**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 June 30, 2007**

**Commission filenumber:  0-12826**

**TOWER BANCORP INC.**

(Exact name of registrantas specified in its charter)

| **Commonwealth of Pennsylvania**                          | ** ** | **25-1445946**       |
|-----------------------------------------------------------|------------|----------------------|
| (State or other  jurisdiction of                          |       | (I.R.S. Employer     |
| incorporation or  organization)                           |       | Identification  No.) |
|                                                      |       |                 |
| **Center  Square**                                        | ** ** | ** **           |
| **Greencastle,  Pennsylvania**                            | ** ** | **17225**            |
| (Address of  principal executive offices)                 |       | (Zip Code)           |
|                                                      |       |                 |
| Registrant’s  telephone 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

Indicate by check mark whether the registrant is alarge accelerated filer, an accelerated filer, or a non-accelerated filer (asdefined in Rule 12b-2 of the Exchange Act).

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

 

Indicate by check mark whether the registrant is ashell company (as defined in Rule 12b-2 of the Exchange Act).

Yes o  No x

Indicate the number of shares outstanding of each ofthe issuer’s classes of common stock, as of the latest practicable date.

2,342,170shares of common stock outstanding at June 30, 2007

 

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TOWER BANCORP,INC.

INDEX
|                                                                                                                     | ** ** | **Page** |
|---------------------------------------------------------------------------------------------------------------------|------------|----------|
|                                                                                                                |       |     |
| PART  I – FINANCIAL INFORMATION                                                                                |       |     |
|                                                                                                                |       |     |
| Item 1 – Financial Statements                                                                                  |       |     |
| Condensed consolidated balance sheets – June 30, 2007  and December 31, 2006                                   |       | 4        |
| Condensed consolidated statements of income – three  months ended June 30, 2007 and 2006                       |       | 5        |
| Condensed consolidated statements of income – six  months ended June 30, 2007 and 2006                         |       | 6        |
| Condensed consolidated statements of comprehensive  income – three and six months ended June 30, 2007 and 2006 |       | 7        |
| Condensed consolidated statements of cash flows – six  months ended June 30, 2007 and 2006                     |       | 8        |
| Notes to condensed consolidated financial statements                                                                |       | 9 - 10   |
| Item 2 – Management’s discussion and analysis of  financial condition and results of operations           |       | 11 - 22  |
| Item 3 – Quantitative and qualitative disclosures  about market risk                                           |       | 23       |
| Item  4 – Controls and procedures                                                                              |       | 24       |
|                                                                                                                |       |     |
| PART II – OTHER  INFORMATION                                                                                   |       | 25       |
|                                                                                                                |       |     |
| Item 1 – Legal proceedings                                                                                     |       | 26       |
| Item 1A – Risk Factors                                                                                         |       | 26       |
| Item 2 – Unregistered sales of equity securities and  use of proceeds                                          |       | 26       |
|                                                                                                                |       |     |
| Item 3 – Defaults upon senior securities                                                                       |       | 27       |
| Item 4 – Submission of matters to a vote of security  holders                                                  |       | 27       |
| Item 5 – Other information                                                                                     |       | 26       |
| Item 6 – Index to Exhibits                                                                                     |       | 26 - 29  |
|                                                                                                                |       |     |
| Signatures                                                                                                          |       | 30       |
|                                                                                                                |       |     |
| Exhibits                                                                                                            |       |     |

 

2

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PART I – FINANCIAL INFORMATION

3

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TOWER BANCORP, INC. AND ITS WHOLLY – OWNEDSUBSIDIARY

CONDENSED CONSOLIDATED BALANCE SHEETS
| ** **                                                                                           | ** ** | **June 30,  2007** | ** ** | **December 31,  2006** | ** ** |
|------------------------------------------------------------------------------------------------------|------------|-------------------------|------------|-----------------------------|------------|
| ** **                                                                                           | ** ** | **(Unaudited)**         | ** ** | **(Audited)***              | ** ** |
| ** **                                                                                           | ** ** | **(000 Omitted)**  | ** ** | ** **                  | ** ** |
| ASSETS                                                                                               |       |                    |       |                        |       |
| Cash and due  from banks                                                                             |       | $                       | 12,275     |                        | $          | 14,128 |   |
| Federal funds  sold                                                                                  |       | 42,356                  |       | 6,530                       |       |
| Interest bearing  balances with banks                                                                |       | 97                      |       | 97                          |       |
| Investment  securities available for sale                                                            |       | 42,452                  |       | 44,478                      |       |
| Equity  securities available for sale                                                                |       | 39,861                  |       | 43,153                      |       |
| Restricted bank  stock                                                                               |       | 2,940                   |       | 3,123                       |       |
| Loans:                                                                                               |       |                    |       |                        |       |
| Real estate  mortgages                                                                               |       | 311,442                 |       | 318,209                     |       |
| Commercial                                                                                           |       | 59,389                  |       | 54,313                      |       |
| Consumer                                                                                             |       | 16,540                  |       | 17,897                      |       |
| Gross loans                                                                                          |       | 387,371                 |       | 390,419                     |       |
| Less: reserve  for possible loan losses                                                              |       | (3,835                  | )          | (3,610                      | )          |
| Loans, net                                                                                           |       | 383,536                 |       | 386,809                     |       |
| Bank premises,  equipment, furniture and fixtures (including real estate owned other than  premises) |       | 11,635                  |       | 11,579                      |       |
| Accrued interest  receivable                                                                         |       | 1,851                   |       | 1,841                       |       |
| Cash surrender  value of life insurance                                                              |       | 10,570                  |       | 10,683                      |       |
| Goodwill                                                                                             |       | 16,558                  |       | 16,535                      |       |
| Core deposit  intangible                                                                             |       | 1,885                   |       | 2,095                       |       |
| Other assets                                                                                         |       | 949                     |       | 1,116                       |       |
| Total assets                                                                                         |       | $                       | 566,965    |                        | $          | 542,167 |   |
|                                                                                                 |       |                    |       |                        |       |
| LIABILITIES AND  STOCKHOLDERS’ EQUITY                                                           |       |                    |       |                        |       |
| LIABILITIES                                                                                          |       |                    |       |                        |       |
| Deposits in  domestic offices:                                                                       |       |                    |       |                        |       |
| Demand                                                                                               |       | $                       | 39,693     |                        | $          | 47,548 |   |
| Savings                                                                                              |       | 229,242                 |       | 188,147                     |       |
| Time                                                                                                 |       | 173,149                 |       | 174,140                     |       |
| Liabilities for  borrowed money                                                                      |       | 36,688                  |       | 41,643                      |       |
| Accrued interest  payable                                                                            |       | 1,039                   |       | 994                         |       |
| Other  liabilities                                                                                   |       | 6,256                   |       | 8,142                       |       |
| Total  liabilities                                                                                   |       | 486,067                 |       | 460,614                     |       |
|                                                                                                 |       |                    |       |                        |       |
| STOCKHOLDERS’ EQUITY                                                                            |       |                    |       |                        |       |
| Capital stock,  common, no par, authorized 5,000,000 shares; 2,420,481 and 1,780,100 shares  issued  |       | 2,225                   |       | 2,225                       |       |
| Additional  paid-in capital                                                                          |       | 34,857                  |       | 34,810                      |       |
| Retained  earnings                                                                                   |       | 38,604                  |       | 36,148                      |       |
| Accumulated  other comprehensive income                                                              |       | 8,269                   |       | 10,731                      |       |
| Less: cost of  treasury stock; 2007 -78,311 shares; 2006 - 63,278 shares                             |       | (3,057                  | )          | (2,361                      | )          |
| Total  stockholders’ equity                                                                     |       | 80,898                  |       | 81,553                      |       |
|                                                                                                 |       |                    |       |                        |       |
| Total liabilities and  stockholders’ equity                                                     |       | $                       | 566,965    |                        | $          | 542,167 |   |

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* Condensed fromaudited financial statements.

Theaccompanying notes are an integral part of these condensed financialstatements.

4

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TOWER BANCORP, INC. AND ITS WHOLLY – OWNEDSUBSIDIARY

CONDENSED CONSOLIDATED STATEMENTS OF INCOME

THREEMONTHS ENDED JUNE 30, 2007 and 2006(UNAUDITED)
| ** **                                           | ** ** | **2007**               | ** ** | **2006**  | ** ** |
|------------------------------------------------------|------------|------------------------|------------|-----------|------------|
| ** **                                           | ** ** | **(000 Omitted)** | ** ** |
| Interest Income                                      |       |                   |       |      |       |
| Interest & fees on loans                         |       | $                      | 7,053      |      | $          | 4,814 |   |
| Interest on investment securities available for sale |       | 695                    |       | 727       |       |
| Interest on federal funds sold                       |       | 546                    |       | 95        |       |
| Total interest & dividend income                 |       | 8,294                  |       | 5,636     |       |
| Interest Expense                                     |       |                   |       |      |       |
| Interest on deposits                                 |       | 3,029                  |       | 1,409     |       |
| Interest on borrowed money                           |       | 508                    |       | 588       |       |
| Total interest expense                               |       | 3,537                  |       | 1,997     |       |
|                                                 |       |                   |       |      |       |
| Net interest income                                  |       | 4,757                  |       | 3,639     |       |
|                                                 |       |                   |       |      |       |
| Provision for  loan losses                           |       | 150                    |       | 70        |       |
|                                                 |       |                   |       |      |       |
| Net interest  income after provision for loan losses |       | 4,607                  |       | 3,569     |       |
|                                                 |       |                   |       |      |       |
| Other Income                                         |       |                   |       |      |       |
| Investment service income                            |       | 240                    |       | 68        |       |
| Service charges on deposit accounts                  |       | 455                    |       | 344       |       |
| Other service charges                                |       | 292                    |       | 228       |       |
| Other operating income                               |       | 184                    |       | 100       |       |
| Investment securities gains (losses)                 |       | 476                    |       | 1,070     |       |
| Total other income                                   |       | 1,647                  |       | 1,810     |       |
|                                                 |       |                   |       |      |       |
| Other Expense                                        |       |                   |       |      |       |
| Salaries, wages and other benefits                   |       | 2,022                  |       | 1,441     |       |
| Occupancy and equipment expense                      |       | 890                    |       | 597       |       |
| Other operating expenses                             |       | 1,057                  |       | 883       |       |
| Total other expenses                                 |       | 3,969                  |       | 2,921     |       |
|                                                 |       |                   |       |      |       |
| Income before taxes                                  |       | 2,285                  |       | 2,458     |       |
| Applicable  income taxes                             |       | 572                    |       | 678       |       |
| Net income                                           |       | $                      | 1,713      |      | $          | 1,780 |   |
|                                                 |       |                   |       |      |       |
| Earnings per  share:                                 |       |                   |       |      |       |
| Basic earnings per share                             |       | $                      | 0.72       |      | $          | 0.92 |   |
| Weighted average shares outstanding                  |       | 2,353,926              |       | 1,943,176 |       |
| Diluted earnings per share                           |       | $                      | 0.72       |      | $          | 0.90 |   |
| Weighted average shares outstanding                  |       | 2,362,399              |       | 1,977,002 |       |
|                                                 |       |                   |       |      |       |
| Dividends declared per  share                        |       | $                      | 0.26       |      | $          | 0.24 |   |

 

Theaccompanying notes are an integral part of these condensed financialstatements.

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TOWER BANCORP, INC. AND ITS WHOLLY – OWNEDSUBSIDIARY

CONDENSED CONSOLIDATED STATEMENTS OF INCOME

SIXMONTHS ENDED JUNE 30, 2007 and 2006(UNAUDITED)
| ** **                                           | ** ** | **2007**               | ** ** | **2006**  | ** ** |
|------------------------------------------------------|------------|------------------------|------------|-----------|------------|
| ** **                                           | ** ** | **(000 Omitted)** | ** ** |
| Interest Income                                      |       |                   |       |      |       |
| Interest & fees on loans                         |       | $                      | 13,983     |      | $          | 8,626 |   |
| Interest on investment securities available for sale |       | 1,468                  |       | 1,415     |       |
| Interest on federal funds sold                       |       | 1,025                  |       | 237       |       |
| Total interest & dividend income                 |       | 16,476                 |       | 10,278    |       |
| Interest Expense                                     |       |                   |       |      |       |
| Interest on deposits                                 |       | 5,960                  |       | 2,501     |       |
| Interest on borrowed money                           |       | 1,022                  |       | 1,069     |       |
| Total interest expense                               |       | 6,982                  |       | 3,570     |       |
|                                                 |       |                   |       |      |       |
| Net interest income                                  |       | 9,494                  |       | 6,708     |       |
|                                                 |       |                   |       |      |       |
| Provision for  loan losses                           |       | 300                    |       | 130       |       |
|                                                 |       |                   |       |      |       |
| Net interest  income after provision for loan losses |       | 9,194                  |       | 6,578     |       |
|                                                 |       |                   |       |      |       |
| Other Income                                         |       |                   |       |      |       |
| Investment service income                            |       | 463                    |       | 176       |       |
| Service charges on deposit accounts                  |       | 853                    |       | 624       |       |
| Other service charges                                |       | 578                    |       | 425       |       |
| Other operating income                               |       | 339                    |       | 175       |       |
| Investment securities gains (losses)                 |       | 1,689                  |       | 1,484     |       |
| Total other income                                   |       | 3,922                  |       | 2,884     |       |
|                                                 |       |                   |       |      |       |
| Other Expense                                        |       |                   |       |      |       |
| Salaries, wages and other benefits                   |       | 4,158                  |       | 2,777     |       |
| Occupancy and equipment expense                      |       | 1,824                  |       | 1,146     |       |
| Other operating expenses                             |       | 2,187                  |       | 1,459     |       |
| Total other expenses                                 |       | 8,169                  |       | 5,382     |       |
|                                                 |       |                   |       |      |       |
| Income before taxes                                  |       | 4,947                  |       | 4,080     |       |
| Applicable  income taxes                             |       | 1,265                  |       | 1,090     |       |
| Net income                                           |       | $                      | 3,682      |      | $          | 2,990 |   |
|                                                 |       |                   |       |      |       |
| Earnings per  share:                                 |       |                   |       |      |       |
| Basic earnings per share                             |       | $                      | 1.56       |      | $          | 1.62 |   |
| Weighted average shares outstanding                  |       | 2,355,853              |       | 1,836,538 |       |
| Diluted earnings per share                           |       | $                      | 1.56       |      | $          | 1.59 |   |
| Weighted average shares outstanding                  |       | 2,364,532              |       | 1,870,399 |       |
|                                                 |       |                   |       |      |       |
| Dividends declared per  share                        |       | $                      | 0.52       |      | $          | 0.48 |   |

 

Theaccompanying notes are an integral part of these condensed financialstatements.

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TOWER BANCORP, INC. AND ITS WHOLLY – OWNEDSUBSIDIARY

CONDENSED CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME

THREEAND SIX MONTHS ENDED JUNE 30, 2007 AND 2006(UNAUDITED)
| ** **                                    | ** ** | **Three Months Ended  June 30** | ** ** |
|-----------------------------------------------|------------|------------------------------------------------|------------|
| ** **                                    | ** ** | **2007**                                       | ** ** | **2006** | ** ** |
| ** **                                    | ** ** | **(000 Omitted)**                         | ** ** |
|                                          |       |                                           |       |   |   |
| Net income                                    |       | $                                              | 1,713      |   | $ | 1,780 |   |
|                                          |       |                                           |       |   |   |
| Other  comprehensive income:                  |       |                                           |       |   |   |
| Unrealized holding gains (losses), net of tax |       | (1,525                                         | )          | (376 | ) |
|                                          |       |                                           |       |   |   |
| Comprehensive income                          |       | $                                              | 188        |   | $ | 1,404 |   |

 
| ** **                                    | ** ** | **Six Months Ended  June 30** | ** ** |
|-----------------------------------------------|------------|----------------------------------------------|------------|
| ** **                                    | ** ** | **2007**                                     | ** ** | **2006** | ** ** |
| ** **                                    | ** ** | **(000 Omitted)**                       | ** ** |
|                                          |       |                                         |       |   |   |
| Net income                                    |       | $                                            | 3,682      |   | $ | 2,990 |   |
|                                          |       |                                         |       |   |   |
| Other  comprehensive income:                  |       |                                         |       |   |   |
| Unrealized holding gains (losses), net of tax |       | (2,462                                       | )          | 556 |   |
|                                          |       |                                         |       |   |   |
| Comprehensive income                          |       | $                                            | 1,220      |   | $ | 3,546 |   |

 

Theaccompanying notes are an integral part of these condensed financialstatements.

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

CONDENSEDCONSOLIDATED STATEMENTS OF CASH FLOWS

SIX MONTHS ENDED JUNE 30, 2007AND 2006(UNAUDITED)
| ** **                                                                         | ** ** | **2007**               | ** ** | **2006** | ** ** |
|------------------------------------------------------------------------------------|------------|------------------------|------------|----------|------------|
| ** **                                                                         | ** ** | **(000 omitted)** | ** ** |
| Cash flows from  operating activities:                                             |       |                   |       |     |       |
| Net income                                                                         |       | $                      | 3,682      |     | $          | 2,990 |   |
| Adjustments to reconcile net income to net cash  provided by operating activities: |       |                   |       |     |       |
| Depreciation and amortization                                                      |       | 647                    |       | 293      |       |
| Provision for loan losses                                                          |       | 300                    |       | 130      |       |
| Granting of stock options                                                          |       | 108                    |       | 108      |       |
| (Gain) on sale of investment securities                                            |       | (1,689                 | )          | (1,484   | )          |
| Other (net)                                                                        |       | (246                   | )          | (2,121   | )          |
| Net cash  provided (used) by operating activities                                  |       | 2,802                  |       | (84      | )          |
|                                                                               |       |                   |       |     |       |
| Cash flows from  investing activities:                                             |       |                   |       |     |       |
| Loans (net)                                                                        |       | 2,972                  |       | (6,975   | )          |
| Purchases of bank premises, equipment, furniture and  fixtures                     |       | (492                   | )          | (1,468   | )          |
| Interest bearing balances with banks                                               |       | 0                      |       | 2,986    |       |
| Purchases of available for sale securities                                         |       | (2,782                 | )          | (7,626   | )          |
| Maturities/sales of available for sale securities                                  |       | 6,362                  |       | 23,638   |       |
| Redemption (purchase) of restricted bank stock                                     |       | (121                   | )          | (164     | )          |
| Cash acquired in acquisition                                                       |       | 0                      |       | 4,596    |       |
| Purchase price of shares exchanged for  cash/transaction costs                     |       | 0                      |       | (2,935   | )          |
| Net cash  provided (used) by investing activities                                  |       | 5,939                  |       | 12,052   |       |
|                                                                               |       |                   |       |     |       |
| Cash flows from  financing activities:                                             |       |                   |       |     |       |
| Federal funds purchased                                                            |       | (35,826                | )          | 1,700    |       |
| Net increase in deposits                                                           |       | 32,251                 |       | (7,208   | )          |
| Payments on long term borrowings                                                   |       | (5,000                 | )          | 0        |       |
| Net increase (decrease) in short term borrowings                                   |       | (36                    | )          | (2,159   | )          |
| Purchase of treasury stock                                                         |       | (940                   | )          | (180     | )          |
| Proceeds from sale of treasury stock                                               |       | 183                    |       | 364      |       |
| Cash dividends paid                                                                |       | (1,226                 | )          | (830     | )          |
| Net cash provided (used) by financing activities                                   |       | (10,594                | )          | (8,313   | )          |
|                                                                               |       |                   |       |     |       |
| Net increase (decrease) in cash and cash equivalents                               |       | (1,853                 | )          | 3,655    |       |
|                                                                               |       |                   |       |     |       |
| Cash and cash equivalents at beginning of period                                   |       | 14,128                 |       | 21,837   |       |
|                                                                               |       |                   |       |     |       |
| Cash and cash  equivalents at end of period                                        |       | $                      | 12,275     |     | $          | 25,492 |   |

 

Theaccompanying notes are an integral part of these condensed financialstatements.

8

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NOTES TO CONDENSEDCONSOLIDATED FINANCIAL STATEMENTS

JUNE 30, 2007(UNAUDITED)

Note 1.                                                          Basisof Presentation

The accompanying unaudited condensed consolidated financial statementshave been prepared in accordance with generally accepted accounting principlesin the United States for interim financial information, and accordingly do notinclude all of the information and footnotes required by generally acceptedaccounting principles for complete financial statements. In the opinion ofmanagement, the accompanying unaudited condensed consolidated financialstatements contain all adjustments (consisting solely of normal recurringadjustments) necessary to present fairly Tower Bancorp, Inc.’s consolidatedfinancial position as of June 30, 2007 and the results of its operations forthe three and six month periods ended June 30, 2007 and 2006. Informationpresented at December 31, 2006 is condensed from audited year-end financialstatements included in the Annual Report on Form 10-K for the year endedDecember 31, 2006.

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

The results of operations for the three and six month periods endedJune 30, 2007 and 2006 are not necessarily indicative of the results to beexpected for the full year.

Note 2.                                                          IncomeTaxes

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

Note 3.                                                          Commitments

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

Note 4.                                                          Mergerwith FNB Financial Corporation

During the second quarter of 2006, the Company merged with FNBFinancial Corporation (“FNB”), parent company of the First National Bank ofMcConnellsburg, located in McConnellsburg, Pennsylvania. The Company acquiredall of FNB’s outstanding shares of common stock. The net assets of FNB wererecorded at fair value. Portions of the cost of acquisition, including certainexpenses related to the merger, were allocated as intangible assets. Allresults of operations subsequent to the merger are included in consolidatedincome totals.

9

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Note 5.                                                          StockOption Plans

During the six months ended June 30, 2007 and 2006, the Companyrecongnized compensation costs for the Company’s stock option plans asdetermined based on the fair value at the grant dates for awards under theplans consistent with the method prescribed by FASB Statement No. 123R.

Note 6.                                                          EarningsPer 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 8,388shares were excluded from the calculation at June 30, 2007 because theeffects were anti-dilutive. Potential dilutive common stock had no effect onincome available to common stockholders.

|                                 | ** ** | **Three Months Ended** | ** ** |
|---------------------------------|------------|----------------------------------|------------|
| ** **                      | ** ** | **June 30, 2007**      | ** ** | **June 30, 2006** | ** ** |
| ** **                      | ** ** | ** **                       | ** ** | **Per** | ** ** | ** ** | ** ** | **Per** | ** ** |
| ** **                      | ** ** | ** **                       | ** ** | **Share** | ** ** | ** ** | ** ** | **Share** | ** ** |
| ** **                      | ** ** | **Shares**                       | ** ** | **Amount** | ** ** | **Shares** | ** ** | **Amount** | ** ** |
| Basic earnings  per share       |       | 2,353,926                        |       | $ | 0.72 |   | 1,943,176 |   | $ | 0.92 |   |
| Effect of  dilutive securities: | ** ** | ** **                       | ** ** | ** ** |   |   | ** ** | ** ** | ** ** |
| Stock options                   |       | 8,473                            | ** ** | ** ** |   | 33,826 | ** ** | ** ** | ** ** |
| Diluted earnings per  share     |       | 2,362,399                        |       | $ | 0.72 |   | 1,977,002 |   | $ | 0.90 |   |

 

|                                 | ** ** | **Six Months Ended** | ** ** |
|---------------------------------|------------|--------------------------------|------------|
| ** **                      | ** ** | **June 30, 2007**    | ** ** | **June 30, 2006** | ** ** |
| ** **                      | ** ** | ** **                     | ** ** | **Per** | ** ** | ** ** | ** ** | **Per** | ** ** |
| ** **                      | ** ** | ** **                     | ** ** | **Share** | ** ** | ** ** | ** ** | **Share** | ** ** |
| ** **                      | ** ** | **Shares**                     | ** ** | **Amount** | ** ** | **Shares** | ** ** | **Amount** | ** ** |
| Basic earnings  per share       |       | 2,355,853                      |       | $ | 1.56 |   | 1,836,538 |   | $ | 1.62 |   |
| Effect of  dilutive securities: | ** ** | ** **                     | ** ** | ** ** |   |   | ** ** | ** ** | ** ** |
| Stock options                   |       | 8,679                          | ** ** | ** ** |   | 33,861 | ** ** | ** ** | ** ** |
| Diluted earnings per  share     |       | 2,364,532                      |       | $ | 1.56 |   | 1,870,399 |   | $ | 1.59 |   |

 

10

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ITEM 2.

MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIALCONDITION AND RESULTS OF OPERATIONS

June 30, 2007

The following is management’s discussion and analysisof the significant changes in the consolidated results of operations, capitalresources and liquidity presented in the accompanying unaudited consolidatedfinancial statements for the Company. This discussion should be read inconjunction with the preceding condensed consolidated financial statements andrelated footnotes, as well as the Company’s December 31, 2006 Annual Report onForm 10-K. Current performance does not guarantee and may not be indicative ofsimilar performance in the future.

In addition to historical information, this quarterlyreport on Form 10-Q contains forward-looking statements. The forward-lookingstatements contained in this report are subject to certain risks, assumptionsand uncertainties. Because of the possibility of change in the underlyingassumptions, actual results could differ materially from those projected in theforward-looking statements. Additional factors that might cause actual resultsto differ materially from those expressed in the forward-looking statementsinclude, but are not limited to:

·                  operating,legal and regulatory risks,

·                  economic,political and competitive forces affecting the Company’s services, and

·                  the risk thatmanagement’s analyses of these risks could be incorrect and/or that thestrategies developed to address them could be unsuccessful.

The Company’s forward-looking statements are relevantonly as of the date on which the statements are made. By making forward-lookingstatements, the Company assumes no duty to update them to reflect new, changingor unanticipated events or circumstances. Readers should carefully review therisk factors described in other periodic reports and public documents that theCompany files from time to time with the Securities and Exchange Commission.

CRITICAL ACCOUNTING POLICIES

Disclosure of the Company’s significant accountingpolicies is included in Note 1 to the consolidated financial statements of theCompany’s Annual Report on Form 10-K for the year ended December 31, 2006. Someof these policies are particularly sensitive requiring significant judgments,estimates and assumptions to be made by management. Additional information iscontained on pages 13 and 17 of this report for the provision and allowance forloan losses.

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OVERVIEW

The merger with FNB Financial Corporation, whichoccurred on June 1, 2006, represents a significant expansion of the TowerBancorp, Inc. franchise. In accordance with generally accepted accountingprinciples (GAAP), comparisons of year-to-date results have not been restatedfor the impact of the FNB Financial Corporation operations for the first fivemonths of 2006 or for the six months of 2007, rendering these comparativeanalyses less useful than the quarterly comparison. Also, on February 28, 2007,the Company dissolved FNB Mortgage Brokers, Inc., a subsidiary of the bankacquired in the merger.

Net income for the six months ended June 30, 2007 and2006 was $3,682,000 and $2,990,000, respectively. The increase of $692,000, or23.1%, is attributable to the Company’s core banking business and the mergerwith FNB Financial Corporation (“FNB”). Net interest income increased 41.5%,other income increased 36.1%, the provision for loan losses increased 130.8%and other expenses increased 51.8%. On a basic and diluted per share basis, netincome for the six months ended June 30, 2007 was $1.56 and $1.56,respectively, as compared with $1.62 and $1.59 for the six months ended June30, 2006. Net income as a percentage of total average stockholders’ equity onan annualized basis, also known as return on average equity, was 9.10% and10.70% for the first six months of 2007 and 2006, respectively. Tangible returnon average equity was 11.69% and 11.30% for the first six months of 2007 and2006 respectively, an increase of 3.45%. The increase in this ratio isattributable to an increased level of net income.

During the first six months of 2007, the Company’sassets increased $24,798,000, or 4.6%, to $566,965,000 as of June 30, 2007 from$542,167,000 as of December 31, 2006. This increase is primarilyattributable to an increase in Federal funds sold, funded by an increase inMoney Market savings accounts (MMDA.) Total loans decreased 0.8% to$387,371,000. Total deposits increased by $32,249,000, or 7.9%, during thefirst six months of 2007 to $442,084,000 as of June 30, 2007 from $409,835,000as of December 31, 2006. As a result of competition in the market, and, toa certain degree, customers’ continued uncertainty as to how to best investtheir monies, deposit growth may not be assumed at the current rates.

RESULTS OF OPERATIONS

Net Interest Income

For the three months ended June 30, 2007, totalinterest income increased by $2,659,000, or 47.2%, to $8,295,000 as comparedwith $5,636,000 for the three months ended June 30, 2006. This increase isprimarily due to the merger with FNB, resulting in an increased level ofearning assets. For the three months ended June 30, 2007, total interest incomeincreased by $113,000, or 1.4%, to $8,295,000 as compared with $8,182,000 forthe three months ended March 31, 2007. During the three months ending June 30,2007 earning assets decreased 0.3% to $517,884,000. For the three months endedJune 30, 2007, loans decreased by $2,979,000 or 0.8% to $387,371,000 whileinvestment securities decreased $302,000 and overnight Fed Funds sold increased$1,795,000. Management continued to target efforts to attract mortgage andsmall commercial loans. During the second quarter 2007, there was no change tothe New York Prime Rate and little fluctuation in the one year treasury rate.

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Total interest expense increased by $1,540,000, or77.1% to $3,537,000 for the three months ended June 30, 2007 from $1,997,000for the three months ended June 30, 2006. This increase is primarily dueto the merger with FNB, to the increased deposit balances and the increasedcosts associated with attracting deposits. Increases in rates were needed toattract deposits, particularly money market accounts. Total interest expenseincreased by $92,000, or 2.7% to $3,537,000 for the three months ended June 30,2007 from $3,445,000 for the three months ended March 31, 2007. This increaseis primarily due to the increase in Money Market deposit accounts.

Net interest income increased by $1,119,000, or 30.8%,to $4,758,000 for the three months ending June 30, 2007 from $3,639,000 for thethree months ending June 30, 2006. This increase is primarily due to the mergerwith FNB and also attributable to the repricing of mortgages. Net interestincome increased by $21,000, or 0.4%, to $4,758,000 for the three months endingJune 30, 2007 from $4,737,000 for the three months ending March 31, 2007.

For the six months ended June 30, 2007, total interestincome increased by $6,198,000, or 60.3%, to $16,476,000 as compared with$10,278,000 for the six months ended June 30, 2006. This increase is primarilydue to the merger with FNB, resulting in an increased level of interest bearingdeposits and borrowings.

Total interest expense increased by $3,412,000, or95.6% to $6,982,000 for the six months ended June 30, 2007 from $3,570,000 forthe six months ended June 30, 2006. This increase is primarily due to themerger with FNB and to the increased deposit balances. Increases in rates werealso needed to attract deposits, particularly money market accounts.

Net interest income increased by $2,786,000, or 41.5%,to $9,494,000 for the six months ending June 30, 2007 from $6,708,000 for thesix months ending June 30, 2006. This increase is primarily due to the mergerwith FNB and also attributable to the repricing of mortgages and, to a lesserextent, commercial loans tied to the one year treasury and prime rates.

Provision for Loan Losses

The provision for loan losses was $150,000 for thethree months ending June 30, 2007 compared with $70,000 for the threemonths ending June 30, 2006, an increase of 114.3%. The increase in theprovision is primarily due to the merger with FNB. The level of provision isattributable to the consistency in the high quality of the loan portfolio.

The provision for loan losses was $300,000 for the sixmonths ending June 30, 2007 compared with $130,000 for the six monthsending June 30, 2006, an increase of 130.8%. The increase in the provision isprimarily due to the merger with FNB. The level of provision is attributable tothe consistency in the high quality of the loan portfolio.

The allowance for loan losses represented 0.99% oftotal loans at June 30, 2007, compared with 0.92% as of December 31, 2006 and0.91% as of June 30, 2006. Management performs ongoing assessments of the loanloss reserve in

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relation to loan portfolio growth, credit exposure toindividual borrowers, overall trends in the loan portfolio and other relevantfactors. Based upon these factors, management believes that as of June 30,2007, the reserve is reasonable and sufficient to support the increased loangrowth in light of the strong asset quality as supported by the ratiosreflected in Table 2 on page 18.

Other Income

For the three months ended June 30, 2007, other incomewas $1,647,000, a decrease of $163,000, or 9.0%, compared with other income of$1,810,000 for the three months ended June 30, 2006. The decrease was primarilydue to a decrease of $594,000 in net gains from the sale of securities, whichwere $476,000 for the three months ended June 30, 2007 and $1,070,000 for thethree months ended June 30, 2006. Other income was positively impacted byincreases of $128,000 in NSF fees, $105,000 in BOLI (of which $85,000 wasproceeds from a death benefit), $101,000 in trust revenues, $73,000 ininvestment service fees, $56,000 in ATM fees, and $25,000 in service charges ondeposit accounts. The increases in NSF fees, ATM fees and services charges ondeposit accounts are primarily due to merging with FNB. The Bank re-establishedits Trust Department in the third quarter of 2006.

For the six months ended June 30, 2007, other incomewas $3,922,000, an increase of $1,038,000, or 36.0%, compared with other incomeof $2,884,000 for the six months ended June 30, 2006. Net gains from the saleof securities increased from $1,484,000 for the six months ending June 30, 2006to $1,689,000 for six months ended June 30, 2007, an increase of $205,000. Otherincome was positively impacted by increases of $224,000 in NSF fees, $207,000in trust revenues, $173,000 in BOLI (of which $132,000 was proceeds from deathbenefits), $109,000 in ATM fees, $81,000 in investment service fees, and$46,000 in service charges on deposit accounts. The increases in NSF fees, ATMfees and services charges on deposit accounts are primarily due to merging withFNB. The Bank re-established its Trust Department in the third quarter of 2006.

Other Expenses

Other expenses, which include salary, occupancy,equipment and all other expenses incidental to the operation of the Company,increased to $3,964,000 for the three months ended June 30, 2007 from 2,921,000for the three months ended June 30, 2006. The $1,048,000, or 35.9% increase wasprimarily due to the merger with FNB, resulting in increased salary andbenefits, occupancy costs and other operating expenses.

Salaries and employee benefit expenses, which make upthe largest component of other expenses, increased $582,000, or 40.4%, to$2,023,000 for the three months ended June 30, 2007 from $1,441,000 for thethree months ended June 30, 2006. The increase is primarily attributable to themerger with FNB, plus normal inflationary increases.

Occupancy and equipment expenses increased $293,000,or 49.2%, to $890,000 for the three months ended June 30, 2007 from $597,000for the three months ended June 30, 2006. The increase is primarily due to themerger with FNB, increasing computer costs by $143,000, depreciation expense by$112,000 and equipment expense by $30,000.

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Other operating expenses during the three months endedJune 30, 2007 increased $174,000, or 19.7% to $1,057,000 from $883,000 duringthe three months ended June 30, 2006. The increase is primarily due to themerger with FNB, increasing Core Deposit Intangible expense by $103,000, statetaxes by $63,000, marketing expense by $47,000 and legal/consultant expense by$47,000.

Other expenses, which include salary, occupancy,equipment and all other expenses incidental to the operation of the Company,increased to $8,169,000 for the six months ended June 30, 2007 from $5,382,000for the six months ended June 30, 2006. The $2,787,000, or 51.8% increase wasprimarily due to the merger with FNB, resulting in increased salary andbenefits, merger with FNB, plus normal inflationary increases.

Salaries and employee benefit expenses, which make upthe largest component of other expenses, increased $1,381,000, or 49.7%, to$4,158,000 for the six months ended June 30, 2007 from $2,777,000 for the sixmonths ended June 30, 2006. The increase is primarily attributable to theincrease in salary expenses of $991,000 and the associated benefit costs.

Occupancy and equipment expenses increased $678,000,or 59.2%, to $1,824,000 for the six months ended June 30, 2007 from $1,146,000for the six months ended June 30, 2006. The increase is primarily due to themerger with FNB, increasing computer costs by $303,000, depreciation expense by$217,000 and equipment expense by $76,000.

Other operating expenses during the six months endedJune 30, 2007 increased $728,000, or 49.9% to $2,187,000 from $1,459,000 duringthe six months ended June 30, 2006. The increase is primarily due to the mergerwith FNB, increasing Core Deposit Intangible expense by $209,000, state taxesby $152,000, legal/consulting expense by $83,000 and marketing expense by$72,000.

Income Taxes

Income tax expense was $572,000 for the three monthsended June 30, 2007, a decrease of $106,000, or 15.6%, compared with $678,000for the three months ended June 30, 2006. Increased tax exempt income from BOLIof $105,000 and tax exempt income from securities and loans of $59,000contributed to the lower tax expense.

Income tax expense was $1,265,000 for the six monthsended June 30, 2007, an increase of $175,000, or 16.1%, compared with$1,090,000 for the six months ended June 30, 2006. The increased tax expense isconsistent with the higher level of net income. The increase in tax expense waspositively impacted to a lesser extent by increases in tax exempt income fromBOLI of $173,000 and tax exempt income from securities and loans of $120,000.

Net Income

Net income for the three months ended June 30, 2007was $1,713,000, a decrease of $67,000, or 3.8%, compared with $1,780,000 forthe three months ended June 30, 2006. The decrease in net income is the resultof increases of $1,119,000 in net interest income, $432,000 in other income(excluding security gains) and a decrease in income taxes of $106,000, offsetby an increase of $80,000 in the provision for loan losses, decrease of$564,000

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in gains on the sale of securities, and an increase of$1,048,000 in other expenses. Basic and diluted earnings per share for thethree months ended June 30, 2007 were $0.72 and $0.72 as compared with $0.92and $0.90 for the three months ended June 30, 2006.

Net income for the six months ended June 30, 2007 was$3,682,000, an increase of $692,000, or 23.1%, compared with $2,990,000 for thesix months ended June 30, 2006. The increase in net income is the result ofincreases of $2,786,000 in net interest income, $1,038,000 in other income(including $ 205 in gains on sales of securities), offset by an increaseof $170,000 in the provision for loan losses, increases of $2,787,000 in otherexpenses and $175,000 in taxes. Basic and diluted earnings per share for thesix months ended June 30, 2007 were $1.56 and $1.56 as compared with $1.62 and$1.59 for the six months ended June 30, 2006.

Securities

The Company’s securities portfolio is comprised ofsecurities that not only provide interest and dividend income, includingtax-exempt income, but also provide a source of liquidity, diversify theearning assets portfolio, allow for the management of risk and tax liability,and provide collateral for repurchase agreements and public fund deposits.Policies are in place to address various aspects of managing the portfolio,including but not limited to, concentrations, liquidity, credit quality,interest rate sensitivity and regulatory guidelines.

Although the Company generally intends to hold its investmentsecurities to maturity, all of the securities portfolio is classified asavailable for sale, with new purchases generally categorized as such.Securities in the available for sale category are accounted for at fair valuewith unrealized appreciation or depreciation, net of tax, reported as aseparate component of stockholders’ equity. Securities in the held to maturitycategory would be accounted for at amortized cost. The Company holds no tradingsecurities in its portfolio. The securities portfolio includes equities ownedby the holding company, most of which are investments in banks, bank holdingcompanies and financial institutions. Equity investments are accounted for atfair market value. The remaining securities, primarily debt instruments, areowned by the bank.

The consolidated securities portfolio at June 30, 2007was $82,313,000, compared to $87,631,000 at December 31, 2006, a decrease of$5,318,000, or 6.1%. The decrease is due primarily to sales and maturities ofsecurities.

Bank Owned Securities

The bank owned securities portfolio at June 30, 2007was $42,452,000, compared to $44,478,000 at December 31, 2006, a decrease of$2,026,000, or 4.6%. The decrease is due primarily to principal paymentsreceived on mortgage backed securities.

The carrying value of the available for sale portionof the portfolio at June 30, 2007 includes an unrealized gain of $538,000(reflected as accumulated other comprehensive income of $355,000 instockholders’ equity, net of a deferred income tax liability of $183,000). Thiscompares with an

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unrealized gain at December 30, 2006 of $791,000(reflected as accumulated other comprehensive income of $522,000 instockholders’ equity, net of a deferred income tax liability of $269,000).

Holding Company Owned Securities

The securities portfolio at June 30, 2007 was$39,861,000, compared to $43,153,000 at December 31, 2006, a decrease of$3,292,000, or 7.6%. The decrease includes a decrease of $3,478,000 inunrealized gains. Realized gains on sale of equity securities were $1,704,000for the six months ended June 30, 2007.

The carrying value of the available for sale portionof the portfolio at June 30, 2007 includes an unrealized gain of$11,991,000 (reflected as accumulated other comprehensive income of $7,914,000in stockholders’ equity, net of a deferred income tax liability of $4,077,000).This compares with an unrealized gain at December 31, 2006 of $15,469,000(reflected as accumulated other comprehensive income of $10,209,000 instockholders’ equity, net of a deferred income tax liability of $5,260,000).

Loans

The loan portfolio comprises the major component ofthe Company’s earning assets and generally is the highest yielding assetcategory. Gross loans receivable, net of unearned fees and origination costs,decreased $3,048,000, or 0.8%, to $387,371,000 at June 30, 2007 from$390,419,000 at December 31, 2006. Gross loans represented 87.6% of totaldeposits at June 30, 2007 as compared with 95.3% at December 31,2006. This decrease is primarily due an increase in total deposits of$32,249,000.

Credit Risk and Loan Quality

The Company continues to be prudent in its efforts tominimize credit risk. The Bank’s written lending policy requires underwriting,loan documentation and credit analysis standards to be met prior to theapproval and funding of any loan. In accordance with that policy, the loanreview process monitors the loan portfolio on an ongoing basis. The Loan Reviewarea then prepares an analysis of the allowance for loan losses which is thensubmitted to the Board of Directors for its assessment as to the adequacy ofthe allowance. The allowance for loan losses is an accumulation of expensesthat has been charged against past and present earnings in anticipation ofpotential losses in the loan portfolio.

The allowance for loan losses at June 30, 2007 andDecember 31, 2006 was $3,835,000 and $3,610,000, respectively. At June 30,2007, the allowance for loan losses represented 0.99% of the gross loanportfolio, compared with 0.92% at December 31, 2006. At June 30, 2007, inconsideration of the strong asset quality, management believes the allowancefor loan loss reserve to be reasonable and adequate to support the loan growthand to address any potential losses.

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Table 1 –“Analysis of Allowance for Loan Loss” -detailsthe activity, which occurred in the allowance over the first six months of 2007and 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               |       | 300      |       | 130      |       |
| Charge-offs:                                          |       |     |       |     |       |
| Commercial                                            |       | 0        |       | 0        |       |
| Real Estate                                           |       | 0        |       | 0        |       |
| Consumer                                              |       | (129     | )          | (10      | )          |
| Total charge-offs                                     |       | (129     | )          | (10      | )          |
|                                                  |       |     |       |     |       |
| Recoveries:                                           |       |     |       |     |       |
| Commercial                                            |       | 2        |       | 2        |       |
| Real Estate                                           |       | 0        |       | 0        |       |
| Consumer                                              |       | 52       |       | 27       |       |
| Total Recoveries                                      |       | 54       |       | 29       |       |
|                                                  |       |     |       |     |       |
| Net (charge-offs)  recoveries                         |       | (75      | )          | 19       |       |
|                                                  |       |     |       |     |       |
| Additions due to  merger with FNB                     |       |     |       | 1,169    |       |
|                                                  |       |     |       |     |       |
| Balance, June 30                                      |       | $        | 3,835      |     | $          | 3,447 |   |
|                                                  |       |     |       |     |       |
| Net (charge-offs) or  recoveries to average net loans |       | (0.02    | )          | 0.01     |       |

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(1) Bank’s loan portfolio is entirely domestic

The Bank’s lending policy is executed through theassignment of tiered loan limit authorities to individual officers of the Bank,the Officer’s Loan Committee and the Board of Directors. Although the Bankmaintains sound credit policies, certain loans may deteriorate for a variety ofreasons. The Bank’s policy is to place all loans on a non-accrual status uponbecoming 90 days delinquent in their payments, unless there is a documented andreasonable expectation of the collection of the delinquent amount. Loans arereviewed monthly as to their status, and on a quarterly basis presented to theBoard of Directors. Management is not aware of any material potential loancredit problems that have not been disclosed in this report.

Table 2 – “Assets Quality Ratios” — summarizespertinent asset quality ratios at June 30, 2007 and December 31, 2006.

**Table 2 –Asset Quality Ratios**
| ** **                                  | ** ** | **6/30/07** | ** ** | **12/31/06** | ** ** |
|---------------------------------------------|------------|-------------|------------|--------------|------------|
| Non-accrual  loans/total loans              |       | 0.66        | %          | 0.18         | %          |
| Non-performing  assets (1)/total loans      |       | 0.69        | %          | 0.28         | %          |
| Net (charge  offs) recoveries/average loans |       | (0.02       | )%         | 0.01         | %          |
| Allowance/total  loans                      |       | 0.99        | %          | 0.92         | %          |
| Allowance/non-accrual  loans                |       | 150         | %          | 525          | %          |
| Allowance/non-performing  loans (1)         |       | 143         | %          | 334          | %          |

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(1) – Includes non-accrual loans

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At June 30, 2007, the Company had other real estateowned (not used in operations) in the amount of $2,301,000. At June 30, 2007and December 31, 2006, the Company had non-accrual loans in the amount of$2,551,000 and $688,000, respectively. This increase is primarily due to alarge commercial loan and several loans secured by real estate being placed onnon-accrual status.

Loan concentrations are considered to exist when thetotal amount of loans to any one or a multiple number of borrowers engaged insimilar activities or having similar characteristics exceeds 10% of loansoutstanding in any one category. The Company maintains a diversified loanportfolio, granting agribusiness, commercial and residential loans tocustomers. The majority of the Bank’s lending is made within its primary marketarea, which includes Fulton County and southern Franklin County, Pennsylvaniaand northern Washington County, Maryland. Although no concentrations exist toone borrower or related group of borrowers, the Bank’s commercial lending isprimarily secured by real estate.

Bank Owned Life Insurance

The Company has Bank Owned Life Insurance (“BOLI”) fora chosen group of employees, namely officers and directors, in which the Bankis the owner and beneficiary of the policies. The Bank’s deposits and proceeds fromthe sale of investment securities funded the BOLI. Earnings from the BOLI arerecognized as other income. The BOLI is profitable from the appreciation of thecash surrender values of the pool of insurance, and its tax advantage to theCompany. This profitability is used to offset a portion of current and futureemployee benefit costs and a Nonqualified Supplemental Executive RetirementPlan for the Company’s Chief Executive Officer.

The Company had $10,570,000 and $10,683,000 in BOLI asof June 30, 2007 and December 31, 2006, respectively. This decrease isprimarily due to the redemption, upon the death of two participants, of lifeinsurance policies with cash values totaling $311,000. Although the BOLI is anasset that may be liquidated, it is the Company’s intention to hold this poolof insurance because it provides tax-exempt income that lowers the Company’stax liability, while enhancing its overall capital position.

Deposits

Deposits are the major source of the Company’s fundsfor lending and investment purposes. Total deposits at June 30, 2007 were$442,084,000, an increase of $32,249,000, or 7.9%, from total deposits of$409,835,000 at December 31, 2006. This increase is primarily due to a largemoney market account opened in January 2007.

Short-Term Borrowings

Short term borrowings at June 30, 2007 were$9,934,000, compared to $9,875,000 at December 31, 2006, an increase of$59,000, or 0.6%. Federal funds purchased, Treasury Tax and Loan demand note,lines of credits with banks and overnight borrowings with the Federal Home LoanBank of Pittsburgh are considered to be short term borrowings. Short termborrowings fluctuate daily to meet the liquidity needs of the Company.

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Long-Term Debt Borrowings

Long term borrowings at June 30, 2007 were$26,754,000, compared to $31,768,000 at December 31, 2006, a decrease of$5,014,000, or 15.8%. This decrease is primarily due to The Federal Home LoanBank calling a $5,000,000 loan in February 2007.

Asset/Liability Management

The management of interest rate risk involvesmeasuring and analyzing the maturity and repricing of interest-earning assetsand interest bearing liabilities at specific points in time. The imbalancebetween interest earning assets and interest bearing liabilities is commonlyreferred to as the interest rate gap. The interest rate gap is one measure ofthe risk inherent in the existing balance sheet as it relates to potentialchanges in net interest income. Maintaining an appropriate balance betweeninterest-earning assets and interest bearing liabilities is a means ofmonitoring and possibly avoiding material fluctuations in the net interestmargin during periods of changing interest rates.

The Company’s overall sensitivity to interest raterisk is low due to its non-complex balance sheet. The Company manages itsbalance sheet with the intent of stabilizing net interest income and neteconomic value under a broad range of interest rate environments. The Companyhas the ability to effect various strategies to manage interest rate risk,which include, but are not limited to, selling newly originated residentialmortgage loans, controlling the volume mix of fixed/variable rate commercialloans, mortgage loans and securities, increasing/ decreasing deposits viainterest rate changes, borrowing from the Federal Home Loan Bank of Pittsburgh,and buying/selling securities. Adjustments to the mix of assets and liabilitiesare made periodically in an effort to give the Company dependable and steadygrowth in net interest income, while at the same time, managing the relatedrisks.

Liquidity

Liquidity represents the Company’s ability toefficiently manage cash flows at reasonable rates to support possiblecommitments to borrowers or the demands of depositors. Liquidity is essentialto compensate for fluctuations in the balance sheet and provide funds forgrowth and normal operating expenditures. Liquidity needs may be met byconverting assets into cash or obtaining sources of additional funding.

Liquidity from asset categories is provided throughcash, amounts due from banks, interest-bearing deposits with banks and federalfunds sold, which were $54,728,000 at June 30, 2007, compared to $20,755,000 atDecember 31, 2006, an increase of $33,973,000 or 163.7%. This increase isprimarily due to a new money market deposit account opened in January 2007. Additionalasset liquidity sources include principal and interest payments from securitiesin the Company’s investment portfolio and cash flow from its amortizing loanportfolio. Longer-term liquidity needs may be met by selling securitiesavailable for sale, selling loans or raising additional capital. At June 30,2007, there was $66,758,000 in liquid securities as compared to $71,337,000 atDecember 31, 2006. Liquid securities decreased by $4,579,000 since year endprimarily due to a decrease of securities held at Tower Bancorp and to a lesserextent principal payments received on mortgage backed securities held by thebank. Liquid securities held at Tower Bancorp decreased $3,292,000 due tosales, calls and maturity of investment securities exceeding purchases andmarket value fluctuations.

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Liability liquidity sources include attractingdeposits at competitive rates. Deposits at June 30, 2007 were $442,084,000,compared to $409,835,000 at December 31, 2006. In addition, the Companyhas borrowing capacity and lines of credit with the Federal Home Loan Bank ofPittsburgh, Atlantic Central Bankers Bank and several local banks.

The Company’s financial statements do not reflectvarious off-balance sheet commitments that are made in the normal course ofbusiness, which may involve some liquidity risk. Off-balance sheet arrangementsare discussed in detail below.

Management is of the opinion that its liquidityposition, at June 30, 2007, is adequate to respond to fluctuations “on” and “off”the balance sheet. In addition, management knows of no trends, demands,commitments, events or uncertainties that may result in, or that are reasonablylikely to result in the Company’s inability to meet anticipated or unexpectedliquidity needs.

Off-Balance Sheet Arrangements

The Company’s financial statements do not reflectvarious off-balance sheet arrangements that are made in the normal course ofbusiness. These commitments consist mainly of loans approved but not yetfunded, unused lines of credit and letters of credit made in accordance withthe same standards as on-balance sheet instruments. Unused commitments at June30, 2007 were $120,583,000, which consisted of $117,537,000 in unfundedcommitments to existing loans and unfunded new loans and $3,046,000 in lettersof credit. Because these instruments have fixed maturity dates, and becausemany of them will expire without being drawn upon, they do not generallypresent a significant liquidity risk to the Company. Management believes thatany amounts actually drawn upon can be funded in the normal course ofoperations. The Company has no investment in or financial relationship with anyunconsolidated entities that are reasonably likely to have a material effect onliquidity or the availability of capital resources.

Capital

The following Table 3 presents the risk-based andleverage capital amounts and ratios at June 30, 2007 for the Company and theBank.

**Table 3 – CapitalRatios**
| ** **                                      | ** ** | ** **                           | ** ** | ** **   | ** ** | ** **                 | ** ** | ** **                 | ** ** | **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                                         |       | $                                    | 63,417     |         | 17.1%      | >                  | 29,755     | >                  | 8.0%       |                     | N/A        |   | N/A |   |
| Bank                                            |       | 45,267                               |       | 12.7%        | >  | 28,581                     | >  | 8.0%                       |       | 35,726                   | >  | 10.0% |   |
|                                            |       |                                 |       |         |       |                       |       |                       |       |                     |       |   |   |
| Tier 1  capital/risk weighted assets:           |       |                                 |       |         |       |                       |       |                       |       |                     |       |   |   |
| Company                                         |       | 54,186                               |       | 14.6%        | >  | 14,877                     | >  | 4.0%                       |       | N/A                      |       | N/A |   |
| Bank                                            |       | 41,432                               |       | 11.6%        | >  | 14,290                     | >  | 4.0%                       |       | 21,436                   | >  | 6.0% |   |
|                                            |       |                                 |       |         |       |                       |       |                       |       |                     |       |   |   |
| Tier 1  capital/average assets                  |       |                                 |       |         |       |                       |       |                       |       |                     |       |   |   |
| Company                                         |       | 54,186                               |       | 9.8%         | >  | 22,163                     | >  | 4.0%                       |       | N/A                      |       | N/A |   |
| Bank                                            |       | 41,432                               |       | 8.1%         | >  | 20,486                     | >  | 4.0%                       | >  | 25,608                   | >  | 5.0% |   |
|                                                 |            |                                      |            |              |            |                            |            |                            |            |                          |            |  |  |  |

 

21

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These capital ratios continue to remain at levels,which are considered to be “well-capitalized” as defined by regulatoryguidelines.

Banking laws and regulations limit the amount of cashdividends that may be paid without prior approval from the Company’s regulatoryagencies. In abidance with such requirements, on April 11, 2007, the Board ofDirectors authorized and declared a quarterly cash dividend in the amount of$0.26 per share, payable on May 18, 2007 to all shareholders of record as ofMay 1, 2007. The payment of this quarterly cash dividend decreased retainedearnings by $613,000.

RECENT ACCOUNTING PRONOUNCEMENTS

In July 2006, the FASB issued Interpretation No. 48, “Accountingfor Uncertainty in Income Taxes: An Interpretation of FASB Statement No. 109”(FIN) 48). FIN 48 clarifies the accounting for uncertainty in income taxesrecognized in an entity’s financial statements in accordance with SFAS 109. TheInterpretation prescribes a recognition threshold and measurement principlesfor the financial statement recognition and measurement of tax positions takenor expected to be taken on a tax return. FIN 48 is effective for fiscal yearsbeginning after December 15, 2006. The Corporation does not expect theimplementation of FIN 48 to have a material impact on its financial statements.

In September 2006, the Financial Accounting StandardsBoard (FASB) issued Statement of Financial Accounting Standards No. 157, “FairValue Measurements” (SFAS 157). SFAS 157 defines fair value, establishes aframework for measuring fair value in generally accepted accounting principles,and expands disclosures about fair value measurements. SFAS 157 does notrequire any new fair value measurements but may change current practice forsome entities. This Statement is effective for financial statements issued forfiscal years beginning after November 15, 2007 and interim periods within thoseyears. The Company does not expect the implementation of SFAS 157 to have amaterial impact on its consolidated financial statements.

In February 2007, the FASB issued Statement ofFinancial Accounting Standards No. 159, “The Fair Value Option for FinancialAssets and Financial Liabilities” (SFAS 159). This statement permits entitiesto choose to measure many financial instruments and certain other items at fairvalue. The objective of this Statement is to improve financial reporting byproviding entities with the opportunity to mitigate volatility in reportedearnings caused by measuring related assets and liabilities differently withouthaving to apply complex hedge accounting provisions. The fair value optionestablished by this Statement permits all entities to choose to measureeligible items at fair value at specified election dates. A business entityshall report unrealized gains and losses on items for which the fair valueoption has been elected in earnings at each subsequent reporting date. The fairvalue option may be applied instrument by instrument and is irrevocable. SFAS159 is effective as of the beginning of an entity’s first fiscal year thatbegins after November 15, 2007. Early adoption is permitted as of the beginningof a fiscal year that begins on or before November 15, 2007, provided theentity also elects to apply the provisions of SFAS 157, “Fair ValueMeasurements”. The Company did not elect to early adopt this pronouncement, anddoes not expect its implementation to have a material impact on itsconsolidated financial statements.

22

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

There have been no material changes to the quantitativeand qualitative disclosures made in Tower Bancorp’s annual report on Form 10-Kfor the year ended December 31, 2006.

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**ITEM 4 – CONTROLS AND PROCEDURES**

**CONTROLS AND PROCEDURES**

The Company’s Chief Executive Officer and ChiefFinancial Officer have evaluated the effectiveness of the Company’s disclosurecontrols and procedures (as such term is defined in the Rules 13a-15(e) underthe Securities Exchange Act of 1934, as amended (the “Exchange Act”))as ofJune 30, 2007. Based on such evaluation, such officers have concludedthat, as of June 30, 2007, the Company’s disclosure controls and procedures areeffective in alerting them on a timely basis to material information relatingto the Company (including its consolidated subsidiary) required to be includedin the Company’s periodic filings under the Exchange Act.

**CHANGES IN INTERNAL CONTROLS**

There have not been any significant changes in theCompany’s internal control over financial reporting or in other factors thatmaterially affected or are reasonably likely to materially affect such controlduring the second quarter of 2007.

24

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PART II – OTHER INFORMATION

25

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PART II– OTHER INFORMATION

Item 1 –Legal Proceedings

The nature of the Company’s business generatessome litigation involving matters arising in the ordinary course of business. However,in the opinion of the Company, after consulting with legal counsel, no legalproceedings are pending, which would have a material effect on the company orsubsidiary. No legal proceedings are pending other than ordinary routinelitigation incidental to the business of the Company and the Bank. In addition,to Management’s knowledge, no governmental authorities have initiated orcontemplated any material legal actions against the Company or the Bank.

Item 1A– Risk Factors

There have been no material changes to the Company’srisk factors since these factors were previously disclosed in the Company’sAnnual Report on Form 10-K for the period ended December 31, 2006.

Item 2 –Unregistered Sales of Equity Securities and Use of Proceeds

ISSUER PURCHASES OF EQUITY SECURITIES
| **Period**    | ** ** | **(a)  Total Number  of shares  purchased** | ** ** | **(b)  Average price  paid per  share** | ** ** | **(c)  Total number  of shares  purchased as  part of  publicly  announced  plan** | ** ** | **(d)  Maximum  number of shares  that may yet  be purchased  under the  plan** | ** ** |
|---------------|------------|-------------------------------------------------------|------------|---------------------------------------------------|------------|--------------------------------------------------------------------------------------------------------|------------|---------------------------------------------------------------------------------------------------------------|------------|
| January 2007  |       | None                                                  |       | N/A                                               |       | None                                                                                                   |       | 91,396                                                                                                        |       |
|          |       |                                                  |       |                                              |       |                                                                                                   |       |                                                                                                          |       |
| February 2007 |       | 1,484                                                 |       | 44.22                                             |       | 1,484                                                                                                  |       | 89,912                                                                                                        |       |
|          |       |                                                  |       |                                              |       |                                                                                                   |       |                                                                                                          |       |
| March 2007    |       | 3,500                                                 |       | 44.26                                             |       | 3,500                                                                                                  |       | 86,412                                                                                                        |       |
|          |       |                                                  |       |                                              |       |                                                                                                   |       |                                                                                                          |       |
| April 2007    |       | None                                                  |       | N/A                                               |       | None                                                                                                   |       | 86,412                                                                                                        |       |
|          |       |                                                  |       |                                              |       |                                                                                                   |       |                                                                                                          |       |
| May 2007      |       | 4,700                                                 |       | 43.40                                             |       | 4,700                                                                                                  |       | 81,712                                                                                                        |       |
|          |       |                                                  |       |                                              |       |                                                                                                   |       |                                                                                                          |       |
| June 2007     |       | 11,831                                                |       | 43.65                                             |       | 11,831                                                                                                 |       | 69,881                                                                                                        |       |
|          |       |                                                  |       |                                              |       |                                                                                                   |       |                                                                                                          |       |
| Total         |       | 21,515                                                |       | 43.71                                             |       | 21,515                                                                                                 |       | 69,881                                                                                                        |       |

 

26

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Item 3 –Defaults Upon Senior Securities

Notapplicable

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

The annual meeting of Tower Bancorp, Inc. was heldon April 11, 2007. Matters that were voted on by security holders were:

1.               Elect four Class BDirectors for three year terms expiring in 2010.

2.               Ratify the selection ofSmith Elliott Kearns & Company, LLC as the independent accountants for theCompany for the year ending December 31, 2007.

3.               Transact any otherbusiness that may properly come before the meeting.

Directors that were re-elected at the annualmeeting were:

Jeff B. ShankFrederic M.FrederickLois E. EastonTerry R. Randall

Each director received affirmative votesrepresenting a majority of the shares outstanding.

Ratification of Smith Elliott Kearns &Company, LLC as the independent accountants for the Company for the year endingDecember 31, 2007 occurred, with affirmative votes representing a majorityof the shares outstanding.

No other matters were voted upon at the annualmeeting.

Item 5 –Other Information

Notapplicable

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).                    |

 

27

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| Exhibit | ** ** | **Description of Exhibit**                                                                                                                                                                                                      |
|---------|------------|---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
|    |       |                                                                                                                                                                                                                            |
| 10.1    |       | Change of Control Agreement of Jeffrey B. Shank  dated as of September 25, 2002  (incorporated by referenced to Exhibit 99.4 of Tower Bancorp, Inc.’s Form  10-Q for the quarter ended September 30, 2002).                |
|    |       |                                                                                                                                                                                                                            |
| 10.2    |       | Change of Control Agreement of Franklin T. Klink,  III dated as of November 26, 2001 (incorporated by reference to Exhibit 10.1  of Tower Bancorp, Inc.’s Form 10-K for the year ended December 31, 2001).                 |
|    |       |                                                                                                                                                                                                                            |
| 10.3    |       | Change of Control Agreement of Donald G. Kunkle  dated as of January 4, 2002  (incorporated by reference to Exhibit 10.2 of Tower Bancorp, Inc.’s Form 10-K  for the year ended December 31, 2001).                        |
|    |       |                                                                                                                                                                                                                            |
| 10.4    |       | Change of Control Agreement of John H. McDowell, Sr.  dated as of December 23, 1998 (incorporated by reference to Exhibit 10.2 of  Tower Bancorp, Inc.’s Form 10-K for the year ended December 31, 1998).                  |
|    |       |                                                                                                                                                                                                                            |
| 10.5    |       | Tower Bancorp, Inc.’s 1995 Non-Qualified Stock  Option Plan (incorporated by reference to Exhibit 99.1 to Tower Bancorp,  Inc.’s Registration Statement on Form S-8 (File No. 333-4066 1)).                           |
|    |       |                                                                                                                                                                                                                            |
| 10.6    |       | Tower Bancorp, Inc. Stock Option Plan for Outside  Directors (incorporated by reference to Exhibit 99.2 to Tower Bancorp, Inc.’s  Registration Statement on Form S-8 (File No. 333-40661)).                                |
|    |       |                                                                                                                                                                                                                            |
| 10.7    |       | Supplemental Executive Retirement Agreement of  Jeffrey B. Shank dated as of September 25,  2002 (incorporated by reference to Exhibit 99.3 of Tower Bancorp,  Inc.’s Form 10-Q for the quarter ended September 30, 2002). |

 

28

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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                                                                                                                                                                     |

 

29

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SIGNATURES

Pursuant to the requirements of the Securities ExchangeAct of 1934, the registrant has duly caused this report to be signed on itsbehalf by the undersigned thereunto duly authorized.
|        | TOWER BANCORP, INC.           |
|--------|-------------------------------|
|   | (REGISTRANT)                  |
|   |                          |
|   | /s/  Jeff B.  Shank      |   |
|   | Jeff B. Shank, President, CEO |
|   | (Principal Executive Officer) |
| Date:  | August 8, 2007                |   |   |
|   |                          |
|   | /s/ Franklin T. Klink, III    |   |
|   | Franklin T. Klink, III,       |
|   | Treasurer                     |
|   | (Principal Financial Officer) |
| Date:  | August 8, 2007                |   |   |

 

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