Penns Woods Bancorp (PWOD) 10-Q 2010 Q2 Quarterly report

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, D.C.  20549

FORM 10-Q

xQuarterly Report pursuant to Section 13 or 15 (d) of the Securities Exchange Act of 1934

for the Quarterly Period Ended June 30, 2010.

oTransition report pursuant to Section 13 or 15 (d) of the Exchange Act

for the Transition Period from                                to                               .

No. 0-17077

(Commission File Number)

PENNS WOODS BANCORP, INC.

(Exact name of Registrant as specified in its charter)

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

300 Market Street, P.O. Box 967 Williamsport, Pennsylvania	17703-0967
(Address of principal executive offices)	(Zip Code)

(570) 322-1111

Registrant’s telephone number, including area code

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.  YES  x  NO  o

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).  YES  o  NO  o

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

Large accelerated filer o	Accelerated filer x
Non-accelerated filer o	Small reporting company o

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).  YES  o  NO  x

On August 5, 2010 there were 3,833,849 shares of the Registrant’s common stock outstanding.

PENNS WOODS BANCORP, INC.

INDEX TO QUARTERLY REPORT ON FORM 10-Q

		Page
		Number
Part I	Financial Information
Item 1.	Financial Statements
Consolidated Balance Sheet (unaudited) as of June 30, 2010 and December 31, 2009		3
Consolidated Statement of Income (unaudited) for the Three and Six Months ended June 30, 2010 and 2009		4
Consolidated Statement of Changes in Shareholders’ Equity (unaudited) for the Six Months ended June 30, 2010 and 2009		5
Consolidated Statement of Comprehensive Income (unaudited) for the Three and Six Months ended June 30, 2010 and 2009		5
Consolidated Statement of Cash Flows (unaudited) for the Six Months ended June 30, 2010 and 2009		6
Notes to Consolidated Financial Statements (unaudited)		7
Item 2.	Management’s Discussion and Analysis of Financial Conditionand Results of Operations	22
Item 3.	Quantitative and Qualitative Disclosures About Market Risk	40
Item 4.	Controls and Procedures	40
Part II	Other Information
Item 1.	Legal Proceedings	41
Item 1A.	Risk Factors	41
Item 2.	Unregistered Sales of Equity Securities and Use of Proceeds	41
Item 3.	Defaults Upon Senior Securities	41
Item 4.	(Removed and Reserved)	41
Item 5.	Other Information	41
Item 6.	Exhibits	42
Signatures		43
Exhibit Index and Exhibits		44

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Part I.  FINANCIAL INFORMATION

Item 1.  Financial Statements

PENNS WOODS BANCORP, INC.

CONSOLIDATED BALANCE SHEET

(UNAUDITED)

	June 30,			December 31,
(In Thousands, Except Share Data)	2010			2009
ASSETS:
Noninterest-bearing balances	$	12,378		$	13,760
Interest-bearing deposits in other financial institutions	11,963			28
Total cash and cash equivalents	24,341			13,788
Investment securities, available for sale, at fair value	225,625			208,768
Investment securities held to maturity (fair value of $83 and $108)	82			107
Loans held for sale	5,584			4,063
Loans	411,960			405,529
Less: Allowance for loan losses	5,047			4,657
Loans, net	406,913			400,872
Premises and equipment, net	7,966			7,988
Accrued interest receivable	3,673			3,523
Bank-owned life insurance	15,188			14,942
Investment in limited partnerships	4,615			4,898
Goodwill	3,032			3,032
Deferred tax asset	8,399			9,491
Other assets	4,873			4,732
TOTAL ASSETS	$	710,291		$	676,204
LIABILITIES:
Interest-bearing deposits	$	442,002		$	417,388
Noninterest-bearing deposits	87,979			79,899
Total deposits	529,981			497,287
Short-term borrowings	14,209			18,354
Long-term borrowings, Federal Home Loan Bank (FHLB)	86,778			86,778
Accrued interest payable	900			1,073
Other liabilities	7,820			5,796
TOTAL LIABILITIES	639,688			609,288
SHAREHOLDERS’ EQUITY
Common stock, par value $8.33, 10,000,000 shares authorized; 4,014,272 and 4,011,985 shares issued	33,452			33,443
Additional paid-in capital	18,032			18,008
Retained earnings	28,910			27,218
Accumulated other comprehensive loss:
Net unrealized loss on available for sale securities	(1,561		)	(3,569		)
Defined benefit plan	(1,920		)	(1,920		)
Less: Treasury stock at cost, 180,596 and 179,028 shares	(6,310		)	(6,264		)
TOTAL SHAREHOLDERS’ EQUITY	70,603			66,916
TOTAL LIABILITIES AND SHAREHOLDERS’ EQUITY	$	710,291		$	676,204

See accompanying notes to the unaudited consolidated financial statements.

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PENNS WOODS BANCORP, INC.

CONSOLIDATED STATEMENT OF INCOME

(UNAUDITED)

	Three Months Ended					Six Months Ended
	June 30,					June 30,
(In Thousands, Except Per Share Data)	2010		2009			2010		2009
INTEREST AND DIVIDEND INCOME:
Loans including fees	$	6,398	$	6,349		$	12,728	$	12,568
Investment securities:
Taxable	1,405		1,374			2,754		2,737
Tax-exempt	1,270		1,249			2,528		2,495
Dividend and other interest income	51		41			103		130
TOTAL INTEREST AND DIVIDEND INCOME	9,124		9,013			18,113		17,930
INTEREST EXPENSE:
Deposits	1,551		2,204			3,261		4,209
Short-term borrowings	56		78			120		236
Long-term borrowings, FHLB	927		926			1,844		1,843
TOTAL INTEREST EXPENSE	2,534		3,208			5,225		6,288
NET INTEREST INCOME	6,590		5,805			12,888		11,642
PROVISION FOR LOAN LOSSES	400		186			700		312
NET INTEREST INCOME AFTER PROVISION FOR LOAN LOSSES	6,190		5,619			12,188		11,330
NON-INTEREST INCOME:
Service charges	537		541			1,047		1,066
Securities gains (losses), net	56		(2,086		)	53		(4,455		)
Earnings on bank-owned life insurance	128		112			299		274
Gain on sale of loans	330		103			512		221
Insurance commissions	273		347			537		701
Other	684		591			1,256		1,025
TOTAL NON-INTEREST INCOME	2,008		(392		)	3,704		(1,168		)
NON-INTEREST EXPENSE:
Salaries and employee benefits	2,615		2,595			5,352		5,077
Occupancy, net	313		318			644		657
Furniture and equipment	322		306			626		613
Pennsylvania shares tax	169		172			338		343
Amortization of investment in limited partnerships	141		141			283		283
Other	1,430		1,353			2,733		2,557
TOTAL NON-INTEREST EXPENSE	4,990		4,885			9,976		9,530
INCOME BEFORE INCOME TAX PROVISION (BENEFIT)	3,208		342			5,916		632
INCOME TAX PROVISION (BENEFIT)	436		(490		)	696		(1,039		)
NET INCOME	$	2,772	$	832		$	5,220	$	1,671
NET INCOME PER SHARE - BASIC	$	0.72	$	0.22		$	1.36	$	0.44
NET INCOME PER SHARE - DILUTED	$	0.72	$	0.22		$	1.36	$	0.44
WEIGHTED AVERAGE SHARES OUTSTANDING - BASIC	3,834,164		3,832,520			3,834,230		3,832,135
WEIGHTED AVERAGE SHARES OUTSTANDING - DILUTED	3,834,291		3,832,596			3,834,370		3,832,173
DIVIDENDS PER SHARE	$	0.46	$	0.46		$	0.92	$	0.92

See accompanying notes to the unaudited consolidated financial statements.

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PENNS WOODS BANCORP, INC.

CONSOLIDATED STATEMENT OF CHANGES IN SHAREHOLDERS’ EQUITY

(UNAUDITED)

									ACCUMULATED
	COMMON			ADDITIONAL					OTHER						TOTAL
	STOCK			PAID-IN		RETAINED			COMPREHENSIVE			TREASURY			SHAREHOLDERS’
(In Thousands, Except Per Share Data)	SHARES	AMOUNT		CAPITAL		EARNINGS			INCOME (LOSS)			STOCK			EQUITY
Balance, December 31, 2008	4,010,528	$	33,421	$	17,959	$	28,177		$	(12,266	)	$	(6,264	)	$	61,027
Comprehensive income:
Net income						1,671									1,671
Other comprehensive income									2,163						2,163
Dividends declared, ($0.92 per share)						(3,526		)							(3,526		)
Common shares issued for employee stock purchase plan	1,457	12		24											36
Balance, June 30, 2009	4,011,985	$	33,433	$	17,983	$	26,322		$	(10,103	)	$	(6,264	)	$	61,371

									ACCUMULATED
	COMMON			ADDITIONAL					OTHER						TOTAL
	STOCK			PAID-IN		RETAINED			COMPREHENSIVE			TREASURY			SHAREHOLDERS’
(In Thousands, Except Per Share Data)	SHARES	AMOUNT		CAPITAL		EARNINGS			INCOME (LOSS)			STOCK			EQUITY
Balance, December 31, 2009	4,013,142	$	33,443	$	18,008	$	27,218		$	(5,489	)	$	(6,264	)	$	66,916
Comprehensive income:
Net income						5,220									5,220
Other comprehensive income									2,008						2,008
Dividends declared, ($0.92 per share)						(3,528		)							(3,528		)
Common shares issued for employee stock purchase plan	1,130	9		24											33
Purchase of treasury stock (1,568 shares)												(46		)	(46		)
Balance, June 30, 2010	4,014,272	$	33,452	$	18,032	$	28,910		$	(3,481	)	$	(6,310	)	$	70,603

PENNS WOODS BANCORP, INC.

CONSOLIDATED STATEMENT OF COMPREHENSIVE INCOME

(UNAUDITED)

	Three Months Ended June 30,							Six Months Ended June 30,
(In Thousands)	2010			2009				2010			2009
Net Income		$	2,772			$	832		$	5,220			$	1,671
Other Comprehensive income:
Change in unrealized gain (loss) on available for sale securities	2,557			3,520				3,095			(1,178	)
Less: Reclassification adjustment for net gains (losses) included in net income	56			(2,086	)			53			(4,455	)
Other comprehensive income before tax expense		2,501				5,606			3,042				3,277
Income tax expense related to other comprehensive income		850				1,906			1,034				1,114
Other comprehensive income, net of tax		1,651				3,700			2,008				2,163
Comprehensive income		$	4,423			$	4,532		$	7,228			$	3,834

See accompanying notes to the unaudited consolidated financial statements.

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PENNS WOODS BANCORP, INC.

CONSOLIDATED STATEMENT OF CASH FLOWS

(UNAUDITED)

	Six Months Ended
	June 30,
(In Thousands)	2010			2009
OPERATING ACTIVITIES:
Net Income	$	5,220		$	1,671
Adjustments to reconcile net income to net cash provided by operating activities:
Depreciation and amortization	385			364
Provision for loan losses	700			312
Accretion and amortization of investment security discounts and premiums	(1,088		)	(518		)
Securities (gains) losses, net	(53		)	4,455
Originations of loans held for sale	(22,939		)	(10,202		)
Proceeds of loans held for sale	21,930			9,450
Gain on sale of loans	(512		)	(221		)
Earnings on bank-owned life insurance	(299		)	(274		)
Other, net	665			(1,327		)
Net cash provided by operating activities	4,009			3,710
INVESTING ACTIVITIES
Investment securities available for sale:
Proceeds from sales	430			4,682
Proceeds from calls and maturities	10,573			5,132
Purchases	(22,486		)	(9,955		)
Investment securities held to maturity:
Proceeds from calls and maturities	26			26
Net increase in loans	(6,773		)	(11,501		)
Acquisition of bank premises and equipment	(363		)	(155		)
Proceeds from the sale of foreclosed assets	79			—
Purchase of bank-owned life insurance	(32		)	(42		)
Proceeds from bank-owned life insurance death benefit	82			—
Investment in limited partnership	—			(738		)
Purchases of regulatory stock	—			(170		)
Net cash used for investing activities	(18,464		)	(12,721		)
FINANCING ACTIVITIES
Net increase in interest-bearing deposits	24,614			75,159
Net increase (decrease) in noninterest-bearing deposits	8,080			(1,526		)
Net decrease in short-term borrowings	(4,145		)	(59,066		)
Dividends paid	(3,528		)	(3,526		)
Issuance of common stock	33			36
Purchase of treasury stock	(46		)	—
Net cash provided by financing activities	25,008			11,077
NET INCREASE IN CASH AND CASH EQUIVALENTS	10,553			2,066
CASH AND CASH EQUIVALENTS, BEGINNING	13,788			16,581
CASH AND CASH EQUIVALENTS, ENDING	$	24,341		$	18,647
SUPPLEMENTAL DISCLOSURES OF CASH FLOW INFORMATION
Interest paid	$	5,398		$	6,385
Income taxes paid	1,600			1,175
Transfer of loans to foreclosed real estate	32			614

See accompanying notes to the unaudited consolidated financial statements.

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PENNS WOODS BANCORP, INC. AND SUBSIDIARIES

NOTES TO

CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

Note 1.  Basis of Presentation

The consolidated financial statements include the accounts of Penns Woods Bancorp, Inc. (the “Company”) and its wholly-owned subsidiaries: Woods Investment Company, Inc., Woods Real Estate Development Company, Inc., and Jersey Shore State Bank (the “Bank”) and its wholly-owned subsidiary, The M Group, Inc. D/B/A The Comprehensive Financial Group (“The M Group”).  All significant inter-company balances and transactions have been eliminated in the consolidation.

The interim financial statements are unaudited but, in the opinion of management, reflect all adjustments necessary for the fair presentation of results for such periods.  The results of operations for any interim period are not necessarily indicative of results for the full year.  These financial statements should be read in conjunction with the financial statements and notes thereto contained in the Company’s Annual Report on Form 10-K for the year ended December 31, 2009.

The accounting policies followed in the presentation of interim financial results are the same as those followed on an annual basis.  These policies are presented on pages 38 through 44 of the Annual Report on Form 10-K for the year ended December 31, 2009.

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

Note 2. Recent Accounting Pronouncements

In December 2009, the FASB issued ASU 2009-16, Accounting for Transfer of Financial Assets.  ASU 2009-16 provides guidance to improve the relevance, representational faithfulness, and comparability of the information that an entity provides in its financial statements about a transfer of financial assets; the effects of a transfer on its financial position, financial performance, and cash flows; and a transferor’s continuing involvement, if any, in transferred financial assets.  ASU 2009-16 is effective for annual periods beginning after November 15, 2009 and for interim periods within those fiscal years.  The adoption of this guidance did not have a material impact on the Company’s financial statements.

In January 2010, the FASB issued ASU 2010-01, Equity (Topic 505): Accounting for Distributions to Shareholders with Components of Stock and Cash — a consensus of the FASB Emerging Issues Task Force. ASU 2010-01 clarifies that the stock portion of a distribution to shareholders that allows them to elect to receive cash or stock with a potential limitation on the total amount of cash that all shareholders can elect to receive in the aggregate is considered a share issuance that is reflected in EPS prospectively and is not a stock dividend.  ASU 2010-01 is effective for interim and annual periods ending on or after December 15, 2009 and should be

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applied on a retrospective basis.  The adoption of this guidance did not have a material impact on the Company’s financial statements.

In January 2010, the FASB issued ASU 2010-05, Compensation — Stock Compensation (Topic 718): Escrowed Share Arrangements and the Presumption of Compensation. ASU 2010-05 updates existing guidance to address the SEC staff’s views on overcoming the presumption that for certain shareholders escrowed share arrangements represent compensation.  ASU 2010-05 is effective January 15, 2010.  The adoption of this guidance did not have a material impact on the Company’s financial statements.

In January 2010, the FASB issued ASU No. 2010-06, Fair Value Measurements and Disclosures (Topic 820): Improving Disclosures about Fair Value Measurements. ASU 2010-06 amends Subtopic 820-10 to clarify existing disclosures, require new disclosures, and includes conforming amendments to guidance on employers’ disclosures about postretirement benefit plan assets. ASU 2010-06 is effective for interim and annual periods beginning after December 15, 2009, except for disclosures about purchases, sales, issuances, and settlements in the roll forward of activity in Level 3 fair value measurements. Those disclosures are effective for fiscal years beginning after December 15, 2010 and for interim periods within those fiscal years.  The Company has presented the necessary disclosures in Note 4 (Net Periodic Benefit Cost-Defined Benefit Plans) herein.

In February 2010, the FASB issued ASU 2010-08, Technical Corrections to Various Topics. ASU 2010-08 clarifies guidance on embedded derivatives and hedging. ASU 2010-08 is effective for interim and annual periods beginning after December 15, 2009. The adoption of this guidance did not have a material impact on the Company’s financial position or results.

In March 2010, the FASB issued ASU 2010-11, Derivatives and Hedging.  ASU 2010-11 provides clarification and related additional examples to improve financial reporting by resolving potential ambiguity about the breadth of the embedded credit derivative scope exception in ASC 815-15-15-8.  ASU 2010-11 is effective at the beginning of the first fiscal quarter beginning after June 15, 2010. The adoption of this guidance did not have a material impact on the Company’s financial statements.

In April 2010, the FASB issued ASU 2010-18, Receivables (Topic 310):  Effect of a Loan Modification When the Loan is a Part of a Pool That is Accounted for as a Single Asset — a consensus of the FASB Emerging Issues Task Force.  ASU 2010-18 clarifies the treatment for a modified loan that was acquired as part of a pool of assets.  Refinancing or restructuring the loan does not make it eligible for removal from the pool, the FASB said.  The amendment will be effective for loans that are part of an asset pool and are modified during financial reporting periods that end July 15, 2010 or later.  The amendment is not expected to have a significant impact on the Company’s financial statements.

In July 2010, FASB issued ASU No. 2010-20, Receivables (Topic 310): Disclosures about the Credit Quality of Financing Receivables and the Allowance for Credit Losses.  ASU 2010-20 is intended to provide additional information to assist financial statement users in assessing an entity’s credit risk exposures and evaluating the adequacy of its allowance for credit losses. The

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disclosures as of the end of a reporting period are effective for interim and annual reporting periods ending on or after December 15, 2010. The disclosures about activity that occurs during a reporting period are effective for interim and annual reporting periods beginning on or after December 15, 2010.  The amendments in ASU 2010-20 encourage, but do not require, comparative disclosures for earlier reporting periods that ended before initial adoption. However, an entity should provide comparative disclosures for those reporting periods ending after initial adoption.  The Company is currently evaluating the impact the adoption of this guidance will have on the Company’s financial position or results of operations.

Note 3. Per Share Data

There are no convertible securities which would affect the denominator in calculating basic and dilutive earnings per share.  Net income as presented on the consolidated statement of income will be used as the numerator.  The following table sets forth the composition of the weighted average common shares (denominator) used in the basic and dilutive per share computation.

	Three Months Ended June 30,				Six Months Ended June 30,
	2010		2009		2010		2009
Weighted average common shares issued	4,013,892		4,011,548		4,013,610		4,011,163
Average treasury stock shares	(179,728	)	(179,028	)	(179,380	)	(179,028	)
Weighted average common shares and common stock equivalents used to calculate basic earnings per share	3,834,164		3,832,520		3,834,230		3,832,135
Additional common stock equivalents (stock options) used to calculate diluted earnings per share	127		76		140		38
Weighted average common shares and common stock equivalents used to calculate diluted earnings per share	3,834,291		3,832,596		3,834,370		3,832,173

Options to purchase 990 shares of common stock at a strike price of $24.72 were outstanding during the six months ended June 30, 2010.   The average market price of the Company’s stock was $31.46 for the six months ended June 30, 2010.  Options to purchase 990 shares of common stock were outstanding during the six months ended June 30, 2009 but were not included in the computation of diluted earnings per share as they were anti-dilutive due to the strike price range being greater than the average market price for the six months ended June 30, 2009.

Note 4.  Net Periodic Benefit Cost-Defined Benefit Plans

For a detailed disclosure on the Company’s pension and employee benefits plans, please refer to Note 12 of the Company’s Consolidated Financial Statements included in the Annual Report on Form 10-K for the year ended December 31, 2009.

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The following sets forth the components of the net periodic benefit cost of the domestic non-contributory defined benefit plan for the six months ended June 30, 2010 and 2009, respectively:

	Three Months Ended						Six Months Ended
	June 30,						June 30,
(In Thousands)	2010			2009			2010			2009
Service cost	$	131		$	136		$	263		$	272
Interest cost	171			170			342			340
Expected return on plan assets	(160		)	(127		)	(321		)	(254		)
Amortization of transition obligation	(1		)	—			(2		)	(1		)
Amortization of prior service cost	7			7			13			13
Amortization of net loss	37			84			73			169
Net periodic cost	$	185		$	270		$	368		$	539

The following table sets forth by level, within the fair value hierarchy detailed in Note 8 (Fair Value Measurements), the Plan’s assets at fair value as of June 30, 2010:

	June 30, 2010
(In Thousands)	Level I		Level II		Level III		Total
Assets:
Cash and cash equivalents	$	206	$	—	$	—	$	206
Mutual funds - taxable fixed income	3,073		—		—		3,073
Mutual funds - domestic equity	3,351		—		—		3,351
Mutual funds - international equity	1,138		—		—		1,138
Total assets at fair value	$	7,768	$	—	$	—	$	7,768

Employer Contributions

The Company previously disclosed in its consolidated financial statements, included in the Annual Report on Form 10-K for the year ended December 31, 2009, that it expected to contribute a minimum of $400,000 to its defined benefit plan in 2010.  As of June 30, 2010, there were contributions of $244,000 made to the plan.

Note 5.  Off Balance Sheet Risk

The Company is a party to financial instruments with off-balance sheet risk in the normal course of business to meet the financing needs of its customers.  These financial instruments are primarily comprised of commitments to extend credit and standby letters of credit.  These instruments involve, to varying degrees, elements of credit, interest rate, or liquidity risk in excess of the amount recognized in the consolidated balance sheet.  The contract amounts of these instruments express the extent of involvement the Company has in particular classes of financial instruments.

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The Company’s exposure to credit loss from nonperformance by the other party to the financial instruments for commitments to extend credit and standby letters of credit is represented by the contractual amount of these instruments.  The Company uses the same credit policies in making commitments and conditional obligations as it does for on-balance sheet instruments.  The Company may require collateral or other security to support financial instruments with off-balance sheet credit risk.

Financial instruments whose contract amounts represent credit risk are as follows at June 30, 2010 and December 31, 2009:

	June 30,		December 31,
(In Thousands)	2010		2009
Commitments to extend credit	$	83,015	$	80,061
Standby letters of credit	1,341		1,334

Commitments to extend credit are legally binding agreements to lend to customers.  Commitments generally have fixed expiration dates or other termination clauses and may require payment of fees.  Since many of the commitments are expected to expire without being drawn upon, the total commitment amounts do not necessarily represent future liquidity requirements.  The Company evaluates each customer’s credit worthiness on a case-by-case basis.  The amount of collateral obtained, if deemed necessary by the Company, on an extension of credit is based on management’s credit assessment of the counterparty.

Standby letters of credit represent conditional commitments issued by the Company to guarantee the performance of a customer to a third party.  These instruments are issued primarily to support bid or performance related contracts.  The coverage period for these instruments is typically a one year period with an annual renewal option subject to prior approval by management.  Fees earned from the issuance of these letters are recognized upon expiration of the coverage period.  For secured letters of credit, the collateral is typically Bank deposit instruments or customer business assets.

Note 6.  Reclassification of Comparative Amounts

Certain comparative amounts for the prior period have been reclassified to conform to current period presentations. Such reclassifications had no effect on net income or shareholders’ equity.

Note 7.  Employee Stock Purchase Plan

The Company maintains the Penns Woods Bancorp, Inc. 2006 Employee Stock Purchase Plan (“Plan”). The Plan is intended to encourage employee participation in the ownership and economic progress of the Company.  The Plan allows for up to 1,000,000 shares to be purchased by employees.  The purchase price of the shares is 95% of market value with an employee eligible to purchase up to the lesser of 15% of base compensation or $12,000 in market value annually.  During the six months ended June 30, 2010 and 2009, there were 1,130 and 1,457 shares issued under the plan, respectively.

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Note 8.  Fair Value Measurements

The following disclosures show the hierarchal disclosure framework associated with the level of pricing observations utilized in measuring assets and liabilities at fair value.

Level I:	Quoted prices are available in active markets for identical assets or liabilities as of the reported date.
Level II:	Pricing inputs are other than quoted prices in active markets, which are either directly or indirectly observable as of the reported date. The nature of these assets and liabilities include items for which quoted prices are available but traded less frequently, and items that are fair valued using other financial instruments, the parameters of which can be directly observed.
Level III:	Assets and liabilities that have little to no pricing observability as of the reported date. These items do not have two-way markets and are measured using management’s best estimate of fair value, where the inputs into the determination of fair value require significant management judgment or estimation.

This hierarchy requires the use of observable market data when available.

The following table presents the assets reported on the balance sheet at their fair value on a recurring basis as of June 30, 2010 and December 31, 2009, by level within the fair value hierarchy. Financial assets and liabilities are classified in their entirety based on the lowest level of input that is significant to the fair value measurement.

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	June 30, 2010
(In Thousands)	Level I		Level II		Level III		Total
Assets measured on a recurring basis:
Investment securities, available for sale
U.S. Government and agency securities	$	—	$	31,694	$	—	$	31,694
State and political securities	—		161,745		—		161,745
Other debt securties	—		19,339		—		19,339
Equity securities	12,847		—		—		12,847
Total assets measured on a recurring basis	$	12,847	$	212,778	$	—	$	225,625

	December 31, 2009
(In Thousands)	Level I		Level II		Level III		Total
Assets measured on a recurring basis:
Investment securities, available for sale:
U.S. Government and agency securities	$	—	$	39,136	$	—	$	39,136
State and political securities	—		144,877		—		144,877
Other debt securties	—		12,976		—		12,976
Equity securities	11,779		—		—		11,779
Total assets measured on a recurring basis	$	11,779	$	196,989	$	—	$	208,768

The following table presents the assets reported on the Consolidated Balance Sheet at their fair value on a non-recurring basis as of June 30, 2010 and December 31, 2009, by level within the fair value hierarchy. Financial assets and liabilities are classified in their entirety based on the lowest level of input that is significant to the fair value measurement.

	June 30, 2010
(In Thousands)	Level I		Level II		Level III		Total
Assets Measured on a Non-recurring Basis:
Impaired Loans	$	—	$	7,652	$	—	$	7,652
Other real estate owned	—		616		—		616

	December 31, 2009
(In Thousands)	Level I		Level II		Level III		Total
Assets Measured on a Non-recurring Basis:
Impaired Loans	$	—	$	7,510	$	—	$	7,510
Other real estate owned	—		672		—		672

Note 9. Estimated Fair Value of Financial Instruments

The Company is required to disclose estimated fair values for its financial instruments.  Fair value estimates are made at a specific point in time, based on relevant market information and information about the financial instrument.  These estimates do not reflect any premium or discount that could result from offering for sale at one time the Company’s entire holdings of a particular financial instrument.  Also, it is the Company’s general practice and intention to hold most of its financial instruments to maturity and not to engage in trading or sales activities.  Because no market exists for a significant portion of the Company’s financial instruments, fair value estimates are based on judgments regarding future expected loss experience, current

13

economic conditions, risk characteristics of various financial instruments, and other factors.  These estimates are subjective in nature and involve uncertainties and matters of significant judgment and therefore cannot be determined with precision.  Changes in assumptions can significantly affect the estimates.

Estimated fair values have been determined by the Company using historical data and an estimation methodology suitable for each category of financial instruments.  The Company’s fair value estimates, methods, and assumptions are set forth below for the Company’s other financial instruments.

As certain assets and liabilities, such as deferred tax assets, premises and equipment, and many other operational elements of the Company, are not considered financial instruments but have value, this estimated fair value of financial instruments would not represent the full market value of the Company.

The estimated fair values of the Company’s financial instruments are as follows at June 30, 2010 and December 31, 2009:

	June 30, 2010				December 31, 2009
	Carrying		Fair		Carrying		Fair
(In Thousands)	Value		Value		Value		Value
Financial assets:
Cash and cash equivalents	$	24,341	$	24,341	$	13,788	$	13,788
Investment securities:
Available for sale	225,625		225,625		208,768		208,768
Held to maturity	82		83		107		108
Loans held for sale	5,584		5,584		4,063		4,063
Loans, net	406,913		402,225		400,872		403,279
Bank-owned life insurance	15,188		15,188		14,942		14,942
Accrued interest receivable	3,673		3,673		3,523		3,523
Financial liabilities:
Interest-bearing deposits	$	442,002	$	435,834	$	417,388	$	408,056
Noninterest-bearing deposits	87,979		87,979		79,899		79,899
Short-term borrowings	14,209		14,209		18,354		18,354
Long-term borrowings, FHLB	86,778		91,363		86,778		89,082
Accrued interest payable	900		900		1,073		1,073

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Cash and Cash Equivalents, Loans Held for Sale, Accrued Interest Receivable, Short-term Borrowings, and Accrued Interest Payable:

The fair value is equal to the carrying value.

Investment Securities:

The fair value of investment securities available for sale and held to maturity is equal to the available quoted market price. If no quoted market price is available, fair value is estimated using the quoted market price for similar securities.  Regulatory stocks’ fair value is equal to the carrying value.

Loans:

Fair values are estimated for portfolios of loans with similar financial characteristics.  Loans are segregated by type such as commercial, commercial real estate, residential real estate, construction real estate, and other consumer.  Each loan category is further segmented into fixed and adjustable rate interest terms and by performing and nonperforming categories.

The fair value of performing loans is calculated by discounting scheduled cash flows through the estimated maturity using estimated market discount rates that reflect the credit and interest rate risk inherent in the loan.  The estimate of maturity is based on the Company’s historical experience with repayments for each loan classification, modified, as required, by an estimate of the effect of current economic and lending conditions.

Fair value for significant nonperforming loans is based on recent external appraisals.  If appraisals are not available, estimated cash flows are discounted using a rate commensurate with the risk associated with the estimated cash flows.  Assumptions regarding credit risk, cash flows, and discounted rates are judgmentally determined using available market information and specific borrower information.

Bank-Owned Life Insurance:

The fair value is equal to the cash surrender value of the life insurance policies.

Deposits:

The fair value of deposits with no stated maturity, such as noninterest-bearing demand deposits, savings, NOW, and money market accounts, is equal to the amount payable on demand as of June 30, 2010 and December 31, 2009.  The fair value of certificates of deposit is based on the discounted value of contractual cash flows.

The fair value estimates above do not include the benefit that results from the low-cost funding provided by the deposit liabilities compared to the cost of borrowing funds in the market, commonly referred to as the core deposit intangible.

Long Term Borrowings:

The fair value of long term borrowings is based on the discounted value of contractual cash flows.

15

Commitments to Extend Credit, Standby Letters of Credit, and Financial Guarantees Written:

There is no material difference between the notional amount and the estimated fair value of off-balance sheet items at June 30, 2010 and December 31, 2009.  The contractual amounts of unfunded commitments and letters of credit are presented in Note 5.

Note 10.  Federal Home Loan Bank Stock

The Bank is a member of the Federal Home Loan Bank of Pittsburgh (the “FHLB”), which is one of 12 regional Federal Home Loan Banks. Each Federal Home Loan Bank serves as a reserve or central bank for its members within its assigned region.  It is funded primarily from funds deposited by member institutions and proceeds from the sale of consolidated obligations of the Federal Home Loan Bank System. It makes loans to members (i.e., advances) in accordance with policies and procedures established by the board of directors of the Federal Home Loan Bank.  As a member, the Bank is required to purchase and maintain stock in the FHLB in an amount equal to the greater of 1% of its aggregate unpaid residential mortgage loans, home purchase contracts or similar obligations at the beginning of each year or 5% of its outstanding advances from the FHLB.  At June 30, 2010, the Bank held $7,271,300 in stock of the FHLB, which was in compliance with this requirement.

The Company evaluated its holding of FHLB stock for impairment and deemed the stock to not be impaired due to the expected recoverability of the par value, which equals the value reflected within the Company’s financial statements.  The decision was based on several items ranging from the estimated true economic losses embedded within the FHLB’s mortgage portfolio to the FHLB’s liquidity position and credit rating.  The Company utilizes the impairment framework outlined in GAAP to evaluate FHLB stock for impairment.

The following factors were evaluated to determine the ultimate recoverability of the par value of the Company’s FHLB stock holding; (i) the significance of the decline in net assets of the FHLB as compared to the capital stock amount for the FHLB and the length of time this situation has persisted; (ii) commitments by the FHLB to make payments required by law or regulation and the level of such payments in relation to the operating performance of the FHLB; (iii) the impact of legislative and regulatory changes on the institutions and, accordingly, on the customer base of the FHLB; (iv) the liquidity position of the FHLB; and (v) whether a decline is temporary or whether it affects the ultimate recoverability of the FHLB stock based on (a) the materiality of the carrying amount to the member institution and (b) whether an assessment of the institution’s operational needs for the foreseeable future allow management to dispose of the stock.

Based on its analysis of these factors, the Company determined that its holding of FHLB stock was not impaired on June 30, 2010.

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Note 11. Investment Securities

The amortized cost and estimated fair values of investment securities at June 30, 2010 and December 31, 2009 are as follows:

	June 30, 2010
			Gross		Gross
	Amortized		Unrealized		Unrealized			Fair
(In Thousands)	Cost		Gains		Losses			Value
Available for sale (AFS)
U.S. Government and agency securities	$	29,335	$	2,359	$	—		$	31,694
State and political securities	167,860		1,623		(7,738		)	161,745
Other debt securities	18,868		641		(170		)	19,339
Total debt securities	216,063		4,623		(7,908		)	212,778
Equity securities	11,927		1,163		(243		)	12,847
Total investment securities AFS	$	227,990	$	5,786	$	(8,151	)	$	225,625
Held to maturity (HTM)
U.S. Government and agency securities	$	5	$	1	$	—		$	6
Other debt securities	77		—		—			77
Total investment securities HTM	$	82	$	1	$	—		$	83

	December 31, 2009
			Gross		Gross
	Amortized		Unrealized		Unrealized			Fair
(In Thousands)	Cost		Gains		Losses			Value
Available for sale (AFS)
U.S. Government and agency securities	$	37,038	$	2,098	$	—		$	39,136
State and political securities	153,914		733		(9,770		)	144,877
Other debt securities	12,271		834		(129		)	12,976
Total debt securities	203,223		3,665		(9,899		)	196,989
Equity securities	10,952		981		(154		)	11,779
Total investment securities AFS	$	214,175	$	4,646	$	(10,053	)	$	208,768
Held to maturity (HTM)
U.S. Government and agency securities	$	6	$	—	$	—		$	6
Other debt securities	101		1		—			102
Total investment securities HTM	$	107	$	1	$	—		$	108

17

The following tables show the Company’s gross unrealized losses and fair value, aggregated by investment category and length of time, that the individual securities have been in a continuous unrealized loss position, at June 30, 2010 and December 31, 2009.

	June 30, 2010
	Less than Twelve Months				Twelve Months or Greater				Total
			Gross				Gross				Gross
	Fair		Unrealized		Fair		Unrealized		Fair		Unrealized
(In Thousands)	Value		Losses		Value		Losses		Value		Losses
U.S. Government and agency securities	$	—	$	—	$	—	$	—	$	—	$	—
State and political securities	36,129		1,593		35,452		6,145		71,581		7,738
Other debt securities	6,537		58		1,013		112		7,550		170
Total debt securities	42,666		1,651		36,465		6,257		79,131		7,908
Equity securities	1,119		167		496		76		1,615		243
Total	$	43,785	$	1,818	$	36,961	$	6,333	$	80,746	$	8,151

	December 31, 2009
	Less than Twelve Months				Twelve Months or Greater				Total
			Gross				Gross				Gross
	Fair		Unrealized		Fair		Unrealized		Fair		Unrealized
(In Thousands)	Value		Losses		Value		Losses		Value		Losses
U.S. Government and agency securities	$	—	$	—	$	—	$	—	$	—	$	—
State and political securities	60,005		2,336		36,267		7,434		96,272		9,770
Other debt securities	—		—		1,191		129		1,191		129
Total debt securities	60,005		2,336		37,458		7,563		97,463		9,899
Equity securities	159		27		918		127		1,077		154
Total	$	60,164	$	2,363	$	38,376	$	7,690	$	98,540	$	10,053

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At June 30, 2010 there were a total of 79 and 99 individual securities that were in a continuous unrealized loss position for less than twelve months and greater than twelve months, respectively.

The Company reviews its position quarterly and has determined that, at June 30, 2010, the declines outlined in the above table represent temporary declines and the Company does not intend to sell and does not believe they will be required to sell these securities before recovery of their cost basis, which may be at maturity.  There were 178 positions that were temporarily impaired at June 30, 2010.  The Company has concluded that the unrealized losses disclosed above are not other than temporary but are the result of interest rate changes, sector credit ratings changes, or company-specific ratings changes that are not expected to result in the non-collection of principal and interest during the period.

The amortized cost and estimated fair value of debt securities at June 30, 2010, by contractual maturity, are shown below. Expected maturities may differ from contractual maturities since borrowers may have the right to call or prepay obligations with or without call or prepayment penalties.

	Available for Sale				Held to Maturity
	Amortized				Amortized
(In Thousands)	Cost		Fair Value		Cost		Fair Value
Due in one year or less	$	1,004	$	1,011	$	25	$	25
Due after one year to five years	17,073		17,682		52		52
Due after five years to ten years	4,261		3,986		—		—
Due after ten years	193,725		190,099		5		6
Total	$	216,063	$	212,778	$	82	$	83

Total gross proceeds from sales of securities available for sale were $430,000 and $4,682,000, for June 30, 2010 and 2009, respectively.  The following table represents gross realized gains and losses on those transactions:

	Six Months Ended June 30,
(In Thousands)	2010		2009
Gross realized gains:
U.S. Government and agency securities	$	—	$	—
State and political securities	—		—
Other debt securities	6		162
Equity securities	56		4
Total gross realized gains	$	62	$	166
Gross realized losses:
U.S. Government and agency securities	$	—	$	—
State and political securities	—		—
Other debt securities	9		37
Equity securities	—		4,584
Total gross realized losses	$	9	$	4,621

19

Gross realized losses for the equity securities portfolio include impairment charges of $0 and $4,584,000 for the six months ended June 30, 2010 and 2009, respectively.

Note 12. Loans

The allocation of the loan portfolio, by delinquency status, as of June 30, 2010 and December 31, 2009 is presented below:

		June 30, 2010
						Past Due
						90 Days
				Past Due		Or More
				30 To 89		& Still		Non-
(In Thousands)		Current		Days		Accruing		Accrual		Total
Commercial and agricultural		$	54,379	$	100	$	14	$	9	$	54,502
Real estate mortgage:
Residential		170,191		1,742		332		952		173,217
Commercial		147,593		1,886		—		1,950		151,429
Construction		19,589		97		—		3,386		23,072
Installment loans to individuals		10,658		99		2		2		10,761
		402,410		$	3,924	$	348	$	6,299	412,981
Less:	Net deferred loan fees	1,021								1,021
	Allowance for loan losses	5,047								5,047
Loans, net		$	396,342							$	406,913

		December 31, 2009
						Past Due
						90 Days
				Past Due		Or More
				30 To 90		& Still		Non-
(In Thousands)		Current		Days		Accruing		Accrual		Total
Commercial and agricultural		$	45,930	$	457	$	182	$	78	$	46,647
Real estate mortgage:
Residential		165,313		7,333		951		749		174,346
Commercial		147,455		2,860		1,429		465		152,209
Construction		18,247		2,992		—		556		21,795
Installment loans to individuals		11,192		311		3		43		11,549
		388,137		$	13,953	$	2,565	$	1,891	406,546
Less:	Net deferred loan fees	1,017								1,017
	Allowance for loan losses	4,657								4,657
Loans, net		$	382,463							$	400,872

The recorded investment in loans for which impairment has been recognized amounted to $8,621,000 at June 30, 2010, compared to $8,312,000 at December 31, 2009.  The valuation allowance related to impaired loans amounted to $969,000 at June 30, 2010 and $802,000 at December 31, 2009.  The increase in impaired loans and valuation allowance is primarily from a few commercial relationships.

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

20

CAUTIONARY STATEMENT FOR PURPOSES OF THE PRIVATE

SECURITIES LITIGATION REFORM ACT OF 1995

This Report contains certain “forward-looking statements” including statements concerning plans, objectives, future events or performance and assumptions and other statements which are other than statements of historical fact.  The Company cautions readers that the following important factors, among others, may have affected and could in the future affect the Company’s actual results and could cause the Company’s actual results for subsequent periods to differ materially from those expressed in any forward-looking statement made by or on behalf of the Company herein:  (i) the effect of changes in laws and regulations, including federal and state banking laws and regulations, with which the Company must comply, and the associated costs of compliance with such laws and regulations either currently or in the future as applicable; (ii) the effect of changes in accounting policies and practices, as may be adopted by the regulatory agencies as well as by the Financial Accounting Standards Board, or of changes in the Company’s organization, compensation and benefit plans; (iii) the effect on the Company’s competitive position within its market area of the  increasing consolidation within the banking and financial services industries, including the increased competition from larger regional and out-of-state banking organizations as well as non-bank providers of various financial services; (iv) the effect of changes in interest rates; and (v) the effect of changes in the business cycle and downturns in the local, regional or national economies.

You should not put undue reliance on any forward-looking statements.  These statements speak only as of the date of this Quarterly Report on Form 10-Q, even if subsequently made available by the Company on its website or otherwise.  The Company undertakes no obligation to update or revise these statements to reflect events or circumstances occurring after the date of this Quarterly Report on Form 10-Q.

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

EARNINGS SUMMARY

Comparison of the Three and Six Months Ended June 30, 2010 and 2009

Summary Results

Net income for the three months ended June 30, 2010 was $2,772,000 compared to $832,000 for the same period of 2009 as after-tax securities losses decreased $1,413,000 (from a loss of $1,376,000 to a gain of $37,000).  Included within the change in after-tax securities losses for the three months ended June 30, 2009 was an other than temporary impairment charge relating to certain equity securities held in the investment portfolio of $2,251,000. Basic and diluted earnings per share for the three months ended June 30, 2010 were $0.72 compared to $0.22 for the three months ended June 30, 2009.  Return on average assets and return on average equity were 1.58% and 15.76% for the three months ended June 30, 2010 compared to 0.51% and 5.45% for the corresponding period of 2009.  Net income from core operations (“operating earnings”) increased to $2,735,000 for the three months ended June 30, 2010 compared to $2,208,000 for the same period of 2009.  Operating earnings per share for the three months ended June 30, 2010 were $0.71 basic and dilutive compared to $0.58 basic and dilutive for the three months ended June 30, 2009.

The six months ended June 30, 2010 generated net income of $5,220,000 compared to $1,671,000 for the same period of 2009.  Comparable results were impacted by a decrease in after-tax securities losses of $2,975,000 (from a loss of $2,940,000 for the 2009 period to a gain of $35,000 for the 2010 period). Earnings per share, basic and diluted, for the six months ended June 30, 2010 were $1.36 as compared to $0.44 for the comparable period of 2009.  Return on average assets and return on average equity were 1.50% and 15.05% for the six months ended June 30, 2010 compared to 0.51% and 5.54% for the corresponding period of 2009.  Operating earnings increased 12.4% to $5,185,000 for the six months ended June 30, 2010 compared to $4,611,000 for the comparable period of 2009, resulting in basic and dilutive operating earnings per share increasing 12.5% to $1.35 from $1.20 for the six month periods ended June 30, 2010 and 2009, respectively.

Management uses the non-GAAP measure of net income from core operations, or operating earnings, in its analysis of the Company’s performance.  This measure, as used by the Company, adjusts net income by excluding significant gains or losses that are unusual in nature.  Because certain of these items and their impact on the Company’s performance are difficult to predict, management believes the presentation of financial measures excluding the impact of such items provides useful supplemental information in evaluating the operating results of the Company’s core businesses.  For purposes of this Quarterly Report on Form 10-Q, net income from core operations, or operating earnings, means net income adjusted to exclude after-tax net securities gains or losses.  These disclosures should not be viewed as a substitute for net income determined in accordance with GAAP, nor are they necessarily comparable to non-GAAP performance measures that may be presented by other companies.

22

Reconciliation of GAAP and non-GAAP Income

	Three Months Ended					Six Months Ended
	June 30,					June 30,
(Dollars in Thousands, Except Per Share Data)	2010		2009			2010		2009
GAAP net income	$	2,772	$	832		$	5,220	$	1,671
Less: securities gains (losses), net of tax	37		(1,376		)	35		(2,940		)
Non-GAAP operating earnings	$	2,735	$	2,208		$	5,185	$	4,611

	Three Months Ended				Six Months Ended
	June 30,				June 30,
	2010		2009		2010		2009
Return on average assets (ROA)	1.58	%	0.51	%	1.50	%	0.51	%
Less: securities gains (losses), net of tax	0.02	%	-0.83	%	0.01	%	-0.90	%
Non-GAAP operating ROA	1.56	%	1.34	%	1.49	%	1.41	%

	Three Months Ended				Six Months Ended
	June 30,				June 30,
	2010		2009		2010		2009
Return on average equity (ROE)	15.76	%	5.45	%	15.05	%	5.54	%
Less: securities gains (losses), net of tax	0.21	%	-9.01	%	0.10	%	-9.76	%
Non-GAAP operating ROE	15.55	%	14.46	%	14.95	%	15.30	%

	Three Months Ended					Six Months Ended
	June 30,					June 30,
	2010		2009			2010		2009
Basic earnings per share (EPS)	$	0.72	$	0.22		$	1.36	$	0.44
Less: securities gains (losses), net of tax	0.01		(0.36		)	0.01		(0.76		)
Non-GAAP basic operating EPS	$	0.71	$	0.58		$	1.35	$	1.20

	Three Months Ended					Six Months Ended
	June 30,					June 30,
	2010		2009			2010		2009
Dilutive EPS	$	0.72	$	0.22		$	1.36	$	0.44
Less: securities gains (losses), net of tax	0.01		(0.36		)	0.01		(0.76		)
Non-GAAP dilutive operating EPS	$	0.71	$	0.58		$	1.35	$	1.20

Interest and Dividend Income

Interest and dividend income for the three months ended June 30, 2010 increased $111,000 to $9,124,000 compared to $9,013,000 for the same period of 2009.  The increase in interest income was led by an increase in loan interest resulting from growth in the average gross loan portfolio of $23,480,000.  The growth offset a decline in the average taxable equivalent yield of 31 basis points (“bp”) caused by the low interest rate environment that has existed over the past year.   The increase in investment portfolio income was the result of portfolio growth that offset a decline of 30 bp in yield.

During the six months ended June 30, 2010, interest and dividend income was $18,113,000, an increase of $183,000 over the same period in 2009.  Interest income on the loan portfolio

23

increased as the growth in the portfolio countered a 28 bp decline in average yield.  The investment portfolio interest income remained steady as the increase in portfolio size was offset by a decline in yield and a reduction in dividends received.  The reduced level of dividend income is the result of a decreased level of equity investment and general decline in dividends paid by the holdings in our portfolio.

Interest and dividend income composition for the three and six months ended June 30, 2010 and 2009 was as follows:

	For The Three Months Ended
	June 30, 2010				June 30, 2009				Change
(In Thousands)	Amount		% Total		Amount		% Total		Amount		%
Loans including fees	$	6,398	70.1	%	$	6,349	70.4	%	$	49	0.8	%
Investment securities:
Taxable	1,405		15.4		1,374		15.2		31		2.3
Tax-exempt	1,270		13.9		1,249		13.9		21		1.7
Dividend and other interest income	51		0.6		41		0.5		10		24.4
Total interest and dividend income	$	9,124	100.0	%	$	9,013	100.0	%	$	111	1.2	%

	For The Six Months Ended
	June 30, 2010				June 30, 2009				Change
(In Thousands)	Amount		% Total		Amount		% Total		Amount			%
Loans including fees	$	12,728	70.3	%	$	12,568	70.1	%	$	160		1.3	%
Investment securities:
Taxable	2,754		15.2		2,737		15.3		17			0.6
Tax-exempt	2,528		13.9		2,495		13.9		33			1.3
Dividend and other interest income	103		0.6		130		0.7		(27		)	(20.8	)
Total interest and dividend income	$	18,113	100.0	%	$	17,930	100.0	%	$	183		1.0	%

Interest Expense

Interest expense for the three months ended June 30, 2010 decreased $674,000 to $2,534,000 compared to $3,208,000 for the same period of 2009.  The substantial decrease associated with deposits is primarily the result of a reduction of 76 bp in rate paid and a shift from higher cost time deposits to core deposits.  Factors that led to the rate decreases include, but are not limited to, Federal Open Market Committee (“FOMC”) interest rate actions and campaigns conducted by the Company during the past two years to attract short-term CDs resulting in an increased repricing frequency.  In addition, the Marcellus Shale natural gas exploration in north central Pennsylvania is creating opportunities to create new and build upon existing deposit relationships.  Short-term borrowings interest expense decreased as the average balance of such borrowings decreased with current short-term borrowings consisting solely of customer repurchase agreements.  Long-term borrowing interest expense remained stable, as there have been no changes to the composition of long-term borrowings.

Interest expense for the six months ended June 30, 2010 decreased 16.9% from the same period of 2009.  The reasons noted for the decline in interest expense for the three month period comparison also apply to the six month period.

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Interest expense composition for the three and six months ended June 30, 2010 and 2009 was as follows:

	For The Three Months Ended
	June 30, 2010				June 30, 2009				Change
(In Thousands)	Amount		% Total		Amount		% Total		Amount			%
Deposits	$	1,551	61.2	%	$	2,204	68.7	%	$	(653	)	(29.6	)%
Short-term borrowings	56		2.2		78		2.4		(22		)	(28.2	)
Long-term borrowings, FHLB	927		36.6		926		28.9		1			0.1
Total interest expense	$	2,534	100.0	%	$	3,208	100.0	%	$	(674	)	(21.0	)%

	For The Six Months Ended
	June 30, 2010				June 30, 2009				Change
(In Thousands)	Amount		% Total		Amount		% Total		Amount			%
Deposits	$	3,261	62.4	%	$	4,209	66.9	%	$	(948	)	(22.5	)%
Short-term borrowings	120		2.3		236		3.8		(116		)	(49.2	)
Long-term borrowings, FHLB	1,844		35.3		1,843		29.3		1			0.1
Total interest expense	$	5,225	100.0	%	$	6,288	100.0	%	$	(1,063	)	(16.9	)%

Net Interest Margin

The net interest margin (“NIM”) for the three months ended June 30, 2010 was 4.56% compared to 4.36% for the corresponding period of 2009.  The increase in the NIM was driven by a 63 bp decline in the rate paid on interest bearing liabilities that more than compensated for a 40 bp decline in the yield on interest earning assets.  The decrease in earning asset yield is due to the impact on the loan and investment portfolios of the current low rate environment.  The decrease in the cost of interest bearing liabilities to 1.87% from 2.50% was driven by a reduction in the rate paid on time deposits of 75 bp.  The reduction in the rate paid on time deposits was the result of a shortening of the time deposit portfolio that has resulted in an increasing repricing frequency during this period of decreasing rates.  The duration of the time deposit portfolio has been lengthening due to the apparent bottoming or near bottoming of deposit rates.

The NIM for the six months ended June 30, 2010 was 4.52% compared to 4.42% for the same period of 2009.  The impact of the items mentioned in the three month discussion also applies to the six month period.  A 77 bp decline in the rate paid on time deposits served as the foundation for a 71 bp decline in rate paid on deposits, while the FOMC and general market actions affected the yield on earning assets and cost of borrowings.

The following is a schedule of average balances and associated yields for the three and six months ended June 30, 2010 and 2009:

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	AVERAGE BALANCES AND INTEREST RATES
	Three Months Ended						Three Months Ended
	June 30, 2010						June 30, 2009
(In Thousands)	Average Balance		Interest		Average Rate		Average Balance		Interest		Average Rate
Assets:
Tax-exempt loans	$	18,750	$	312	6.67	%	$	16,934	$	271	6.42	%
All other loans	398,988		6,192		6.22	%	377,324		6,170		6.56	%
Total loans	417,738		6,504		6.24	%	394,258		6,441		6.55	%
Taxable securities	112,538		1,454		5.17	%	101,984		1,415		5.55	%
Tax-exempt securities	108,011		1,924		7.13	%	103,848		1,892		7.29	%
Total securities	220,549		3,378		6.13	%	205,832		3,307		6.43	%
Interest-bearing deposits	8,938		2		0.09	%	1,371		—		0.00	%
Total interest-earning assets	647,225		9,884		6.12	%	601,461		9,748		6.52	%
Other assets	54,681						55,793
Total assets	$	701,906					$	657,254
Liabilities and shareholders’ equity:
Savings	$	65,483	45		0.28	%	$	61,383	81		0.53	%
Super Now deposits	64,931		92		0.57	%	56,645		131		0.93	%
Money market deposits	101,361		291		1.15	%	64,374		367		2.29	%
Time deposits	209,344		1,123		2.15	%	224,918		1,625		2.90	%
Total interest-bearing deposits	441,119		1,551		1.41	%	407,320		2,204		2.17	%
Short-term borrowings	12,306		56		1.82	%	18,035		78		1.73	%
Long-term borrowings, FHLB	86,778		927		4.23	%	86,778		926		4.22	%
Total borrowings	99,084		983		3.92	%	104,813		1,004		3.79	%
Total interest-bearing liabilities	540,203		2,534		1.87	%	512,133		3,208		2.50	%
Demand deposits	83,205						73,930
Other liabilities	8,150						10,113
Shareholders’ equity	70,348						61,078
Total liabilities and shareholders’ equity	$	701,906					$	657,254
Interest rate spread					4.25	%					4.02	%
Net interest income/margin			$	7,350	4.56	%			$	6,540	4.36	%

1.Information on this table has been calculated using average daily balance sheets to obtain average balances.

2.Nonaccrual loans have been included with loans for the purpose of analyzing net interest earnings.

3.Income and rates on a fully taxable equivalent basis include an adjustment for the difference between annual income from tax-exempt obligations and the taxable equivalent of such income at the standard 34% tax rate.

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	AVERAGE BALANCES AND INTEREST RATES
	Six Months Ended						Six Months Ended
	June 30, 2010						June 30, 2009
(In Thousands)	Average Balance		Interest		Average Rate		Average Balance		Interest		Average Rate
Assets:
Tax-exempt loans	$	18,018	$	604	6.76	%	$	16,420	$	538	6.61	%
All other loans	397,018		12,329		6.26	%	375,687		12,213		6.56	%
Total loans	415,036		12,933		6.28	%	392,107		12,751		6.56	%
Taxable securities	109,607		2,854		5.21	%	101,937		2,867		5.63	%
Tax-exempt securities	107,515		3,830		7.12	%	102,757		3,780		7.36	%
Total securities	217,122		6,684		6.16	%	204,694		6,647		6.49	%
Interest bearing deposits	8,257		3		0.07	%	700		—		0.00	%
Total interest-earning assets	640,415		19,620		6.16	%	597,501		19,398		6.53	%
Other assets	54,988						55,459
Total assets	$	695,403					$	652,960
Liabilities and shareholders’ equity:
Savings	$	63,891	97		0.31	%	$	60,517	159		0.53	%
Super Now deposits	63,994		201		0.63	%	55,276		260		0.95	%
Money market deposits	94,313		579		1.24	%	52,888		580		2.21	%
Time deposits	214,749		2,384		2.24	%	215,069		3,210		3.01	%
Total interest-bearing deposits	436,947		3,261		1.50	%	383,750		4,209		2.21	%
Short-term borrowings	13,518		120		1.79	%	39,641		236		1.19	%
Long-term borrowings, FHLB	86,778		1,844		4.23	%	86,778		1,843		4.22	%
Total borrowings	100,296		1,964		3.90	%	126,419		2,079		3.27	%
Total interest-bearing liabilities	537,243		5,225		1.95	%	510,169		6,288		2.48	%
Demand deposits	80,636						72,633
Other liabilities	8,142						9,870
Shareholders’ equity	69,382						60,288
Total liabilities and shareholders’ equity	$	695,403					$	652,960
Interest rate spread					4.21	%					4.05	%
Net interest income/margin			$	14,395	4.52	%			$	13,110	4.42	%

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The following table presents the adjustment to convert net interest income to net interest income on a fully taxable equivalent basis for the three and six months ended June 30, 2010 and 2009.

	For the Three Months Ended				For the Six Months Ended
	June 30,				June 30,
(In Thousands)	2010		2009		2010		2009
Total interest income	$	9,124	$	9,013	$	18,113	$	17,930
Total interest expense	2,534		3,208		5,225		6,288
Net interest income	6,590		5,805		12,888		11,642
Tax equivalent adjustment	760		735		1,507		1,468
Net interest income (fully taxable equivalent)	$	7,350	$	6,540	$	14,395	$	13,110

The following table sets forth the respective impact that both volume and rate changes have had on net interest income on a fully taxable equivalent basis for the three and six month periods ended June 30, 2010 and 2009:

	Three Months Ended June 30,									Six Months Ended June 30,
	2010 vs 2009									2010 vs 2009
	Increase (Decrease)									Increase (Decrease)
	Due to									Due to
(In Thousands)	Volume			Rate			Net			Volume			Rate			Net
Interest income:
Loans, tax-exempt	$	30		$	11		$	41		$	39		$	27		$	66
Loans	1,360			(1,338		)	22			999			(883		)	116
Taxable investment securities	491			(452		)	39			773			(786		)	(13		)
Tax-exempt investment securities	238			(206		)	32			243			(193		)	50
Interest bearing deposits	2			—			2			3			—			3
Total interest-earning assets	2,121			(1,985		)	136			2,057			(1,835		)	222
Interest expense:
Savings deposits	34			(70		)	(36		)	16			(78		)	(62		)
Super Now deposits	101			(140		)	(39		)	65			(124		)	(59		)
Money market deposits	744			(820		)	(76		)	493			(494		)	(1		)
Time deposits	(106		)	(396		)	(502		)	(5		)	(821		)	(826		)
Short-term borrowings	(48		)	26			(22		)	(200		)	84			(116		)
Long-term borrowings, FHLB	—			1			1			—			1			1
Total interest-bearing liabilities	725			(1,399		)	(674		)	369			(1,432		)	(1,063		)
Change in net interest income	$	1,396		$	(586	)	$	810		$	1,688		$	(403	)	$	1,285

Provision for Loan Losses

The provision for loan losses is based upon management’s quarterly review of the loan portfolio.  The purpose of the review is to assess loan quality, identify impaired loans, analyze delinquencies, ascertain loan growth, evaluate potential charge-offs and recoveries, and assess general economic conditions in the markets served.  An external independent loan review is also performed annually for the Bank.  Management remains committed to an aggressive program of problem loan identification and resolution.

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The allowance for loan losses is determined by applying loss factors to outstanding loans by type, excluding loans for which a specific allowance has been determined.  Loss factors are based on management’s consideration of the nature of the portfolio segments, changes in mix and volume of the loan portfolio, and historical loan loss experience.  In addition, management considers industry standards and trends with respect to non-performing loans and its knowledge and experience with specific lending segments.

Although management believes it uses the best information available to make such determinations and that the allowance for loan losses is adequate at June 30, 2010, future adjustments could be necessary if circumstances or economic conditions differ substantially from the assumptions used in making the initial determinations.  A downturn in the local economy, increased unemployment, and delays in receiving financial information from borrowers could result in increased levels of nonperforming assets, charge-offs, loan loss provisions, and reductions in income.  Additionally, as an integral part of the examination process, bank regulatory agencies periodically review the Bank’s loan loss allowance.  The banking agencies could require the recognition of additions to the loan loss allowance based on their judgment of information available to them at the time of their examination.

While determining the appropriate allowance level, management has attributed the allowance for loan losses to various portfolio segments; however, the allowance is available for the entire portfolio as needed.

The allowance for loan losses increased from $4,657,000 at December 31, 2009 to $5,047,000 at June 30, 2010.  At June 30, 2010 and December 31, 2009, the allowance for loan losses to total loans was 1.23% and 1.15%, respectively.

The provision for loan losses totaled $400,000 and $700,000 for the three and six months ended June 30, 2010, compared to $186,000 and $312,000 for the same periods in 2009.  The amount of the increase in the provision was the result of several factors, including but not limited to, an increase in gross loans of $19,886,000 since June 30, 2009, a ratio of annualized net charge-offs to average loans of 0.15% for the six months ended June 30, 2010, a ratio of nonperforming loans to total loans of 1.61% at June 30, 2010, and a ratio of the allowance for loan losses to nonperforming loans of 75.94% at June 30, 2010.  Nonperforming loans increased to $6,646,000 at June 30, 2010 from $4,456,000 at December 31, 2009 due to a commercial real estate loan being changed to nonaccrual status.  Internal loan review and analysis and the continued uncertainty surrounding the economy, coupled with the ratios noted previously, dictated an increase in the provision for loan losses.  The increase did not equate to the change in charge-offs and nonperforming loans due to the economic situation and the collateral status of the nonperforming loans and overall loan portfolio in general, which limits the loan specific allocation of the allowance for loan losses.

Following is a table showing the changes in the allowance for loan losses for the six months ended June 30, 2010 and 2009:

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	For the Six Months Ended
(In Thousands)	June 30, 2010			June 30, 2009
Balance at beginning of period	$	4,657		$	4,356
Charge-offs:
Real estate	53			192
Commercial and industrial	261			64
Installment loans to individuals	70			90
Total charge-offs	384			346
Recoveries:
Real estate	10			8
Commercial and industrial	—			—
Installment loans to individuals	64			47
Total recoveries	74			55
Net charge-offs	310			291
Additions charged to operations	700			312
Balance at end of period	$	5,047		$	4,377
Ratio of net annualized charge-offs during the period to average loans outstanding during the period	0.15		%	0.15		%

Following is a table showing the changes in total nonperforming loans as of:

	Total Nonperforming Loans
			90 Days
(In Thousands)	Nonaccrual		Past Due		Total
June 30, 2010	$	6,299	$	347	$	6,646
March 31, 2010	3,703		160		3,863
December 31, 2009	1,891		2,565		4,456
September 30, 2009	1,448		4,396		5,844
June 30, 2009	2,089		578		2,667

Loans not included above which are troubled debt restructurings, totaled $744,000, $426,000, and $0 at June 30, 2010, December 31, 2009, and June 30, 2009, respectively.

Non-interest Income

Total non-interest income for the three months ended June 30, 2010 compared to the same period in 2009 increased $2,400,000 to $2,008,000 due to a $2,142,000 decrease in net securities losses.  Excluding net securities gains and losses, non-interest income for the second quarter of 2010 would have increased $258,000 compared to the 2009 period.  Deposit service charges decreased minimally as overdraft fee income decreased slightly, in addition to customers migrating to no service charge checking accounts that were introduced in previous periods as part of customer acquisition and retention programs.  Gain on sale of loans provided the primary increase in non-interest income.  The significant increase was primarily the result of increased volume attributed to the home buyer tax credit.

Insurance commissions for the three months ended June 30, 2010 decreased due to a softening market and shift in product mix.  Management of The M Group continues to pursue new and

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build upon current relationships.  The sales call program continues to expand to other financial institutions, which results in additional revenue for The M Group if another sales outlet is added.  However, the addition of another sales outlet for The M Group can take up to a year or more to be completed.

Total non-interest income for the six months ended June 30, 2010 compared to the same period in 2009 increased $4,872,000.  Excluding net securities gains, non-interest income would have increased $364,000 compared to the 2009 period.   The increase in non-interest income for the six month period is the result of the same items noted in the three month discussion.

Non-interest income composition for the three and six months ended June 30, 2010 and 2009 was as follows:

	For the Three Months Ended
	June 30, 2010				June 30, 2009					Change
(In Thousands)	Amount		% Total		Amount			% Total		Amount			%
Deposit service charges	$	537	26.7	%	$	541		(138.0	)%	$	(4	)	(0.7	)%
Securities gains (losses), net	56		2.8		(2,086		)	532.1		2,142			102.7
Bank owned life insurance	128		6.4		112			(28.6	)	16			14.3
Gain on sale of loans	330		16.4		103			(26.3	)	227			220.4
Insurance commissions	273		13.6		347			(88.5	)	(74		)	(21.3	)
Other	684		34.1		591			(150.7	)	93			15.7
Total non-interest income	$	2,008	100.0	%	$	(392	)	100.0	%	$	2,400		(612.2	)%

	For the Six Months Ended
	June 30, 2010				June 30, 2009					Change
(In Thousands)	Amount		% Total		Amount			% Total		Amount			%
Deposit service charges	$	1,047	28.3	%	$	1,066		(91.3	)%	$	(19	)	(1.8	)%
Securities gains (losses), net	53		1.4		(4,455		)	381.5		4,508			101.2
Bank owned life insurance	299		8.1		274			(23.5	)	25			9.1
Gain on sale of loans	512		13.8		221			(18.9	)	291			131.7
Insurance commissions	537		14.5		701			(60.0	)	(164		)	(23.4	)
Other	1,256		33.9		1,025			(87.8	)	231			22.5
Total non-interest income	$	3,704	100.0	%	$	(1,168	)	100.0	%	$	4,872		(417.1	)%

Non-interest Expense

Total non-interest expense increased $105,000 for the three months ended June 30, 2010 compared to the same period of 2009.  The increase in salaries and employee benefits was attributable to several items including standard cost of living wage adjustments for employees, increased pension expense, and other benefit costs.  Other expenses increased primarily due to normal anticipated inflationary adjustments to ongoing business operating costs.

Total non-interest expense increased $446,000 for the six months ended June 30, 2010 compared to the same period of 2009.  The increase in non-interest expense for the six month period is the result of the same items noted in the three month discussion.

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Non-interest expense composition for the six months ended June 30, 2010 and 2009 was as follows:

	For the Three Months Ended
	June 30, 2010				June 30, 2009				Change
(In Thousands)	Amount		% Total		Amount		% Total		Amount			%
Salaries and employee benefits	$	2,615	52.4	%	$	2,595	53.1	%	$	20		0.8	%
Occupancy, net	313		6.3		318		6.5		(5		)	(1.6	)
Furniture and equipment	322		6.5		306		6.3		16			5.2
Pennsylvania shares tax	169		3.4		172		3.5		(3		)	(1.7	)
Amortization of investment in limited partnerships	141		2.8		141		2.9		—			—
Other	1,430		28.6		1,353		27.7		77			5.7
Total non-interest expense	$	4,990	100.0	%	$	4,885	100.0	%	$	105		2.1	%

	For the Six Months Ended
	June 30, 2010				June 30, 2009				Change
(In Thousands)	Amount		% Total		Amount		% Total		Amount			%
Salaries and employee benefits	$	5,352	53.6	%	$	5,077	53.3	%	$	275		5.4	%
Occupancy, net	644		6.5		657		6.9		(13		)	(2.0	)
Furniture and equipment	626		6.3		613		6.4		13			2.1
Pennsylvania shares tax	338		3.4		343		3.6		(5		)	(1.5	)
Amortization of investment in limited partnerships	283		2.8		283		3.0		—			—
Other	2,733		27.4		2,557		26.8		176			6.9
Total non-interest expense	$	9,976	100.0	%	$	9,530	100.0	%	$	446		4.7	%

Provision for Income Taxes

Income taxes increased $926,000 and $1,735,000 for the three and six months ended June 30, 2010 compared to the same period of 2009.  The primary cause of the changes in tax expense is the impact of net securities losses in the three and six month periods of 2009.  Excluding the impact of the net securities gains and losses, the effective tax rate for the three and six months ended June 30, 2010 was 13.23% and 11.36% compared to 9.02% and 9.36% for the same period of 2009.  The Company currently is in a deferred tax asset position due to the low income housing tax credits earned both currently and previously.  Management has reviewed the deferred tax asset and has determined that the asset will be utilized within the appropriate carry forward period and therefore does not require a valuation allowance.

ASSET/LIABILITY MANAGEMENT

Cash and Cash Equivalents

Cash and cash equivalents increased $10,553,000 from $13,788,000 at December 31, 2009 to $24,341,000 at June 30, 2010 primarily as a result of the following activities during the six months ended June 30, 2010:

Loans Held for Sale

Activity regarding loans held for sale resulted in loan originations exceeding sale proceeds, less $512,000 in realized gains, by $1,521,000 for the six months ended June 30, 2010.

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Loans

Gross loans increased $6,431,000 since December 31, 2009 due primarily to an increase of non-real estate and construction loans, which was partially offset by a decrease in residential and commercial real estate loans.

The allocation of the loan portfolio, by category, as of June 30, 2010 and December 31, 2009 is presented below:

	June 30, 2010				December 31, 2009				Change
(In Thousands)	Amount		% Total		Amount		% Total		Amount			%
Commercial, financial and agricultural	$	54,502	13.2	%	$	46,647	11.5	%	$	7,855		16.8	%
Real estate mortgage:
Residential	173,217		42.0		174,346		43.1		(1,129		)	(0.6	)
Commercial	151,429		36.8		152,209		37.5		(780		)	(0.5	)
Construction	23,072		5.6		21,795		5.4		1,277			5.9
Installment loans to individuals	10,761		2.6		11,549		2.8		(788		)	(6.8	)
Less: Net deferred loan fees	1,021		(0.2	)	1,017		(0.3	)	4			0.4
Gross loans	$	411,960	100.0	%	$	405,529	100.0	%	$	6,431		1.6	%

Investments

The estimated fair value of the investment securities portfolio at June 30, 2010 has increased $16,832,000 since December 31, 2009.  The change is primarily due to purchases of state and political securities and short-term corporate securities as the level of net unrealized losses remained constant.  The unrealized losses within the debt securities portfolio are the result of market activity, not credit issues/ratings, as approximately 90% of the debt securities portfolio is currently rated A or higher by either S&P or Moody’s.

The Company considers various factors, which include examples from applicable accounting guidance, when analyzing the available for sale portfolio for possible other than temporary impairment.  The Company primarily considers the following factors in its analysis: length of time and severity of the market value being less than carrying value, reduction of dividend paid (equities), continued payment of dividend/interest, credit rating, and financial condition of an issuer, intent and ability to hold until anticipated recovery (which may be maturity), and general outlook for the economy, specific industry, and entity in question.

The bond portion of the portfolio review is conducted with emphases on several factors.  Continued payment of principal and interest is given primary importance with credit rating and financial condition of the issuer following as the next most important.  Credit ratings were reviewed with the ratings of the bonds being satisfactory.  Those that were not currently rated were discussed with a third party and/or underwent an internal financial review.  The Company also monitors whether each of the investments incurred a decline in market value from carrying value of at least 20% for twelve consecutive months or a similar decline of at least 50% for six consecutive months.  Each bond is reviewed to determine whether it is a general obligation bond, which is backed by the credit and taxing power of the issuing jurisdiction, or revenue bond, which is only payable from specified revenues.  Based on the review undertaken by the

33

Company, the Company determined that the decline in value of the various bond holdings were deemed to be temporary and were the result of the general market downturns and interest rate/yield curve changes, not credit issues.  The fact that almost all of such bonds are general obligation bonds further solidified the Company’s determination that the decline in the value of these bond holdings is temporary.

The fair value of the equity portfolio continues to fluctuate as the economic turbulence continues to impact financial sector stock pricing.  The stock market improvement over the first six months of 2010 has led to an increase in net unrealized gains of $182,000 to $1,163,000 at June 30, 2010.  In addition, the amortized cost of the equity securities portfolio has increased $975,000 as the Company has begun to build the portfolio balance, while continuing to diversify geographic risk.

The equity portion of the portfolio, which is invested entirely in financial institutions, is reviewed for possible other than temporary impairment in a similar manner to the bond portfolio with greater emphasis placed on the length of time the market value has been less than the carrying value and financial sector outlook.  The Company also reviews dividend payment activities and, in the case of financial institutions, whether or not such issuer was participating in the TARP Capital Purchase Program.  The starting point for the equity analysis is the length and severity of a market price decline.  The Company monitors two primary measures: 20% decline for twelve consecutive months and 50% decline for six consecutive months in market value from carrying value.

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The distribution of credit ratings by amortized cost and estimated fair values for the debt security portfolio at June 30, 2010 follows:

	A- to AAA				B- to BBB+				C to CCC+				Not Rated				Total
(In Thousands)	Amortized		Fair		Amortized		Fair		Amortized		Fair		Amortized		Fair		Amortized		Fair
Available for sale (AFS)	Cost		Value		Cost		Value		Cost		Value		Cost		Value		Cost		Value
U.S. Government and agency securities	$	29,335	$	31,694	$	—	$	—	$	—	$	—	$	—	$	—	$	29,335	$	31,694
State and political securities	152,431		147,993		5,823		5,129		—		—		9,606		8,623		167,860		161,745
Other debt securities	18,022		18,561		800		733		—		—		46		45		18,868		19,339
Total debt securities AFS	$	199,788	$	198,248	$	6,623	$	5,862	$	—	$	—	$	9,652	$	8,668	$	216,063	$	212,778
Held to maturity (HTM)
U.S. Government and agency securities	$	5	$	6	$	—	$	—	$	—	$	—	$	—	$	—	$	5	$	6
Other debt securities	77		77		—		—		—		—		—		—		77		77
Total debt securities HTM	$	82	$	83	$	—	$	—	$	—	$	—	$	—	$	—	$	82	$	83

Financing Activities

Deposits

Total deposits increased 6.6% or $32,694,000 from December 31, 2009 to June 30, 2010.  The growth was led by a substantial increase in money market deposits of 35.7% from December 31, 2009 to June 30, 2010.  The increase in core deposits (deposits less time deposits) has provided relationship driven funding for the loan and investment portfolios, while also reducing the utilization of FHLB borrowings.  The increase in deposits is the result of a deposit gathering program coupled with customers coming back to their hometown bank in the wake of the economic turbulence.  Electronic delivery channels, such as remote deposit capture and mobile banking, are being emphasized as efforts to capitalize on the economic stimulus being provided by the Marcellus Shale natural gas exploration.

Deposit balances and their changes for the periods being discussed follow:

	June 30, 2010				December 31, 2009				Change
(In Thousands)	Amount		% Total		Amount		% Total		Amount			%
Demand deposits	$	87,979	16.6	%	$	79,899	16.1	%	$	8,080		10.1	%
NOW accounts	65,802		12.4		64,361		12.9		1,441			2.2
Money market deposits	101,301		19.1		74,634		15.0		26,667			35.7
Savings deposits	66,789		12.6		60,827		12.2		5,962			9.8
Time deposits	208,110		39.3		217,566		43.8		(9,456		)	(4.3	)
Total deposits	$	529,981	100.0	%	$	497,287	100.0	%	$	32,694		6.6	%

Borrowed Funds

Total borrowed funds decreased 3.9% or $4,145,000 to $100,987,000 at June 30, 2010 compared to $105,132,000 at December 31, 2009.  The decrease in borrowed funds is primarily the result of growth in deposits as part of the previously discussed deposit gathering campaigns that were utilized to provide loan portfolio funding and to reduce the level of total borrowings.  FHLB

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repurchase agreements were utilized as their structure allowed for a reduction in interest expense, while providing the ability to reduce the borrowings at our discretion as deposit levels increased.

	June 30, 2010				December 31, 2009				Change
(In Thousands)	Amount		% Total		Amount		% Total		Amount			%
Short-term borrowings:
FHLB repurchase agreements	$	—	—	%	$	5,155	4.9	%	$	(5,155	)	(100.0	)%
Securities sold under agreement to repurchase	14,209		14.1		13,199		12.6		1,010			7.7
Total short-term borrowings	14,209		14.1		18,354		17.5		(4,145		)	(22.6	)
Long-term borrowings, FHLB	86,778		85.9		86,778		82.5		—			—
Total borrowed funds	$	100,987	100.0	%	$	105,132	100.0	%	$	(4,145	)	(3.9	)%

Capital

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

Bank holding companies are required to comply with the Federal Reserve Board’s risk-based capital guidelines.  The risk-based capital rules are designed to make regulatory capital requirements more sensitive to differences in risk profiles among banks and bank holding companies and to minimize disincentives for holding liquid assets.  Specifically, each is required to maintain certain minimum dollar amounts and ratios of total risk-based, tier I risk-based, and tier I leverage capital. In addition to the capital requirements, the Federal Deposit Insurance Corporation Improvements Act (FDICIA) established five capital categories ranging from “well capitalized” to “critically undercapitalized.” To be classified as “well capitalized”, total risk-based, tier I risked-based, and tier I leverage capital ratios must be at least 10%, 6%, and 5%, respectively.

Capital ratios as of June 30, 2010 and December 31, 2009 were as follows:

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	June 30, 2010				December 31, 2009
(In Thousands)	Amount		Ratio		Amount		Ratio
Total Capital (to Risk-weighted Assets)
Actual	$	69,907	15.2	%	$	67,738	15.4	%
For Capital Adequacy Purposes	36,828		8.0		35,094		8.0
To Be Well Capitalized	46,036		10.0		43,867		10.0
Tier I Capital (to Risk-weighted Assets)
Actual	$	64,446	14.0	%	$	62,709	14.3	%
For Capital Adequacy Purposes	18,414		4.0		17,547		4.0
To Be Well Capitalized	27,621		6.0		26,320		6.0
Tier I Capital (to Average Assets)
Actual	$	64,446	9.3	%	$	62,709	9.3	%
For Capital Adequacy Purposes	27,785		4.0		26,914		4.0
To Be Well Capitalized	34,732		5.0		33,642		5.0

Liquidity; Interest Rate Sensitivity and Market Risk

The asset/liability committee addresses the liquidity needs of the Company to ensure that sufficient funds are available to meet credit demands and deposit withdrawals as well as to the placement of available funds in the investment portfolio.  In assessing liquidity requirements, equal consideration is given to the current position as well as the future outlook.

The following liquidity measures are monitored for compliance and were within the limits cited at June 30, 2010:

1.  Net Loans to Total Assets, 85% maximum

2.  Net Loans to Total Deposits, 100% maximum

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

4.  Cumulative 1 Year Maturity GAP %, +/- 25% maximum

Fundamental objectives of the Company’s asset/liability management process are to maintain adequate liquidity while minimizing interest rate risk.  The maintenance of adequate liquidity provides the Company with the ability to meet its financial obligations to depositors, loan customers, and shareholders.  Additionally, it provides funds for normal operating expenditures and business opportunities as they arise.  The objective of interest rate sensitivity management is to increase net interest income by managing interest sensitive assets and liabilities in such a way that they can be repriced in response to changes in market interest rates.

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The Bank, like other financial institutions, must have sufficient funds available to meet its liquidity needs for deposit withdrawals, loan commitments and originations, and expenses.  In order to control cash flow, the Bank estimates future cash flows from deposits, loan payments, and investment security payments.  The primary sources of funds are deposits, principal and interest payments on loans and investment securities, FHLB borrowings, and brokered deposits.  Management believes the Bank has adequate resources to meet its normal funding requirements.

Management monitors the Company’s liquidity on both a long and short-term basis, thereby providing management necessary information to react to current balance sheet trends.  Cash flow needs are assessed and sources of funds are determined.  Funding strategies consider both customer needs and economical cost.  Both short and long-term funding needs are addressed by maturities and sales of available for sale investment securities, loan repayments and maturities, and liquidating money market investments such as federal funds sold.  The use of these resources, in conjunction with access to credit provides core funding to satisfy depositor, borrower, and creditor needs.

Management monitors and determines the desirable level of liquidity.  Consideration is given to loan demand, investment opportunities, deposit pricing and growth potential, as well as the current cost of borrowing funds.  The Company has a current borrowing capacity at the FHLB of $216,627,000.  In addition to this credit arrangement, the Company has additional lines of credit with correspondent banks of $13,934,000. Management believes it has sufficient liquidity to satisfy estimated short-term and long-term funding needs.  FHLB borrowings totaled $86,778,000 as of June 30, 2010.

Interest rate sensitivity, which is closely related to liquidity management, is a function of the repricing characteristics of the Company’s portfolio of assets and liabilities.  Asset/liability management strives to match maturities and rates between loan and investment security assets with the deposit liabilities and borrowings that fund them.  Successful asset/liability management results in a balance sheet structure which can cope effectively with market rate fluctuations. The matching process is affected by segmenting both assets and liabilities into future time periods (usually 12 months, or less) based upon when repricing can be effected.  Repriceable assets are subtracted from repriceable liabilities, for a specific time period to determine the “gap”, or difference. Once known, the gap is managed based on predictions about future market interest rates.  Intentional mismatching, or gapping, can enhance net interest income if market rates move as predicted.  However, if market rates behave in a manner contrary to predictions, net interest income will suffer.  Gaps, therefore, contain an element of risk and must be prudently managed.  In addition to gap management, the Company has an asset/liability management policy which incorporates a market value at risk calculation which is used to determine the effects of interest rate movements on shareholders’ equity and a simulation analysis to monitor the effects of interest rate changes on the Company’s balance sheet.

The Company currently maintains a GAP position of being liability sensitive.  The Company has strategically taken this position as it has decreased the duration of the time deposit portfolio, while continuing to maintain a primarily fixed rate earning asset portfolio with a duration greater than the liabilities utilized to fund earning assets.  Lengthening of the liability portfolio coupled

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with the addition of limited short-term assets is being undertaken.  These actions are expected to reduce, but not eliminate, the liability sensitive structure of the balance sheet.

A market value at risk calculation is utilized to monitor the effects of interest rate changes on the Company’s balance sheet and more specifically shareholders’ equity.  The Company does not manage the balance sheet structure in order to maintain compliance with this calculation.  The calculation serves as a guideline with greater emphases placed on interest rate sensitivity.  Changes to calculation results from period to period are reviewed as changes in results could be a signal of future events.  As of the most recent analysis, the results of the market value at risk calculation were outside of established guidelines due to the strategic direction being taken.

Interest Rate Sensitivity

In this analysis the Company examines the result of a 100 and 200 basis point change in market interest rates and the effect on net interest income. It is assumed that the change is instantaneous and that all rates move in a parallel manner.  Assumptions are also made concerning prepayment speeds on mortgage loans and mortgage securities.

The following is a rate shock forecast for the twelve month period ended June 30, 2011 assuming a static balance sheet as of June 30, 2010.

	Parallel Rate Shock in Basis Points
(In Thousands)	-200			-100			Static		+100			+200
Net interest income	$	23,295		$	24,567		$	25,092	$	25,294		$	25,657
Change from static	(1,797		)	(525		)	—		202			565
Percent change from static	-7.16		%	-2.09		%	—		0.81		%	2.25		%

The model utilized to create the report presented above makes various estimates at each level of interest rate change regarding cash flow from principal repayment on loans and mortgage-backed securities and or call activity on investment securities.  Actual results could differ significantly from these estimates which would result in significant differences in the calculated projected change.  In addition, the limits stated above do not necessarily represent the level of change under which management would undertake specific measures to realign its portfolio in order to reduce the projected level of change.  Generally, management believes the Company is well positioned to respond expeditiously when the market interest rate outlook changes.

Inflation

The asset and liability structure of a financial institution is primarily monetary in nature.  Therefore, interest rates rather than inflation have a more significant impact on the Company’s performance.  Interest rates are not always affected in the same direction or magnitude as prices of other goods and services, but are reflective of fiscal policy initiatives or economic factors which are not measured by a price index.

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Item 3.  Quantitative and Qualitative Disclosures About Market Risk

Market risk for the Company is comprised primarily of interest rate risk exposure and liquidity risk.  Interest rate risk and liquidity risk management is performed at the Bank level as well as the Company level.  The Company’s interest rate sensitivity is monitored by management through selected interest rate risk measures produced by an independent third party.  There have been no substantial changes in the Company’s gap analyses or simulation analyses compared to the information provided in the Annual Report on Form 10-K for the period ended December 31, 2009.  Additional information and details are provided in the “Liquidity and Interest Rate Sensitivity” section of “Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations.”

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

Item 4.  Controls and Procedures

An analysis was performed under the supervision and with the participation of the Company’s management, including the Chief Executive Officer and the Chief Financial Officer, of the effectiveness of the design and operation of the Company’s disclosure controls and procedures. Based on that evaluation, the Company’s Chief Executive Officer and Chief Financial Officer concluded that the Company’s disclosure controls and procedures were effective as of June 30, 2010.  There were no changes in the Company’s internal control over financial reporting that occurred during the quarter ended June 30, 2010, that have materially affected, or are reasonably likely to materially affect, the Company’s internal control over financial reporting.

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Part II.  OTHER INFORMATION

Item 1.          Legal Proceedings

None.

Item 1A.  Risk Factors

There are no material changes to the risk factors set forth in Part I, Item 1A, “Risk Factors,” of the Company’s Annual Report on Form 10-K for the year ended December 31, 2009.  Please refer to that section for disclosures regarding the risks and uncertainties related to the Company’s business.

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

	Total	Average		Total Number of	Maximum Number (or
	Number of	Price Paid		Shares (or Units)	Approximate Dollar Value)
	Shares (or	per Share		Purchased as Part of	of Shares (or Units) that
	Units)	(or Units)		Publicly Announced	May Yet Be Purchased
Period	Purchased	Purchased		Plans or Programs	Under the Plans or Programs
Month #1 (April 1 - April 30, 2010)	—	$	—	—	78,344
Month #2 (May 1 - May 31, 2010)	1,568	29.27		1,568	76,776
Month #3 (June 1 - June 30, 2010)	—	—		—	76,776

On April 27, 2010, the Board of Directors extended the previously approved authorization to repurchase up to 197,000 shares, or approximately 5%, of the outstanding shares of the Company for an additional year to April 30, 2011.  To date, there have been 120,224 shares repurchased under this plan.

Item 3.          Defaults Upon Senior Securities

None

Item 4.          (Removed and Reserved)

Item 5.          Other Information

None

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Item 6.          Exhibits

(3)  (i)	Articles of Incorporation of the Registrant, as presently in effect (incorporated by reference to Exhibit 3(i) of the Registrant’s Annual Report on Form 10-K for the year ended December 31, 2005).
(3)  (ii)	Bylaws of the Registrant’s as presently in effect (incorporated by reference to Exhibit 3(ii) of the Registrant’s Current Report on Form 8-K filed June 17, 2005).
(31) (i)	Rule 13a-14(a)/Rule 15d-14(a) Certification of Chief Executive Officer.
(31) (ii)	Rule 13a-14(a)/Rule 15d-14(a) Certification of Chief Financial Officer.
(32) (i)	Section 1350 Certification of Chief Executive Officer.
(32) (ii)	Section 1350 Certification of Chief Financial Officer.

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SIGNATURES

Pursuant to the requirements of the Securities Exchange Act of 1934, the Registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.

	PENNS WOODS BANCORP, INC.
	(Registrant)
Date:   August 9, 2010	/s/ Ronald A. Walko
	Ronald A. Walko, President and Chief Executive Officer
	(Principal Executive Officer)
Date:   August 9, 2010	/s/ Brian L. Knepp
	Brian L. Knepp, Chief Financial Officer
	(Principal Financial Officer and Principal Accounting Officer)

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EXHIBIT INDEX

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

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