**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 March 31, 2006**

 

**Commission file number:  0-12826**

 

**TOWER BANCORP INC.**

(Exact name of registrant as specified in itscharter)

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

 

Indicateby check mark whether the registrant is a large accelerated filer, anaccelerated filer, or a non-accelerated filer (as defined in Rule 12b-2 of theExchange Act)

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

 

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

 

Yes  o    No  ý

 

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

 

1,732,419shares of common stock outstanding at March 31, 2006

 

 

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TOWER BANCORP, INC.

 

INDEX

 
| PART I - FINANCIAL INFORMATION                                                                           |   |
|----------------------------------------------------------------------------------------------------------|--------|
|                                                                                                     |   |
| Item 1 -  Financial Statements                                                                           |   |
| Condensed  consolidated balance sheets - March 31, 2006 and December 31, 2005                            | 4      |
| Condensed  consolidated statements of income - three months ended March 31, 2006 and  2005               | 5      |
| Condensed  consolidated statements of comprehensive income - three months ended March  31, 2006 and 2005 | 6      |
| Condensed  consolidated statements of cash flows - three months ended March 31, 2006 and  2005           | 7      |
| Notes  to condensed consolidated financial statements                                                    | 8      |
| Item 2 - Management’s discussion and analysis of  financial condition and results of operations     | 10     |
| Item 3 - Quantitative and  qualitative disclosures about market risk                                     | 20     |
| Item 4 - Controls and procedures                                                                         | 21     |
|                                                                                                     |   |
| PART II - OTHER INFORMATION                                                                              | 22     |
|                                                                                                     |   |
| Item 1 - Legal proceedings                                                                               | 23     |
| Item 1A - Risk Factors                                                                                   | 23     |
| Item 2 - Unregistered sales  of equity securities and use of proceeds                                    | 23     |
| Item 3 - Defaults upon  senior securities                                                                | 23     |
| Item 4 - Submission of  matters to a vote of security holders                                            | 23     |
| Item 5 - Other information                                                                               | 24     |
| Item 6 - Index to Exhibits                                                                               | 24     |
|                                                                                                     |   |
| Signatures                                                                                               | 27     |
|                                                                                                     |   |
| Exhibits                                                                                                 |   |

 

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PART I - FINANCIALINFORMATION

 

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TOWER BANCORP, INC. AND ITS WHOLLY-OWNEDSUBSIDIARY

 

CONDENSED CONSOLIDATEDBALANCE SHEETS

 
| ** **                                                                   | ** ** | **March 31,  2006  (Unaudited)** | ** ** | **December 31,  2005  (Audited) *** | ** ** |
|------------------------------------------------------------------------------|------------|----------------------------------|------------|-------------------------------------|------------|
| ** **                                                                   | ** ** | ** **                       | ** ** |
| ** **                                                                   | ** ** | ** **                       | ** ** |
| ** **                                                                   | ** ** | **(000 Omitted)**                | ** ** |
| ASSETS                                                                       |       |                             |       |                                |       |
| Cash and due  from banks                                                     |       | $                                | 9,596      |                                | $          | 11,744 |   |
| Federal funds  sold                                                          |       | 11,405                           |       | 10,093                              |       |
| Interest bearing  balances with banks                                        |       | 97                               |       | 3,083                               |       |
| Investment  securities available for sale                                    |       | 79,330                           |       | 83,157                              |       |
| Restricted bank  stock                                                       |       | 2,166                            |       | 2,177                               |       |
| Loans                                                                        |       | 228,265                          |       | 229,308                             |       |
| Less: reserve  for possible loan losses                                      |       | (2,202                           | )          | (2,129                              | )          |
| Bank premises,  equipment, furniture and fixtures                            |       | 6,856                            |       | 5,855                               |       |
| Accrued interest  receivable                                                 |       | 1,223                            |       | 1,103                               |       |
| Cash surrender  value of life insurance                                      |       | 7,465                            |       | 7,387                               |       |
| Other assets                                                                 |       | 1,324                            |       | 445                                 |       |
| Total assets                                                                 |       | $                                | 345,525    |                                | $          | 352,223 |   |
|                                                                         |       |                             |       |                                |       |
| LIABILITIES AND  CAPITAL                                                     |       |                             |       |                                |       |
| Deposits in  domestic offices:                                               |       |                             |       |                                |       |
| Demand                                                                       |       | $                                | 28,087     |                                | $          | 29,162 |   |
| Savings                                                                      |       | 132,518                          |       | 144,952                             |       |
| Time                                                                         |       | 90,163                           |       | 87,064                              |       |
| Liabilities for  borrowed money                                              |       | 36,077                           |       | 35,516                              |       |
| Accrued interest  payable                                                    |       | 391                              |       | 364                                 |       |
| Other  liabilities                                                           |       | 7,896                            |       | 6,776                               |       |
| Total  liabilities                                                           |       | 295,132                          |       | 303,834                             |       |
|                                                                         |       |                             |       |                                |       |
| EQUITY CAPITAL                                                               |       |                             |       |                                |       |
| Capital stock,  common, authorized 5,000,000 shares; 1,780,100 shares issued |       | 2,225                            |       | 2,225                               |       |
| Additional  paid-in capital                                                  |       | 6,871                            |       | 6,760                               |       |
| Retained  earnings                                                           |       | 32,447                           |       | 31,618                              |       |
| Accumulated  other comprehensive income                                      |       | 10,489                           |       | 9,557                               |       |
| Less: cost of  treasury stock; 2006 - 47,681 shares; 2005 - 52,008 shares    |       | (1,639                           | )          | (1,771                              | )          |
| Total equity  capital                                                        |       | 50,393                           |       | 48,389                              |       |
|                                                                         |       |                             |       |                                |       |
| Total  liabilities and capital                                               |       | $                                | 345,525    |                                | $          | 352,223 |   |
|                                                                              |            |                                  |            |                                     |            |  |  |  |  |

 

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*      Condensed from audited financialstatements.

 

The accompanying notes are an integral partof these

condensed financial statements.

 

4

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TOWER BANCORP, INC. AND ITS WHOLLY-OWNEDSUBSIDIARY

 

CONDENSED CONSOLIDATEDSTATEMENTS OF INCOME

THREE MONTHS ENDED MARCH 31, 2006 AND 2005

(UNAUDITED)

 
| ** **                                            | ** ** | **2006**               | ** ** | **2005** | ** ** |
|-------------------------------------------------------|------------|------------------------|------------|----------|------------|
| ** **                                            | ** ** | **(000 Omitted)** | ** ** |
| Interest Income                                       |       |                   |       |     |       |
| Interest &  fees on loans                         |       | $                      | 3,812      |     | $          | 3,208 |   |
| Interest on  investment securities available for sale |       | 688                    |       | 503      |       |
| Interest on  deposits with banks                      |       | 142                    |       | 14       |       |
| Total interest  & dividend income                 |       | 4,642                  |       | 3,725    |       |
| Interest Expense                                      |       |                   |       |     |       |
| Interest on  deposits                                 |       | 1,092                  |       | 656      |       |
| Interest on  borrowed money                           |       | 481                    |       | 417      |       |
| Total interest  expense                               |       | 1,573                  |       | 1,073    |       |
|                                                  |       |                   |       |     |       |
| Net interest  income                                  |       | 3,069                  |       | 2,652    |       |
|                                                  |       |                   |       |     |       |
| Provision for  loan losses                            |       | 60                     |       | 90       |       |
|                                                  |       |                   |       |     |       |
| Net interest  income after provision for loan losses  |       | 3,009                  |       | 2,562    |       |
|                                                  |       |                   |       |     |       |
| Other Income                                          |       |                   |       |     |       |
| Investment  service income                            |       | 108                    |       | 62       |       |
| Service charges  on deposit accounts                  |       | 280                    |       | 232      |       |
| Other service  charges                                |       | 197                    |       | 133      |       |
| Other operating  income                               |       | 75                     |       | 14       |       |
| Investment  securities gains (losses)                 |       | 414                    |       | 198      |       |
| Total other  income                                   |       | 1,074                  |       | 639      |       |
|                                                  |       |                   |       |     |       |
| Other Expense                                         |       |                   |       |     |       |
| Salaries, wages  and other benefits                   |       | 1,336                  |       | 1,107    |       |
| Occupancy and  equipment expense                      |       | 549                    |       | 460      |       |
| Other operating  expenses                             |       | 576                    |       | 409      |       |
| Total other  expenses                                 |       | 2,461                  |       | 1,976    |       |
|                                                  |       |                   |       |     |       |
| Income before  taxes                                  |       | 1,622                  |       | 1,225    |       |
| Applicable  income taxes                              |       | 412                    |       | 308      |       |
| Net income                                            |       | $                      | 1,210      |     | $          | 917 |   |
|                                                  |       |                   |       |     |       |
| Earnings per  share:                                  |       |                   |       |     |       |
| Basic earnings  per share                             |       | $                      | 0.70       |     | $          | 0.53 |   |
| Weighted average  shares outstanding                  |       | $                      | 1,728,715  |     | $          | 1,725,644 |   |
| Diluted earnings  per share                           |       | $                      | 0.69       |     | $          | 0.52 |   |
| Weighted average  shares outstanding                  |       | $                      | 1,762,611  |     | $          | 1,757,100 |   |

 

The accompanying notes are an integral partof these

condensed financial statements.

 

5

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TOWER BANCORP, INC. AND ITS WHOLLY-OWNEDSUBSIDIARY

 

CONDENSED CONSOLIDATEDSTATEMENTS OF COMPREHENSIVE INCOME

THREE MONTHS ENDED MARCH 31, 2006 AND 2005

(UNAUDITED)

 
| ** **                                     | ** ** | **2006**               | ** ** | **2005** | ** ** |
|------------------------------------------------|------------|------------------------|------------|----------|------------|
| ** **                                     | ** ** | **(000 Omitted)** | ** ** |
|                                           |       |                   |       |     |       |
| Net income                                     |       | $                      | 1,210      |     | $          | 917 |   |
|                                           |       |                   |       |     |       |
| Other  comprehensive income:                   |       |                   |       |     |       |
| Unrealized  holding gains (losses), net of tax |       | 932                    |       | 172      |       |
|                                           |       |                   |       |     |       |
| Comprehensive  income                          |       | $                      | 2,142      |     | $          | 1,089 |   |

 

The accompanying notes are an integral partof these

condensed financial statements.

 

6

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# TOWER BANCORP, INC. AND ITSWHOLLY-OWNED SUBSIDIARY

#  

CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS

Three Months Ended March 31, 2006 and 2005

(UNAUDITED)

 
| ** **                                                                         | ** ** | **2006**               | ** ** | **2005** | ** ** |
|------------------------------------------------------------------------------------|------------|------------------------|------------|----------|------------|
| ** **                                                                         | ** ** | **(000 Omitted)** | ** ** |
| Cash flows from  operating activities:                                             |       |                   |       |     |       |
| Net income                                                                         |       | $                      | 1,210      |     | $          | 917 |   |
| Adjustments to  reconcile net income to net cash provided by operating activities: |       |                   |       |     |       |
| Depreciation and  amortization                                                     |       | 104                    |       | 99       |       |
| Provision for  loan losses                                                         |       | 60                     |       | 90       |       |
| Granting of  stock options                                                         |       | 108                    |       | 0        |       |
| (Gain) on sale  of investment securities                                           |       | (414                   | )          | (198     | )          |
| (Increase) in  cash surrender value of life insurance                              |       | (78                    | )          | (93      | )          |
| (Increase)  decrease in other assets                                               |       | (879                   | )          | (196     | )          |
| (Increase)  decrease in interest receivable                                        |       | (120                   | )          | (91      | )          |
| (Decrease)  increase in interest payable                                           |       | 27                     |       | 13       |       |
| Increase  (decrease) in other liabilities                                          |       | 640                    |       | (184     | )          |
| Net cash  provided by operating activities                                         |       | 658                    |       | 357      |       |
|                                                                               |       |                   |       |     |       |
| Cash flows from  investing activities:                                             |       |                   |       |     |       |
| Loans (net)                                                                        |       | 1,056                  |       | 1,251    |       |
| Purchases of  bank premises, equipment, furniture and fixtures                     |       | (1,105                 | )          | (91      | )          |
| Interest bearing  balances with banks                                              |       | 2,986                  |       | 0        |       |
| Purchases of  available for sale securities                                        |       | (6,069                 | )          | (1,201   | )          |
| Maturities/sales  of available for sale securities                                 |       | 11,756                 |       | 1,849    |       |
| Redemption  (purchase) of restricted bank stock                                    |       | 11                     |       | (311     | )          |
| Net cash  provided(used) by investing activities                                   |       | 8,635                  |       | 1,497    |       |
|                                                                               |       |                   |       |     |       |
| Cash flows from  financing activities:                                             |       |                   |       |     |       |
| Net increase  (decrease) in deposits                                               |       | (10,410                | )          | 2,463    |       |
| Cash dividends  paid                                                               |       | (415                   | )          | (1,242   | )          |
| Purchase of  treasury stock                                                        |       | (68                    | )          | (146     | )          |
| Debt (net)                                                                         |       | 561                    |       | 584      |       |
| Proceeds from  sale of capital stock                                               |       | 203                    |       | 244      |       |
| Net cash  provided (used) by financing activities                                  |       | (10,129                | )          | 1,903    |       |
|                                                                               |       |                   |       |     |       |
| Net increase  (decrease) in cash and cash equivalents                              |       | (836                   | )          | 3,757    |       |
|                                                                               |       |                   |       |     |       |
| Cash and cash  equivalents at beginning of year                                    |       | 21,837                 |       | 10,045   |       |
|                                                                               |       |                   |       |     |       |
| Cash and cash  equivalents at end of period                                        |       | $                      | 21,001     |     | $          | 13,802 |   |
|                                                                               |       |                   |       |     |       |
| Cash and cash  equivalents consists of:                                            |       |                   |       |     |       |
| Cash and due  from banks                                                           |       | $                      | 9,596      |     | $          | 10,332 |   |
| Federal funds  sold                                                                |       | 11,405                 |       | 3,470    |       |
| Total cash and  cash equivalents                                                   |       | $                      | 21,001     |     | $          | 13,802 |   |

 

The accompanying notes are an integral partof these

condensed financial statements.

 

7

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NOTES TO CONDENSEDCONSOLIDATED FINANCIAL STATEMENTS

MARCH 31, 2006

(UNAUDITED)

 

Note 1.                                                          Basis of Presentation

 

The accompanying unaudited condensed consolidatedfinancial statements have been prepared in accordance with generally acceptedaccounting principles in the United States for interim financial information,and accordingly do not include all of the information and footnotes required bygenerally accepted accounting principles for complete financial statements. Inthe opinion of management, the accompanying unaudited condensed consolidatedfinancial statements contain all adjustments (consisting solely of normalrecurring adjustments) necessary to present fairly Tower Bancorp, Inc.’sconsolidated financial position as of March 31, 2006 and the results of itsoperations and cash flows for the three month periods ended March 31, 2006 and 2005.Information presented at December 31, 2005 is condensed from audited year-endfinancial statements included in the Annual Report on Form 10-K for the yearended December 31, 2005.

 

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

 

The results of operations for the three month periodsended March 31, 2006 and 2005 are not necessarily indicative of theresults to be expected for the full year.

 

Note 2.                                                          Income Taxes

 

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

 

Note 3.                                                          Commitments

 

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

 

Note 4.                                                          Entry into a Material Definitive Agreement/SubsequentEvent

 

On September 21, 2005, Tower Bancorp, Inc. (OTC BB:TOBC-OB)(“Tower”), parent company of The First National Bank of Greencastle andFNB Financial Corporation (OTC BB: FNBBD-OB)(“FNB”), parent company of TheFirst National Bank of McConnellsburg signed a definitive agreement to combinetheir companies.

 

8

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Pursuant to the terms of the agreement, FNBshareholders will be entitled to receive either 0.8663 shares of Tower commonstock or $ 39.00 for each share of FNB common stock. Each shareholder ofFNB will have the right to receive shares of Tower common stock for a portionof their shares and cash for the remaining portion of their shares. Shareholderelection will be subject to allocation procedures, which are intended to ensurethat a minimum 85% of the FNB common stock will be converted into shares ofTower common stock and up to 15% of the FNB common stock will be paid in cash. Thetotal value of the merger is valued at $ 31.2 million.

 

The transaction has received shareholder approvalsby Tower and FNB shareholders and on May 5, 2006 received final regulatoryapproval. The transaction is expected to close with an effective date of June1, 2006.

 

Note 5.                                                          Stock Option Plans

 

During the quarter ended March 31, 2006, theCorporation recognized compensation costs for the Corporation’s stock optionplans as determined based on the fair value at the grant dates for awards underthe plans consistent with the method prescribed by FASB Statement No. 123R.

 

The Corporation’s net income was reduced by$ 72,000 or 4 cents per share, as a result of implementing this newaccounting pronouncement.

 

During the quarter ended March 31, 2005, the Corporationapplied APB Opinion 25 and related interpretations in accounting for its stockoption plans. Accordingly, only compensation cost for the intrinsic value ofoptions has been recognized. Had compensation cost for the Corporation’s stockoption plans been determined based on the fair value at the grant dates forawards under the plans consistent with the method prescribed by FASB StatementNo. 123R, the Corporation’s net income and earnings per share would have beenadjusted to the pro forma amounts indicated below:

 
| ** **                            | ** ** | ** **  | ** ** | **2005  Three Months Ended  March 31** | ** ** |
|---------------------------------------|------------|-------------|------------|-------------------------------------------------------|------------|
| ** **                            | ** ** | ** **  | ** ** | ** **                                            |
|                                  |       |        |       |                                                  |       |
| Net income (000)  omitted             |       | As reported |       | $                                                     | 917        |   |
|                                  |       | Pro forma   |       | 883                                                   |       |
|                                  |       |        |       |                                                  |       |
| Basic earnings  per share             |       | As reported |       | 0.53                                                  |       |
|                                  |       | Pro forma   |       | 0.51                                                  |       |
|                                  |       |        |       |                                                  |       |
| Earnings per  share assuming dilution |       | As reported |       | 0.52                                                  |       |
|                                  |       | Pro forma   |       | 0.50                                                  |       |
|                                       |            |             |            |                                                       |            |  |

 

9

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ITEM 2.

 

MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION

ANDRESULTS OF OPERATIONS

 

March31, 2006

 

Thefollowing is management’s discussion and analysis of the significant changes inthe consolidated results of operations, capital resources and liquiditypresented in the accompanying unaudited consolidated financial statements forthe Company. This discussion should be read in conjunction with the preceding condensedconsolidated financial statements and related footnotes, as well as the Company’sDecember 31, 2005 Annual Report on Form 10-K. Current performance does notguarantee and may not be indicative of similar performance in the future.

 

Inaddition to historical information, this quarterly report on Form 10-Q containsforward-looking statements. The forward-looking statements contained in thisreport are subject to certain risks, assumptions and uncertainties. Because ofthe possibility of change in the underlying assumptions, actual results coulddiffer materially from those projected in the forward-looking statements.Additional factors that might cause actual results to differ materially fromthose expressed in the forward-looking statements include, but are not limitedto:

 

-                    operating, legal and regulatory risks,

 

-                    economic, political and competitive forcesaffecting the Company’s services, and

 

-                    the risk that management’s analyses of theserisks could be incorrect and/or that the strategies developed to address themcould be unsuccessful.

 

TheCompany’s forward-looking statements are relevant only as of the date on whichthe statements are made. By making forward-looking statements, the Companyassumes no duty to update them to reflect new, changing or unanticipated eventsor circumstances. Readers should carefully review the risk factors described inother periodic reports and public documents that the Company files from time totime with the Securities and Exchange Commission.

 

CRITICALACCOUNTING POLICIES

 

Disclosureof the Company’s significant accounting policies is included in Note 1 to theconsolidated financial statements of the Company’s Annual Report on Form 10-Kfor the year ended December 31, 2005. Some of these policies are particularlysensitive requiring significant judgments, estimates and assumptions to be madeby management. Additional information is contained on pages 12 and 15 of thisreport for the provision and allowance for loan losses.

 

10

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OVERVIEW

 

Netincome for the three months ended March 31, 2006 and 2005 was $1,210,000 and$917,000, respectively. The increase of $293,000, or 32.0%, is attributable tothe Company’s core banking business, where net interest income increased 15.7%,other income increased 68.1% and the provision for loan losses decreased 33.3%.On a basic and diluted per share basis, net income for the three months endedMarch 31, 2006 was $0.70 and $0.69, respectively, as compared with $0.53 and $0.52for the three months ended March 31, 2005. Net income as a percentage ofaverage assets on an annualized basis, also known as return on average assets,increased to 1.41% for the first three months of 2006 from 1.18% for the firstthree months of 2005 as a result of increased net income. Net income as apercentage of total average stockholders’ equity on an annualized basis, alsoknown as return on average equity, was 9.92% and 8.31% for the first threemonths of 2006 and 2005, respectively. The increase in this ratio is alsoattributable to an increased level of net income.

 

Duringthe first three months of 2006, the Company’s assets decreased $6,698,000, or1.9%, to $345,525,000 as of March 31, 2006 from $352,223,000 as ofDecember 31, 2005. This decrease is primarily attributable to reduction insecurity investments, which decreased to $79,330,000 as of March 31, 2006 from $83,157,000as of December 31, 2005 due mostly to the maturing of $6,000,000short-term bank owned investments purchased to match the funding provided by alarge money market deposit account opened in June 2005 for an estate. Totaldeposits decreased by $10,410,000, or 4.0%, during the first three months of2006 to $250,768,000 as of March 31, 2006 from $261,178,000 as ofDecember 31, 2005. This compares to an increase of $2,463,000, or 1.1%, to$232,753,000 at March 31, 2005 from $230,290,000 as of December 31, 2004. Thedecrease in total deposits during the first three months of 2006 was dueprimarily to one money market account for an estate that distributed proceedsduring the first three months of 2006. As a result of competition in themarket, and, to a certain degree, customers’ continued uncertainty as to how tobest invest their monies, deposit growth may not be assumed at the currentrates.

 

RESULTSOF OPERATIONS

 

NetInterest Income

 

Forthe three months ended March 31, 2006, total interest income increased by $917,000,or 24.6%, to $4,642,000 as compared with $3,725,000 for the three months endedMarch 31, 2005. This increase is primarily due to investment security growthand an increase in the one year Treasury rate and the prime rate. This increaseis the result of a 10.4% increase in average interest-earning assets, whichgrew to $325,953,000 for the first three months of 2006, from $295,371,000 forthe first three months of 2005. The growth in average interest earning assetswas partially attributable to increased investment securities, which werefunded from the cash flow generated from the reduction of overnight borrowingsand deposit growth. In addition, management targeted efforts to attractmortgage and small commercial loans. Further impacting interest income were two25-basis point increases in the prime rate, increases in the Federal funds rateand increases in the one year Treasury during the first three months of 2006that resulted in higher yields on interest earning assets.

 

11

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Totalinterest expense increased by $500,000, or 46.6%, to $1,573,000 for the threemonths ended March 31, 2006 from $1,073,000 for the three months ended March 31,2005. This increase is not only attributable to the increased deposit balancesand the increased costs associated with attracting deposits at a time whenshort-term interest rates are rising, but is also impacted by the higher costsassociated with borrowings. Increases in rates were needed to attract deposits,particularly money market accounts, which increased 141 basis points to 2.43%. Theinterest expense for money market accounts increased $215,000 to $310,000 forthe three months ended March 31, 2006, from $95,000 for the three months endedMarch 31, 2005.

 

Netinterest income increased by $417,000, or 15.7%, to $3,069,000 for the threemonths ended March 31, 2006 from $2,652,000 for the three months ended March31, 2005. This increase is attributable to the repricing of mortgages and, to alesser extent, commercial loans tied to the one year treasury and prime ratesplus the increased earning assets funded by deposit growth. The net interestrate spread was 3.5% for the three months ending March 31, 2006, and the netinterest margin was 4.0%. Due to a large investment portfolio at the holdingcompany level, these ratios are lower than the Bank’s separate performance of4.2% net interest spread and 4.4% net interest margin for the same period in2005.

 

Provisionfor Loan Losses

 

Theprovision for loan losses was $60,000 for the three months ended March 31,2006 compared with $90,000 for the three months ended March 31, 2005, a deceaseof 33.3%. The decrease in the provision is attributable to the consistency inthe high quality of the loan portfolio.

 

Theallowance for loan losses represented 0.96% of total loans at March 31, 2006,compared with 0.93% as of December 31, 2005 and 0.87% as of March 31, 2005.Management performs ongoing assessments of the loan loss reserve in relation toloan portfolio growth, credit exposure to individual borrowers, overall trendsin the loan portfolio and other relevant factors. Based upon these factors,management believes that as of March 31, 2006, the reserve is reasonable andsufficient to support the increased loan growth in light of the strong assetquality as supported by the ratios reflected in Table 2 on page 16.

 

OtherIncome

 

Forthe three months ended March 31, 2006, other income was $1,074,000, an increaseof $435,000, or 68.1%, compared with other income of $639,000 for the threemonths ended March 31, 2005. The increase was primarily due to an increase of $216,000in gains from the sale of equity securities, which were $414,000 for the threemonths ended March 31, 2006 and $198,000 for the three months ended March 31,2005. Other income was positively impacted by increases of $48,000 in NSF fees,$36,000 in investment services, $30,000 in mortgage banking activities, whichwas a new offering as of June 2005, and $28,000 in ATM fees.

 

12

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OtherExpenses

 

Otherexpenses, which include salary, occupancy, equipment and all other expensesincidental to the operation of the Company, increased to $2,461,000 for thethree months ended March 31, 2006 from 1,976,000 for the three months endedMarch 31, 2005. The $485,000, or 24.5% increase was primarily due to increasesin salary and benefits, occupancy costs and accounting/consulting fees relatedto SOX 404 compliance.

 

Salariesand employee benefit expenses, which make up the largest component of otherexpenses, increased $229,000, or 20.7%, to $1,336,000 for the three monthsended March 31, 2006 from $1,107,000 for the three months ended March 31, 2005.The increase is primarily attributable to the increase in salary expenses of$158,000 and the associated benefit costs.

 

Occupancyand equipment expenses increased $89,000, or 19.4%, to $549,000 for the threemonths ended March 31, 2006 from $460,000 for the three months ended March 31,2005. The increase is primarily due to increased depreciation and computerservices and rent expense associated with a lease agreement entered into inJune 2005 for a new office located on Eastern Boulevard, Hagerstown.

 

Otheroperating expenses during the three months ended March 31, 2006 increased$167,000, or 40.8% to $576,000 from $409,000 during the three months endedMarch 31, 2005. This increase was primarily due to increases of $39,000 inholding company expenses, $23,000 in accounting fees, $16,000 in postage and$12,000 in state taxes.

 

IncomeTaxes

 

Incometax expense was $412,000 for the three months ended March 31, 2006, an increaseof $104,000, or 33.8%, compared with $308,000 for the three months ended March31, 2005. The increased tax expense is consistent with the higher level of netincome.

 

NetIncome

 

Netincome for the three months ended March 31, 2006 was $1,210,000, an increase of$293,000, or 32.0%, compared with $917,000 for the three months ended March 31,2005. The increase in net income is the result of increases of $417,000 in netinterest income, $435,000 in other income, and a decrease of $30,000 in theprovision for loan losses, offset by increases of $485,000 in other expensesand $104,000 in taxes. Basic and diluted earnings per share for the threemonths ended March 31, 2006 were $0.70 and $0.69 as compared with $0.53 and$0.52 for the three months ended March 31, 2005.

 

FINANCIALCONDITION

 

Securities

 

TheCompany’s securities portfolio is comprised of securities that not only provideinterest and dividend income, including tax-exempt income, but also provide asource of liquidity, diversify the earning assets portfolio, allow for themanagement of risk and tax liability, and provide collateral for repurchaseagreements and public fund deposits. Policies are in place to address variousaspects of managing the portfolio, including but not limited to,concentrations, liquidity, credit quality, interest rate sensitivity andregulatory guidelines.

 

13

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Althoughthe Company generally intends to hold its investment securities to maturity, asignificant portion of the securities portfolio is classified as available forsale, with new purchases generally categorized as such. Securities in theavailable for sale category are accounted for at fair value with unrealizedappreciation or depreciation, net of tax, reported as a separate component ofstockholders’ equity. Securities in the held to maturity category are accountedfor at amortized cost. All securities held as of March 31, 2006 are classifiedas available for sale. The Company holds no trading securities in its portfolio.The securities portfolio includes equities owned by the holding company, mostof which are investments in banks, bank holding companies and financialinstitutions. Equity investments are accounted for at fair market value. Theremaining securities, primarily debt instruments, are owned by the bank.

 

Theconsolidated securities portfolio at March 31, 2006 was $79,330,000, comparedto $83,157,000 at December 31, 2005, a decrease of $3,827,000, or 4.6%. Thedecrease is due primarily to the maturing of $6,000,000 short-term bank ownedinvestments purchased to match the funding provided by a large money marketdeposit account open in June 2005 for an estate.

 

BankOwned Securities

 

Thebank owned securities portfolio at March 31, 2006 was $40,218,000, compared to$46,422,000 at December 31, 2005, a decrease of $6,204,000, or 13.4%. Thedecrease is due primarily to the maturing of $6,000,000 short-term bank ownedinvestments purchased to match the funding provided by a large money marketdeposit account open in June 2005 for an estate.

 

Thecarrying value of the available for sale portion of the portfolio atMarch 31, 2006 includes an unrealized gain of $737,000 (reflected asaccumulated other comprehensive income of $487,000 in stockholders’ equity, netof a deferred income tax liability of $250,000). This compares with anunrealized gain at December 31, 2005 of $723,000 (reflected as accumulatedother comprehensive income of $477,000 in stockholders’ equity, net of adeferred income tax liability of $246,000).

 

HoldingCompany Owned Securities

 

Thesecurities portfolio at March 31, 2006 was $39,112,000, compared to $36,735,000at December 31, 2005, an increase of $2,378,000, or 6.5%. The increase isattributable to the purchase of $6,046,000 equity securities plus $1,397,000increase of unrealized gains less the sale of $5,479,000 equity securities. Gainon sale of equity securities was $414,000.

 

Thecarrying value of the available for sale portion of the portfolio at March 31,2006 includes an unrealized gain of $15,155,000 (reflected as accumulated othercomprehensive income of $10,002,000 in stockholders’ equity, net of a deferredincome tax liability of $5,153,000). This compares with an unrealized gain atDecember 31, 2005 of $13,758,000 (reflected as accumulated other comprehensiveincome of $9,080,000 in stockholders’ equity, net of a deferred income taxliability of $4,678,000).

 

14

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Loans

 

Theloan portfolio comprises the major component of the Company’s earning assetsand generally is the highest yielding asset category. Gross loans receivable,net of unearned fees and origination costs, decreased $1,043,000, or 0.5%, to$228,265,000 at March 31, 2006 from $229,308,000 at December 31, 2005. Grossloans represented 91.0% of total deposits at March 31, 2006 as comparedwith 87.8% at December 31, 2005, since deposit decreases have outpacedloan decreases. Commercial loan growth was modest while mortgage loansdecreased during the first three month of 2006. In June 2005, the Company beganselling mortgage loans to Federal Home Loan Bank of Pittsburgh in order tooffer long term fixed rate mortgages while managing long term interest raterisk.

 

CreditRisk and Loan Quality

 

TheCompany continues to be prudent in its efforts to minimize credit risk. TheBank’s written lending policy requires underwriting, loan documentation andcredit analysis standards to be met prior to the approval and funding of anyloan. In accordance with that policy, the loan review process monitors the loanportfolio on an ongoing basis. The Credit Administration area and theaccounting department then prepares an analysis of the allowance for loanlosses which is then submitted to the Board of Directors for its assessment asto the adequacy of the allowance. The allowance for loan losses is anaccumulation of expenses that has been charged against past and presentearnings in anticipation of potential losses in the loan portfolio.

 

Theallowance for loan losses at March 31, 2006 and December 31, 2005 was$2,202,000 and $2,129,000, respectively, compared to $1,993,000 at March 31,2005. The increase in the allowance is attributable to the shift in the loanmix, where there has been continued growth in commercial loans, which generallycarry a higher level of credit risk. At March 31, 2006, the allowance for loanlosses represented 0.96% of the gross loan portfolio, compared with 0.93% atDecember 31, 2005. This compares to 0.87% at March 31, 2005. At March 31, 2006,in consideration 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.

 

15

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Table1 -”Analysis of Allowance for Loan Loss” -details the activity, which occurredin the allowance over the first three months of 2006 and 2005.

 

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

 
| **(in thousands)**                             | ** ** | **2006** | ** ** | **2005** | ** ** |
|-----------------------------------------------------|------------|----------|------------|----------|------------|
| Balance, January  1                                 |       | $        | 2,129      |     | $          | 1,902 |   |
| Provision  charged to operating expense             |       | 60       |       | 90       |       |
| Charge-offs:                                        |       |     |       |     |       |
| Commercial                                          |       | 0        |       | 0        |       |
| Real Estate                                         |       | 0        |       | 0        |       |
| Consumer                                            |       | (2       | )          | (7       | )          |
| Total  charge-offs                                  |       | (2       | )          | (7       | )          |
|                                                |       |     |       |     |       |
| Recoveries:                                         |       |     |       |     |       |
| Commercial                                          |       | 1        |       | 3        |       |
| Real Estate                                         |       | 0        |       | 0        |       |
| Consumer                                            |       | 14       |       | 5        |       |
| Total Recoveries                                    |       | 15       |       | 8        |       |
|                                                |       |     |       |     |       |
| Net charge-offs                                     |       | 13       |       | 1        |       |
|                                                |       |     |       |     |       |
| Balance, March  31                                  |       | $        | 2,202      |     | $          | 1,993 |   |
|                                                |       |     |       |     |       |
| Net charge-offs  or recoveries to average net loans |       | 0.01     |       | 0.00     |       |

 

----

(1)   Bank’s loan portfolio isentirely domestic

 

TheBank’s lending policy is executed through the assignment of tiered loan limitauthorities to individual officers of the Bank, the Officer’s Loan Committeeand the Board of Directors. Although the Bank maintains sound credit policies,certain loans may deteriorate for a variety of reasons. The Bank’s policy is toplace all loans on a non-accrual status upon becoming 90 days delinquent intheir payments, unless there is a documented and reasonable expectation of thecollection of the delinquent amount. Loans are reviewed monthly as to theirstatus, and on a quarterly basis presented to the Board of Directors.Management is not aware of any material potential loan problems that have notbeen disclosed in this report.

 

Table2 – “Assets Quality Ratios” – summarizes pertinent asset quality ratios atMarch 31, 2006 and December 31, 2005.

 

**Table 2 - Asset Quality Ratios**

 
| ** **                                  | ** ** | **3/31/06** | ** ** | **12/31/05** | ** ** |
|---------------------------------------------|------------|-------------|------------|--------------|------------|
| Non-accrual  loans/total loans              |       | 0.01        | %          | 0.02         | %          |
| Non-performing  assets (1)/total loans      |       | 0.01        | %          | 0.05         | %          |
| Net charge offs  (recoveries)/average loans |       | (0.01       | )%         | 0.02         | %          |
| Allowance/total  loans                      |       | 0.96        | %          | 0.93         | %          |
| Allowance/non-accrual  loans                |       | 104.86      | %          | 47.31        | %          |
| Allowance/non-performing  loans (1)         |       | 78.64       | %          | 20.47        | %          |

 

----

(1)   Includes non-accrual loans

 

16

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AtMarch 31, 2006, the Company had other real estate owned (not used inoperations) in the amount of $1,635,000, which was the same amount as ofDecember 31, 2005. At March 31, 2006 and December 31, 2005, the Company hadnon-accrual loans in the amount of $21,000 and $45,000, respectively.

 

Loanconcentrations are considered to exist when the total amount of loans to anyone or a multiple number of borrowers engaged in similar activities or havingsimilar characteristics exceeds 10% of loans outstanding in any one category.The Company maintains a diversified loan portfolio, granting agribusiness,commercial and residential loans to customers. The majority of the Bank’slending is made within its primary market area, which includes southernFranklin County, Pennsylvania and northern Washington County, Maryland.

 

BankOwned Life Insurance

 

TheCompany has Bank Owned Life Insurance (“BOLI”) for a chosen group of employees,namely officers, where the Bank is the owner and beneficiary of the policies.The Bank’s deposits and proceeds from the sale of investment securities fundedthe BOLI. Earnings from the BOLI are recognized as other income. The BOLI isprofitable from the appreciation of the cash surrender values of the pool ofinsurance, and its tax advantage to the Company. This profitability is used tooffset a portion of current and future employee benefit costs and aNonqualified Supplemental Executive Retirement Plan for the Company’s ChiefExecutive Officer.

 

TheCompany had $7,465,000 and $7,387,000 in BOLI as of March 31, 2006 and December 31,2005, respectively. Although the BOLI is an asset that may be liquidated, it isthe Company’s intention to hold this pool of insurance because it providestax-exempt income that lowers the Company’s tax liability, while enhancing itsoverall capital position.

 

Deposits

 

Depositsare the major source of the Company’s funds for lending and investmentpurposes. Total deposits at March 31, 2006 were $250,768,000, a decrease of$10,410,000, or 4.0%, from total deposits of $261,178,000 at December 31, 2005.The decrease in deposits included a money market account opened June 2005 foran estate with a $12,800,000 balance on December 31, 2005 that was disbursedprior to March 31, 2006. Time deposit accounts increased $3,099,000 during thefirst three months of 2006. The cost of deposits has increased due to theincreased costs associated with attracting deposits at a time when short terminterest rates are rising. Higher rates impacted the cost of interest bearingdeposits, which increased to 1.95% as of March 2006 from 1.79% as of December2005 and 1.31% as of March 2005.

 

Short-TermBorrowings

 

Shortterm borrowings at March 31, 2006 were $6,077,000, compared to $5,516,000 atDecember 31, 2005, an increase of $561,000, or 10.2%. Federal funds purchased,Treasury Tax and Loan demand note, lines of credits with banks and overnightborrowings with the Federal Home Loan Bank of Pittsburgh are considered to beshort term borrowings. Short term borrowings fluctuate

 

17

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dailyto meet the liquidity needs of the Company. The Company had short term sourcesof borrowings in the amount of $25,000,000 overnight line from the Federal HomeLoan Bank of Pittsburgh and $10,100,000 from area banks. As of December 31,2005, the maximum borrowing capacity with the Federal Home Loan Bank ofPittsburgh is approximately $169,249,000, of which the $25,000,000 overnightline is part.

 

Long-TermDebt and Borrowing Capacity

 

Therewere $30 million outstanding in fixed rate term loans with the Federal HomeLoan Bank of Pittsburgh at March 31, 2006, the same amount borrowed at December31, 2005 and March 31, 2005. The $30 million borrowing is comprised of thefollowing fixed rate borrowings (in thousands):

 
| **Maturity**        | ** ** | **Loan Type** | ** ** | **Amount** | ** ** | **Rate** | ** ** |
|---------------------|------------|--------------------|------------|------------|------------|----------|------------|
| September 15,  2008 |       | Convertible        |       | $          | 5,000      |     | 5.40       | % |
| November 20,  2008  |       | Convertible        |       | 5,000      |       | 4.63     | %          |
| November 24,  2008  |       | Convertible        |       | 5,000      |       | 5.01     | %          |
| April 6, 2011       |       | Convertible        |       | 5,000      |       | 5.25     | %          |
| November 27,  2012  |       | Convertible        |       | 5,000      |       | 3.99     | %          |
| May 7, 2018         |       | Convertible        |       | 5,000      |       | 4.13     | %          |
|                |       | Total              |       | $          | 30,000     |     | 4.74       | % |

 

TheBank has a total maximum borrowing capacity for both short and long-termborrowings of approximately $169,249,000 with the Federal Home Loan Bank ofPittsburgh, out of which $30 million represents fixed rate term loans, thatwere outstanding at March 31, 2006, and resulted in an unused borrowingcapacity of $139,249,000.

 

Asset/LiabilityManagement

 

Themanagement of interest rate risk involves measuring and analyzing the maturityand repricing of interest-earning assets and interest bearing liabilities atspecific points in time. The imbalance between interest-earning assets andinterest bearing liabilities is commonly referred to as the interest rate gap.The interest rate gap is one measure of the risk inherent in the existingbalance sheet as it relates to potential changes in net interest income.Maintaining an appropriate balance between interest-earning assets and interestbearing liabilities is a means of monitoring and possibly avoiding materialfluctuations in the net interest margin during periods of changing interestrates.

 

TheCompany’s overall sensitivity to interest rate risk is low due to itsnon-complex balance sheet. The Company manages its balance sheet with theintent of stabilizing net interest income and net economic value under a broadrange of interest rate environments. The Company has the ability to effectvarious strategies to manage interest rate risk, which include, but are notlimited to, selling newly originated residential mortgage loans, controllingthe volume mix of fixed/variable rate commercial loans, mortgage loans andsecurities, increasing/ decreasing deposits via interest rate changes,borrowing from the Federal Home Loan Bank of Pittsburgh, and buying/sellingsecurities. Adjustments to the mix of assets and liabilities are madeperiodically in an effort to give the Company dependable and steady growth innet interest income, while at the same time, managing the related risks.

 

18

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Liquidity

 

Liquidityrepresents the Company’s ability to efficiently manage cash flows at reasonablerates to support possible commitments to borrowers or the demands ofdepositors. Liquidity is essential to compensate for fluctuations in thebalance sheet and provide funds for growth and normal operating expenditures.Liquidity needs may be met by converting assets into cash or obtaining sourcesof additional funding.

 

Liquidityfrom asset categories is provided through cash, amounts due from banks,interest-bearing deposits with banks and federal funds sold, which were$21,098,000 at March 31, 2006, compared to $24,920,000 at December 31, 2005.Additional asset liquidity sources include principal and interest payments fromsecurities in the Company’s investment portfolio and cash flow from itsamortizing loan portfolio. Longer-term liquidity needs may be met by sellingsecurities available for sale, selling loans or raising additional capital. AtMarch 31, 2006, there were $63,965,000 in liquid securities as compared to$67,601,000 at December 31, 2005. Liquid securities decreased by $3,636,000since year end due to sales, calls and maturity of investment securitiesexceeding purchases.

 

Liabilityliquidity sources include attracting deposits at competitive rates. Deposits atMarch 31, 2006 were $250,768,000, compared to $261,178,000 at December 31,2005. In addition, the Company has borrowing capacity and lines of credit theFederal Home Loan Bank of Pittsburgh, Atlantic Central Bankers Bank and severallocal banks.

 

TheCompany’s financial statements do not reflect various off-balance sheetcommitments that are made in the normal course of business, which may involvesome liquidity risk. Off-balance sheet arrangements are discussed in detailbelow.

 

Managementis of the opinion that its liquidity position, at March 31, 2006, is adequateto respond to fluctuations “on” and “off” the balance sheet. In addition,management knows of no trends, demands, commitments, events or uncertaintiesthat may result in, or that are reasonably likely to result in the Company’sinability to meet anticipated or unexpected liquidity needs.

 

Off-BalanceSheet Arrangements

 

TheCompany’s financial statements do not reflect various off-balance sheetarrangements that are made in the normal course of business. These commitmentsconsist mainly of loans approved but not yet funded, unused lines of credit andletters of credit made in accordance with the same standards as on-balancesheet instruments. Unused commitments at March 31, 2006 were $70,553,000, whichconsisted of $69,154,000 in unfunded commitments to existing loans and unfundednew loans and $1,399,000 in letters of credit. Because these instruments havefixed maturity dates, and because many of them will expire without being drawnupon, they do not generally present a significant liquidity risk to theCompany. Management believes that any amounts actually drawn upon can be fundedin the normal course of operations. The Company has no investment in orfinancial relationship with any unconsolidated entities that are reasonablylikely to have a material effect on liquidity or the availability of capitalresources.

 

19

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Capital

 

Thefollowing Table 3 presents the risk-based and leverage capital amounts andratios at March 31, 2006 for the Company and the Bank.

 

**Table 3 - Capital Ratios**

 
| ** **                                      | ** ** | **Actual**                           | ** ** | **Minimum for  Capital Adequacy  Purposes** | ** ** | **To be Well  Capitalized under  Prompt Corrective  Action Provisions** | ** ** |
|-------------------------------------------------|------------|--------------------------------------|------------|-------------------------------------------------------|------------|--------------------------------------------------------------------------------------------------|------------|
| ** **                                      | ** ** | **Amount**                           | ** ** | **Ratio**                                             | ** ** | **Amount**                                                                                       | ** ** | **Ratio** | ** ** | **Amount** | ** ** | **Ratio** | ** ** |
| ** **                                      | ** ** | **(Dollars in Thousands)** | ** ** |
| Total risk based  capital/risk weighted assets: |       |                                 |       |                                                  |       |                                                                                             |       |   |   |   |   |   |   |
| Company                                         |       | $                                    | 48,926     |                                                  | 21.9       | %                                                                                                | >17,894 |   | >8.0 | % | N/A |   | N/A |   |
| Bank                                            |       | 27,406                               |       | 14.1                                                  | %          | >15,595                                                                                       |       | >8.0 | % | 19,494 |   | >10.0 | % |
|                                            |       |                                 |       |                                                  |       |                                                                                             |       |   |   |   |   |   |   |
| Tier 1  capital/risk weighted assets:           |       |                                 |       |                                                  |       |                                                                                             |       |   |   |   |   |   |   |
| Company                                         |       | 39,904                               |       | 17.8                                                  | %          | >8,947                                                                                        |       | >4.0 | % | N/A |   | N/A |   |
| Bank                                            |       | 25,204                               |       | 12.9                                                  | %          | >7,797                                                                                        |       | >4.0 | % | 11,696 |   | >6.0 | % |
|                                            |       |                                 |       |                                                  |       |                                                                                             |       |   |   |   |   |   |   |
| Tier 1  capital/average assets                  |       |                                 |       |                                                  |       |                                                                                             |       |   |   |   |   |   |   |
| Company                                         |       | 39,904                               |       | 11.9                                                  | %          | >13,469                                                                                       |       | >4.0 | % | N/A |   | N/A |   |
| Bank                                            |       | 25,204                               |       | 8.1                                                   | %          | >12,424                                                                                       |       | >4.0 | % | >15,530 |   | >5.0 | % |
|                                                 |            |                                      |            |                                                       |            |                                                                                                  |            |  |  |  |  |  |  |  |

 

Thesecapital ratios continue to remain at levels, which are considered to be “well-capitalized”as defined by regulatory guidelines.

 

Bankinglaws and regulations limit the amount of cash dividends that may be paidwithout prior approval from the Company’s regulatory agencies. In abidance withsuch requirements, on March 22, 2006, the Board of Directors authorized anddeclared a quarterly cash dividend in the amount of $0.24 per share, payable onApril 21, 2006 to all shareholders of record as of April 3, 2006. Thepayment of this quarterly cash dividend decreased retained earnings by$415,000.

 

**ITEM 3 - QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK**

 

Therehave been no material changes to the quantitative and qualitative disclosuresmade in Tower Bancorp’s annual report on Form 10-K for the year ended December31, 2005.

 

20

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**ITEM 4 - CONTROLS AND PROCEDURES**

 

**CONTROLSAND PROCEDURES**

 

The Corporation’s Chief Executive Officer and Chief Financial Officerhave evaluated the effectiveness of the Corporation’s disclosure controls andprocedures (as such term is defined in the Rules 13a-15(e) under the SecuritiesExchange Act of 1934, as amended (the “Exchange Act”))as of March 31, 2006. Basedon such evaluation, such officers have concluded that, as of March 31, 2006,the Corporation’s disclosure controls and procedures are effective in alertingthem on a timely basis to material information relating to the Corporation(including its consolidated subsidiary) required to be included in theCorporation’s periodic filings under the Exchange Act.

 

**CHANGESIN INTERNAL CONTROLS**

 

There have not been any significant changes in the Corporation’sinternal control over financial reporting or in other factors that materiallyaffected or are reasonably likely to materially affect such control during the firstquarter of 2006.

 

21

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PART II – OTHER INFORMATION

 

22

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Item 1 – Legal Proceedings

 

The nature of the Company’s business generates somelitigation 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. No legalproceedings are pending other than ordinary routine litigation incidental tothe business of the Company and the Bank. In addition, to Management’sknowledge, no governmental authorities have initiated or contemplated anymaterial legal actions against the Company or the Bank.

 

Item 1A – Risk Factors

 

There have been no 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, 2005.

 

Item 2 – Unregistered Sales of Equity Securities andUse 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 2006  |       | None                                                  |       | N/A                                               |       | None                                                                                                   |       | 9,585                                                                                                     |       |
|          |       |                                                  |       |                                              |       |                                                                                                   |       |                                                                                                      |       |
| February 2006 |       | 1,500                                                 |       | 45.25                                             |       | 1,500                                                                                                  |       | 8,085                                                                                                     |       |
|          |       |                                                  |       |                                              |       |                                                                                                   |       |                                                                                                      |       |
| March 2006    |       | None                                                  |       | N/A                                               |       | None                                                                                                   |       | 8,085                                                                                                     |       |
|          |       |                                                  |       |                                              |       |                                                                                                   |       |                                                                                                      |       |
| Total         |       | 1,500                                                 |       | 45.25                                             |       | 1,500                                                                                                  |       | 8,085                                                                                                     |       |

 

Item 3 - Defaults Upon Senior Securities

 

Not applicable

 

Item 4 - Submission of Matters to a Vote of SecurityHolders

 

A special meeting of the shareholders of TowerBancorp, Inc. was held on March 14, 2006. The matter that was voted on bysecurity holders was approval and adoption of the Agreement and Plan of Mergerbetween Tower Bancorp, Inc. and FNB Financial Corporation. The merger agreementwas adopted and approved by a vote of 1,210,804 in favor, 28,277 against, and8,437 abstaining. No other matters were voted upon at the special meeting.

 

23

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Item 5 - Other Information

 

Not applicable

 

Item 6 – Index to Exhibits

 
| **Exhibit** | ** ** | **Description of Exhibit**                                                                                                                                                                                                                                                                                          |
|-------------|------------|-------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
|        |       |                                                                                                                                                                                                                                                                                                                          |
| 2.1         |       | Agreement and Plan of  Merger, dated as of September 21, 2005, by and between Tower Bancorp, Inc.  and FNB Financial Corporation (incorporated by reference to Annex A to Tower  Bancorp, Inc.’s Proxy Statement/ Prospectus to the Registration Statement on  Form S-4 (File No. 333-130485 filed on January 25, 2006). |
|        |       |                                                                                                                                                                                                                                                                                                                          |
| 3.1         |       | Articles  of Incorporation of Tower Bancorp, Inc. (incorporated by reference to Exhibit  3.1 of Tower Bancorp, Inc.’s Form 10-Q for the quarter ended September 30,  2005).                                                                                                                                              |
|        |       |                                                                                                                                                                                                                                                                                                                          |
| 3.2         |       | Bylaws  of Tower Bancorp, Inc. (incorporated by reference to Exhibit 3.2 of Tower  Bancorp, Inc.’s Form 10-Q for the quarter ended September 30, 2005).                                                                                                                                                                  |
|        |       |                                                                                                                                                                                                                                                                                                                          |
| 10.1        |       | Change of Control  Agreement of Jeffrey B. Shank dated as of September *25,*2002 (incorporated by referenced to  Exhibit 99.4 of Tower Bancorp, Inc.’s Form 10-Q for the quarter ended  September 30, 2002).                                                                                                             |
|        |       |                                                                                                                                                                                                                                                                                                                          |
| 10.2        |       | Change of Control  Agreement of Franklin T. Klink, III dated as of November 26, 2001  (incorporated by reference to Exhibit 10.1 of Tower Bancorp, Inc.’s Form 10-K  for the year ended December 31, 2001).                                                                                                              |
|        |       |                                                                                                                                                                                                                                                                                                                          |
| 10.3        |       | Change of Control  Agreement of Donald G. Kunkle dated as of January *4,*2002 (incorporated by reference to Exhibit 10.2 of  Tower Bancorp, Inc.’s Form 10-K for the year ended December 31, 2001).                                                                                                                      |

 

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| **Exhibit** | ** ** | **Description of Exhibit**                                                                                                                                                                                                             |
|-------------|------------|--------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
|        |       |                                                                                                                                                                                                                                             |
| 10.4        |       | Change of Control  Agreement of John H. McDowell, Sr. dated as of December 23, 1998  (incorporated by reference to Exhibit 10.2 of Tower Bancorp, Inc.’s Form 10-K  for the year ended December 31, 1998).                                  |
|        |       |                                                                                                                                                                                                                                             |
| 10.5        |       | Tower Bancorp, Inc.’s 1995  Non-Qualified Stock Option Plan (incorporated by reference to Exhibit 99.1 to  Tower Bancorp, Inc.’s Registration Statement on Form S-8 (File No. 333-4066  1)).                                           |
|        |       |                                                                                                                                                                                                                                             |
| 10.6        |       | Tower Bancorp, Inc. Stock  Option Plan for Outside Directors (incorporated by reference to Exhibit 99.2  to Tower Bancorp, Inc.’s Registration Statement on Form S-8 (File No.  333-40661)).                                                |
|        |       |                                                                                                                                                                                                                                             |
| 10.7        |       | Supplemental Executive  Retirement Agreement of Jeffrey B. Shank dated as of September *25,*2002 (incorporated by reference to  Exhibit 99.3 of Tower Bancorp, Inc.’s Form 10-Q for the quarter ended  September 30, 2002).                 |
|        |       |                                                                                                                                                                                                                                             |
| 10.8        |       | Form of Amendment and  Restatement of the First National Bank of Greencastle Group Term Replacement  Plan A (incorporated by reference to Exhibit 10.8 of Tower Bancorp, Inc.’s  Registration Statement on Form S-4 (File No. 333-130485)). |
|        |       |                                                                                                                                                                                                                                             |
| 10.9        |       | Form of Amendment and  Restatement of the First National Bank of Greencastle Group Term Replacement  Plan B (incorporated by reference to Exhibit 10.8 of Tower Bancorp, Inc.’s  Registration Statement on Form S-4 (File No. 333-130485)). |

 

25

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| **Exhibit** | ** ** | **Description of Exhibit**                                                                                                                                                                                                        |
|-------------|------------|---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
|        |       |                                                                                                                                                                                                                                        |
| 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)). |
|        |       |                                                                                                                                                                                                                                        |
| 31.1        |       | Certification of Chief Executive Officer pursuant to Section 302 of  the Sarbanes-Oxley Act of 2002.                                                                                                                                        |
|        |       |                                                                                                                                                                                                                                        |
| 31.2        |       | Certification of Chief Financial Officer pursuant to Section 302 of  the Sarbanes-Oxley Act of 2002.                                                                                                                                        |
|        |       |                                                                                                                                                                                                                                        |
| 32.1        |       | Certification of Chief Executive Officer pursuant to 18 U.S.C.  Section 1350                                                                                                                                                                |
|        |       |                                                                                                                                                                                                                                        |
| 32.2        |       | Certification of Chief Financial Officer pursuant to 18 U.S.C.  Section 1350                                                                                                                                                                |

 

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SIGNATURES

 

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

 

 
|   | TOWER BANCORP, INC.            |
|--------|--------------------------------|
|   | (REGISTRANT)                   |
|   |
|   |
|   | /s/ Jeff B. Shank              |   |
|   | Jeff B. Shank, President, CEO  |
|   | (Principal Executive  Officer) |
| Date:  | May 10, 2006                   |   |   |
|   |
|   |
|   | /s/Franklin T. Klink, III      |   |
|   | Franklin T. Klink, III,        |
|   | Treasurer                      |
|   | (Chief Financial Officer)      |
| Date:  | May 10, 2006                   |   |   |
|        |                                |  |  |  |  |

 

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