Table of Contents

 

 

 

**FORM 10-Q**

 

**SECURITIES AND EXCHANGE COMMISSION**

**Washington, D.C.  20549**

** **

**QUARTERLY REPORT UNDER SECTION 13OR 15(d)**

**OF THE SECURITIES EXCHANGE ACT OF1934**

 

**For the quarter ended June 30, 2008**

**Commission file number:  0-12826**

 

**TOWER BANCORP INC.**

(Exact name of registrant as specified in itscharter)

 

| **Commonwealth of Pennsylvania** | ** ** | **25-1445946**      |
|----------------------------------|------------|---------------------|
| (State or other jurisdiction of  |       | (I.R.S. Employer    |
| incorporation or organization)   |       | Identification No.) |

 

| **Center Square**                        |       |       |
|------------------------------------------|------------|------------|
| **Greencastle, Pennsylvania**            | ** ** | **17225**  |
| (Address of principal executive offices) |       | (Zip Code) |

 

Registrant’s telephonenumber, includingarea code:   **(717)597-2137**

 

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

Yes  x     No  o

 

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

 

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

 

Indicateby check mark whether the registrant is a shell company (as defined in Rule 12b-2of the Exchange Act).

 

Yes  o     No  x

 

Indicatethe number of shares outstanding of each of the issuer’s classes of commonstock, as of the latest practicable date.

 

2,314,843shares of common stock outstanding at July 23, 2008

 

 

 

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TOWER BANCORP, INC.

 

INDEX

 
| ** **                                                                                                                | **Page**     |
|---------------------------------------------------------------------------------------------------------------------------|--------------|
| PART I – FINANCIAL INFORMATION                                                                                  |         |
| Item 1 – Financial  Statements                                                                                       |         |
| Condensed  consolidated balance sheets – June 30, 2008 and December 31, 2007                               | 4            |
| Condensed consolidated  statements of income - three months ended June 30, 2008 and 2007                             | 5            |
| Condensed consolidated  statements of income – six months ended June 30, 2008 and 2007                          | 6            |
| Condensed consolidated  statements of comprehensive income – three and six months ended June 30,  2008 and 2007 | 7            |
| Condensed consolidated  statements of cash flows – six months ended June 30, 2008 and 2007                      | 8            |
| Notes to condensed consolidated financial statements                                                                      | 9 – 15  |
| Item 2 –  Management’s discussion and analysis of financial condition and results of  operations                | 16 – 27 |
| Item 3 – Quantitative and qualitative disclosures  about market risk                                                 | 28           |
| Item 4 – Controls and procedures                                                                                     | 28           |
|                                                                                                                      |         |
| PART II  - OTHER INFORMATION                                                                                         | 29           |
|                                                                                                                      |         |
| Item  1 – Legal proceedings                                                                                          | 30           |
| Item  1A – Risk Factors                                                                                              | 30           |
| Item 2 – Unregistered sales of equity securities and  use of proceeds                                                | 30           |
| Item 3 – Defaults upon senior securities                                                                             | 31           |
| Item 4 – Submission of matters to a vote of security  holders                                                        | 31           |
| Item  5 – Other information                                                                                          | 31           |
| Item  6 – Index to Exhibits                                                                                          | 31 – 33 |
|                                                                                                                      |         |
| Signatures                                                                                                                | 34           |
|                                                                                                                      |         |
| Exhibits                                                                                                                  | 35 – 40 |

 

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PART I- FINANCIAL INFORMATION

 

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TOWER BANCORP, INC. AND ITSWHOLLY-OWNED SUBSIDIARY

 

CONDENSEDCONSOLIDATED BALANCE SHEETS

 
| ** **                                                                                          | ** ** | **June 30,**      | ** ** | **December 31,** | ** ** |
|-----------------------------------------------------------------------------------------------------|------------|------------------------|------------|-----------------------|------------|
| ** **                                                                                          | ** ** | **2008**               | ** ** | **2007**              | ** ** |
| ** **                                                                                          | ** ** | **(Unaudited)**        | ** ** | **(Audited)***        | ** ** |
| ** **                                                                                          | ** ** | **(000 Omitted)** | ** ** |
| ASSETS                                                                                              |       |                   |       |                  |       |
| Cash and due  from banks                                                                            |       | $                      | 13,376     |                  | $          | 16,770 |   |
| Federal funds  sold                                                                                 |       | 7,175                  |       | 20,081                |       |
| Interest bearing  balances with banks                                                               |       | 800                    |       | 0                     |       |
| Investment  securities available for sale                                                           |       | 61,362                 |       | 49,985                |       |
| Equity  securities available for sale                                                               |       | 25,692                 |       | 33,861                |       |
| Restricted bank  stock                                                                              |       | 4,342                  |       | 2,914                 |       |
| Loans:                                                                                              |       |                   |       |                  |       |
| Real estate  mortgages                                                                              |       | 356,103                |       | 350,976               |       |
| Commercial                                                                                          |       | 26,625                 |       | 30,444                |       |
| Consumer                                                                                            |       | 16,136                 |       | 17,059                |       |
| Gross loans                                                                                         |       | 398,864                |       | 398,479               |       |
| Less: reserve  for possible loan losses                                                             |       | (4,055                 | )          | (3,854                | )          |
| Loans, net                                                                                          |       | 394,809                |       | 394,625               |       |
| Bank premises,  equipment, furniture and fixtures, net                                              |       | 11,446                 |       | 9,861                 |       |
| Real estate  owned other than premises                                                              |       | 2,172                  |       | 2,313                 |       |
| Accrued interest  receivable                                                                        |       | 1,972                  |       | 1,861                 |       |
| Cash surrender  value of life insurance                                                             |       | 10,989                 |       | 10,768                |       |
| Goodwill                                                                                            |       | 16,558                 |       | 16,558                |       |
| Core deposit  intangible                                                                            |       | 1,505                  |       | 1,693                 |       |
| Other assets                                                                                        |       | 1,694                  |       | 346                   |       |
| Total assets                                                                                        |       | $                      | 553,892    |                  | $          | 561,636 |   |
|                                                                                                |       |                   |       |                  |       |
| LIABILITIES AND  STOCKHOLDERS’ EQUITY                                                          |       |                   |       |                  |       |
| LIABILITIES                                                                                         |       |                   |       |                  |       |
| Deposits in  domestic offices:                                                                      |       |                   |       |                  |       |
| Demand                                                                                              |       | $                      | 40,723     |                  | $          | 46,860 |   |
| Savings                                                                                             |       | 226,291                |       | 223,904               |       |
| Time                                                                                                |       | 162,396                |       | 169,166               |       |
| Liabilities for  borrowed money                                                                     |       | 46,637                 |       | 37,735                |       |
| Accrued interest  payable                                                                           |       | 728                    |       | 999                   |       |
| Other  liabilities                                                                                  |       | 3,507                  |       | 4,558                 |       |
| Total  liabilities                                                                                  |       | 480,282                |       | 483,222               |       |
|                                                                                                |       |                   |       |                  |       |
| STOCKHOLDERS’  EQUITY                                                                          |       |                   |       |                  |       |
| Capital stock,  common, no par, authorized 5,000,000 shares; 2,420,481 and 2,420,481 shares  issued |       | 2,225                  |       | 2,225                 |       |
| Additional  paid-in capital                                                                         |       | 34,821                 |       | 34,831                |       |
| Retained  earnings                                                                                  |       | 41,478                 |       | 40,696                |       |
| Accumulated  other comprehensive income (loss)                                                      |       | (766                   | )          | 4,558                 |       |
| Less: cost of  treasury stock; 2008 - 104,688 shares; 2007 - 98,055 shares                          |       | (4,148                 | )          | (3,896                | )          |
| Total  stockholders’ equity                                                                    |       | 73,610                 |       | 78,414                |       |
|                                                                                                |       |                   |       |                  |       |
| Total  liabilities and stockholders’ equity                                                    |       | $                      | 553,892    |                  | $          | 561,636 |   |

 

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| * |   | Condensed from audited financial statements. |   |
|---|--------|----------------------------------------------|--------|

 

The accompanying notes arean integral part of these condensed financial statements.

 

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TOWER BANCORP, INC. AND ITSWHOLLY-OWNED SUBSIDIARY

 

CONDENSEDCONSOLIDATED STATEMENTS OF INCOME

THREE MONTHS ENDED JUNE 30,2008 and 2007

(UNAUDITED)

 
| ** **                                            | ** ** | **2008**               | ** ** | **2007**  | ** ** |
|-------------------------------------------------------|------------|------------------------|------------|-----------|------------|
| ** **                                            | ** ** | **(000 Omitted)** | ** ** |
| Interest Income                                       |       |                   |       |      |       |
| Interest &  fees on loans                    |       | $                      | 6,831      |      | $          | 7,053 |   |
| Interest on  investment securities available for sale |       | 944                    |       | 695       |       |
| Interest on  federal funds sold                       |       | 77                     |       | 546       |       |
| Total interest  income                                |       | 7,852                  |       | 8,294     |       |
| Interest Expense                                      |       |                   |       |      |       |
| Interest on  deposits                                 |       | 2,096                  |       | 3,029     |       |
| Interest on  borrowed money                           |       | 529                    |       | 508       |       |
| Total interest  expense                               |       | 2,625                  |       | 3,537     |       |
|                                                  |       |                   |       |      |       |
| Net interest  income                                  |       | 5,227                  |       | 4,757     |       |
|                                                  |       |                   |       |      |       |
| Provision for  loan losses                            |       | 150                    |       | 150       |       |
|                                                  |       |                   |       |      |       |
| Net interest  income after provision for loan losses  |       | 5,077                  |       | 4,607     |       |
|                                                  |       |                   |       |      |       |
| Other Income                                          |       |                   |       |      |       |
| Investment  service income                            |       | 171                    |       | 240       |       |
| Service charges  on deposit accounts                  |       | 466                    |       | 455       |       |
| Other service  charges                                |       | 291                    |       | 292       |       |
| Other operating  income                               |       | 105                    |       | 184       |       |
| Investment  securities gains                          |       | 327                    |       | 476       |       |
| Total other  income                                   |       | 1,360                  |       | 1,647     |       |
|                                                  |       |                   |       |      |       |
| Other Expense                                         |       |                   |       |      |       |
| Salaries, wages  and other benefits                   |       | 2,029                  |       | 2,022     |       |
| Occupancy and  equipment expense                      |       | 1,030                  |       | 890       |       |
| Professional  fees                                    |       | 249                    |       | 280       |       |
| Amortization of  core deposit intangible              |       | 92                     |       | 103       |       |
| Marketing                                             |       | 156                    |       | 121       |       |
| Taxes not based  on income                            |       | 170                    |       | 154       |       |
| Other operating  expenses                             |       | 551                    |       | 399       |       |
| Total other  expenses                                 |       | 4,277                  |       | 3,969     |       |
|                                                  |       |                   |       |      |       |
| Income before  taxes                                  |       | 2,160                  |       | 2,285     |       |
| Applicable  income taxes                              |       | 562                    |       | 572       |       |
| Net income                                            |       | $                      | 1,598      |      | $          | 1,713 |   |
|                                                  |       |                   |       |      |       |
| Earnings per  share:                                  |       |                   |       |      |       |
| Basic earnings  per share                             |       | $                      | 0.69       |      | $          | 0.72 |   |
| Weighted average  shares outstanding                  |       | 2,317,971              |       | 2,353,926 |       |
| Diluted earnings  per share                           |       | $                      | 0.69       |      | $          | 0.72 |   |
| Weighted average  shares outstanding                  |       | 2,322,447              |       | 2,362,399 |       |
|                                                  |       |                   |       |      |       |
| Dividends  declared per share                         |       | $                      | 0.28       |      | $          | 0.26 |   |

 

The accompanying notes arean integral part of these condensed financial statements.

 

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TOWER BANCORP, INC. AND ITSWHOLLY-OWNED SUBSIDIARY

 

CONDENSEDCONSOLIDATED STATEMENTS OF INCOME

SIX MONTHS ENDED JUNE 30,2008 and 2007

(UNAUDITED)

 
| ** **                                            | ** ** | **2008**               | ** ** | **2007**  | ** ** |
|-------------------------------------------------------|------------|------------------------|------------|-----------|------------|
| ** **                                            | ** ** | **(000 Omitted)** | ** ** |
| Interest Income                                       |       |                   |       |      |       |
| Interest &  fees on loans                    |       | $                      | 13,923     |      | $          | 13,983 |   |
| Interest on  investment securities available for sale |       | 1,856                  |       | 1,468     |       |
| Interest on  federal funds sold                       |       | 245                    |       | 1,025     |       |
| Total interest  income                                |       | 16,024                 |       | 16,476    |       |
| Interest Expense                                      |       |                   |       |      |       |
| Interest on  deposits                                 |       | 4,588                  |       | 5,960     |       |
| Interest on  borrowed money                           |       | 1,053                  |       | 1,022     |       |
| Total interest  expense                               |       | 5,641                  |       | 6,982     |       |
|                                                  |       |                   |       |      |       |
| Net interest  income                                  |       | 10,383                 |       | 9,494     |       |
|                                                  |       |                   |       |      |       |
| Provision for  loan losses                            |       | 550                    |       | 300       |       |
|                                                  |       |                   |       |      |       |
| Net interest  income after provision for loan losses  |       | 9,833                  |       | 9,194     |       |
|                                                  |       |                   |       |      |       |
| Other Income                                          |       |                   |       |      |       |
| Investment  service income                            |       | 409                    |       | 463       |       |
| Service charges  on deposit accounts                  |       | 907                    |       | 853       |       |
| Other service  charges                                |       | 611                    |       | 578       |       |
| Other operating  income                               |       | 216                    |       | 339       |       |
| Investment  securities gains (losses)                 |       | 724                    |       | 1,689     |       |
| Total other  income                                   |       | 2,867                  |       | 3,922     |       |
|                                                  |       |                   |       |      |       |
| Other Expense                                         |       |                   |       |      |       |
| Salaries, wages  and other benefits                   |       | 4,293                  |       | 4,158     |       |
| Occupancy and  equipment expense                      |       | 2,012                  |       | 1,824     |       |
| Professional  fees                                    |       | 500                    |       | 537       |       |
| Amortization of  core deposit intangible              |       | 188                    |       | 210       |       |
| Marketing                                             |       | 235                    |       | 202       |       |
| Taxes not based  on income                            |       | 342                    |       | 338       |       |
| Other operating  expenses                             |       | 1,038                  |       | 900       |       |
| Total other  expenses                                 |       | 8,608                  |       | 8,169     |       |
|                                                  |       |                   |       |      |       |
| Income before  taxes                                  |       | 4,092                  |       | 4,947     |       |
| Applicable  income taxes                              |       | 1,010                  |       | 1,265     |       |
| Net income                                            |       | $                      | 3,082      |      | $          | 3,682 |   |
|                                                  |       |                   |       |      |       |
| Earnings per  share:                                  |       |                   |       |      |       |
| Basic earnings  per share                             |       | $                      | 1.33       |      | $          | 1.56 |   |
| Weighted average  shares outstanding                  |       | 2,318,236              |       | 2,355,853 |       |
| Diluted earnings  per share                           |       | $                      | 1.33       |      | $          | 1.56 |   |
| Weighted average  shares outstanding                  |       | 2,323,568              |       | 2,364,532 |       |
|                                                  |       |                   |       |      |       |
| Dividends  declared per share                         |       | $                      | 0.56       |      | $          | 0.52 |   |

 

The accompanying notes arean integral part of these condensed financial statements.

 

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TOWER BANCORP, INC. AND ITSWHOLLY-OWNED SUBSIDIARY

 

CONDENSEDCONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME

THREE AND SIX MONTHS ENDEDJUNE 30, 2008 and 2007

(UNAUDITED)

 
| ** **                                     | ** ** | **Three Months Ended** | ** ** |
|------------------------------------------------|------------|----------------------------------|------------|
| ** **                                     | ** ** | **June 30**                 | ** ** |
| ** **                                     | ** ** | **2008**                         | ** ** | **2007** | ** ** |
| ** **                                     | ** ** | **(000 Omitted)**           | ** ** |
|                                           |       |                             |       |   |   |
| Net income                                     |       | $                                | 1,598      |   | $ | 1,713 |   |
|                                           |       |                             |       |   |   |
| Other  comprehensive income:                   |       |                             |       |   |   |
| Net (gains)  realized, net of tax              |       | (215                             | )          | (314 | ) |
| Change in fair  value, net of tax              |       | (4,157                           | )          | (1,211 | ) |
|                                           |       |                             |       |   |   |
| Unrealized  holding gains (losses), net of tax |       | (4,372                           | )          | (1,525 | ) |
|                                           |       |                             |       |   |   |
| Comprehensive  income (loss)                   |       | $                                | (2,774     | ) | $ | 188 |   |

 
| ** **                                     | ** ** | **Six Months Ended** | ** ** |
|------------------------------------------------|------------|--------------------------------|------------|
| ** **                                     | ** ** | **June 30**               | ** ** |
| ** **                                     | ** ** | **2008**                       | ** ** | **2007** | ** ** |
| ** **                                     | ** ** | **(000 Omitted)**         | ** ** |
|                                           |       |                           |       |   |   |
| Net income                                     |       | $                              | 3,082      |   | $ | 3,682 |   |
|                                           |       |                           |       |   |   |
| Other  comprehensive income:                   |       |                           |       |   |   |
| Net (gains)  realized, net of tax              |       | (478                           | )          | (1,115 | ) |
| Change in fair  value, net of tax              |       | (4,846                         | )          | (1,347 | ) |
|                                           |       |                           |       |   |   |
| Unrealized  holding gains (losses), net of tax |       | (5,324                         | )          | (2,462 | ) |
|                                           |       |                           |       |   |   |
| Comprehensive  income (loss)                   |       | $                              | (2,242     | ) | $ | 1,220 |   |

 

The accompanying notes arean integral part of these condensed financial statements.

 

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# TOWER BANCORP, INC. AND ITS WHOLLY-OWNED SUBSIDIARY

#  

CONDENSEDCONSOLIDATED STATEMENTS OF CASH FLOWS

SIX MONTHS ENDED JUNE 30,2008 and 2007

(UNAUDITED)

 
| ** **                                                                        | ** ** | **2008**               | ** ** | **2007** | ** ** |
|-----------------------------------------------------------------------------------|------------|------------------------|------------|----------|------------|
| ** **                                                                        | ** ** | **(000 omitted)** | ** ** |
| Cash flows from  operating activities:                                            |       |                   |       |     |       |
| Net income                                                                        |       | $                      | 3,082      |     | $          | 3,682 |   |
| Adjustments to  reconcile net income to net cash providedby operating activities: |       |                   |       |     |       |
| Depreciation and  amortization                                                    |       | 539                    |       | 647      |       |
| Provision for  loan losses                                                        |       | 550                    |       | 300      |       |
| Stock-based  compensation                                                         |       | 78                     |       | 108      |       |
| (Gain) on sale  of investment securities                                          |       | (724                   | )          | (1,689   | )     |
| Other (net)                                                                       |       | (1,364                 | )          | (246     | )          |
| Net cash  provided by operating activities                                        |       | 2,161                  |       | 2,802    |       |
|                                                                              |       |                   |       |     |       |
| Cash flows from  investing activities:                                            |       |                   |       |     |       |
| Loans (net)                                                                       |       | (598                   | )          | 2,972    |       |
| Purchases of  bank premises, equipment, furniture and fixtures                    |       | (2,746                 | )          | (492     | )          |
| Interest bearing  balances with banks                                             |       | (800                   | )          | 0        |       |
| Purchases of  available for sale securities                                       |       | (14,488                | )          | (2,782   | )          |
| Maturities/sales  of available for sale securities                                |       | 3,988                  |       | 6,362    |       |
| Redemption  (purchase) of restricted bank stock                                   |       | (1,428                 | )          | (121     | )          |
| Proceeds from  sale of other real estate owned                                    |       | 826                    |       | 0        |       |
| Net cash  provided (used) by investing activities                                 |       | (15,246                | )          | 5,939    |       |
|                                                                              |       |                   |       |     |       |
| Cash flows from  financing activities:                                            |       |                   |       |     |       |
| (Increase)  decrease in federal funds sold                                        |       | 12,906                 |       | (35,826  | )          |
| Net increase  (decrease) in deposits                                              |       | (10,576                | )          | 32,251   |       |
| Long term  borrowings                                                             |       | 10,580                 |       | 0        |       |
| Payments on long  term borrowings                                                 |       | (1,605                 | )          | (5,000   | )          |
| Net increase  (decrease) in short term borrowings                                 |       | (63                    | )          | (36      | )          |
| Purchase of  treasury stock                                                       |       | (520                   | )          | (940     | )          |
| Proceeds from  sale of treasury stock                                             |       | 268                    |       | 183      |       |
| Cash dividends  paid                                                              |       | (1,299                 | )          | (1,226   |       |
| Net cash  provided (used) by financing activities                                 |       | 9,691                  |       | (10,594  | )          |
|                                                                              |       |                   |       |     |       |
| Net decrease in  cash and cash equivalents                                        |       | (3,394                 | )          | (1,853   | )          |
|                                                                              |       |                   |       |     |       |
| Cash and cash  equivalents at beginning of period                                 |       | 16,770                 |       | 14,128   |       |
|                                                                              |       |                   |       |     |       |
| Cash and cash  equivalents at end of period                                       |       | $                      | 13,376     |     | $          | 12,275 |   |

 

The accompanying notes arean integral part of these condensed financial statements.

 

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NOTESTO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

June 30, 2008

(UNAUDITED)

 

Note1.           Basis of Presentation

 

The accompanying unaudited condensed consolidated financial statementshave been prepared in accordance with generally accepted accounting principlesin the United States for interim financial information, and accordingly do notinclude all of the information and footnotes required by generally accepted accountingprinciples for complete financial statements. In the opinion of management, the accompanying unaudited condensedconsolidated financial statements contain all adjustments (consisting solely ofnormal recurring adjustments) necessary to present fairly Tower Bancorp, Inc.’sconsolidated financial position as of June 30, 2008 and the results of itsoperations for the three and six month periods ended June 30, 2008 and2007.  Information presented at December 31,2007 is condensed from audited year-end financial statements included in theAnnual Report on Form 10-K for the year ended December 31, 2007.

 

The condensed consolidated financial statements include the accounts ofTower Bancorp, Inc. (the “Company”) and its wholly owned subsidiary, theFirst National Bank of Greencastle (the “Bank”).  All significant intercompany accounts andtransactions have been eliminated.

 

The results of operations for the three and six month periods ended June 30,2008 and 2007 are not necessarily indicative of the results to be expected forthe full year.

 

CRITICAL ACCOUNTING POLICIES

 

Disclosure of the Company’s significant accountingpolicies is included in Note 1 to the consolidated financial statements of theCompany’s Annual Report on Form 10-K for the year ended December 31,2007.  Some of these policies areparticularly sensitive requiring significant judgments, estimates andassumptions to be made by management. Additional information is contained on pages 18, 23, and 24 of thisreport for the provision and allowance for loan losses.

 

CHANGE IN ACCOUNTING PRINCIPLE

 

In September 2006, the Emerging Issues Task Forceof the FASB (EITF) issued EITF 06-04. This pronouncement affects the recording of post retirement costs ofinsurance of bank owned life insurance policies in instances where the Companyhas promised a continuation of life insurance coverage to persons postretirement.  EITF 06-04 requires that aliability equal to the present value of the cost of post retirement insurancebe recorded during the insured employees’ term of service.  The terms of this pronouncement require theinitial recording of this liability with a corresponding adjustment to retainedearnings to reflect the implementation of the pronouncement.  This EITF becomes effective for fiscal yearsbeginning after December 15, 2007. The effect of this change on January 1, 2008 was a reduction inretained earnings and an increase in accrued benefit liabilities of$ 1,001,000.

 

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Note1.           Basis of Presentation(Continued)

 

RECENT ACCOUNTING PRONOUNCEMENTS

 

In December 2007,the Financial Accounting Standards Board (FASB) issued Statement of FinancialAccounting Standards No. 141(R), “Business Combinations” (SFAS141(R)).  The Standard will change thefinancial accounting and reporting of business combination transactions.  SFAS 141(R) establishes the criteria forhow an acquiring entity in a business combination recognizes the assetsacquired and liabilities assumed in the transaction; establishes theacquisition date fair value as the measurement objective for all assetsacquired and liabilities assumed; and requires the acquirer to disclose toinvestors and other users all of the information they need to evaluate andunderstand the nature and financial effect of the business combination.  Acquisition related costs including finder’sfees, advisory, legal, accounting, valuation and other professional and consultingfees are required to be expensed as incurred. SFAS 141(R) is effective for fiscal years beginning after December 15,2008 and early implementation is not permitted. The company does not expect theimplementation to have a material impact on its financial statements.

 

In December 2007,the FASB issued Statement of Financial Accounting Standards No.160, “NoncontrollingInterests in Consolidated Financial Statements” (SFAS 160).  SFAS 160 requires the Company to establishaccounting and reporting standards for the noncontrolling interest in asubsidiary and for the deconsolidation of a subsidiary.  This Statement is effective for fiscal years,and interim periods within those fiscal years, beginning on or after December 15,2008. Earlier adoption is prohibited. The company does not expect the implementation of SFAS 160 to have amaterial impact on its financial statements.

 

In March 2008, theFASB issued Statement of Financial Accounting Standards No. No. 161, “Disclosuresabout Derivative Instruments and Hedging Activities — an amendment of FASBStatement No. 133”**(SFAS161).  SFAS 161 changes the disclosurerequirements for derivative instruments and hedging activities.  Entities are required to provide enhanceddisclosures about (a) how and why an entity uses derivative instruments, (b) howderivative instruments and related hedged items are accounted for underStatement 133 and its related interpretations, and (c) how derivativeinstruments and related hedged items affect an entity’s financial position,financial performance and cash flows. SFAS 161 is effective for fiscal years and interim periods beginningafter November 15, 2008, with early application permitted. The company does not expect theimplementation of SFAS 161 to have a material impact on its financialstatements.

 

RECLASSIFICATION

 

Certainreclassifications have been made to the loan balances in the 2007 financialstatements to conform to reporting for 2008.

 

Note2.           Income Taxes

 

Income tax expense is less than the amount calculated using thestatutory tax rate primarily as a result of tax exempt income earned from stateand municipal securities and loans.

 

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Note3.           Commitments

 

In the normal course of business, the Company makes various commitmentsand incurs certain contingent liabilities which are not reflected in theaccompanying financial statements.  Thesecommitments include various guarantees and commitments to extend credit and thebank does not anticipate any losses as a result of these transactions.

 

Note4.           Stock Compensation Plans

 

At June 30, 2008, the Company had two stock-based compensationplans.  On January 1, 2006, theCompany adopted FASB Statement No. 123 (R) using the modifiedprospective method.  The fair value ofeach grant is estimated at the grant date using the Black-Scholesoption-pricing model.

 

Included in salaries and employee benefits expense for the six monthsended June 30, 2008 and 2007 is $ 58,000 and $ 70,000,respectively, of stock-based compensation expense.  Also included in other operating expense forthe six months ended June 30, 2008 and 2007 is $ 20,000 and$ 38,000, respectively, of stock-based compensation expense.

 

Stock option plan activity for the six months ended June 30, 2008is summarized below:

 
| ** **                           | ** ** | **Shares** | ** ** | **Weighted  Average  Exercise  Price** | ** ** | **Weighted  Average  Remaining  Contractual  Life  (in years)** | ** ** | **Value of  Unexercised  In-The-Money  Options  (in  thousands)** | ** ** |
|--------------------------------------|------------|------------|------------|----------------------------------------|------------|----------------------------------------------------------------------|------------|------------------------------------------------------------------------|------------|
| Outstanding at  January 1, 2008 |       | 34,858     |       | 34.34                                  |       | 6                                                                    |       | 289,000                                                                |       |
| Granted                              |       | 6,500      |       | 31.85                                  |       | 7.75                                                                 |       | 41,000                                                                 |       |
| Exercised                            |       | 6,788      |       | 22.36                                  |       | N/A                                                                  |       | N/A                                                                    |       |
| Forfeited                            |       | 3,187      |       | 40.79                                  |       | N/A                                                                  |       | N/A                                                                    |       |
| Outstanding at  June 30, 2008   |       | 31,383     |       | 35.76                                  |       | 6                                                                    |       | 155,000                                                                |       |
| Exercisable at  June 30, 2008   |       | 26,383     |       | 34.75                                  |       | 5                                                                    |       | 155,000                                                                |       |

 

The total value of in-the-money options exercised during the first sixmonths ended June 30, 2008 was $109,000.

 

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Note 5.           Earnings Per Share

 

The following shows the weighted average number ofshares used in computing earnings per share and the effect on the weightedaverage number of shares of diluted potential common stock. Options on 26,907shares were excluded from the calculation at June 30, 2008 because theeffects were anti-dilutive. Potential dilutive common stock had no effect onincome available to common stockholders.

 
| ** **                      | ** ** | **Three Months Ended** | ** ** |
|---------------------------------|------------|----------------------------------|------------|
| ** **                      | ** ** | **June 30, 2008**      | ** ** | **June 30, 2007** | ** ** |
| ** **                      | ** ** | ** **                       | ** ** | **Per** | ** ** | ** ** | ** ** | **Per** | ** ** |
| ** **                      | ** ** | ** **                       | ** ** | **Share** | ** ** | ** ** | ** ** | **Share** | ** ** |
| ** **                      | ** ** | **Shares**                       | ** ** | **Amount** | ** ** | **Shares** | ** ** | **Amount** | ** ** |
| Basic earnings  per share       |       | 2,317,971                        |       | $ | 0.69 |   | 2,353,926 |   | $ | 0.72 |   |
| Effect of  dilutive securities: |       |                             |       |   |   |   |   |   |   |
| Stock options                   |       | 4,476                            |       |   |   | 8,473 |   |   |   |
| Diluted earnings  per share     |       | 2,322,447                        |       | $ | 0.69 |   | 2,362,399 |   | $ | 0.72 |   |

 
| ** **                      | ** ** | **Six Months Ended** | ** ** |
|---------------------------------|------------|--------------------------------|------------|
| ** **                      | ** ** | **June 30, 2008**    | ** ** | **June 30, 2007** | ** ** |
| ** **                      | ** ** | ** **                     | ** ** | **Per** | ** ** | ** ** | ** ** | **Per** | ** ** |
| ** **                      | ** ** | ** **                     | ** ** | **Share** | ** ** | ** ** | ** ** | **Share** | ** ** |
| ** **                      | ** ** | **Shares**                     | ** ** | **Amount** | ** ** | **Shares** | ** ** | **Amount** | ** ** |
| Basic earnings  per share       |       | 2,318,236                      |       | $ | 1.33 |   | 2,355,853 |   | $ | 1.56 |   |
| Effect of  dilutive securities: |       |                           |       |   |   |   |   |   |   |
| Stock options                   |       | 5,332                          |       |   |   | 8,679 |   |   |   |
| Diluted earnings  per share     |       | 2,323,568                      |       | $ | 1.33 |   | 2,364,532 |   | $ | 1.56 |   |

 

Note6.           Investment Securities in aLoss Position

 

The following table shows the Company’s gross unrealized losses andfair value, aggregated by investment category and length of time thatindividual securities have been in a continuous unrealized loss position, at June 30,2008 and December 31, 2007:

 
| ** **                                       | ** ** | **June 30, 2008**            | ** ** |
|--------------------------------------------------|------------|----------------------------------------|------------|
| ** **                                       | ** ** | **(000 omitted)**                 | ** ** |
| ** **                                       | ** ** | **Less than 12 Months** | ** ** | **12 Months or Greater** | ** ** | **Total** | ** ** |
| **Description**                                  | ** ** | **Fair Value**                    | ** ** | **Unrealized  Losses** | ** ** | **Fair  Value** | ** ** | **Unrealized  Losses** | ** ** | **Fair  Value** | ** ** | **Unrealized  Losses** | ** ** |
| Obligations of  other U. S. government agencies  |       | $                                      | 0          |   | $ | 0 |   | $ | 0 |   | $ | 0 |   | $ | 0 |   | $ | 0 |   |
| Mortgage-backed  securities                      |       | 4,473                                  |       | 11 |   | 10 |   | 0 |   | 4,483 |   | 11 |   |
| Corporate bonds                                  |       | 1,943                                  |       | 171 |   | 392 |   | 99 |   | 2,335 |   | 270 |   |
| Equities                                         |       | 8,743                                  |       | 3,960 |   | 3,920 |   | 1,417 |   | 12,663 |   | 5,377 |   |
| Obligations of  state and political subdivisions |       | 9,263                                  |       | 193 |   | 0 |   | 0 |   | 9,263 |   | 193 |   |
| Total                                            |       | $                                      | 24,422     |   | $ | 4,335 |   | $ | 4,322 |   | $ | 1,516 |   | $ | 28,744 |   | $ | 5,851 |   |

 

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Note6.           Investment Securities in aLoss Position (Continued)

 
| ** **                                       | ** ** | **December 31, 2007**        | ** ** |
|--------------------------------------------------|------------|----------------------------------------|------------|
| ** **                                       | ** ** | **(000 omitted)**                 | ** ** |
| ** **                                       | ** ** | **Less than 12 Months** | ** ** | **12 Months or Greater** | ** ** | **Total** | ** ** |
| **Description**                                  | ** ** | **Fair Value**                    | ** ** | **Unrealized  Losses** | ** ** | **Fair  Value** | ** ** | **Unrealized  Losses** | ** ** | **Fair  Value** | ** ** | **Unrealized  Losses** | ** ** |
| Obligations of  other U. S. government agencies  |       | $                                      | 0          |   | $ | 0 |   | $ | 0 |   | $ | 0 |   | $ | 0 |   | $ | 0 |   |
| Mortgage-backed  securities                      |       | 190                                    |       | 1 |   | 941 |   | 11 |   | 1,131 |   | 12 |   |
| Corporate bonds                                  |       | 854                                    |       | 108 |   | 458 |   | 32 |   | 1,312 |   | 140 |   |
| Equities                                         |       | 7,988                                  |       | 1,647 |   | 2,215 |   | 443 |   | 10,203 |   | 2,090 |   |
| Obligations of  state and political subdivisions |       | 1,236                                  |       | 0 |   | 6,041 |   | 22 |   | 7,277 |   | 22 |   |
| Total                                            |       | $                                      | 10,268     |   | $ | 1,756 |   | $ | 9,655 |   | $ | 508 |   | $ | 19,923 |   | $ | 2,264 |   |

 

Management evaluatessecurities for other-than-temporary impairment at least on a quarterly basis,but management’s intent is to hold all investments until maturity unlessmarket, economic or specific investment concerns warrant a sale ofsecurities.  Consideration is given to (1) thelength of time and the extent to which the fair value has been less than cost, (2) thefinancial condition and near-term prospects of the issuer, and (3) theintent and ability of the Corporation to retain its investment in the issuerfor a period of time sufficient to allow for any anticipated recovery in fairvalue.

 

At June 30,2008, six (6) mortgage-backed securities, five (5) corporate bonds,eighty-three (83) equities, and nineteen (19) obligations of state andpolitical subdivisions had unrealized losses. Management has determined that no declines are deemed to be other thantemporary.

 

At December 31,2007, five (5) mortgage-backed securities, three (3) corporate bonds,sixty (60) equities, and fifteen (15) obligations of state and politicalsubdivisions had unrealized losses. Management has determined that no declines are deemed to be other thantemporary.

 

Note 7.           Fair Value Measurements

 

SFAS No. 157, *Fair Value Measurements*, defines fairvalue, establishes a framework for measuring fair value, establishes athree-level valuation hierarchy for disclosure of fair value measurement andenhances disclosure requirements for fair value measurements.  The valuation hierarchy is based upon thetransparency of inputs to the valuation of an asset or liability as of themeasurement date.  The three levels aredefined as follows:

 
| · |   | Level 1 |   | inputs  to the valuation methodology are quoted prices (unadjusted) for identical  assets or liabilities in active markets. |
|--------|--------|--------------|--------|-----------------------------------------------------------------------------------------------------------------------------|

 

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Note 7.           Fair Value Measurements(Continued)

 
| · |   | Level 2 |   | inputs  to the valuation methodology include quoted prices for similar assets and  liabilities in active markets, and inputs that are observable for the asset  or liability, either directly or indirectly, for substantially the full term  of the financial instrument. |
|--------|--------|--------------|--------|----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
|   |   |         |   |                                                                                                                                                                                                                                                                       |
| · |   | Level 3 |   | inputs  to the valuation methodology are unobservable and significant to the fair  valuemeasurement.                                                                                                                                                                       |

 

Following is a descriptionof the valuation methodologies used for instruments measured at fair value, aswell as the general classification of such instruments pursuant to thevaluation hierarchy:

 

Securities

 

Where quoted prices areavailable in an active market, securities are classified within level 1 of thevaluation hierarchy. Level 1 securities would include highly liquid governmentbonds, mortgage products and exchange traded equities.  If quoted market prices are not available,then fair values are estimated by using pricing models, quoted prices ofsecurities with similar characteristics, or discounted cash flow.  Level 2 securities would include U.S. agencysecurities, mortgage-backed agency securities, obligations of states andpolitical subdivisions and certain corporate, asset backed and othersecurities.  In certain cases where thereis limited activity or less transparency around inputs to the valuation,securities are classified within level 3 of the valuation hierarchy.  Currently, all equity securities held by theholding company with a total fair value of $ 26,000,000 are considered tobe Level 1 Securities.  All others areconsidered to be Level 2.

 

Loans held for sale

 

Loans held for sale arerequired to be measured at lower of cost or fair value. Under SFAS No. 157,market value is to represent fair value. Management obtains quotes or bids on all or part of these loans directlyfrom the purchasing financial institutions. Premiums received or to be receivedon the quotes or bids are indicative of the fact that cost is lower than fairvalue.  At June 30, 2008, the entire****balance of loans held for sale was recorded at its cost.

 

Impaired loans

 

SFAS No. 157 applies toloans measured for impairment using the practical expedients permitted by SFAS No. 114,Accounting by Creditors for Impairmentof a Loan, including impaired loans measured at an observable marketprice (if available), or at the fair value of the loan’s collateral (if theloan is collateral dependent).  Fairvalue of the loan’s collateral, when the loan is dependent on collateral, isdetermined by appraisals or independent valuation which is then adjusted forthe cost related to liquidation of the collateral.

 

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Note 7.           Fair Value Measurements(Continued)

 

Other Real Estate Owned

 

Certain assets such as otherreal estate owned (OREO) are measured at fair value less cost to sell.  We believe that the fair value component inits valuation follows the provisions of SFAS No. 157.

 

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ITEM2.

 

MANAGEMENT’S DISCUSSIONAND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

 

June 30, 2008

 

The following ismanagement’s discussion and analysis of the significant changes in theconsolidated results of operations, capital resources and liquidity presentedin the accompanying unaudited consolidated financial statements for theCompany. This discussion should be read in conjunction with the precedingcondensed consolidated financial statements and related footnotes, as well asthe Company’s December 31, 2007 Annual Report on Form 10-K. Currentperformance does not guarantee and may not be indicative of similar performancein the future.

 

In addition to historicalinformation, this quarterly report on Form 10-Q contains forward-lookingstatements. The forward-looking statements contained in this report are subjectto certain risks, assumptions and uncertainties. Because of the possibility ofchange in the underlying assumptions, actual results could differ materiallyfrom those projected in the forward-looking statements. Additional factors thatmight cause actual results to differ materially from those expressed in theforward-looking statements include, but are not limited to:

 

·                  operating, legal and regulatory risks;

·                  economic, political and competitive forces affectingthe Company’s services; and

·                  the risk that management’s analyses of these riskscould be incorrect and/or that the strategies developed to address them could beunsuccessful.

 

The Company’sforward-looking statements are relevant only as of the date on which thestatements are made. By making forward-looking statements, the Company assumesno duty to update them to reflect new, changing or unanticipated events orcircumstances. Readers should carefully review the risk factors described inother periodic reports and public documents that the Company files from time totime with the Securities and Exchange Commission.

 

OVERVIEW

 

Net income for the threemonths ended June 30, 2008 and 2007 was $1,598,000 and $1,713,000,respectively. The decrease of $115,000, or 6.7%, is attributable to a decreaseof investment security gains and increased occupancy and equipmentexpense.  Net interest income increased9.9%, other income decreased 17.4%, the provision for loan losses remained thesame and other expenses increased 7.8%. On a basic and diluted per share basis,net income for the three months ended June 30, 2008 was $0.69 and $0.69,respectively, as compared with $0.72 and $0.72 for the three months ended June 30,2007.

 

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Net income for the sixmonths ended June 30, 2008 and 2007 was $3,082,000 and $3,682,000,respectively. The decrease of $600,000, or 16.3%, is attributable to a decreaseof investment security gains and an increased provision expense for theallowance for loan losses.  Net interestincome increased 9.4%, other income decreased 26.9%, the provision for loanlosses increased 83.3% and other expenses increased 5.4%. On a basic anddiluted per share basis, net income for the six months ended June 30, 2008was $1.33 and $1.33, respectively, as compared with $1.56 and $1.56 for the sixmonths ended June 30, 2007. Net income as a percentage of total averagestockholders’ equity on an annualized basis, also known as return on averageequity, was 7.87% and 9.10% for the first six months of 2008 and 2007,respectively.  Return on average tangibleequity was 10.28% and 11.69% for the first six months of 2008 and 2007respectively, a decrease of 12.1%. The decrease in this ratio is attributableto a decreased level of net income.

 

During the first sixmonths of 2008, the Company’s assets decreased $ 7,744,000, or 1.4%, to$553,892,000 as of June 30, 2008 from $ 561,636,000 as of December 31,2007. This decrease is primarily attributable to a decrease in Federal fundssold.  Federal funds sold decreased 64.3%to $ 7,175,000 due primarily to a decrease in deposits and increases ininvestments and loans.  Total loansremained the same at $ 399,000,000. Total deposits decreased by $ 10,520,000, or 2.4%, during the firstsix months of 2008 to $ 429,410,000 as of June 30, 2008 from$ 439,930,000 as of December 31, 2007. As a result of competition inthe market, and, to a certain degree, customers’ continued uncertainty as tohow to best invest their monies, deposit increases may not be assumed tocontinue at historical levels.

 

RESULTS OF OPERATIONS

 

Net Interest Income

 

For the three monthsended June 30, 2008, total interest income decreased by $ 442,000, or5.3%, to $ 7,852,000 as compared with $8,294,000 for the three monthsended June 30, 2007.  This decreaseis primarily due to decreased yields on overnight federal funds sold.  Earning assets decreased 2.6% to$ 498,235,000, loans increased $ 9,851,000 or 2.5% to$ 398,864,000, investment securities decreased $ 4,884,000 andovernight federal funds sold decreased $ 17,835,000. Management continuedto target efforts to attract mortgage and small commercial loans. During thefirst quarter of 2008, there was a 25 basis point decrease in the New YorkPrime Rate and an 88 basis point increase in the One Year Constant MaturityTreasury Rate.

 

Total interest expensedecreased by $912,000, or 25.8% to $2,625,000 for the three months ended June 30,2008 from $3,537,000 for the three months ended June 30, 2007. Thisdecrease is primarily due to lower deposit rates and lower rates on bank borrowings.  The cost of interest bearing funds at thebank decreased to 2.36% for the second quarter of 2008 compared to 3.13% forthe second quarter of 2007.

 

Net interest incomeincreased by $470,000, or 9.9%, to $5,227,000 for the three months ending June 30,2008 from $4,757,000 for the three months ending June 30, 2007. Thisincrease is primarily due to the lower cost of interest bearing funds at thebank.

 

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For the six months ended June 30,2008, total interest income decreased by $ 452,000, or 2.7%, to$ 16,024,000 as compared with $16,476,000 for the six months ended June 30,2007. This decrease is primarily due to decreased yields on overnight federalfunds sold.  Earning assets decreasedfrom December 31, 2007 by 1.4% to $ 498,235,000, loans increased by$ 385,000 or 0.1% to $ 398,864,000, investment securities increased$ 4,636,000 and overnight federal funds sold decreased $12,906,000.  Management continued to target efforts toattract mortgage and small commercial loans. During the first six months of 2008, there was a 225 basis pointdecrease in the New York Prime Rate and an 84 basis point decrease in the OneYear Constant Maturity Treasury Rate.

 

Total interest expensedecreased by $ 1,341,000, or 19.2% to $ 5,641,000 for the six monthsended June 30, 2008 from $ 6,982,000 for the six months ended June 30,2007.  This decrease is primarily due tolower deposit rates and lower rates on bank borrowings.  The cost of interest bearing funds at thebank decreased to 2.54% for the first six months of 2008 compared to 3.12% forthe first six months of 2007.

 

Net interestincome increased by $ 889,000, or 9.4%, to $ 10,383,000 for the sixmonths ended June 30, 2008 from $9,494,000 for the six months ended June 30,2007.  This increase is primarily due tothe lower cost of interest bearing funds at the bank.

 

Provision for Loan Losses

 

The provision for loanlosses was $ 150,000 for the three months ended June 30, 2008compared with $ 150,000 for the three months ended June 30,2007.  The level of provision iscommensurate with the risk identified in the loan portfolio.

 

The provision for loanlosses was $ 550,000 for the six months ended June 30, 2008 comparedwith $ 300,000 for the six months ended June 30, 2007, an increase of83.3%.  The increase in the provision isin response to a slower housing market, declining prices of real estate, andincreased delinquencies.  The level ofprovision is commensurate with the risk identified in the loan portfolio.

 

Theallowance for loan losses represented 1.02% of total loans at June 30,2008, compared with 0.97% as of December 31, 2007 and 0.99% as of June 30,2007. Management performs ongoing assessments of the loan loss reserve in relation to loan portfolio growth, creditexposure to individual borrowers, overall trends in the loan portfolio,including delinquencies, and other relevant factors. Based upon these factors,management believes that as of June 30, 2008, the reserve is reasonableand sufficient to support the current level of loans in light of the strongasset quality as supported by the ratios reflected in Table 2 on page 24.

 

Other Income

 

For the three months endedJune 30, 2008, other income was $ 1,360,000, a decrease of$ 287,000, or 17.4%, compared with other income of $ 1,647,000 forthe three months ended June 30, 2007. The decrease was primarily due to adecrease of $ 149,000 in net gains from the sale of securities, which were$ 327,000 for the three months ended June 30, 2008 and $ 476,000for the three months ended June 30, 2007. Other income was positivelyimpacted by an increase of $ 22,000 in trust revenues.  Other income was negatively

 

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impacted by a$ 92,000 decrease in revenues from investment service fees, $ 72,000decrease of BOLI income and $ 16,000 increase in mortgage servicing rightsvaluation expense.  During the secondquarter of 2007, BOLI income included $ 85,000 which were proceeds from adeath benefit.  The bank beganrecognizing mortgage servicing rights valuation in the third quarter of 2007.

 

For the six months ended June 30,2008, other income was $ 2,867,000, a decrease of $ 1,055,000, or26.9%, compared with other income of $ 3,922,000 for the six months ended June 30,2007. The decrease was primarily due to a decrease of $ 965,000 in net gainsfrom the sale of securities, which were $ 724,000 for the six months endedJune 30, 2008 and $ 1,689,000 for the six months ended June 30,2007. Other income was positively impacted by an increase of $ 46,000 inNSF fees and an increase of $ 42,000 in trust revenues.  Other income was negatively impacted by a$ 107,000 decrease in BOLI income, a $ 96,000 decrease in revenuesfrom investment service fees, and $ 32,000 increase in mortgage servicingrights valuation expense.  During thefirst six months of 2007, BOLI income included $ 132,000 which were deathbenefits proceeds.  The bank beganrecognizing mortgage servicing rights valuation in the third quarter of2007.  In February 2008, the bankinitiated a cash rewards program for debit cards.  The Bank re-established and reactivated itsTrust Department in the third quarter of 2006.

 

Other Expenses

 

Other expenses, whichinclude salary, occupancy, equipment and all other expenses incidental to theoperation of the Company, increased to $4,277,000 for the three months ended June 30,2008 from $3,969,000 for the three months ended June 30, 2007. The$308,000, or 7.8% increase was primarily due to a $90,000 increase in dataprocessing expenses, a $78,000 increase of employee benefits and healthinsurance expenses, and $56,000 increase in FDIC insurance premium expense.

 

Salaries and employeebenefit expenses, which make up the largest component of other expenses,increased $ 7,000, or less than 1%, to $ 2,029,000 for the threemonths ended June 30, 2008 from $ 2,022,000 for the three monthsended June 30, 2007. Health insurance expense increased $ 78,000 or31.3% while salary expense was down $ 69,000 due to deferral of FASB91costs to originate loans.

 

Occupancy and equipmentexpenses increased $ 140,000, or 15.7%, to $ 1,030,000 for the threemonths ended June 30, 2008 from $ 890,000 for the three months ended June 30,2007.  The increase is primarily due to a$ 90,000, or 25.2%, increase of data processing expense, and a$ 34,000, or 24.2%, increase of equipment depreciation expense.  The bank has updated security systems at anumber of branches and continues to invest in computer network initiatives.

 

Other operating expensesduring the three months ended June 30, 2008 increased $ 161,000, or15.2% to $ 1,218,000 from $ 1,057,000 during the three months ended June 30,2007. The increase is primarily due to an increase of $ 56,000 in FDICinsurance premium expense, a $ 32,000 increase in meeting and travelexpense and a $ 28,000 increase in supply expenses.

 

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Other expenses, whichinclude salary, occupancy, equipment and all other expenses incidental to theoperation of the Company, increased to $8,608,000 for the six months ended June 30,2008 from $ 8,169,000 for the six months ended June 30, 2007. The$ 439,000, or 5.4% increase was primarily due to a $ 218,000 increaseof employee benefits and health insurance expenses, $ 90,000 increase indata processing expenses, and an $ 82,000 increase in FDIC insurancepremium expense.

 

Salaries and employeebenefit expenses, which make up the largest component of other expenses,increased $ 135,000, or 3.3%, to $ 4,293,000 for the six months endedJune 30, 2008 from $ 4,158,000 for the six months ended June 30,2007.  The increase is primarilyattributable to a $ 147,000 increase of health insurance premium expenseand a $ 70,000 increase of employee benefit expense.  The employee benefit expense included aone-time charge of $ 98,000 to make the final 2007 contributions to theprofit sharing and employee stock ownership plans.  Health insurance premiums increased 32.2%.

 

Occupancy and equipmentexpenses increased $ 188,000, or 10.3%, to $ 2,012,000 for the sixmonths ended June 30, 2008 from $ 1,824,000 for the six months ended June 30,2007.  The increase is primarily due to$90,000 or 12.0% increase of data processing expense and $ 47,000 or 17.2%increase of equipment depreciation expense. The bank has updated security systems at a number of branches andcontinues to invest in computer network initiatives.

 

Other operating expensesduring the six months ended June 30, 2008 increased $ 116,000, or5.3% to $ 2,303,000 from $ 2,187,000 during the six months ended June 30,2007.  The increase is primarily due toan increase of $ 82,000 of FDIC insurance premium expense.

 

Income Taxes

 

Income tax expense was$ 562,000 for the three months ended June 30, 2008, a decrease of$ 10,000, or 1.7%, compared with $572,000 for the three months ended June 30,2007.  The lower income tax expense isdue to lower pre-tax income.

 

Income tax expense was$1,010,000 for the six months ended June 30, 2008, a decrease of$ 255,000, or 20.2%, compared with $1,265,000 for the six months ended June 30,2007.  The lower income tax expense isdue to lower pre-tax income.

 

Net Income

 

Net income for the threemonths ended June 30, 2008 was $ 1,598,000, a decrease of$ 115,000, or 6.7%, compared with $ 1,713,000 for the three monthsended June 30, 2007. The decrease in net income is the result of adecrease of $ 287,000 in other income and a $ 308,000 increase inother operating expenses.  Offsetting theabove decreases in net income were a $ 470,000 increase in net interestincome and a $ 10,000 decrease in federal income tax expense. Basic anddiluted earnings per share for the three months ended June 30, 2008 were$ 0.69 and $ 0.69 as compared with $ 0.72 and $ 0.72 forthe three months ended June 30, 2007.

 

Net income for the sixmonths ended June 30, 2008 was $ 3,082,000, a decrease of$ 600,000, or 16.3%, compared with $ 3,682,000 for the six monthsended June 30, 2007.  The decreasein net income is the result of a decrease of $ 965,000 in security gains,a $ 439,000 increase in other

 

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expenses, a$ 250,000 increase in the allowance for loan loss provision expense and a$ 90,000 decrease in other income, excluding security gains.  Offsetting the above decreases in net incomewere a $ 889,000 increase in net interest income and a $ 255,000decrease in federal income tax expense. Basic and diluted earnings per sharefor the six months ended June 30, 2008 were $ 1.33 and $ 1.33,respectively, as compared with $ 1.56 and $ 1.56, respectively, forthe six months ended June 30, 2007.

 

Securities

 

The Company’s securitiesportfolio is comprised of securities that not only provide interest anddividend income, including tax-exempt income, but also provide a source ofliquidity, diversify the earning assets portfolio, allow for the management ofrisk and tax liability, and provide collateral for repurchase agreements and publicfund deposits. Policies are in place to address various aspects of managing theportfolio, including but not limited to, concentrations, liquidity, creditquality, interest rate sensitivity and regulatory guidelines.

 

Although the Companygenerally intends to hold its investment securities to maturity, all of thesecurities portfolio is classified as available for sale, with new purchasesgenerally categorized as such. Securities in the available for sale categoryare accounted for at fair value with unrealized appreciation or depreciation,net of tax, reported as a separate component of stockholders’ equity.Securities in the held to maturity category, of which the Company has none,would be accounted for at amortized cost. The Company holds no tradingsecurities in its portfolio. The securities portfolio includes equities ownedby the holding company, most of which are investments in banks, bank holdingcompanies and financial institutions. Equity investments are accounted for atfair market value. The remaining securities, primarily debt instruments, areowned by the bank.

 

The consolidatedsecurities portfolio at June 30, 2008 was $ 87,054,000, compared to$ 83,846,000 at December 31, 2007, an increase of $ 3,208,000,or 3.8%. The increase is due primarily to the net purchase of $ 13,505,000investment securities by the bank, offset by $ 7,801,000 decrease inunrealized gains on investments held by the holding company.

 

Bank Owned Securities

 

The bank owned securitiesportfolio at June 30, 2008 was $ 61,362,000, compared to$ 49,985,000 at December 31, 2007, an increase of $ 11,377,000,or 22.8%.  The increase is due primarilyto the purchase of $ 15,085,000 security investments, the maturity orcalling of $ 1,580,000 and a $ 266,000 decrease in unrealized gains,less principal payments on mortgage backed securities.

 

The carrying value of theavailable for sale portion of the portfolio at June 30, 2008 includes anunrealized gain of $ 563,000 (reflected as accumulated other comprehensiveincome of $ 372,000 in stockholders’ equity, net of a deferred income taxliability of $ 191,000). This compares with an unrealized gain at December 31,2007 of $ 829,000 (reflected as accumulated other comprehensive income of$ 547,000 in stockholders’ equity, net of a deferred income tax liabilityof $ 282,000).

 

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Holding Company OwnedSecurities

 

The securities portfolioat June 30, 2008 was $ 25,692,000, compared to $ 33,861,000 at December 31,2007, a decrease of $ 8,169,000, or 24.1%. The decrease includes a decrease of $ 7,801,000 in unrealizedgains.  The securities portfolio isexclusively invested in financial institutions and bank holding companies.  This sector has underperformed the broaderstock indexes in recent quarters. Realized gains on sale of equity securities were $ 722,000 for thesix months ended June 30, 2008.

 

The carrying value of theavailable for sale portion of the portfolio at June 30, 2008 includes anunrealized loss of $ 1,724,000 (reflected as accumulated othercomprehensive - loss of $ 1,138,000 in stockholders’ equity, net of adeferred income tax asset of $ 586,000). This compares with an unrealized gain at December 31, 2007 of$ 6,077,000 (reflected as accumulated other comprehensive income of$ 4,011,000 in stockholders’ equity, net of a deferred income taxliability of $ 2,066,000).

 

Loans

 

The loan portfoliocomprises the major component of the Company’s earning assets and generally isthe highest yielding asset category. Gross loans receivable, net of unearned fees and origination costs,increased $ 385,000, or less than 1% to $ 398,864,000 at June 30,2008 from $ 398,479,000 at December 31, 2007. Gross loans represented92.9% of total deposits at June 31, 2008 as compared with 90.6% at December 31,2007. This increase is primarily due a decrease in deposits, particularly timedeposits.

 

Credit Risk and LoanQuality

 

The Company continues tobe prudent in its efforts to minimize credit risk. The Bank’s written lendingpolicy requires underwriting, loan documentation and credit analysis standardsto be met prior to the approval and funding of any loan. In accordance withthat policy, the loan review process monitors the loan portfolio on an ongoingbasis. The Loan Review area then prepares an analysis of the allowance for loanlosses which is then submitted to the Board of Directors for its assessment asto the adequacy of the allowance. The allowance for loan losses is anaccumulation of expenses that has been charged against past and presentearnings in anticipation of potential losses in the loan portfolio.

 

The allowance for loanlosses at June 30, 2008 and December 31, 2007 was $ 4,055,000 and$ 3,854,000, respectively.  At June 30,2008, the allowance for loan losses represented 1.02% of the gross loanportfolio, compared with 0.97% at December 31, 2007.  This increase is due to an increasedprovision for loan losses in response to a slower housing market, decliningprices of real estate, and increased delinquencies and no significant change ingross loan volumes.  At June 30,2008, in consideration of the bank’s assessment of asset quality, managementbelieves the allowance for loan loss reserve to be reasonable and adequate tosupport the loan growth and to address any potential losses.

 

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Table 1 –“Analysis ofAllowance for Loan Loss” -details the activity which occurred in the allowanceover the first six months of 2008 and 2007.

 

**Table 1 –Analysis of Allowance for Loan Loss (1)**

 
| **(in thousands)**                               | ** ** | **2008** | ** ** | **2007** | ** ** |
|-------------------------------------------------------|------------|----------|------------|----------|------------|
| Balance,  January 1                              |       | $        | 3,854      |     | $          | 3,610 |   |
| Provision  charged to operating expense               |       | 550      |       | 300      |       |
| Charge-offs:                                          |       |     |       |     |       |
| Commercial                                            |       | (268     | )          | 0        |       |
| Real Estate                                           |       | 0        |       | 0        |       |
| Consumer                                              |       | (134     | )          | (129     | )          |
| Total  charge-offs                                    |       | (402     | )          | (129     | )          |
|                                                  |       |     |       |     |       |
| Recoveries:                                           |       |     |       |     |       |
| Commercial                                            |       | 21       |       | 2        |       |
| Real Estate                                           |       | 0        |       | 0        |       |
| Consumer                                              |       | 32       |       | 52       |       |
| Total Recoveries                                      |       | 53       |       | 54       |       |
|                                                  |       |     |       |     |       |
| Net  (charge-offs) recoveries                         |       | (349     | )          | (75      | )          |
|                                                  |       |     |       |     |       |
| Balance,  June 30                                |       | $        | 4,055      |     | $          | 3,835 |   |
|                                                  |       |     |       |     |       |
| Net  (charge-offs) or recoveries to average net loans |       | (0.09    | )          | (0.02    | )          |

 

----

(1) Bank’s loanportfolio is entirely domestic

 

The Bank’s lending policyis executed through the assignment of tiered loan limit authorities toindividual officers of the Bank, the Officer’s Loan Committee and the Board ofDirectors. Although the Bank maintains sound credit policies, certain loans maydeteriorate for a variety of reasons. The Bank’s policy is to place all loanson a non-accrual status upon becoming 90 days delinquent in their payments,unless there is a documented and reasonable expectation of the collection of thedelinquent amount. Loans are reviewed monthly as to their status, and on aquarterly basis presented to the Board of Directors. Management is not aware ofany material potential loan credit problems that have not been disclosed inthis report.

 

A loan is consideredimpaired when, based on current information and events, it is probable that theCompany will not be able to collect the scheduled payments of principal orinterest when due according to the contractual terms of the loanagreement.  The larger commercial loansare evaluated for impairment.  Impairmentis measured on a loan-by-loan basis by comparing the contractual principal andinterest payments to the present value of expected future cash flows discountedat the loan’s effective interest rate, the loan’s obtainable market price, orthe fair value of the collateral if the loan is collateral dependent.  Consumer loans such as residential mortgagesand installments, comprised of smaller balance homogeneous loans, are collectivelyevaluated for impairment.  Interestincome generally is not recognized on specific impaired loans unless thelikelihood of further loss is remote. Interest income on such loans is recognized only to the extent ofinterest payments received.

 

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A summary of the loansthat the Company has identified as impaired follows:

 
| ** **         | ** ** | **6/30/08**             | ** ** | **12/31/07** | ** ** |
|--------------------|------------|-------------------------|------------|--------------|------------|
| ** **         | ** ** | **(in thousands)** | ** ** |
| Balance            |       | $                       | 7,199      |         | $          | 7,059 |   |
| Related  allowance |       | 842                     |       | 940          |       |
|                    |            |                         |            |              |            |  |  |

 

Table 2 – “Assets QualityRatios” – summarizes pertinent asset quality ratios at June 30, 2008 and December 31,2007.

 

**Table 2 –Asset Quality Ratios**

 
| ** **                                  | ** ** | **6/30/08** | ** ** | **12/31/07** | ** ** |
|---------------------------------------------|------------|-------------|------------|--------------|------------|
| Non-accrual  loans/total loans              |       | 1.23        | %          | 1.10         | %          |
| Non-performing  assets (1)/total loans      |       | 1.37        | %          | 1.36         | %          |
| Net (charge  offs) recoveries/average loans |       | (0.09       | )%         | (0.09        | )%         |
| Allowance/total  loans                      |       | 1.02        | %          | 0.97         | %          |
| Allowance/non-accrual  loans                |       | 82.3        | %          | 87.7         | %          |
| Allowance/non-performing  loans (1)         |       | 76.9        | %          | 71.1         | %          |

 

----

(1) – Includesnon-accrual loans

 

At June 30, 2008 andDecember 31, 2007, the Company had other real estate owned (not used inoperations) in the amount of $2,172,000 and $2,313,000 respectively of which$ 175,000 and $ 25,000, respectively, represents foreclosedproperty.  At June 30, 2008 and December 31,2007, the Company had non-accrual loans in the amount of $ 4,925,000 and$4,397,000, respectively.  The Companyalso had loans 90 days or more past due (still accruing interest) of$ 350,000 and $ 1,001,000 at June 30, 2008 and December 31,2007, respectively.

 

Loan concentrations areconsidered to exist when the total amount of loans to any one or a multiplenumber of borrowers engaged in similar activities or having similarcharacteristics exceeds 10% of loans outstanding in any one category. TheCompany maintains a diversified loan portfolio, granting agribusiness,commercial and residential loans to customers. The majority of the Bank’slending is made within its primary market area, which includes Fulton Countyand southern Franklin County, Pennsylvania and northern Washington County,Maryland. Although no concentrations exist to one borrower or related group ofborrowers or industry sector, the Bank’s commercial lending is primarilysecured by real estate.

 

Bank Owned Life Insurance

 

The Company has BankOwned Life Insurance (“BOLI”) for certain officers and directors, in which theBank is the owner and beneficiary of the policies. The Bank’s deposits andproceeds from the sale of investment securities funded the BOLI. Earnings fromthe BOLI are recognized as other income. The BOLI is profitable from theappreciation of the cash surrender values of the pool of insurance, and its taxadvantage to the Company. This profitability is used to offset a portion ofcurrent and future employee and director benefit costs.

 

The Company had$10,989,000 and $10,768,000 in BOLI as of June 30, 2008 and December 31,2007, respectively. This increase is primarily due to the cash valueappreciation.  Although the BOLI is anasset that may be liquidated, it is the Company’s intention to hold this poolof insurance because it provides tax-exempt income that lowers the Company’stax liability, while enhancing its overall capital position.

 

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Deposits

 

Deposits are the majorsource of the Company’s funds for lending and investment purposes. Totaldeposits at June 30, 2008 were $ 429,410,000, a decrease of$ 10,520,000, or 2.4%, from total deposits of $ 439,930,000 at December 31,2007. This decrease is primarily due to a $ 6,770,000 decrease in timedeposits, which have declined due to lower rates being offered by the bank anda $ 6,137,000 decrease in demand deposits, which management considers tobe normal fluctuations in these types of accounts.

 

Short-Term Borrowings

 

Short term borrowings at June 30,2008 were $ 9,913,000, compared to $ 10,996,000 at December 31,2007, a decrease of $ 1,083,000, or 9.8%. Federal funds purchased,Treasury Tax and Loan demand note, lines of credits with banks and overnightborrowings with the Federal Home Loan Bank of Pittsburgh are considered to beshort term borrowings. Short term borrowings fluctuate daily to meet theliquidity needs of the Company.

 

Long-Term Debt Borrowings

 

Long term borrowings at June 30,2008 were $36,724,000, compared to $26,740,000 at December 31, 2007, anincrease of $9,984,000, or 37.3%. This increase is primarily due to a$ 10,000,000 borrowing with the Federal Home Loan Bank for a term of 10years commencing February 2008.

 

Asset/LiabilityManagement

 

The management ofinterest rate risk involves measuring and analyzing the maturity and repricingof interest-earning assets and interest-bearing liabilities at specific pointsin time. The imbalance between interest-earning assets and interest-bearingliabilities is commonly referred to as the interest rate gap.  The interest rate gap is one measure of therisk inherent in the existing balance sheet as it relates to potential changesin net interest income.  Maintaining anappropriate balance between interest-earning assets and interest-bearingliabilities is a means of monitoring and possibly avoiding materialfluctuations in the net interest margin during periods of changing interestrates.

 

The Company’s overallsensitivity to interest rate risk is low due to its non-complex balance sheet.The Company manages its balance sheet with the intent of stabilizing netinterest income and net economic value under a broad range of interest rateenvironments. The Company has the ability to effect various strategies tomanage interest rate risk, which include, but are not limited to, selling newlyoriginated residential mortgage loans, controlling the volume mix offixed/variable rate commercial loans, mortgage loans and securities,increasing/ decreasing deposits via interest rate changes, borrowing from theFederal Home Loan Bank of Pittsburgh, and buying/selling securities.Adjustments to the mix of assets and liabilities are made periodically in aneffort to give the Company dependable and steady growth in net interest income,while at the same time, managing the related risks.

 

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Liquidity

 

Liquidity represents theCompany’s ability to efficiently manage cash flows at reasonable rates tosupport possible commitments to borrowers or the demands of depositors. Liquidityis essential to compensate for fluctuations in the balance sheet and providefunds for growth and normal operating expenditures. Liquidity needs may be metby converting assets into cash or obtaining sources of additional funding.

 

Liquidity from assetcategories is provided through cash, amounts due from banks, interest-bearingdeposits with banks and federal funds sold, which were $ 21,351,000 at June 30,2008, compared to $36,851,000 at December 31, 2007, a decrease of$ 15,500,000 or 42.1%.  Thisdecrease is primarily due to a decrease of $ 12,906,000 in federal fundssold.  Additional asset liquidity sourcesinclude principal and interest payments from securities in the Company’sinvestment portfolio and cash flow from its amortizing loan portfolio.  Longer-term liquidity needs may be met byselling securities available for sale, selling loans or raising additionalcapital.  At June 30, 2008, therewas $ 72,933,000 in liquid securities as compared to $ 68,573,000 at December 31,2007.  Liquid securities increased by$ 4,360,000 since the end of 2007, primarily due to the purchase ofinvestment securities available for sale at the bank.  Liquid securities held at Tower Bancorpdecreased $ 8,169,000 due to sales, calls and maturity of investment securitiesexceeding purchases and market value fluctuations.

 

Liability liquiditysources include attracting deposits at competitive rates.  Deposits at June 30, 2008 were$ 429,410,000, compared to $ 439,930,000 at December 31,2007.  In addition, the Company hasborrowing capacity and lines of credit with the Federal Home Loan Bank ofPittsburgh, Atlantic Central Bankers Bank and several local banks.

 

The Company’s financialstatements do not reflect various off-balance sheet commitments that are madein the normal course of business, which may involve some liquidity risk.Off-balance sheet arrangements are discussed in detail below.

 

Management is of theopinion that its liquidity position at June 30, 2008 is adequate torespond to fluctuations “on” and “off” the balance sheet.  In addition, management knows of no trends,demands, commitments, events or uncertainties that may result in, or that arereasonably likely to result in the Company’s inability to meet anticipated orunexpected liquidity needs.

 

Off-Balance SheetArrangements

 

The Company’s financialstatements do not reflect various off-balance sheet arrangements that are madein the normal course of business.  Thesecommitments consist mainly of loans approved but not yet funded, unused linesof credit and letters of credit made in accordance with the same standards ason-balance sheet instruments. Unused commitments at June 30, 2008 were$ 106,462,000, which consisted of $ 104,023,000 in unfundedcommitments to existing loans and unfunded new loans and $ 2,439,000 inletters of credit.  Because theseinstruments have fixed maturity dates, and because many of them will expirewithout being drawn upon, they do not generally present a significant liquidityrisk to the Company.  Management believesthat any amounts actually drawn upon can be funded in the normal course ofoperations.  The Company has noinvestment in or financial relationship with any unconsolidated entities thatare reasonably likely to have a material effect on liquidity or the availabilityof capital resources.

 

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Capital

 

The following Table 3presents the risk-based and leverage capital amounts and ratios at June 30,2008 for the Company and the Bank.

 

**Table 3 –Capital Ratios**

 
|                                            |   |                                 |   |      |         |       |                      |                       |       |                       |       | **To be Well** |       |
|-------------------------------------------------|--------|--------------------------------------|--------|-----------|--------------|------------|---------------------------|----------------------------|------------|----------------------------|------------|--------------------------|------------|
|                                            |   |                                 |   |      |         |       | **Minimum for**      |                       |       | **Capitalized under** |       |
|                                            |   |                                 |   |      |         |       | **Capital Adequacy** |                       |       | **Prompt Corrective** |       |
|                                            |   | **Actual**                           |   |      | **Purposes** |       |                      | **Action Provisions** |       |
|                                            |   | **Amount**                           |   | **Ratio** |         |       | **Amount**                |                       | **Ratio**  |                       |       | **Amount**               |       | **Ratio** |   |
|                                            |   | **(Dollars in Thousands)** |   |
| Total risk based  capital/risk weighted assets: |   |                                 |   |      |         |       |                      |                       |       |                       |       |                     |       |   |   |
| Company                                         |   | $                                    | 59,203 |      | 16.1         | %          | >                 | 29,483                     | >  | 8.0                        | %          |                     | N/A        |   | N/A |   |
| Bank                                            |   | 48,499                               |   | 13.2      | %            | >  | 29,336                    | >                  | 8.0        | %                          |       | 36,670                   | >  | 10.0 | % |
|                                            |   |                                 |   |      |         |       |                      |                       |       |                       |       |                     |       |   |   |
| Tier 1  capital/risk weighted assets:           |   |                                 |   |      |         |       |                      |                       |       |                       |       |                     |       |   |   |
| Company                                         |   | 55,148                               |   | 15.0      | %            | >  | 14,742                    | >                  | 4.0        | %                          |       | N/A                      |       | N/A |   |
| Bank                                            |   | 44,444                               |   | 12.1      | %            | >  | 14,668                    | >                  | 4.0        | %                          |       | 22,002                   | >  | 6.0 | % |
|                                            |   |                                 |   |      |         |       |                      |                       |       |                       |       |                     |       |   |   |
| Tier 1  capital/average assets                  |   |                                 |   |      |         |       |                      |                       |       |                       |       |                     |       |   |   |
| Company                                         |   | 55,148                               |   | 10.1      | %            | >  | 21,907                    | >                  | 4.0        | %                          |       | N/A                      |       | N/A |   |
| Bank                                            |   | 44,444                               |   | 8.6       | %            | >  | 20,648                    | >                  | 4.0        | %                          | >  | 25,810                   | >  | 5.0 | % |
|                                                 |        |                                      |        |           |              |            |                           |                            |            |                            |            |                          |            |  |  |  |

 

These capital ratioscontinue to remain at levels which are considered to be “well-capitalized” asdefined by regulatory guidelines.

 

Banking laws and regulationslimit the amount of cash dividends that may be paid without prior approval fromthe Company’s regulatory agencies. In abidance with such requirements, on April 9,2008, the Board of Directors authorized and declared a quarterly cash dividendin the amount of $0.28 per share, payable on May 16, 2008 to allshareholders of record as of May 1, 2008. The payment of this quarterlycash dividend decreased retained earnings by $649,000.

 

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**ITEM 3 – QUANTITATIVE ANDQUALITATIVE DISCLOSURES ABOUT MARKET RISK**

 

Therehave been no material changes to the quantitative and qualitative disclosuresmade in Tower Bancorp’s annual report on Form 10-K for the year ended December 31,2007.

 

**ITEM 4 – CONTROLS AND PROCEDURES**

 

**CONTROLS AND PROCEDURES**

 

The Company’s Chief Executive Officer and Chief Financial Officer haveevaluated the effectiveness of the Company’s disclosure controls and procedures(as such term is defined in the Rules 13a-15(e) under the SecuritiesExchange Act of 1934, as amended (the “Exchange Act”))as of June 30, 2008.Based on such evaluation, such officers have concluded that, as of June 30,2008, the Company’s disclosure controls and procedures are effective inalerting them on a timely basis to material information relating to the Company(including its consolidated subsidiary) required to be included in the Company’speriodic filings under the Exchange Act.

 

**CHANGES IN INTERNAL CONTROLS**

 

Duringthe quarter ended June 30, 2008, management made a number of changes toremediate material weaknesses noted in our December 31, 2007 10-Kfiling.  Our full time Loan ReviewOfficer conducted independent loan reviews throughout the second quarter.  The reviews included an assessment ofmanagement risk identification for loans. An outside accounting firm will test the Loan Review Officer’s workperiodically.  The same firm will alsoreview the methodology surrounding the allowance for loan loss calculation.

 

Inorder to improve our management information system in the lending area, we haveincluded some additional coding of assets, and are in the process of asystem-wide review of the loan portfolio to assure completeness of thiscoding.  We also are risk-rating thecommercial portfolio to aid management of the bank in determining quarterlyallowance requirements.  All loan policyexceptions are being noted and more detailed coding has been implemented todetermine risk exposure in the various business sectors. Trend analysis will beused in the future to note any concentrations in any of the sectors.

 

Creditadministration is doing a completely independent credit analysis of borrowersover a defined threshold and obtaining current financial information from theborrowers in order to do the analysis. We now have a procedure in place toassure receipt of current financial information for all commercial loans inthis defined threshold on an on-going basis.

 

Aconsulting firm has been engaged to review the bank’s management systems, loanadministration and operations.  Theirwork began during the second quarter.

 

Thebank’s loan policy continues to be developed and some of the procedures thataccompany sections of the policy have already been completed.

 

Managementbelieves the above steps show substantial progress has been made to remediatethe material weaknesses noted in our December 31, 2007 10-K filing.  Management expects further steps to be takenin subsequent periods to continue to strengthen controls.

 

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PART II – OTHERINFORMATION

 

29

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PART II – OTHERINFORMATION

 

Item 1 – Legal Proceedings

 

The nature of the Company’sbusiness generates some litigation involving matters arising in the ordinarycourse of business.  In the opinion ofTower’s management, Tower has adequate legal defenses and/or insurance coveragerespecting any and each of these actions and does not believe that they willmaterially affect Tower’s operations or financial position.  However, in the opinion of the Company, afterconsulting with legal counsel, no legal proceedings are pending which areexpected to have a material adverse effect on the company or subsidiary. Nolegal proceedings are pending other than ordinary routine litigation incidentalto the business of the Company and the Bank. In addition, to Management’sknowledge, no governmental authorities have initiated or contemplated anymaterial legal actions against the Company or the Bank.

 

Item 1A – Risk Factors

 

There have been no materialchanges to the Company’s risk factors since these factors were previouslydisclosed in the Company’s Annual Report on Form 10-K for the period endedDecember 31, 2007.

 

Item 2 – Unregistered Sales of Equity Securities andUse of Proceeds

 

On September 13, 2006,the Board of Directors authorized the Company to redeem or repurchase 100,000shares of the Company’s common stock from specific shareholders or in the openmarket.  The stock repurchase plan doesnot expire.

 

ISSUER PURCHASES OF EQUITY SECURITIES

 
| **Period**      | ** ** | **(a)  Total Number  of shares  purchased** | ** ** | **(b)  Average price  paid per  share** | ** ** | **(c)  Total number  of shares  purchased as  part of  publicly  announced  plan** | ** ** | **(d)  Maximum  number of shares  that may yet  be purchased  under the  plan** | ** ** |
|-----------------|------------|-------------------------------------------------------|------------|---------------------------------------------------|------------|--------------------------------------------------------------------------------------------------------|------------|---------------------------------------------------------------------------------------------------------------|------------|
|            |       |                                                  |       |                                              |       |                                                                                                   |       |                                                                                                          |       |
| April 2008 |       | 48                                                    |       | 39.25                                             |       | 48                                                                                                     |       | 38,833                                                                                                        |       |
|            |       |                                                  |       |                                              |       |                                                                                                   |       |                                                                                                          |       |
| May 2008   |       | 0                                                     |       | N/A                                               |       | 0                                                                                                      |       | 38,833                                                                                                        |       |
|            |       |                                                  |       |                                              |       |                                                                                                   |       |                                                                                                          |       |
| June 2008  |       | 3,980                                                 |       | 38.41                                             |       | 3,980                                                                                                  |       | 34,853                                                                                                        |       |
|            |       |                                                  |       |                                              |       |                                                                                                   |       |                                                                                                          |       |
| Total           |       | 4,028                                                 |       | 38.42                                             |       | 4,028                                                                                                  |       | 34,853                                                                                                        |       |

 

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Item3 – Defaults Upon Senior Securities

 

Not applicable

 

Item4 – Submission of Matters to a Vote of Security Holders

 

The annual meeting of Tower Bancorp, Inc. washeld on April 9, 2008.  Matters thatwere voted on by security holders were:

 

1.                                  Elect two Class C Directors forthree year terms expiring in 2011.

 

2.                                  Ratify the selection of Smith ElliottKearns & Company, LLC as the independent accountants for the Companyfor the year ending December 31, 2008.

 

3.                                  Transact any other business that mayproperly come before the meeting.

 

Directors that werere-elected at the annual meeting were:

 

Kermit G. HicksPatricia A. Carbaugh

 

Each director receivedaffirmative votes representing a majority of the shares outstanding.

 

Directors continuing toserve and their term expirations are as follows:

 
| **Class A Directors**          | ** ** | **Class B Directors**          |
|------------------------------------------|------------|------------------------------------------|
| **(to serve until 2009)** | ** ** | **(to serve until 2010)** |
|                                     |       |                                     |
| Mark E. Gayman                           |       | Jeff B. Shank                            |
| James H.  Craig, Jr.                |       | Frederic M. Frederick                    |
| Harry D. Johnston                        |       | Lois E. Easton                           |
|                                     |       | Terry L. Randall                         |

 

Ratification of SmithElliott Kearns & Company, LLC as the independent accountants for theCompany for the year ending December 31, 2008 occurred, with affirmativevotes representing a majority of the shares outstanding.

 

No other matters werevoted upon at the annual meeting.

 

Item5 – Other Information

 

There have been no material changes to the proceduresfor which a shareholder may recommend nominees to the Company’s Board ofDirectors.

 

Item6 – Index to Exhibits

 
| **Exhibit** | ** ** | **Description of Exhibit**                                                                                                                                                                      |
|-------------|------------|-----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
|        |       |                                                                                                                                                                                                      |
| 3.1         |       | Articles of  Incorporation of Tower Bancorp, Inc. (incorporated by reference to  Exhibit 3.1 of Tower Bancorp, Inc.’s Form 10-Q for the quarter  ended September 30, 2005). |
|        |       |                                                                                                                                                                                                      |
| 3.2         |       | Bylaws of Tower  Bancorp, Inc. (incorporated by reference to Exhibit 3.2 of Tower  Bancorp, Inc.’s Form 10-Q for the quarter ended September 30,  2005).                    |

 

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| **Exhibit** | ** ** | **Description of Exhibit**                                                                                                                                                                                                                                       |
|-------------|------------|----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
| 10.1        |       | Change of Control  Agreement of Jeffrey B. Shank dated as of September 25, 2002  (incorporated by referenced to Exhibit 99.4 of Tower  Bancorp, Inc.’s Form 10-Q for the quarter ended September 30,  2002).                                 |
|        |       |                                                                                                                                                                                                                                                                       |
| 10.2        |       | Change of Control  Agreement of Franklin T. Klink, III dated as of November 26, 2001  (incorporated by reference to Exhibit 10.1 of Tower Bancorp, Inc.’s  Form 10-K for the year ended December 31, 2001).                             |
|        |       |                                                                                                                                                                                                                                                                       |
| 10.3        |       | Change of Control  Agreement of Donald G. Kunkle dated as of January 4, 2002 (incorporated  by reference to Exhibit 10.2 of Tower Bancorp, Inc.’s  Form 10-K for the year ended December 31, 2001).                                          |
|        |       |                                                                                                                                                                                                                                                                       |
| 10.4        |       | Change of Control  Agreement of John H. McDowell, Sr. dated as of December 23, 1998  (incorporated by reference to Exhibit 10.2 of Tower Bancorp, Inc.’s  Form 10-K for the year ended December 31, 1998).                              |
|        |       |                                                                                                                                                                                                                                                                       |
| 10.5        |       | Tower  Bancorp, Inc.’s 1995 Non-Qualified Stock Option Plan (incorporated by reference  to Exhibit 99.1 to Tower Bancorp, Inc.’s Registration Statement on  Form S-8 (File No. 333-4066 1)).                                            |
|        |       |                                                                                                                                                                                                                                                                       |
| 10.6        |       | Tower  Bancorp, Inc. Stock Option Plan for Outside Directors (incorporated by  reference to Exhibit 99.2 to Tower Bancorp, Inc.’s Registration  Statement on Form S-8 (File No. 333-40661)).                                                 |
|        |       |                                                                                                                                                                                                                                                                       |
| 10.7        |       | Supplemental Executive  Retirement Agreement of Jeffrey B. Shank dated as of September 25, 2002  (incorporated by reference to Exhibit 99.3 of Tower Bancorp, Inc.’s  Form 10-Q for the quarter ended September 30, 2002).                   |
|        |       |                                                                                                                                                                                                                                                                       |
| 10.8        |       | Form of Amendment  and Restatement of the First National Bank of Greencastle Group Term  Replacement Plan A (incorporated by reference to Exhibit 10.8 of Tower  Bancorp, Inc.’s Registration Statement on Form S-4 (File  No. 333-130485)). |
|        |       |                                                                                                                                                                                                                                                                       |
| 10.9        |       | Form of Amendment  and Restatement of the First National Bank of Greencastle Group Term  Replacement Plan B (incorporated by reference to Exhibit 10.8 of Tower  Bancorp, Inc.’s Registration Statement on Form S-4 (File  No. 333-130485)). |
|        |       |                                                                                                                                                                                                                                                                       |
| 10.10       |       | Form of Amendment  an Restatement of the First National Bank of Greencastle Executive Bonus  Agreement (incorporated by reference to Exhibit 10.8 of Tower  Bancorp, Inc.’s Registration Statement on Form S-4 (File  No. 333-130485)).      |
|        |       |                                                                                                                                                                                                                                                                       |
| 10.11       |       | First National Bank of  Greencastle Employees’ Stock Ownership Plan Incorporated by reference to  Exhibit 99.3 to Tower Bancorp, Inc.’s Registration Statement on  Form S-8(File No.333-40661).                                                   |
|        |       |                                                                                                                                                                                                                                                                       |
| 31.1        |       | Certification of Chief  Executive Officer pursuant to Section 302 of the Sarbanes-Oxley Act of  2002.                                                                                                                                                                 |
|        |       |                                                                                                                                                                                                                                                                       |
| 31.2        |       | Certification of Chief  Financial Officer pursuant to Section 302 of the Sarbanes-Oxley Act of  2002.                                                                                                                                                                 |

 

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| **Exhibit** | ** ** | **Description of Exhibit**                                              |
|-------------|------------|-----------------------------------------------------------------------------------|
| 32.1        |       | Certification of Chief  Executive Officer pursuant to 18 U.S.C. Section 1350 |
|        |       |                                                                              |
| 32.2        |       | Certification of Chief  Financial Officer pursuant to 18 U.S.C. Section 1350 |

 

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SIGNATURES

 

Pursuant to the requirements of the SecuritiesExchange Act of 1934, the registrant has duly caused this report to be signedon its behalf by the undersigned thereunto duly authorized.

 
|   | TOWER BANCORP, INC.              |
|--------|----------------------------------|
|   | (REGISTRANT)                     |
|   |                             |
|   | /s/  Jeff B. Shank          |
|   | Jeff B. Shank,  President, CEO   |
|   | (Principal Executive  Officer)   |
| Date:  | July 31, 2008               |   |   |
|   |                             |
|   | /s/ Franklin T.  Klink, III |
|   | Franklin T.  Klink, III,    |
|   | Treasurer                        |
|   | (Principal Financial  Officer)   |
| Date:  | July 31, 2008               |   |   |

 

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