |   |   |   |
| Demand deposits                     |       | 69,203                                                      |       |   |   |   |   | 69,219 |   |   |   |   |   |
| Other  liabilities                  |       | 6,866                                                       |       |   |   |   |   | 5,245 |   |   |   |   |   |
| Shareholders’  equity          |       | 73,252                                                      |       |   |   |   |   | 74,255 |   |   |   |   |   |
|                                |       |                                                        |       |   |   |   |   |   |   |   |   |   |   |
|                                |       | $                                                           | 589,380    |   |   |   |   |   | $ | 574,133 |   |   |   |   |   |
| Interest rate  spread               |       |                                                        |       |   |   | 3.24 | % |   |   |   |   | 3.41 | % |
| Net interest  income/margin         |       |                                                        |       | $ | 16,209 |   | 3.96 | % |   |   | $ | 16,269 |   | 4.06 | % |

 

----

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

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

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

 

18

----

 

# **The following table presents theadjustment to convert net interest income to net interest income on a fullytaxable equivalent basis for the three and nine month periods ended September30, 2007 and 2006.**

# ** **

| ** **                                      | ** ** | **For the Three Months Ended** | ** ** | **For the Nine Months Ended** | ** ** |
|-------------------------------------------------|------------|----------------------------------------------------|------------|---------------------------------------------------|------------|
| ** **                                      | ** ** | **September 30,**                             | ** ** | **September 30,**                            | ** ** |
| **(In Thousands)**                         | ** ** | **2007**                                           | ** ** | **2006**                                          | ** ** | **2007** | ** ** | **2006** | ** ** |
|                                            |       |                                               |       |                                              |       |   |   |   |   |
| Total interest  income                          |       | $                                                  | 8,977      |                                              | $          | 8,547 |   | $ | 26,449 |   | $ | 24,916 |   |
| Total interest  expense                         |       | 4,112                                              |       | 3,707                                             |       | 12,050 |   | 10,317 |   |
|                                            |       |                                               |       |                                              |       |   |   |   |   |
| Net interest  income                            |       | 4,865                                              |       | 4,840                                             |       | 14,399 |   | 14,599 |   |
| Tax equivalent  adjustment                      |       | 611                                                |       | 560                                               |       | 1,810 |   | 1,670 |   |
|                                            |       |                                               |       |                                              |       |   |   |   |   |
| Net interest  income (fully taxable equivalent) |       | $                                                  | 5,476      |                                              | $          | 5,400 |   | $ | 16,209 |   | $ | 16,269 |   |

# ** **

# **The following table sets forth therespective impact that both volume and rate changes have had on net interestincome on a fully taxable equivalent basis for the three and nine month periodsended September 30, 2007 and 2006:**

# ** **

| ** **                          | ** ** | **Three Months Ended September 30,** | ** ** | **Nine Months Ended September 30,** | ** ** |
|-------------------------------------|------------|----------------------------------------------------------|------------|---------------------------------------------------------|------------|
| ** **                          | ** ** | **2007 vs 2006**                               | ** ** | **2007 vs 2006**                              | ** ** |
| ** **                          | ** ** | **Increase (Decrease)**                             | ** ** | **Increase (Decrease)**                            | ** ** |
| ** **                          | ** ** | **Due to**                                          | ** ** | **Due to**                                         | ** ** |
| **(In Thousands)**             | ** ** | **Volume**                                               | ** ** | **Rate**                                                | ** ** | **Net** | ** ** | **Volume** | ** ** | **Rate** | ** ** | **Net** | ** ** |
| Interest income:                    |       |                                                     |       |                                                    |       |   |   |   |   |   |   |   |   |
| Loans,  tax-exempt                  |       | $                                                        | (10        | )                                                       | $          | 1 |   | $ | (9 | ) | $ | (11 | ) | $ | (1 | ) | $ | (12 | ) |
| Loans                               |       | 118                                                      |       | 154                                                     |       | 272 |   | 642 |   | 677 |   | 1,319 |   |
| Taxable  investment securities      |       | 25                                                       |       | 41                                                      |       | 66 |   | (419 | ) | 355 |   | (64 | ) |
| Tax-exempt  investment securities   |       | 71                                                       |       | 87                                                      |       | 158 |   | 425 |   | (4 | ) | 421 |   |
| Interest bearing  deposits          |       | (6                                                       | )          | ––                                            |       | (6 | ) | 15 |   | (6 | ) | 9 |   |
| Total  interest-earning assets      |       | 198                                                      |       | 283                                                     |       | 481 |   | 652 |   | 1,021 |   | 1,673 |   |
|                                |       |                                                     |       |                                                    |       |   |   |   |   |   |   |   |   |
| Interest  expense:                  |       |                                                     |       |                                                    |       |   |   |   |   |   |   |   |   |
| Savings deposits                    |       | (6                                                       | )          | (22                                                     | )          | (28 | ) | (21 | ) | (48 | ) | (69 | ) |
| Super Now  deposits                 |       | (2                                                       | )          | (15                                                     | )          | (17 | ) | (16 | ) | (17 | ) | (33 | ) |
| Money market  deposits              |       | (2                                                       | )          | 2                                                       |       | –– |   | 3 |   | 44 |   | 47 |   |
| Time deposits                       |       | 197                                                      |       | 236                                                     |       | 433 |   | 939 |   | 1,079 |   | 2,018 |   |
| Short-term  borrowings              |       | 63                                                       |       | (1                                                      | )          | 62 |   | (184 | ) | 63 |   | (121 | ) |
| Long-term  borrowings, FHLB         |       | (59                                                      | )          | 14                                                      |       | (45 | ) | (159 | ) | 50 |   | (109 | ) |
| Total  interest-bearing liabilities |       | 191                                                      |       | 214                                                     |       | 405 |   | 562 |   | 1,171 |   | 1,733 |   |
| Change in net  interest income      |       | $                                                        | 7          |                                                    | $          | 69 |   | $ | 76 |   | $ | 90 |   | $ | (150 | ) | $ | (60 | ) |

# ** **

# **Provisionfor Loan Losses**

# ** **

Theprovision for loan losses is based upon management’s quarterly review of theloan portfolio. The purpose of the review is to assess loan quality, identifyimpaired loans, analyze delinquencies, ascertain loan growth, evaluatepotential charge-offs and recoveries, and assess general economic conditions inthe markets served. An external independent loan review is also

 

19

----

 

performedannually for the Bank. Management remains committed to an aggressive program ofproblem loan identification 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. Lossfactors are based on management’s consideration of the nature of the portfoliosegments, changes in mix and volume of the loan portfolio, and historical loanloss experience. In addition, management considers industry standards andtrends with respect to non-performing loans and its knowledge and experiencewith specific lending segments.

 

Although managementbelieves it uses the best information available to make such determinations andthat the allowance for loan losses is adequate at September 30, 2007, futureadjustments could be necessary if circumstances or economic conditions differsubstantially from the assumptions used in making the initial determinations. Adownturn in the local economy, employment, and delays in receiving financialinformation from borrowers could result in increased levels of nonperformingassets, 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 couldrequire the recognition of additions to the loan loss allowance based on theirjudgment of information 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 decreased from $4,185,000 at December 31, 2006 to $4,092,000 atSeptember 30, 2007. At September 30, 2007, the allowance for loan losses was1.14% of total loans compared to 1.16% of total loans at December 31, 2006. Management’sconclusion is that the allowance for loan losses is adequate to provide for possible losses inherent inthe loan portfolio as of the balance sheet date.

 

The provision for loanlosses totaled $10,000 and $60,000 for the three and nine months endedSeptember 30, 2007, respectively, as compared to $89,000 and $485,000 for thesame periods in 2006. The decrease in the provision was the result of severalcontinuing positive factors, including but not limited to, a ratio ofannualized net charge offs to average loans of 0.06% for the nine months endedSeptember 30, 2007, a ratio of nonperforming loans to total loans of 0.28% atSeptember 30, 2007, and a ratio of the allowance for loan losses tononperforming loans of 403.95% at September 30, 2007. In addition, gross loanshave declined $2,669,000 since December 31, 2006 due to a softening of the loanmarket and the payoff of several commercial loans.

 

Based upon this analysis,as well as the others noted above, management has concluded that the allowancefor loan losses remains at a level adequate to provide for probable lossesinherent in its loan portfolio.

 

20

----

 

**Non-interestIncome**

 

Totalnon-interest income for the three months ended September 30, 2007 compared tothe same period in 2006 decreased $381,000 to $2,006,000 primarily as a resultof the amount of net securities gains realized during the three month periodended September 30, 2006. Excluding net securities gains, non-interest incomewould have increased $180,000 as compared to the 2006 period. Deposit servicecharges declined $50,000 as overdraft protection fees declined and customersmigrated to new checking accounts having reduced or no service charges. Otherincome increased due primarily to revenue generated from increased debit cardtransactions, merchant card commissions, and commissions generated by The MGroup for securities transactions.

 

Insurancecommissions for the three months ended September 30, 2007 increased $123,000 ascompared to the same period in 2006 due to a shift in product mix. Managementof The M Group continues to pursue new and build upon current relationships. Thesales call program continues to expand to other financial institutions, whichresults in additional revenue for The M Group. However, the addition of anothersales outlet for The M-Group can take up to a year or more to be completed.

 

Totalnon-interest income for the nine months ended September 30, 2007 compared tothe same period in 2006 decreased $774,000. Excluding net securities gains,non-interest income would have remained stable as compared to the 2006 period. Thedecrease in non-interest income for the nine month period is the result of thesame items noted in the three month discussion.

 

Non-interestincome composition for the three and nine months ended September 30, 2007 and2006 were as follows:

 

21

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| ** **                 | ** ** | **For The Three Months Ended** | ** ** |
|----------------------------|------------|----------------------------------------------------|------------|
| ** **                 | ** ** | **September 30, 2007**                   | ** ** | **September 30, 2006** | ** ** | **Change** | ** ** |
| **(In Thousands)**    | ** ** | **Amount**                                         | ** ** | **% Total** | ** ** | **Amount** | ** ** | **% Total** | ** ** | **Amount** | ** ** | **%** | ** ** |
| Deposit service  charges   |       | $                                                  | 546        |   | 27.2 | % | $ | 596 |   | 25.0 | % | $ | (50 | ) | (8.4 | )% |
| Securities  gains, net     |       | —                                             |       | — |   | 561 |   | 23.5 |   | (561 | ) | (100.0 | ) |
| Bank owned life  insurance |       | 109                                                |       | 5.4 |   | 94 |   | 3.9 |   | 15 |   | 16.0 |   |
| Gain on sale of  loans     |       | 282                                                |       | 14.1 |   | 264 |   | 11.1 |   | 18 |   | 6.8 |   |
| Insurance  commissions     |       | 625                                                |       | 31.2 |   | 502 |   | 21.0 |   | 123 |   | 24.5 |   |
| Other                      |       | 444                                                |       | 22.1 |   | 370 |   | 15.5 |   | 74 |   | 19.9 |   |
| Total non-interest  income |       | $                                                  | 2,006      |   | 100.0 | % | $ | 2,387 |   | 100.0 | % | $ | (381 | ) | (16.0 | )% |

 
| ** **                 | ** ** | **For The Nine Months Ended** | ** ** |
|----------------------------|------------|---------------------------------------------------|------------|
| ** **                 | ** ** | **September 30, 2007**                  | ** ** | **September 30, 2006** | ** ** | **Change** | ** ** |
| **(In Thousands)**    | ** ** | **Amount**                                        | ** ** | **% Total** | ** ** | **Amount** | ** ** | **% Total** | ** ** | **Amount** | ** ** | **%** | ** ** |
| Deposit service  charges   |       | $                                                 | 1,654      |   | 26.8 | % | $ | 1,773 |   | 25.5 | % | $ | (119 | ) | (6.7 | )% |
| Securities  gains, net     |       | 619                                               |       | 10.0 |   | 1,385 |   | 20.0 |   | (766 | ) | (55.3 | ) |
| Bank owned life  insurance |       | 310                                               |       | 5.0 |   | 272 |   | 3.9 |   | 38 |   | 14.0 |   |
| Gain on sale of  loans     |       | 654                                               |       | 10.6 |   | 624 |   | 9.0 |   | 30 |   | 4.8 |   |
| Insurance  commissions     |       | 1,613                                             |       | 26.2 |   | 1,732 |   | 25.0 |   | (119 | ) | (6.9 | ) |
| Other                      |       | 1,316                                             |       | 21.4 |   | 1,154 |   | 16.6 |   | 162 |   | 14.0 |   |
| Total  non-interest income |       | $                                                 | 6,166      |   | 100.0 | % | $ | 6,940 |   | 100.0 | % | $ | (774 | ) | (11.2 | )% |

 

**Non-interestExpense**

 

Totalnon-interest expense increased $316,000 for the three months ended September30, 2007 compared to the same period of 2006. The increase in salaries andemployee benefits was attributable to several items including standard cost ofliving wage adjustments for employees, new additions to our staff, and increasedbenefit costs. Occupancy expense increased due to the new branch inMontoursville, which opened in the third quarter of 2006, and increased cost ofmaintenance and property taxes. Other expenses increased primarily due tonormal anticipated inflationary adjustments to ongoing business operating costsand the amortization related to a low income housing partnership that beganoperation during the fourth quarter of 2006.

 

Totalnon-interest expenses increased $755,000 for the nine months ended September 30,2007 as compared to the same period of 2006. As noted above in the three monthdiscussion, the new Montoursville branch in addition to normal increases ingeneral business expenses and the amortization of a low income housingpartnership, impacted the level of non-interest expenses.

 

Non-interestexpense composition for the three and nine months ended September 30, 2007 and2006 were as follows:

 

22

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| ** **                      | ** ** | **For The Three Months Ended** | ** ** |
|---------------------------------|------------|----------------------------------------------------|------------|
| ** **                      | ** ** | **September 30, 2007**                   | ** ** | **September 30, 2006** | ** ** | **Change** | ** ** |
| **(In Thousands)**         | ** ** | **Amount**                                         | ** ** | **% Total** | ** ** | **Amount** | ** ** | **% Total** | ** ** | **Amount** | ** ** | **%** | ** ** |
| Salaries and  employee benefits |       | $                                                  | 2,330      |   | 52.6 | % | $ | 2,174 |   | 52.8 | % | $ | 156 |   | 7.2 | % |
| Occupancy, net                  |       | 319                                                |       | 7.2 |   | 308 |   | 7.5 |   | 11 |   | 3.6 |   |
| Furniture and  equipment        |       | 267                                                |       | 6.0 |   | 309 |   | 7.5 |   | (42 | ) | (13.6 | ) |
| Pennsylvania  shares tax        |       | 160                                                |       | 3.6 |   | 151 |   | 3.7 |   | 9 |   | 6.0 |   |
| Other                           |       | 1,354                                              |       | 30.6 |   | 1,172 |   | 28.5 |   | 182 |   | 15.5 |   |
| Total  non-interest expense     |       | $                                                  | 4,430      |   | 100.0 | % | $ | 4,114 |   | 100.0 | % | $ | 316 |   | 7.7 | % |

 
| ** **                      | ** ** | **For The Nine Months Ended** | ** ** |
|---------------------------------|------------|---------------------------------------------------|------------|
| ** **                      | ** ** | **September 30, 2007**                  | ** ** | **September 30, 2006** | ** ** | **Change** | ** ** |
| **(In Thousands)**         | ** ** | **Amount**                                        | ** ** | **% Total** | ** ** | **Amount** | ** ** | **% Total** | ** ** | **Amount** | ** ** | **%** | ** ** |
| Salaries and  employee benefits |       | $                                                 | 6,912      |   | 53.6 | % | $ | 6,620 |   | 54.5 | % | $ | 292 |   | 4.4 | % |
| Occupancy, net                  |       | 987                                               |       | 7.7 |   | 826 |   | 6.8 |   | 161 |   | 19.5 |   |
| Furniture and equipment         |       | 850                                               |       | 6.6 |   | 894 |   | 7.4 |   | (44 | ) | (4.9 | ) |
| Pennsylvania  shares tax        |       | 482                                               |       | 3.7 |   | 447 |   | 3.7 |   | 35 |   | 7.8 |   |
| Other                           |       | 3,667                                             |       | 28.4 |   | 3,356 |   | 27.6 |   | 311 |   | 9.3 |   |
| Total  non-interest expense     |       | $                                                 | 12,898     |   | 100.0 | % | $ | 12,143 |   | 100.0 | % | $ | 755 |   | 6.2 | % |

 

**Provisionfor Income Taxes**

 

Incometaxes decreased $451,000 and $889,000 for the three and nine month periodsended September 30, 2007 compared to the same periods of 2006. The effectivetax rates for the three and nine months ended September 30, 2007 were 4.48% and8.79%, respectively, as compared to 18.52% and 17.48% for the same periods of2006. The decline in the effective tax rate is consistent with management’srepositioning of the investment portfolio from taxable investment securities totax-exempt investment securities, additional tax credits related to investmentsin low income housing projects, and greater than anticipated tax losses on thehousing projects. The current effective tax rate has resulted in a deferred taxasset due to the low income housing tax credits. Management has reviewed thedeferred tax asset and has determined that the asset will be utilized withinthe appropriate carry forward period and therefore does not require a valuationallowance.

 

# **ASSET/LIABILITYMANAGEMENT**

# ** **

# **Cashand Cash Equivalents**

# ** **

Cash and cash equivalentsdecreased $2,130,000 from $15,373,000 at December 31, 2006 to $13,243,000 atSeptember 30, 2007 primarily as a result of the following activities during thenine months ended September 30, 2007:

 

# **LoansHeld for Sale**

# ** **

Activity regarding loansheld for sale resulted in loan originations exceeding sale proceeds, less$654,000 in realized gains, by $2,787,000 for the nine months ended September30, 2007.

 

23

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**Loans**

 

Gross loans decreased$2,669,000 since December 31, 2006 due to the early payoff of several largecommercial loans coupled with increased competition for commercial loans and asoftening of the market.

 

The allocation of the loan portfolio, by category,as of September 30, 2007 and December 31, 2006 is presented below:

 
| ** **                               | ** ** | **September 30,** | ** ** | **December 31,** | ** ** | **Change** | ** ** |
|------------------------------------------|------------|------------------------|------------|-----------------------|------------|------------|------------|
| **(In Thousands)**                  | ** ** | **2007**               | ** ** | **2006**              | ** ** | **Amount** | ** ** | **%** | ** ** |
| Commercial,  financial, and agricultural |       | $                      | 35,868     |                  | $          | 36,995     |       | $ | (1,127 | ) | (3.0 | )% |
| Real estate  mortgage:                   |       |                   |       |                  |       |       |       |   |   |
| Residential                              |       | 162,163                |       | 158,219               |       | 3,944      |       | 2.5 |   |
| Commercial                               |       | 129,726                |       | 135,404               |       | (5,678     | )          | (4.2 | ) |
| Construction                             |       | 17,492                 |       | 16,749                |       | 743        |       | 4.4 |   |
| Installment  loans to individuals        |       | 13,400                 |       | 14,035                |       | (635       | )          | (4.5 | ) |
| Less: Net  deferred loan fees            |       | 934                    |       | 1,018                 |       | (84        | )          | (8.3 | ) |
| Gross loans                              |       | $                      | 357,715    |                  | $          | 360,384    |       | $ | (2,669 | ) | (0.7 | )% |

 

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 $1,195,000 at September 30, 2007, as compared to $574,000 atDecember 31, 2006. The valuation allowance related to impaired loans amountedto $98,000 at September 30, 2007 and $42,000 at December 31, 2006. The increasein impaired loans is primarily from a single commercial relationship thataccounted for $523,000 of the increase, while the increase in valuationallowance is the result of a second commercial relationship that had a specificcollateral weakness.

 

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

 

**Investments**

 

Theestimated fair value of the investment securities portfolio in total hasincreased $19,550,000 since December 31, 2006, while the amortized costincreased $25,613,000. The majority of the changes in value incurred within thestate and municipal segment of the portfolio. The amortized cost position instate and political securities increased $6,115,000 as the Bank continued itsstrategy to build call protection, maintain taxable equivalent yields, reducethe effective federal

 

24

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incometax rate, and invest in communities across the Commonwealth of Pennsylvania andthe country. The amortized cost position of other debt securities increased$13,806,000 as the Bank began a leverage transaction to enhance earning assetyields in a softening loan market. The increased level of unrealized losses,which offset the increase in amortized cost, was the result of changes in theyield curve, not credit quality, as the credit quality of the portfolio remainssound.

 

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

 

25

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| ** **                             | ** ** | **September 30, 2007** | ** ** |
|----------------------------------------|------------|----------------------------------|------------|
| ** **                             | ** ** | ** **                       | ** ** | **Gross** | ** ** | **Gross** | ** ** | **Estimated** | ** ** |
| ** **                             | ** ** | **Amortized**                    | ** ** | **Unrealized** | ** ** | **Unrealized** | ** ** | **Fair** | ** ** |
| **(In Thousands)**                | ** ** | **Cost**                         | ** ** | **Gains** | ** ** | **Losses** | ** ** | **Value** | ** ** |
| Available for  sale (AFS)              |       |                             |       |   |   |   |   |   |   |
| U.S. Government  and agency securities |       | $                                | 60,732     |   | $ | 69 |   | $ | (714 | ) | $ | 60,087 |   |
| State and  political securities        |       | 110,773                          |       | 561 |   | (2,287 | ) | 109,047 |   |
| Other debt  securities                 |       | 15,799                           |       | 36 |   | (173 | ) | 15,662 |   |
| Total debt  securities                 |       | 187,304                          |       | 666 |   | (3,174 | ) | 184,796 |   |
| Equity  securities                     |       | 20,274                           |       | 1,000 |   | (1,312 | ) | 19,962 |   |
| Total investment  securities AFS       |       | $                                | 207,578    |   | $ | 1,666 |   | $ | (4,486 | ) | $ | 204,758 |   |
|                                   |       |                             |       |   |   |   |   |   |   |
| Held to maturity  (HTM)                |       |                             |       |   |   |   |   |   |   |
| U.S. Government  and agency securities |       | $                                | 14         |   | $ | 1 |   | $ | — |   | $ | 15 |   |
| Other debt  securities                 |       | 262                              |       | 1 |   | — |   | 263 |   |
| Total investment  securities HTM       |       | $                                | 276        |   | $ | 2 |   | $ | — |   | $ | 278 |   |

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

 

26

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# **Financing Activities**

# ** **

# **Deposits**

# ** **

Totaldeposits increased 2.4% or $9,663,000 from December 31, 2006 to September 30,2007. The mix of deposits has shifted from December 31, 2006 to September 30,2007 as brokered deposits have decreased substantially and customer timedeposits have increased. The shift is the result of the Bank strategicallyattracting short-term customer time deposits and utilizing the funds gatheredto replace maturing brokered time deposits and higher cost short-term FHLBadvances. The amount of brokered deposits is continuously monitored and is usedto supplement deposits, not as a primary source of deposits.

 

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

 
| ** **                | ** ** | **September 30, 2007** | ** ** | **December 31, 2006** | ** ** | **Change** | ** ** |
|---------------------------|------------|----------------------------------|------------|---------------------------------|------------|------------|------------|
| **(In Thousands)**   | ** ** | **Amount**                       | ** ** | **% Total**                | ** ** | **Amount** | ** ** | **% Total** | ** ** | **Amount** | ** ** | **%** | ** ** |
| Demand deposits           |       | $                                | 72,990     |                            | 18.0       | %          | $          | 73,160 |   | 18.5 | % | $ | (170 | ) | (0.2 | )% |
| NOW accounts              |       | 47,129                           |       | 11.6                            |       | 46,156     |       | 11.7 |   | 973 |   | 2.1 |   |
| Money market  deposits    |       | 22,295                           |       | 5.5                             |       | 23,137     |       | 5.9 |   | (842 | ) | (3.6 | ) |
| Savings deposits          |       | 59,883                           |       | 14.8                            |       | 59,289     |       | 15.0 |   | 594 |   | 1.0 |   |
| Time deposits             |       | 189,313                          |       | 46.8                            |       | 168,420    |       | 42.6 |   | 20,893 |   | 12.4 |   |
| Time deposits -  brokered |       | 13,244                           |       | 3.3                             |       | 25,029     |       | 6.3 |   | (11,785 | ) | (47.1 | ) |
| Total deposits            |       | $                                | 404,854    |                            | 100.0      | %          | $          | 395,191 |   | 100.0 | % | $ | 9,663 |   | 2.4 | % |

# ** **

# **Borrowed Funds**

# ** **

Total borrowed fundsincreased 11.6% to $131,171,000 at September 30, 2007 as compared to$117,575,000 at December 31, 2006. The increase in borrowed funds is primarilythe result of an investment portfolio leverage strategy that was initiatedduring September 2007. The leverage program at September 30, 2007 accounted for$20,000,000 in borrowings split evenly between short-term and long-term FHLBborrowings. Off setting the increase related to the leverage strategy were thepreviously discussed time deposit gathering campaigns that were utilized toprovide funds to reduce the level of higher cost short-term borrowings and toassist in replacing long-term borrowing maturities. Long-term borrowingsincreased due to the maturity of four borrowings totaling $16,500,000 thatcarried an average rate of 3.99% offset by two new $10,000,000 FHLB borrowingsthat mature in 2017 and carry a rate of 4.28% and 4.15%, respectively.

 

27

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| ** **                                     | ** ** | **September 30, 2007** | ** ** | **December 31, 2006** | ** ** | **Change** | ** ** |
|------------------------------------------------|------------|----------------------------------|------------|---------------------------------|------------|------------|------------|
| **(In Thousands)**                        | ** ** | **Amount**                       | ** ** | **% Total**                | ** ** | **Amount** | ** ** | **% Total** | ** ** | **Amount** | ** ** | **%** | ** ** |
| Short-term  borrowings:                        |       |                             |       |                            |       |       |       |   |   |   |   |   |   |
| FHLB repurchase  agreements                    |       | $                                | 12,870     |                            | 9.8        | %          | $          | 18,706 |   | 15.9 | % | $ | (5,836 | ) | (31.2 | )% |
| Short-term borrowings,  FHLB                   |       | 15,000                           |       | 11.4                            |       | —     |       | — |   | 15,000 |   | — |   |
| Securities sold  under agreement to repurchase |       | 16,923                           |       | 12.9                            |       | 15,991     |       | 13.6 |   | 932 |   | 5.8 |   |
| Total short-term  borrowings                   |       | 44,793                           |       | 34.1                            | %          | 34,697     |       | 29.5 | % | 10,096 |   | 29.1 |   |
|                                           |       |                             |       |                            |       |       |       |   |   |   |   |   |   |
| Long-term borrowings,  FHLB                    |       | 86,378                           |       | 65.9                            |       | 82,878     |       | 70.5 |   | 3,500 |   | 4.2 |   |
| Total borrowed  funds                          |       | $                                | 131,171    |                            | 100.0      | %          | $          | 117,575 |   | 100.0 | % | $ | 13,596 |   | 11.6 | % |

 

# **Capital**

# ** **

## The adequacy of theCompany’s capital is reviewed on an ongoing basis with reference to the size,composition, and quality of the Company’s resources and regulatory guidelines. Managementseeks to maintain a level of capital sufficient to support existing assets andanticipated asset growth, maintain favorable access to capital markets, andpreserve high quality credit ratings.

##  

## Bank holding companiesare required to comply with the Federal Reserve Board’s risk-based capitalguidelines. The risk-based capital rules are designed to make regulatorycapital requirements more sensitive to differences in risk profiles among banksand bank holding companies and to minimize disincentives for holding liquidassets. Specifically, each is required to maintain certain minimum dollaramounts and ratios of Total risk-based, Tier I risk-based, and Tier I leveragecapital requirements. In addition to the capital requirements, the FederalDeposit Insurance Corporation Improvements Act (FDICIA) established fivecapital categories ranging from “well capitalized” to “criticallyundercapitalized.” To be classified as “well capitalized”, Total risk-based,Tier I risked-based, and Tier I leverage capital ratios must be at least 10%,6%, and 5%, respectively.

 

28

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Capitalratios as of September 30, 2007 and December 31, 2006 were as follows:

# ** **

| ** **                     | ** ** | **2007**   | ** ** | **2006**  | ** ** |
|--------------------------------|------------|------------|------------|-----------|------------|
| **(In Thousands)**        | ** ** | **Amount** | ** ** | **Ratio** | ** ** | **Amount** | ** ** | **Ratio** | ** ** |
| Total Capital                  |       |       |       |      |       |   |   |   |   |
| (to  Risk-weighted Assets)     |       |       |       |      |       |   |   |   |   |
|                           |       |       |       |      |       |   |   |   |   |
| Actual                         |       | $          | 72,574     |      | 18.6       | % | $ | 73,098 |   | 20.5 | % |
| For Capital  Adequacy Purposes |       | 31,149     |       | 8.0       |       | 28,515 |   | 8.0 |   |
| To Be Well  Capitalized        |       | 38,937     |       | 10.0      |       | 35,643 |   | 10.0 |   |
|                           |       |       |       |      |       |   |   |   |   |
| Tier I Capital                 |       |       |       |      |       |   |   |   |   |
| (to  Risk-weighted Assets)     |       |       |       |      |       |   |   |   |   |
|                           |       |       |       |      |       |   |   |   |   |
| Actual                         |       | $          | 68,482     |      | 17.6       | % | $ | 67,869 |   | 19.0 | % |
| For Capital  Adequacy Purposes |       | 15,575     |       | 4.0       |       | 14,257 |   | 4.0 |   |
| To Be Well  Capitalized        |       | 23,362     |       | 6.0       |       | 21,386 |   | 6.0 |   |
|                           |       |       |       |      |       |   |   |   |   |
| Tier I Capital                 |       |       |       |      |       |   |   |   |   |
| (to Average  Assets)           |       |       |       |      |       |   |   |   |   |
|                           |       |       |       |      |       |   |   |   |   |
| Actual                         |       | $          | 68,482     |      | 11.6       | % | $ | 67,869 |   | 12.0 | % |
| For Capital  Adequacy Purposes |       | 23,714     |       | 4.0       |       | 22,591 |   | 4.0 |   |
| To Be Well  Capitalized        |       | 29,643     |       | 5.0       |       | 28,239 |   | 5.0 |   |

 

# **Liquidityand Interest Rate Sensitivity**

# ** **

## The asset/liabilitycommittee addresses the liquidity needs of the Company to ensure thatsufficient funds are available to meet credit demands and deposit withdrawalsas well as to the placement of available funds in the investment portfolio. Inassessing liquidity requirements, equal consideration is given to the currentposition as well as the future outlook.

##  

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

 

1. Net Loans to TotalAssets, 85% maximum

2. Net Loans to TotalDeposits, 100% maximum

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

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

 

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

 

29

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providesthe Company with the ability to meet its financial obligations to depositors,loan customers, and shareholders. Additionally, it provides funds for normaloperating expenditures and business opportunities as they arise. The objectiveof interest rate sensitivity management is to increase net interest income bymanaging interest sensitive assets and liabilities in such a way that they canbe 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 to control cash flow, the Bank estimatesfuture flows of cash from deposits, loan payments, and investment securitypayments. The primary sources of funds are deposits, principal and interestpayments on loans and investment securities, FHLB borrowings, and brokereddeposits. Management believes the Bank has adequate resources to meet itsnormal 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 and sources of funds are determined. Fundingstrategies consider both customer needs and economical cost. Both short andlong-term funding needs are addressed by maturities and sales of available forsale investment securities, loan repayments and maturities, and liquidatingmoney market investments such as federal funds sold. The use of theseresources, in conjunction with access to credit provides core ingredients tosatisfy depositor, borrower, and creditor needs.

 

Managementmonitors and determines the desirable level of liquidity. Consideration isgiven to loan demand, investment opportunities, deposit pricing and growthpotential, as well as the current cost of borrowing funds. The Company has acurrent borrowing capacity at the FHLB of $218,872,000. In addition to this credit arrangement, theCompany has additional lines of credit with correspondent banks of $29,535,000.Management believes it has sufficient liquidity to satisfy estimated short-termand long-term funding needs. FHLB borrowings totaled $114,248,000 as ofSeptember 30, 2007.

 

Interestrate sensitivity, which is closely related to liquidity management, is afunction of the repricing characteristics of the Company’s portfolio of assetsand liabilities. Asset/liability management strives to match maturities andrates between loan and investment security assets with the deposit liabilitiesand borrowings that fund them. Successful asset/liability management results ina balance sheet structure which can cope effectively with market ratefluctuations. The matching process is affected by segmenting both assets andliabilities into future time periods (usually 12 months, or less) based uponwhen repricing can be effected. Repriceable assets are subtracted fromrepriceable liabilities, for a specific time period to determine the “gap”, ordifference. Once known, the gap is managed based on predictions about futuremarket interest rates. Intentional mismatching, or gapping, can enhance netinterest income if market rates move as predicted. However, if market ratesbehave in a manner contrary to predictions, net interest income will suffer. Gaps,therefore, contain an element of risk and 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.

 

30

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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-K forthe year ended December 31, 2006.

 

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 than inflation have a more significant impact on theCompany’s performance. Interest rates are not always affected in the samedirection or magnitude as prices of other goods and services, but arereflective of fiscal policy initiatives or economic factors which are notmeasured by a price index.

 

**Item 3. Quantitative and Qualitative Disclosures About Market Risk**

 

Marketrisk for the Company is comprised primarily of interest rate risk exposure andliquidity risk. Interest rate risk and liquidity risk management is performedat the Bank level as well as the Company level. The Company’s interest ratesensitivity is monitored by management through selected interest rate riskmeasures produced by an independent third party. There have been no substantialchanges in the Company’s gap analyses or simulation analyses compared to theinformation provided in the Annual Report on Form 10-K for the period endedDecember 31, 2006. Additional information and details are provided in the “Liquidityand Interest Rate Sensitivity” section of “Item 2. Management’s Discussion andAnalysis of Financial Condition and Results of Operations.”

 

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

 

**Item 4. Controls and Procedures**

 

An analysis was performed under the supervision and with theparticipation of the Company’s management, including the Chief ExecutiveOfficer and the Principal Financial Officer, of the effectiveness of the designand operation of the Company’s disclosure controls and procedures. Based onthat evaluation, the Company’s Chief Executive Officer and Principal FinancialOfficer concluded that the Company’s disclosure controls and procedures wereeffective as of September 30, 2007. There were no changes in the Company’sinternal control over financial reporting that occurred during the quarterended September 30, 2007, that have materially affected, or are reasonablylikely to materially affect, the Company’s internal control over financialreporting.

 

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### **PartII. OTHER INFORMATION**

### ** **

**Item 1.    Legal Proceedings**

 

None.

 

**Item 1A. Risk Factors**

 

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

 

**Item 2.    Unregistered Sales of Equity Securities andUse 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 (July  1-July 31, 2007)           |       | 6,000               |       | $                   | 34.06      |                                    | 6,000      |                                                | 133,570    |   |
|                                      |       |                |       |                |       |                                    |       |                                                |       |
| Month#2 (August  1-August 31, 2007)       |       | 5,000               |       | 31.75               |       | 5,000                                   |       | 128,570                                             |       |
|                                      |       |                |       |                |       |                                    |       |                                                |       |
| Month#3  (September 1-September 30, 2007) |       | —              |       | —              |       | —                                  |       | 128,570                                             |       |
|                                           |            |                     |            |                     |            |                                         |            |                                                     |            |  |

 

On April 24, 2007, theBoard of Directors extended the authorization to repurchase up to 197,000shares, or approximately 5%, of the outstanding shares of the Company for anadditional year to April 25, 2008. The repurchase plan was originally for a oneyear period expiring on April 25, 2007. To date, there have been 68,430 sharesrepurchased under this plan.

 

**Item 3.    Defaults Upon Senior Securities**

 

None

 

**Item 4.    Submission of Matters to a Vote of SecurityHolders**

 

None

 

### **Item 5.    OtherInformation**

### ** **

None

 

32

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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, 2006). |
|-----------------------|--------|--------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
| (3)    (ii) |   | Bylaws  of the Registrant’s as presently in effect (incorporated by reference to  Exhibit 3(ii) of the Registrant’s Current Report on Form 8-K filed June 17,  2005).                              |
| (31)  (i)             |   | Rule  13a-14(a)/Rule 15d-14(a) Certification of Chief Executive Officer.                                                                                                                                     |
| (31)  (ii)            |   | Rule  13a-14(a)/Rule 15d-14(a) Certification of Principal Financial Officer.                                                                                                                                 |
| (32)  (i)             |   | Certification  of Chief Executive Officer Section 1350.                                                                                                                                                      |
| (32)  (ii)            |   | Certification  of Principal Financial Officer Section 1350.                                                                                                                                                  |

 

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## **SIGNATURES**

##  

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

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

 

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**EXHIBIT INDEX**

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

 

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