**FORM 10-Q**

 

**SECURITIES AND EXCHANGE COMMISSION**

**Washington, D.C. 20549**

 

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

**OF THE SECURITIES EXCHANGE ACT OF 1934**

 

**For the quarter ended September 30, 2007**

**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’stelephone number, including area code:    **(717) 597-2137**

 

Indicateby check mark whether the registrant (1) has filed all reports required to befiled by Section 13 or 15(d) of the Securities Exchange Act of 1934 during thepreceding 12 months (or for shorter period that the registrant was required tofile such reports), and (2) has been subject to such filing requirements forthe past 90 days.

Yes      x    No      o

 

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

 

Largeaccelerated filer o   Accelerated filer x   Non-accelerated filer o

 

Indicateby check mark whether the registrant is a shell company (as defined in Rule12b-2 of the Exchange Act).

 

Yes x    No o

 

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

 

2,337,577shares of common stock outstanding at September 30, 2007

 

 

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TOWER BANCORP, INC.

 

INDEX
|                                                                                                                       | **Page** |
|----------------------------------------------------------------------------------------------------------------------------|----------|
|                                                                                                                       |     |
| PART I -  FINANCIAL INFORMATION                                                                                            |     |
|                                                                                                                       |     |
| Item 1 - Financial Statements                                                                                              |     |
| Condensed consolidated  balance sheets – September 30, 2007 and December 31, 2006                                     | 4        |
| Condensed consolidated  statements of income - three months ended September 30, 2007 and 2006                              | 5        |
| Condensed consolidated  statements of income - three months ended September 30, 2007 and 2006                              | 6        |
| Condensed consolidated  statements of comprehensive income – three and nine months ended September  30, 2007 and 2006 | 7        |
| Condensed consolidated  statements of cash flows – nine months ended September 30, 2007 and 2006                      | 8        |
| Notes to condensed  consolidated financial statements                                                                      | 9-11     |
| Item 2 -  Management’s discussion and analysis of financial condition and results of  operations                      | 12-25    |
| Item 3 -  Quantitative and qualitative disclosures about market risk                                                       | 26       |
| Item 4 - Controls and  procedures                                                                                          | 27       |
|                                                                                                                       |     |
| PART II - OTHER  INFORMATION                                                                                               | 28       |
|                                                                                                                       |     |
| Item  1 – Legal proceedings                                                                                           | 29       |
| Item  1A – Risk Factors                                                                                               | 29       |
| Item 2 –  Unregistered sales of equity securities and use of proceeds                                                 | 29       |
| Item 3 –  Defaults upon senior securities                                                                             | 30       |
| Item 4 –  Submission of matters to a vote of security holders                                                         | 30       |
| Item  5 – Other information                                                                                           | 30       |
| Item  6 – Index to Exhibits                                                                                           | 30-31    |
|                                                                                                                       |     |
| Signatures                                                                                                                 | 32       |
|                                                                                                                       |     |
| Exhibits                                                                                                                   |     |

 

2

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PART I - FINANCIALINFORMATION

 

3

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TOWER BANCORP, INC. AND ITS WHOLLY-OWNEDSUBSIDIARY

 

CONDENSED CONSOLIDATEDBALANCE SHEETS

 
| ** **                                                                                          | ** ** | **September 30,** | ** ** | **December 31,** | ** ** |
|-----------------------------------------------------------------------------------------------------|------------|------------------------|------------|-----------------------|------------|
| ** **                                                                                          | ** ** | **2007**               | ** ** | **2006**              | ** ** |
| ** **                                                                                          | ** ** | **(Unaudited)**        | ** ** | **(Audited)***        | ** ** |
| ** **                                                                                          | ** ** | **(000 Omitted)** | ** ** |
| ASSETS                                                                                              |       |                   |       |                  |       |
| Cash and due  from banks                                                                            |       | $                      | 12,074     |                  | $          | 14,128 |   |
| Federal funds  sold                                                                                 |       | 37,486                 |       | 6,530                 |       |
| Interest bearing  balances with banks                                                               |       | 0                      |       | 97                    |       |
| Investment  securities available for sale                                                           |       | 46,071                 |       | 44,478                |       |
| Equity  securities available for sale                                                               |       | 37,221                 |       | 43,153                |       |
| Restricted bank  stock                                                                              |       | 2,937                  |       | 3,123                 |       |
| Loans:                                                                                              |       |                   |       |                  |       |
| Real estate  mortgages                                                                              |       | 307,862                |       | 318,209               |       |
| Commercial                                                                                          |       | 64,959                 |       | 54,313                |       |
| Consumer                                                                                            |       | 21,911                 |       | 17,897                |       |
| Gross loans                                                                                         |       | 394,732                |       | 390,419               |       |
| Less:     reserve  for possible loan losses                                |       | (3,985                 | )          | (3,610                | )          |
| Loans,   net                                                                         |       | 390,747                |       | 386,809               |       |
| Bank premises,  equipment, furniture and fixtures                                                   |       | 11,593                 |       | 11,579                |       |
| Accrued interest  receivable                                                                        |       | 2,073                  |       | 1,841                 |       |
| Cash surrender  value of life insurance                                                             |       | 10,669                 |       | 10,683                |       |
| Goodwill                                                                                            |       | 16,558                 |       | 16,535                |       |
| Core deposit  intangible                                                                            |       | 1,789                  |       | 2,095                 |       |
| Other assets                                                                                        |       | 1,643                  |       | 1,116                 |       |
| Total assets                                                                                        |       | $                      | 570,861    |                  | $          | 542,167 |   |
|                                                                                                |       |                   |       |                  |       |
| LIABILITIES AND  STOCKHOLDERS’ EQUITY  LIABILITIES                                             |       |                   |       |                  |       |
| Deposits in  domestic offices:                                                                      |       |                   |       |                  |       |
| Demand                                                                                              |       | $                      | 43,416     |                  | $          | 47,548 |   |
| Savings                                                                                             |       | 230,288                |       | 188,147               |       |
| Time                                                                                                |       | 172,741                |       | 174,140               |       |
| Liabilities for  borrowed money                                                                     |       | 37,236                 |       | 41,643                |       |
| Accrued interest  payable                                                                           |       | 1,146                  |       | 994                   |       |
| Other liabilities                                                                                   |       | 5,772                  |       | 8,142                 |       |
| Total  liabilities                                                                                  |       | 490,599                |       | 460,614               |       |
|                                                                                                |       |                   |       |                  |       |
| 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                                                                         |       | 34,836                 |       | 34,810                |       |
| Retained  earnings                                                                                  |       | 39,814                 |       | 36,148                |       |
| Accumulated  other comprehensive income                                                             |       | 6,644                  |       | 10,731                |       |
| Less: cost of  treasury stock; 2007 - 82,904 shares; 2006 - 63,278 shares                           |       | (3,257                 | )          | (2,361                | )          |
| Total  stockholders’ equity                                                                    |       | 80,262                 |       | 81,553                |       |
|                                                                                                |       |                   |       |                  |       |
| Total  liabilities and stockholders’ equity                                                    |       | $                      | 570,861    |                  | $          | 542,167 |   |

 

----

*   Condensedfrom audited financial statements.

 

The accompanying notes are an integral partof these condensed financial statements.

 

4

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TOWER BANCORP, INC. AND ITS WHOLLY-OWNEDSUBSIDIARY

 

CONDENSED CONSOLIDATEDSTATEMENTS OF INCOME

THREE MONTHS ENDED SEPTEMBER 30, 2007 and2006

(UNAUDITED)

 
| ** **                                            | ** ** | **2007**               | ** ** | **2006**  | ** ** |
|-------------------------------------------------------|------------|------------------------|------------|-----------|------------|
| ** **                                            | ** ** | **(000 Omitted)** | ** ** |
| Interest Income                                       |       |                   |       |      |       |
| Interest &  fees on loans                         |       | $                      | 7,233      |      | $          | 6,762 |   |
| Interest on  investment securities available for sale |       | 689                    |       | 865       |       |
| Interest on  federal funds sold                       |       | 565                    |       | 97        |       |
| Total interest  income                                |       | 8,487                  |       | 7,724     |       |
| Interest Expense                                      |       |                   |       |      |       |
| Interest on  deposits                                 |       | 3,095                  |       | 2,335     |       |
| Interest on  borrowed money                           |       | 498                    |       | 789       |       |
| Total interest  expense                               |       | 3,593                  |       | 3,124     |       |
|                                                  |       |                   |       |      |       |
| Net interest  income                                  |       | 4,894                  |       | 4,600     |       |
|                                                  |       |                   |       |      |       |
| Provision for  loan losses                            |       | 150                    |       | 100       |       |
|                                                  |       |                   |       |      |       |
| Net interest  income after provision for loan losses  |       | 4,744                  |       | 4,500     |       |
|                                                  |       |                   |       |      |       |
| Other Income                                          |       |                   |       |      |       |
| Investment  service income                            |       | 227                    |       | 63        |       |
| Service charges  on deposit accounts                  |       | 471                    |       | 440       |       |
| Other service  charges                                |       | 636                    |       | 286       |       |
| Other operating  income                               |       | 101                    |       | 123       |       |
| Investment  securities gains (losses)                 |       | 172                    |       | 1,273     |       |
| Total other  income                                   |       | 1,607                  |       | 2,185     |       |
|                                                  |       |                   |       |      |       |
| Other Expense                                         |       |                   |       |      |       |
| Salaries, wages  and other benefits                   |       | 1,965                  |       | 2,252     |       |
| Occupancy and  equipment expense                      |       | 890                    |       | 927       |       |
| Other operating  expenses                             |       | 994                    |       | 1,284     |       |
| Total other  expenses                                 |       | 3,849                  |       | 4,463     |       |
|                                                  |       |                   |       |      |       |
| Income before  taxes                                  |       | 2,502                  |       | 2,222     |       |
| Applicable income  taxes                              |       | 684                    |       | 712       |       |
| Net income                                            |       | $                      | 1,818      |      | $          | 1,510 |   |
|                                                  |       |                   |       |      |       |
| Earnings per  share:                                  |       |                   |       |      |       |
| Basic earnings  per share                             |       | $                      | 0.78       |      | $          | 0.64 |   |
| Weighted average  shares outstanding                  |       | 2,340,221              |       | 2,371,117 |       |
| Diluted earnings  per share                           |       | $                      | 0.77       |      | $          | 0.63 |   |
| Weighted average  shares outstanding                  |       | 2,348,148              |       | 2,404,735 |       |
|                                                  |       |                   |       |      |       |
| Dividends  declared per share                         |       | $                      | 0.26       |      | $          | 0.24 |   |

 

The accompanying notes are an integral partof these condensed financial statements.

 

5

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TOWER BANCORP, INC. AND ITS WHOLLY-OWNEDSUBSIDIARY

 

CONDENSED CONSOLIDATEDSTATEMENTS OF INCOME

NINE MONTHS ENDED SEPTEMBER 30, 2007 and 2006

(UNAUDITED)

 
| ** **                                            | ** ** | **2007**               | ** ** | **2006**  | ** ** |
|-------------------------------------------------------|------------|------------------------|------------|-----------|------------|
| ** **                                            | ** ** | **(000 Omitted)** | ** ** |
| Interest Income                                       |       |                   |       |      |       |
| Interest &  fees on loans                         |       | $                      | 21,216     |      | $          | 15,388 |   |
| Interest on  investment securities available for sale |       | 2,158                  |       | 2,280     |       |
| Interest on  federal funds sold                       |       | 1,590                  |       | 334       |       |
| Total interest  income                                |       | 24,964                 |       | 18,002    |       |
| Interest Expense                                      |       |                   |       |      |       |
| Interest on  deposits                                 |       | 9,056                  |       | 4,836     |       |
| Interest on  borrowed money                           |       | 1,520                  |       | 1,858     |       |
| Total interest  expense                               |       | 10,576                 |       | 6,694     |       |
|                                                  |       |                   |       |      |       |
| Net interest  income                                  |       | 14,388                 |       | 11,308    |       |
|                                                  |       |                   |       |      |       |
| Provision for  loan losses                            |       | 450                    |       | 230       |       |
|                                                  |       |                   |       |      |       |
| Net interest  income after provision for loan losses  |       | 13,938                 |       | 11,078    |       |
|                                                  |       |                   |       |      |       |
| Other Income                                          |       |                   |       |      |       |
| Investment  service income                            |       | 690                    |       | 239       |       |
| Service charges  on deposit accounts                  |       | 1,324                  |       | 1,064     |       |
| Other service  charges                                |       | 1,214                  |       | 711       |       |
| Other operating  income                               |       | 440                    |       | 298       |       |
| Investment  securities gains (losses)                 |       | 1,861                  |       | 2,757     |       |
| Total other  income                                   |       | 5,529                  |       | 5,069     |       |
|                                                  |       |                   |       |      |       |
| Other Expense                                         |       |                   |       |      |       |
| Salaries, wages  and other benefits                   |       | 6,123                  |       | 5,029     |       |
| Occupancy and  equipment expense                      |       | 2,714                  |       | 2,073     |       |
| Other operating  expenses                             |       | 3,181                  |       | 2,743     |       |
| Total other  expenses                                 |       | 12,018                 |       | 9,845     |       |
|                                                  |       |                   |       |      |       |
| Income before  taxes                                  |       | 7,449                  |       | 6,302     |       |
| Applicable  income taxes                              |       | 1,949                  |       | 1,802     |       |
| Net income                                            |       | $                      | 5,500      |      | $          | 4,500 |   |
|                                                  |       |                   |       |      |       |
| Earnings per  share:                                  |       |                   |       |      |       |
| Basic earnings  per share                             |       | $                      | 2.34       |      | $          | 2.23 |   |
| Weighted average  shares outstanding                  |       | 2,350,585              |       | 2,016,689 |       |
| Diluted earnings  per share                           |       | $                      | 2.33       |      | $          | 2.20 |   |
| Weighted average  shares outstanding                  |       | 2,359,013              |       | 2,050,468 |       |
|                                                  |       |                   |       |      |       |
| Dividends  declared per share                         |       | $                      | 0.78       |      | $          | 0.72 |   |

 

The accompanying notes are an integral partof these condensed financial statements.

 

6

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TOWER BANCORP, INC. AND ITS WHOLLY-OWNEDSUBSIDIARY

 

CONDENSED CONSOLIDATEDSTATEMENTS OF COMPREHENSIVE INCOME

THREE AND NINE MONTHS ENDED SEPTEMBER 30,2007 AND 2006

(UNAUDITED)

 
| ** **                                     | ** ** | **Three Months Ended** | ** ** |
|------------------------------------------------|------------|----------------------------------|------------|
| ** **                                     | ** ** | **September 30**            | ** ** |
| ** **                                     | ** ** | **2007**                         | ** ** | **2006** | ** ** |
| ** **                                     | ** ** | **(000  Omitted)**               | ** ** |
|                                           |       |                             |       |   |   |
| Net income                                     |       | $                                | 1,818      |   | $ | 1,510 |   |
|                                           |       |                             |       |   |   |
| Other  comprehensive income:                   |       |                             |       |   |   |
| Unrealized  holding gains (losses), net of tax |       | (1,625                           | )          | 161 |   |
|                                           |       |                             |       |   |   |
| Comprehensive  income                          |       | $                                | 193        |   | $ | 1,671 |   |

 
|                                           |   | **Nine Months Ended** |   |
|------------------------------------------------|--------|---------------------------------|--------|
|                                           |   | **September 30**           |   |
|                                           |   | **2007**                        |   | **2006** |   |
|                                           |   | **(000 Omitted)**          |   |
|                                           |   |                            |   |   |   |
| Net income                                     |   | $                               | 5,500  |   | $ | 4,500 |   |
|                                           |   |                            |   |   |   |
| Other  comprehensive income:                   |   |                            |   |   |   |
| Unrealized  holding gains (losses), net of tax |   | (4,087                          | )      | 717 |   |
|                                           |   |                            |   |   |   |
| Comprehensive  income                          |   | $                               | 1,413  |   | $ | 5,217 |   |

 

The accompanying notes are an integral partof these condensed financial statements.

 

7

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# TOWER BANCORP, INC. AND ITSWHOLLY-OWNED SUBSIDIARY

#  

CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS

NINE MONTHS ENDED SEPTEMBER 30, 2007 AND 2006

(UNAUDITED)

 
| ** **                                                                         | ** ** | **2007**               | ** ** | **2006** | ** ** |
|------------------------------------------------------------------------------------|------------|------------------------|------------|----------|------------|
| ** **                                                                         | ** ** | **(000 omitted)** | ** ** |
| Cash flows from  operating activities:                                             |       |                   |       |     |       |
| Net income                                                                         |       | $                      | 5,500      |     | $          | 4,500 |   |
| Adjustments to  reconcile net income to net cash provided by operating activities: |       |                   |       |     |       |
| Depreciation and  amortization                                                     |       | 949                    |       | 568      |       |
| Provision for  loan losses                                                         |       | 450                    |       | 230      |       |
| Granting of  stock options                                                         |       | 108                    |       | 108      |       |
| (Gain) on sale  of investment securities                                           |       | (1,861                 | )          | (2,757   | )          |
| Other (net)                                                                        |       | (224                   | )          | (1,588   | )          |
| Net cash  provided (used) by operating activities                                  |       | 4,922                  |       | 1,061    |       |
|                                                                               |       |                   |       |     |       |
| Cash flows from  investing activities:                                             |       |                   |       |     |       |
| Loans (net)                                                                        |       | (4,388                 | )          | (14,278  | )          |
| Purchases of  bank premises, equipment, furniture and fixtures                     |       | (655                   | )          | (1,852   | )          |
| Interest bearing  balances with banks                                              |       | 97                     |       | 3,086    |       |
| Purchases of  available for sale securities                                        |       | (7,979                 | )          | (8,863   | )          |
| Maturities/sales  of available for sale securities                                 |       | 8,293                  |       | 30,792   |       |
| Redemption  (purchase) of restricted bank stock                                    |       | (121                   | )          | (423     | )          |
| Cash acquired in  acquisition                                                      |       | 0                      |       | 4,594    |       |
| Purchase price  of shares exchanged for cash/transaction costs                     |       | 0                      |       | (2,935   | )          |
| Net cash  provided (used) by investing activities                                  |       | (4,753                 | )          | 10,121   |       |
|                                                                               |       |                   |       |     |       |
| Cash flows from  financing activities:                                             |       |                   |       |     |       |
| Federal funds  purchased                                                           |       | (30,956                | )          | (15,425  | )          |
| Net increase in  deposits                                                          |       | 36,610                 |       | 2,191    |       |
| Net payments in  long term borrowings                                              |       | (5,000                 | )          | 0        |       |
| Net increase  (decrease) in short term borrowings                                  |       | (65                    | )          | (2,480   | )          |
| Purchase of  treasury stock                                                        |       | (1,155                 | )          | (372     | )          |
| Proceeds from  sale of treasury stock                                              |       | 177                    |       | 286      |       |
| Cash dividends  paid                                                               |       | (1,834                 | )          | (1,401   | )          |
| Net cash  provided (used) by financing activities                                  |       | (2,223                 | )          | (17,201  | )          |
|                                                                               |       |                   |       |     |       |
| Net increase  (decrease) in cash and cash equivalents                              |       | (2,054                 | )          | (6,019   | )          |
|                                                                               |       |                   |       |     |       |
| Cash and cash  equivalents at beginning of period                                  |       | 14,128                 |       | 21,837   |       |
|                                                                               |       |                   |       |     |       |
| Cash and cash  equivalents at end of period                                        |       | $                      | 12,074     |     | $          | 15,818 |   |

 

The accompanying notes are an integral partof these condensed financial statements.

 

8

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NOTES TO CONDENSEDCONSOLIDATED FINANCIAL STATEMENTS

September 30, 2007

(UNAUDITED)

 

Note 1.                                 Basis of Presentation

 

The accompanying unaudited condensed consolidatedfinancial statements have been prepared in accordance with generally acceptedaccounting principles in the United States for interim financial information,and accordingly do not include all of the information and footnotes required bygenerally accepted accounting principles for complete financial statements. Inthe opinion of management, the accompanying unaudited condensed consolidatedfinancial statements contain all adjustments (consisting solely of normalrecurring adjustments) necessary to present fairly Tower Bancorp, Inc.’sconsolidated financial position as of September 30, 2007 and the results of itsoperations for the three and nine month periods ended September 30, 2007 and2006. Information presented at December 31, 2006 is condensed from auditedyear-end financial statements included in the Annual Report on Form 10-K forthe year ended December 31, 2006.

 

The condensed consolidated financial statementsinclude the accounts of Tower Bancorp, Inc. (the “Company”) and its whollyowned subsidiary, the First National Bank of Greencastle (the “Bank”). Allsignificant intercompany accounts and transactions have been eliminated.

 

The results of operations for the three and ninemonth periods ended September 30, 2007 and 2006 are not necessarily indicativeof the results to be expected for the full year.

 

Note 2.                                 Income Taxes

 

Income tax expense is less than the amountcalculated using the statutory tax rate primarily as a result of tax exemptincome earned from state and municipal securities and loans.

 

Note 3.                                 Commitments

 

In the normal course of business, the Company makesvarious commitments and incurs certain contingent liabilities which are notreflected in the accompanying financial statements. These commitments includevarious guarantees and commitments to extend credit and the bank does notanticipate any losses as a result of these transactions.

 

9

----

 

Note 4.                                 Merger with FNB Financial Corporation

 

During the second quarter of 2006, FNB FinancialCorporation (“FNB”), parent company of the First National Bank ofMcConnellsburg, located in McConnellsburg, Pennsylvania merged with and intothe Company. The Company acquired all of FNB’s outstanding shares of commonstock. The net assets of FNB were recorded at fair value. Portions of the costof acquisition, including certain expenses related to the merger, wereallocated as intangible assets. All results of operations subsequent to themerger are included in consolidated income totals. Thus while 2007 resultsinclude nine months of post-merger activity, the 2006 results only include fourmonths of post-merger activity. In addition, the First National Bank ofMcConnellsburg’s charter was merged into the First National Bank of Greencastlein August 2006.

 

Note 5.                                 Stock Option Plans

 

At September 30, 2007, the Company had twostock-based compensation plans. On January 1, 2006, the Company adopted FASBStatement No. 123 (R) using the modified prospective method. The fair value ofeach grant is estimated at the grant date using the Black-Scholesoption-pricing model.

 

Included in salaries and employee benefits expensefor the nine months ended September 30, 2007 and 2006 is $70,000 and $69,000,respectively, of stock-based compensation expense. Also included in otheroperating expense for the nine months ended September 30, 2007 and 2006 is$38,000 and $40,000, respectively, of stock-based compensation expense.

 

Stock option plan activity for the nine months endedSeptember 30, 2007 is 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, 2007 |       | 32,674     |       | 31.77                                  |       | 6                                                                    |       | 436,000                                                                  |       |
| Granted                         |       | 5,929      |       | 32.92                                  |       | 10                                                                   |       | 70,000                                                                   |       |
| Exercised                       |       | 3,632      |       | 9.96                                   |       | N/A                                                                  |       | N/A                                                                      |       |
| Forfeited                       |       | 0          |       | N/A                                    |       | N/A                                                                  |       | N/A                                                                      |       |
| Outstanding at  Sept. 30, 2007  |       | 34,971     |       | 34.23                                  |       | 6                                                                    |       | 325,000                                                                  |       |
| Exercisable at  Sept. 30, 2007  |       | 30,645     |       | 32.75                                  |       | 5                                                                    |       | 325,000                                                                  |       |

 

The total value of in-the-money options exercisedduring the first nine months ended September 30, 2007 was $124,000.

 

10

----

 

Note 6.                                 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 12,474shares were excluded from the calculation at September 30, 2007 becausethe effects were anti-dilutive. Potential dilutive common stock had no effecton income available to common stockholders.

 
| ** **                      | ** ** | **Three Months Ended** | ** ** |
|---------------------------------|------------|----------------------------------|------------|
| ** **                      | ** ** | **September 30, 2007** | ** ** | **September 30, 2006** | ** ** |
| ** **                      | ** ** | ** **                       | ** ** | **Per** | ** ** | ** ** | ** ** | **Per** | ** ** |
| ** **                      | ** ** | ** **                       | ** ** | **Share** | ** ** | ** ** | ** ** | **Share** | ** ** |
| ** **                      | ** ** | **Shares**                       | ** ** | **Amount** | ** ** | **Shares** | ** ** | **Amount** | ** ** |
| Basic earnings  per share       |       | 2,340,221                        |       | $ | 0.78 |   | 2,371,117 |   | $ | 0.64 |   |
| Effect of  dilutive securities: |       |                             |       |   |   |   |   |   |   |
| Stock options                   |       | 7,927                            |       |   |   | 33,618 |   |   |   |
| Diluted earnings  per share     |       | 2,348,148                        |       | $ | 0.77 |   | 2,404,735 |   | $ | 0.63 |   |

 
| ** **                      | ** ** | **Nine Months Ended**  | ** ** |
|---------------------------------|------------|----------------------------------|------------|
| ** **                      | ** ** | **September 30, 2007** | ** ** | **September 30, 2006** | ** ** |
| ** **                      | ** ** | ** **                       | ** ** | **Per** | ** ** | ** ** | ** ** | **Per** | ** ** |
| ** **                      | ** ** | ** **                       | ** ** | **Share** | ** ** | ** ** | ** ** | **Share** | ** ** |
| ** **                      | ** ** | **Shares**                       | ** ** | **Amount** | ** ** | **Shares** | ** ** | **Amount** | ** ** |
| Basic earnings  per share       |       | 2,350,585                        |       | $ | 2.34 |   | 2,016,689 |   | $ | 2.23 |   |
| Effect of  dilutive securities: |       |                             |       |   |   |   |   |   |   |
| Stock options                   |       | 8,428                            |       |   |   | 33,779 |   |   |   |
| Diluted earnings  per share     |       | 2,359,013                        |       | $ | 2.33 |   | 2,050,468 |   | $ | 2.20 |   |

 

11

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ITEM 2.MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OFOPERATIONS

 

September 30, 2007

 

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, 2006 Annual Report on Form 10-K. Current performancedoes not guarantee and may not be indicative of similar performance in thefuture.

 

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 couldbe unsuccessful.

 

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.

 

CRITICAL ACCOUNTINGPOLICIES

 

Disclosure of the Company’ssignificant accounting policies is included in Note 1 to the consolidatedfinancial statements of the Company’s Annual Report on Form 10-K for the yearended December 31, 2006. Some of these policies are particularly sensitiverequiring significant judgments, estimates and assumptions to be made bymanagement. Additional information is contained on pages 15 and 20 of thisreport for the provision and allowance for loan losses.

 

12

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OVERVIEW

 

The merger with FNBFinancial Corporation, which occurred on June 1, 2006, represents a significantexpansion of the Tower Bancorp, Inc. franchise. In accordance with generallyaccepted accounting principles (GAAP), comparisons of year-to-date results havenot been restated for the impact of the FNB Financial Corporation operationsfor the first five months of 2006 or for the nine months of 2007, renderingthese comparative analyses less useful than the quarterly comparison. Also, onFebruary 28, 2007, the Company dissolved FNB Mortgage Brokers, Inc., asubsidiary of the bank acquired in the merger.

 

Net income for the ninemonths ended September 30, 2007 and 2006 was $5,500,000 and $4,500,000,respectively. The increase of $1,000,000, or 22.2%, is attributable to theCompany’s core banking business and the merger with FNB Financial Corporation (“FNB”).Net interest income increased 27.3%, other income increased 9.1%, the provisionfor loan losses increased 95.7% and other expenses increased 22.1%. On a basicand diluted per share basis, net income for the nine months ended September 30,2007 was $2.34 and $2.33, respectively, as compared with $2.23 and $2.20 forthe nine months ended September 30, 2006. Net income as a percentage of totalaverage stockholders’ equity on an annualized basis, also known as return onaverage equity, was 8.77% and 9.50% for the first nine months of 2007 and 2006,respectively. Return on average tangible equity was 11.26% and 10.15% for thefirst nine months of 2007 and 2006 respectively, an increase of 10.94%. Theincrease in this ratio is attributable to an increased level of net income.

 

During the first ninemonths of 2007, the Company’s assets increased $28,694,000, or 5.3%, to$570,861,000 as of September 30, 2007 from $542,167,000 as of December 31,2006. This increase is primarily attributable to an increase in Federal fundssold, funded by an increase in Money Market savings accounts (MMDA). Totalloans increased 1.1% to $394,732,000. Total deposits increased by $36,610,000,or 8.9%, during the first nine months of 2007 to $446,445,000 as of September30, 2007 from $409,835,000 as of December 31, 2006. As a result ofcompetition in the market, and, to a certain degree, customers’ continueduncertainty as to how to best invest their monies, deposit growth may not beassumed at the current rates.

 

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RESULTS OF OPERATIONS

 

Net Interest Income

 

For the three monthsended September 30, 2007, total interest income increased by $763,000, or 9.9%,to $8,487,000 as compared with $7,724,000 for the three months ended September30, 2006. This increase is primarily due to increased yield on loans andinvestment securities. For the three months ended September 30, 2007, totalinterest income increased by $193,000, or 2.3%, to $8,487,000, as compared with$8,294,000 for the three months ended June 30, 2007. During the three monthsending September 30, 2007 earning assets increased 0.7% to $518,447,000. Forthe three months ended September 30, 2007, loans increased by $7,361,000 or1.9% to $394,732,000 while investment securities increased $976,000 andovernight Fed Funds sold decreased $4,870,000. Management continued to targetefforts to attract mortgage and small commercial loans. During the thirdquarter of 2007, there was a 50 basis point decrease in the New York Prime Rateand about an 80 basis point drop in the One Year Constant Maturity TreasuryRate.

 

Total interest expenseincreased by $469,000, or 15.0% to $3,593,000 for the three months endedSeptember 30, 2007 from $3,124,000 for the three months ended September 30,2006. This increase is primarily due to the increased deposit balances and theincreased costs associated with attracting deposits. Increases in rates wereneeded to attract deposits, particularly money market accounts. Total interestexpense increased by $56,000, or 1.6% to $3,593,000 for the three months endedSeptember 30, 2007 from $3,537,000 for the three months ended June 30, 2007.This increase is primarily due to $638,000 increase in interest bearingdeposits and higher rates paid on money market accounts.

 

Net interest incomeincreased by $294,000, or 6.4%, to $4,894,000 for the three months endingSeptember 30, 2007 from $4,600,000 for the three months ending September 30,2006. This increase is primarily due to the merger with FNB and alsoattributable to the repricing of mortgages. Net interest income increased by$137,000, or 2.9%, to $4,894,000 for the three months ending September 30, 2007from $4,757,000 for the three months ending June 30, 2007.

 

For the nine months endedSeptember 30, 2007, total interest income increased by $6,962,000, or 38.7%, to$24,964,000 as compared with $18,002,000 for the nine months ended September30, 2006. This increase is primarily due to the merger with FNB, resulting inan increased level of investments.

 

Total interest expenseincreased by $3,882,000, or 58.0% to $10,576,000 for the nine months endedSeptember 30, 2007 from $6,694,000 for the nine months ended September 30,2006. This increase is primarily due to the merger with FNB and to theincreased deposit balances. Increases in rates were also needed to attractdeposits, particularly money market accounts.

 

Net interest incomeincreased by $3,080,000, or 27.2%, to $14,388,000 for the nine months endingSeptember 30, 2007 from $11,308,000 for the nine months ending September 30,2006. This increase is primarily due to the merger with FNB and alsoattributable to the repricing of mortgages and, to a lesser extent, commercialloans tied to the one year treasury and prime rates.

 

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Provision for Loan Losses

 

The provision for loanlosses was $150,000 for the three months ending September 30, 2007 comparedwith $100,000 for the three months ending September 30, 2006, an increase of50.0%. The increase in the provision is primarily due to the merger with FNB whichsignificantly increased the balance and changed the composition of the loanportfolio. The level of provision is commensurate with the risk identified inthe loan portfolio.

 

The provision for loanlosses was $450,000 for the nine months ending September 30, 2007 compared with$230,000 for the nine months ending September 30, 2006, an increase of 95.7%.The increase in the provision is primarily due to the merger with FNB. Thelevel of provision is commensurate with the risk identified in the loan portfolio.

 

Theallowance for loan losses represented 1.00% of total loans at September 30,2007, compared with 0.92% as of December 31, 2006 and 0.92% as of September 30,2006. 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 andother relevant factors. Based upon these factors, management believes that asof September 30, 2007, the reserve is reasonable and sufficient to support theincreased loan growth in light of the strong asset quality as supported by theratios reflected in Table 2 on page 21.

 

Other Income

 

For the three monthsended September 30, 2007, other income was $1,607,000, a decrease of $578,000,or 26.5%, compared with other income of $2,185,000 for the three months endedSeptember 30, 2006. The decrease was primarily due to a decrease of $1,101,000in net gains from the sale of securities, which were $172,000 for the threemonths ended September 30, 2007 and $1,273,000 for the three months endedSeptember 30, 2006. Other income was positively impacted by increases of$315,000 for the value of mortgage servicing rights, $111,000 in trustrevenues, $53,000 in investment service fees and $30,000 in ATM fees. In thethird quarter the bank recognized the value of the mortgage servicing rightsand the credit enhancement on $26,555,000 of loans sold to the FHLB ofPittsburgh over the last two years. The increase in ATM fees is primarily dueto merging with FNB which resulted in additional ATMs. The Bank re-establishedand reactivated its Trust Department in the third quarter of 2006.

 

For the nine months endedSeptember 30, 2007, other income was $5,529,000, an increase of $460,000, or9.1%, compared with other income of $5,069,000 for the nine months endedSeptember 30, 2006. Net gains from the sale of securities decreased from$2,757,000 for the nine months ending September 30, 2006 to $1,861,000 for ninemonths ended September 30, 2007, a decrease of $896,000 or 32.5%. Other incomewas positively impacted by increases of $318,000 in trust revenues, $315,000for the value of mortgage servicing rights, $215,000 in NSF fees, $207,000 in trust revenues, $177,000 in BOLI (ofwhich $132,000 was proceeds from death benefits), $139,000 in ATM fees, and$133,000 in investment service fees. In the third quarter the bank recognizedthe value of the mortgage servicing rights and the credit enhancement on$26,555,000 of loans sold to the FHLB of Pittsburgh over the last two years. Theincreases in NSF fees and ATM fees are primarily due to merging with FNB. TheBank re-established and reactivated its Trust Department in the third quarterof 2006.

 

15

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Other Expenses

 

Other expenses, which includesalary, occupancy, equipment and all other expenses incidental to the operationof the Company, decreased to $3,849,000 for the three months ended September30, 2007 from $4,463,000 for the three months ended September 30, 2006. The$614,000, or 13.8% decrease was primarily due to realizing the efficienciesfrom the merger with FNB, resulting in decreased salary and benefits, occupancycosts and other operating expenses as explained below.

 

Salaries and employeebenefit expenses, which make up the largest component of other expenses,decreased $287,000, or 12.7%, to $1,965,000 for the three months endedSeptember 30, 2007 from $2,252,000 for the three months ended September 30,2006. The decrease is primarily attributable to the fact that during the thirdquarter of 2006, one time charges of $320,000 were expensed for officer changeof control agreements related to the merger with FNB. The employee benefitsexpense includes $97,000 vacation accrual expense not included in the thirdquarter 2006 expenses.

 

Occupancy and equipmentexpenses decreased $37,000, or 4.0%, to $890,000 for the three months endedSeptember 30, 2007 from $927,000 for the three months ended September 30, 2006.The decrease is primarily due to increased computer costs in the third quarterof 2006 related to the merger with FNB.

 

Other operating expensesduring the three months ended September 30, 2007 decreased $290,000, or 22.6%to $994,000 from $1,284,000 during the three months ended September 30, 2006.The decrease is primarily due to efficiencies gained in the merger with FNB,decreasing telephone expenses by $42,000, audit and examination expense by$43,000, postage expense by $31,000, supply expenses by $31,000 and marketingexpense by $29,000.

 

Other expenses, whichinclude salary, occupancy, equipment and all other expenses incidental to theoperation of the Company, increased to $12,018,000 for the nine months endedSeptember 30, 2007 from $9,845,000 for the nine months ended September 30,2006. The $2,173,000, or 22.1% increase was primarily due to the merger withFNB, resulting in increased salary and benefits, occupancy and other operatingexpenses.

 

Salaries and employeebenefit expenses, which make up the largest component of other expenses,increased $1,094,000, or 21.8%, to $6,123,000 for the nine months endedSeptember 30, 2007 from $5,029,000 for the nine months ended September 30,2006. The increase is primarily attributable to the merger with FNB, andincreases in salary expenses of $646,000, employee benefits of $318,000 andhealth insurance expense of $174,000. The employee benefits expense includes$188,000 vacation accrual expense not included in the September 30, 2006expense.

 

Occupancy and equipmentexpenses increased $641,000, or 30.9%, to $2,714,000 for the nine months endedSeptember 30, 2007 from $2,073,000 for the nine months ended September 30,2006. The increase is primarily due to the merger with FNB, increasing computercosts by $228,000, depreciation expense by $204,000 and equipment expense by$81,000.

 

16

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Other operating expensesduring the nine months ended September 30, 2007 increased $438,000, or 16.0% to$3,181,000 from $2,743,000 during the nine months ended September 30, 2006. Theincrease is primarily due to the merger with FNB, increasing Core DepositIntangible expense by $163,000, state taxes by $176,000, legal/consultingexpense by $67,000 and marketing expense by $43,000.

 

Income Taxes

 

Income tax expense was$684,000 for the three months ended September 30, 2007, a decrease of $28,000,or 3.9%, compared with $712,000 for the three months ended September 30, 2006.

 

Income tax expense was$1,949,000 for the nine months ended September 30, 2007, an increase of$147,000, or 8.2%, compared with $1,802,000 for the nine months ended September30, 2006. The increased tax expense is consistent with the higher level of netincome. The increase in tax expense was positively impacted to a lesser extentby increases in tax exempt income from BOLI of $177,000 and tax exempt incomefrom securities and loans of $85,000.

 

Net Income

 

Net income for the threemonths ended September 30, 2007 was $1,818,000, an increase of $308,000, or20.4%, compared with $1,510,000 for the three months ended September 30, 2006.The increase in net income is the result of increases of $294,000 in netinterest income, $523,000 in other income (excluding security gains), a$614,000 decrease in other operating expenses, a $1,101,000 decrease insecurity gains and a decrease in income taxes of $28,000, offset by an increaseof $50,000 in the provision for loan losses. Basic and diluted earnings pershare for the three months ended September 30, 2007 were $0.78 and $0.77as compared with $0.64 and $0.63 for the three months ended September 30, 2006.

 

Net income for the ninemonths ended September 30, 2007 was $5,500,000, an increase of $1,000,000, or22.2%, compared with $4,500,000 for the nine months ended September 30, 2006.The increase in net income is the result of increases of $3,080,000 in netinterest income, $1,356,000 in other income (excluding security gains), offsetby an increase of $220,000 in the provision for loan losses, an increase of$2,173,000 in other expenses, $896,000 decrease in security gains and $147,000increase in taxes. Basic and diluted earnings per share for the nine monthsended September 30, 2007 were $2.34 and $2.33 as compared with $2.23 and $2.20for the nine months ended September 30, 2006.

 

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 andpublic fund deposits. Policies are in place to address various aspects ofmanaging the portfolio, including but not limited to, concentrations,liquidity, credit quality, interest rate sensitivity and regulatory guidelines.

 

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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 would be accounted for at amortizedcost. The Company holds no trading securities in its portfolio. The securitiesportfolio includes equities owned by the holding company, most of which areinvestments in banks, bank holding companies and financial institutions. Equityinvestments are accounted for at fair market value. The remaining securities,primarily debt instruments, are owned by the bank.

 

The consolidatedsecurities portfolio at September 30, 2007 was $83,292,000, compared to$87,631,000 at December 31, 2006, a decrease of $4,339,000, or 5.0%. Thedecrease is due primarily to decreases in the fair values of securities.

 

Bank Owned Securities

 

The bank owned securitiesportfolio at September 30, 2007 was $46,071,000, compared to $44,478,000 atDecember 31, 2006, an increase of $1,593,000, or 3.6%. The increase is dueprimarily to the purchase of $5,000,000 mortgage backed securities, lessmaturities and principal payments on mortgage backed securities.

 

The carrying value of theavailable for sale portion of the portfolio at September 30, 2007 includes anunrealized gain of $477,000 (reflected as accumulated other comprehensiveincome of $315,000 in stockholders’ equity, net of a deferred income taxliability of $162,000). This compares with an unrealized gain at December 31,2006 of $791,000 (reflected as accumulated other comprehensive income of$522,000 in stockholders’ equity, net of a deferred income tax liability of$269,000).

 

Holding Company OwnedSecurities

 

The securities portfolioat September 30, 2007 was $37,221,000, compared to $43,153,000 at December 31,2006, a decrease of $5,932,000, or 13.7%. The decrease includes $5,879,000 inunrealized losses. Realized gains on sale of equity securities were $1,875,000for the nine months ended September 30, 2007.

 

The carrying value of theavailable for sale portion of the portfolio at September 30, 2007 includesan unrealized gain of $9,590,000 (reflected as accumulated other comprehensiveincome of $6,329,000 in stockholders’ equity, net of a deferred income taxliability of $3,261,000). This compares with an unrealized gain at December 31,2006 of $15,469,000 (reflected as accumulated other comprehensive income of$10,209,000 in stockholders’ equity, net of a deferred income tax liability of$5,260,000).

 

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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 unearnedfees and origination costs, increased $4,313,000, or 1.1%, to $394,732,000 atSeptember 30, 2007 from $390,419,000 at December 31, 2006. Gross loansrepresented 88.4% of total deposits at September 30, 2007 as compared with95.3% at December 31, 2006. This decrease is primarily due an increase intotal deposits of $36,610,000.

 

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 September 30, 2007 and December 31, 2006 was $3,985,000 and$3,610,000, respectively. At September 30, 2007, the allowance for loan lossesrepresented 1.01% of the gross loan portfolio, compared with 0.92% at December31, 2006. At September 30, 2007, in consideration of the strong asset quality,management believes the allowance for loan loss reserve to be reasonable andadequate to support 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 nine months of 2007 and 2006.

 

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

 
| **(in thousands)**                               | ** ** | **2007** | ** ** | **2006** | ** ** |
|-------------------------------------------------------|------------|----------|------------|----------|------------|
| Balance, January  1                                   |       | $        | 3,610      |     | $          | 2,129 |   |
| Provision  charged to operating expense               |       | 450      |       | 230      |       |
| Charge-offs:                                          |       |     |       |     |       |
| Commercial                                            |       | 0        |       | 0        |       |
| Real Estate                                           |       | 0        |       | 0        |       |
| Consumer                                              |       | (147     | )          | (23      | )          |
| Total  charge-offs                                    |       | (147     | )          | (23      | )          |
|                                                  |       |     |       |     |       |
| Recoveries:                                           |       |     |       |     |       |
| Commercial                                            |       | 3        |       | 2        |       |
| Real Estate                                           |       | 0        |       | 0        |       |
| Consumer                                              |       | 69       |       | 28       |       |
| Total Recoveries                                      |       | 72       |       | 30       |       |
|                                                  |       |     |       |     |       |
| Net  (charge-offs) recoveries                         |       | (75      | )          | 7        |       |
|                                                  |       |     |       |     |       |
| Additions due to  merger with FNB                     |       | 0        |       | 1,163    |       |
|                                                  |       |     |       |     |       |
| Balance,  September 30                                |       | $        | 3,985      |     | $          | 3,529 |   |
|                                                  |       |     |       |     |       |
| Net (charge-offs)  or recoveries to average net loans |       | (0.02    | )          | 0.01     |       |

 

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(1) Bank’s loan portfoliois 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 ofthe delinquent 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.

 

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Table 2 – “Assets QualityRatios” – summarizes pertinent asset quality ratios at September 30, 2007 andDecember 31, 2006.

 

**Table 2 –Asset Quality Ratios**

 
| ** **                                  | ** ** | **9/30/07** | ** ** | **12/31/06** | ** ** |
|---------------------------------------------|------------|-------------|------------|--------------|------------|
| Non-accrual  loans/total loans              |       | 0.83        | %          | 0.18         | %          |
| Non-performing  assets (1)/total loans      |       | 0.88        | %          | 0.28         | %          |
| Net (charge  offs) recoveries/average loans |       | (0.02       | )%         | 0.01         | %          |
| Allowance/total  loans                      |       | 1.01        | %          | 0.92         | %          |
| Allowance/non-accrual  loans                |       | 122         | %          | 525          | %          |
| Allowance/non-performing  loans (1)         |       | 115         | %          | 334          | %          |

 

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(1) – Includesnon-accrual loans

 

At September 30, 2007,the Company had other real estate owned (not used in operations) in the amountof $2,294,000. At September 30, 2007 and December 31, 2006, the Company hadnon-accrual loans in the amount of $3,272,000 and $688,000, respectively. Thisincrease is primarily due to a large commercial loan and several loans securedby real estate being placed on non-accrual status.

 

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$10,669,000 and $10,683,000 in BOLI as of September 30, 2007 andDecember 31, 2006, respectively. This decrease is primarily due to theredemption, upon the death of two participants, of life insurance policies withcash values totaling $311,000 less cash value appreciation. Although the BOLIis an asset that may be liquidated, it is the Company’s intention to hold thispool of 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 September 30, 2007 were $446,445,000, an increase of $36,610,000,or 8.9%, from total deposits of $409,835,000 at December 31, 2006. Thisincrease is primarily due to a large money market account opened in January2007.

 

Short-Term Borrowings

 

Short term borrowings atSeptember 30, 2007 were $10,490,000, compared to $9,875,000 at December 31,2006, an increase of $615,000, or 6.2%. Federal funds purchased, Treasury Taxand Loan demand note, lines of credits with banks and overnight borrowings withthe Federal Home Loan Bank of Pittsburgh are considered to be short termborrowings. Short term borrowings fluctuate daily to meet the liquidity needsof the Company.

 

Long-Term Debt Borrowings

 

Long term borrowings atSeptember 30, 2007 were $26,747,000, compared to $31,768,000 at December 31,2006, a decrease of $5,021,000, or 15.8%. This decrease is primarily due to TheFederal Home Loan Bank calling a $5,000,000 loan in February 2007.

 

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 rategap is one measure of the risk inherent in the existing balance sheet as itrelates to potential changes in net interest income. Maintaining an appropriatebalance between interest-earning assets and interest bearing liabilities is ameans of monitoring and possibly avoiding material fluctuations in the netinterest margin during periods of changing interest rates.

 

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 net interestincome 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. Adjustmentsto the mix of assets and liabilities are made periodically in an effort to givethe Company dependable and steady growth in net interest income, while at thesame 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.Liquidity is essential to compensate for fluctuations in the balance sheet andprovide funds for growth and normal operating expenditures. Liquidity needs maybe met by converting assets into cash or obtaining sources of additionalfunding.

 

Liquidity from assetcategories is provided through cash, amounts due from banks, interest-bearingdeposits with banks and federal funds sold, which were $49,560,000 at September30, 2007, compared to $20,755,000 at December 31, 2006, an increase of$28,805,000 or 138.8%. This increase is primarily due to a new money marketdeposit account opened in January 2007. 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 by selling securities available forsale, selling loans or raising additional capital. At September 30, 2007, therewas $68,028,000 in liquid securities as compared to $71,337,000 at December 31,2006. Liquid securities decreased by $3,309,000 since year end primarily due toa decrease of securities held at Tower Bancorp and to a lesser extent principalpayments received on mortgage backed securities held by the bank. Liquidsecurities held at Tower Bancorp decreased $5,932,000 due to sales, calls andmaturity of investment securities exceeding purchases and market valuefluctuations.

 

Liability liquiditysources include attracting deposits at competitive rates. Deposits at September30, 2007 were $446,445,000, compared to $409,835,000 at December 31, 2006.In addition, the Company has borrowing capacity and lines of credit with theFederal Home Loan Bank of Pittsburgh, Atlantic Central Bankers Bank and severallocal 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 September 30, 2007 is adequate torespond to fluctuations “on” and “off” the balance sheet. In addition,management knows of no trends, demands, commitments, events or uncertaintiesthat may result in, or that are reasonably likely to result in the Company’sinability to meet anticipated or unexpected liquidity needs.

 

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Off-Balance SheetArrangements

 

The Company’s financialstatements do not reflect various off-balance sheet arrangements that are madein the normal course of business. These commitments consist mainly of loansapproved but not yet funded, unused lines of credit and letters of credit madein accordance with the same standards as on-balance sheet instruments. Unusedcommitments at September 30, 2007 were $115,953,000, which consisted of$112,322,000 in unfunded commitments to existing loans and unfunded new loansand $3,631,000 in letters of credit. Because these instruments have fixedmaturity dates, and because many of them will expire without being drawn upon,they do not generally present a significant liquidity risk to the Company.Management believes that any amounts actually drawn upon can be funded in thenormal course of operations. The Company has no investment in or financialrelationship with any unconsolidated entities that are reasonably likely tohave a material effect on liquidity or the availability of capital resources.

 

Capital

 

The following Table 3presents the risk-based and leverage capital amounts and ratios at September30, 2007 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                                         |       | $                                    | 63,572     |         | 16.7       | %>                      | 30,426     | >                  | 8.0        | %                        | N/A        |   | N/A |   |
| Bank                                            |       | 46,699                               |       | 12.8         | %>      | 29,303                     | >  | 8.0                        | %          | 36,628                   | >  | 10.0 | % |
|                                            |       |                                 |       |         |       |                       |       |                       |       |                     |       |   |   |
| Tier 1  capital/risk weighted assets:           |       |                                 |       |         |       |                       |       |                       |       |                     |       |   |   |
| Company                                         |       | 55,271                               |       | 14.5         | %>      | 15,213                     | >  | 4.0                        | %          | N/A                      |       | N/A |   |
| Bank                                            |       | 42,714                               |       | 11.7         | %>      | 14,651                     | >  | 4.0                        | %          | 21,977                   | >  | 6.0 | % |
|                                            |       |                                 |       |         |       |                       |       |                       |       |                     |       |   |   |
| Tier 1  capital/average assets                  |       |                                 |       |         |       |                       |       |                       |       |                     |       |   |   |
| Company                                         |       | 55,271                               |       | 9.9          | %>      | 22,454                     | >  | 4.0                        | %          | N/A                      |       | N/A |   |
| Bank                                            |       | 42,714                               |       | 8.3          | %>      | 20,709                     | >  | 4.0                        | %>      | 25,886                   | >  | 5.0 | % |
|                                                 |            |                                      |            |              |            |                            |            |                            |            |                          |            |  |  |  |

 

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

 

Banking laws andregulations limit the amount of cash dividends that may be paid without priorapproval from the Company’s regulatory agencies. In abidance with suchrequirements, on July 11, 2007, the Board of Directors authorized and declareda quarterly cash dividend in the amount of $0.26 per share, payable on August17, 2007 to all shareholders of record as of August 1, 2007. The paymentof this quarterly cash dividend decreased retained earnings by $609,000.

 

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RECENT ACCOUNTINGPRONOUNCEMENTS

 

In July 2006, the FASBissued Interpretation No. 48, “Accounting for Uncertainty in Income Taxes: AnInterpretation of FASB Statement No. 109” (FIN) 48). FIN 48 clarifies theaccounting for uncertainty in income taxes recognized in an entity’s financialstatements in accordance with SFAS 109. The Interpretation prescribes a recognitionthreshold and measurement principles for the financial statement recognitionand measurement of tax positions taken or expected to be taken on a tax return.FIN 48 is effective for fiscal years beginning after December 15, 2006. Theimplementation of FIN 48 did not have a material impact on the Company’sfinancial statements.

 

In September 2006, theFinancial Accounting Standards Board (FASB) issued Statement of FinancialAccounting Standards No. 157, “Fair Value Measurements” (SFAS 157). SFAS 157 definesfair value, establishes a framework for measuring fair value in generallyaccepted accounting principles, and expands disclosures about fair valuemeasurements. SFAS 157 does not require any new fair value measurements but maychange current practice for some entities. This Statement is effective forfinancial statements issued for fiscal years beginning after November 15, 2007and interim periods within those years. The Company does not expect theimplementation of SFAS 157 to have a material impact on its consolidatedfinancial statements.

 

In February 2007, theFASB issued Statement of Financial Accounting Standards No. 159, “The FairValue Option for Financial Assets and Financial Liabilities” (SFAS 159). Thisstatement permits entities to choose to measure many financial instruments andcertain other items at fair value. The objective of this Statement is toimprove financial reporting by providing entities with the opportunity tomitigate volatility in reported earnings caused by measuring related assets andliabilities differently without having to apply complex hedge accountingprovisions. The fair value option established by this Statement permits allentities to choose to measure eligible items at fair value at specifiedelection dates. A business entity shall report unrealized gains and losses onitems for which the fair value option has been elected in earnings at eachsubsequent reporting date. The fair value option may be applied instrument byinstrument and is irrevocable. SFAS 159 is effective as of the beginning of anentity’s first fiscal year that begins after November 15, 2007. Early adoptionis permitted as of the beginning of a fiscal year that begins on or beforeNovember 15, 2007, provided the entity also elects to apply the provisions ofSFAS 157, “Fair Value Measurements”. The Company did not elect to early adoptthis pronouncement, and does not expect its implementation to have a materialimpact on its consolidated financial statements.

 

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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 December31, 2006.

 

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**ITEM 4 – CONTROLS AND PROCEDURES**

 

**CONTROLS AND PROCEDURES**

 

TheCompany’s Chief Executive Officer and Chief Financial Officer have evaluatedthe effectiveness of the Company’s disclosure controls and procedures (as suchterm is defined in the Rules 13a-15(e) under the Securities Exchange Act of1934, as amended (the “Exchange Act”))as of September 30, 2007. Based onsuch evaluation, such officers have concluded that, as of September 30, 2007,the Company’s disclosure controls and procedures are effective in alerting themon a timely basis to material information relating to the Company (includingits consolidated subsidiary) required to be included in the Company’s periodicfilings under the Exchange Act.

 

**CHANGES IN INTERNAL CONTROLS**

 

Therehave not been any changes in the Company’s internal control over financialreporting or in other factors that materially affected or are reasonably likelyto materially affect such control during the third quarter of 2007.

 

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PART II – OTHER INFORMATION

 

28

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PART II – OTHER INFORMATION

 

Item 1 – Legal Proceedings

 

The nature of the Company’sbusiness generates some litigation involving matters arising in the ordinarycourse of business. However, in the opinion of the Company, after consultingwith legal counsel, no legal proceedings are pending, which would have amaterial effect on the company or subsidiary. No legal proceedings are pendingother than ordinary routine litigation incidental to the business of theCompany and the Bank. In addition, to Management’s knowledge, no governmentalauthorities have initiated or contemplated any material legal actions againstthe 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, 2006.

 

Item 2 – Unregistered Sales of Equity Securities andUse of Proceeds

 

ISSUER PURCHASES OF EQUITYSECURITIES

 
| **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** | ** ** |
|----------------|------------|-------------------------------------------------------|------------|---------------------------------------------------|------------|--------------------------------------------------------------------------------------------------------|------------|---------------------------------------------------------------------------------------------------------------|------------|
|           |       |                                                  |       |                                              |       |                                                                                                   |       |                                                                                                          |       |
| July 2007      |       | 1,450                                                 |       | 43.75                                             |       | 1,450                                                                                                  |       | 68,431                                                                                                        |       |
|           |       |                                                  |       |                                              |       |                                                                                                   |       |                                                                                                          |       |
| August 2007    |       | 1,772                                                 |       | 42.59                                             |       | 1,772                                                                                                  |       | 66,659                                                                                                        |       |
|           |       |                                                  |       |                                              |       |                                                                                                   |       |                                                                                                          |       |
| September 2007 |       | 1,771                                                 |       | 43.11                                             |       | 1,771                                                                                                  |       | 64,888                                                                                                        |       |
|           |       |                                                  |       |                                              |       |                                                                                                   |       |                                                                                                          |       |
| Total          |       | 4,993                                                 |       | 43.62                                             |       | 4,993                                                                                                  |       | 64,888                                                                                                        |       |

 

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Item 3– Defaults Upon Senior Securities

 

Notapplicable

 

Item 4– Submission of Matters to a Vote of Security Holders

 

Notapplicable

 

Item 5– Other Information

 

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

 

Item 6– 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).                                                                    |
|        |       |                                                                                                                                                                                                                            |
| 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). |

 

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| **Exhibit** | ** ** | **Description of Exhibit**                                                                                                                                                                                                                       |
|-------------|------------|--------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
|        |       |                                                                                                                                                                                                                                             |
| 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.                                                                                                                                             |
|        |       |                                                                                                                                                                                                                                             |
| 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 signed onits behalf by the undersigned thereunto duly authorized.

 
|                               |   | TOWER BANCORP, INC.            |
|------------------------------------|--------|--------------------------------|
|                               |   | (REGISTRANT)                   |
|                               |   |                           |
|                               |   | /s/ Jeff B. Shank              |   |
|                               |   | Jeff B. Shank,  President, CEO |
|                               |   | (Principal Executive  Officer) |
| Date:  November  7, 2007 |   |                           |
|                               |   |                           |
|                               |   | /s/ Franklin T. Klink,  III    |   |
|                               |   | Franklin T. Klink, III,        |
|                               |   | Treasurer                      |
|                               |   | (Principal Financial  Officer) |
| Date:  November  7, 2007 |   |                           |
|                                    |        |                                |  |  |

 

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