PENNS WOODS BANCORP, INC.
INDEX TO QUARTERLY REPORT ON FORM 10-Q

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Part I.  FINANCIAL INFORMATION

Item 1.  Financial Statements

PENNS WOODS BANCORP, INC.

CONSOLIDATED BALANCE SHEET

(UNAUDITED)

See accompanying notes to the unaudited consolidated financial statements.

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PENNS WOODS BANCORP, INC.

CONSOLIDATED STATEMENT OF INCOME

(UNAUDITED)

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)

See accompanying notes to the unaudited consolidated financial statements.

PENNS WOODS BANCORP, INC.

CONSOLIDATED STATEMENT OF COMPREHENSIVE INCOME

(UNAUDITED)

See accompanying notes to the unaudited consolidated financial statements.

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PENNS WOODS BANCORP, INC.

CONSOLIDATED STATEMENT OF CASH FLOWS

(UNAUDITED)

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.  All of those adjustments are of a normal, recurring nature.  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 financial statements and notes thereto contained in the Company’s Annual Report on Form 10-K for the year ended December 31, 2006.

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 40 thru 46 of the Annual Report on Form 10-K for the year ended December 31, 2006.

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 February 2006, the Financial Accounting Standards Board (“FASB”) issued Statement of Financial Accounting Standards (“FAS”) No. 155, Accounting for Certain Hybrid Instruments, as an amendment of FASB Statements No. 133 and 140.  FAS No. 155 allows financial instruments that have embedded derivatives to be accounted for as a whole (eliminating the need to bifurcate the derivative from its host) if the holder elects to account for the whole instrument on a fair value basis.  This statement is effective for all financial instruments acquired or issued after the beginning of an entity’s first fiscal year that begins after September 15, 2006.  The adoption of this standard is not expected to have a material effect on the Company’s results of operations or financial position.

In March 2006, the FASB issued FAS No. 156, Accounting for Servicing of Financial Assets.  This Statement, which is an amendment to FAS No. 140, will simplify the accounting for servicing assets and liabilities, such as those common with mortgage securitization activities.  Specifically, FAS No. 156 addresses the recognition and measurement of separately recognized servicing assets and liabilities and provides an approach to simplify efforts to obtain hedge-like

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(offset) accounting.  FAS No. 156 also clarifies when an obligation to service financial assets should be separately recognized as a servicing asset or a servicing liability, requires that a separately recognized servicing asset or servicing liability be initially measured at fair value, if practicable, and permits an entity with a separately recognized servicing asset or servicing liability to choose either of the amortization or fair value methods for subsequent measurement.  The provisions of FAS No. 156 are effective as of the beginning of the first fiscal year that begins after September 15, 2006.   The adoption of this standard is not expected to have a material effect on the Company’s results of operations or financial position.

In September 2006, the FASB issued FAS No. 157, Fair Value Measurements, which provides enhanced guidance for using fair value to measure assets and liabilities. The standard applies whenever other standards require or permit assets or liabilities to be measured at fair value. The Standard does not expand the use of fair value in any new circumstances. FAS No. 157 is effective for financial statements issued for fiscal years beginning after November 15, 2007 and interim periods within those fiscal years. Early adoption is permitted.  The adoption of this standard is not expected to have a material effect on the Company’s results of operations or financial position.

In September 2006, the FASB issued FAS No. 158, Employers’ Accounting for Defined Benefit Pension and Other Post  Retirement  Plans, an amendment of FASB Statements  No.  87, 88, 106 and 132(R).  FAS No. 158 requires that a company  recognize the overfunded or underfunded  status of its defined benefit post  retirement  plans (other than  multiemployer  plans) as an asset or liability in its statement of financial  position and that it recognize changes  in the funded  status in the year in which the  changes  occur  through other  comprehensive  income.  FAS No. 158 also requires the  measurement  of defined  benefit  plan  assets and  obligations  as of the fiscal  year end,  in addition  to  footnote  disclosures.  On December 31, 2006, the Company adopted FAS No. 158, except for the measurement provisions, which are effective for fiscal years ending after December 15, 2008.  The adoption of this standard is not expected to have a material effect on the Company’s results of operations or financial position.

In February 2007, the FASB issued FAS No. 159, The Fair Value Option for Financial Assets and Financial Liabilities — Including an amendment of FASB Statement No. 115, which provides all entities with an option to report selected financial assets and liabilities at fair value. The objective of the FAS No. 159 is to improve financial reporting by providing entities with the opportunity to mitigate volatility in earnings caused by measuring related assets and liabilities differently without having to apply the complex provisions of hedge accounting.  FAS No. 159 is effective as of the beginning of an entity’s first fiscal year beginning after November 15, 2007.  Early adoption is permitted as of the beginning of a fiscal year that begins on or before November 15, 2007 provided the entity also elects to apply the provisions of FAS No. 157, Fair Value Measurements.  The adoption of this standard is not expected to have a material effect on the Company’s results of operations or financial position.

In June 2006, the FASB issued FASB Interpretation No. 48 (“FIN 48”), Accounting for Uncertainty in Income Taxes. FIN 48 is an interpretation of FAS No. 109, Accounting for Income

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Taxes, and it seeks to reduce the diversity in practice associated with certain aspects of measurement and recognition in accounting for income taxes. In addition, FIN No. 48 requires expanded disclosure with respect to the uncertainty in income taxes and is effective for fiscal years beginning after December 15, 2006.  The adoption of this standard is not expected to have a material effect on the Company’s results of operations or financial position.

In September 2006, the FASB reached consensus on the guidance provided by Emerging Issues Task Force Issue 06-4 (“EITF 06-4”), Accounting for Deferred Compensation and Postretirement Benefit Aspects of Endorsement Split-Dollar Life Insurance Arrangements.  The guidance is applicable to endorsement split-dollar life insurance arrangements, whereby the employer owns and controls the insurance policy, that are associated with a postretirement benefit.  EITF 06-4 requires that for a split-dollar life insurance arrangement within the scope of the Issue, an employer should recognize a liability for future benefits in accordance with FAS No. 106 (if, in substance, a postretirement benefit plan exists) or Accounting Principles Board Opinion No. 12 (if the arrangement is, in substance, an individual deferred compensation contract) based on the substantive agreement with the employee.  EITF 06-4 is effective for fiscal years beginning after December 15, 2007.  The Company is currently evaluating the impact the adoption of the EITF will have on the Company’s results of operations or financial condition.

In September 2006, the FASB reached consensus on the guidance provided by Emerging Issues Task Force Issue 06-5(“EITF 06-5”), Accounting for Purchases of Life Insurance—Determining the Amount That Could Be Realized in Accordance with FASB Technical Bulletin No. 85-4, Accounting for Purchases of Life Insurance.  EITF 06-5 states that a policyholder should consider any additional amounts included in the contractual terms of the insurance policy other than the cash surrender value in determining the amount that could be realized under the insurance contract.  EITF 06-5 also states that a policyholder should determine the amount that could be realized under the life insurance contract assuming the surrender of an individual-life by individual-life policy (or certificate by certificate in a group policy). EITF 06-5 is effective for fiscal years beginning after December 15, 2006.   The Company is currently evaluating the impact the adoption of the standard will have on the Company’s results of operations or financial condition.

In March 2007, the FASB ratified Emerging Issues Task Force Issue No. 06-10 (“EITF 06-10”), Accounting for Collateral Assignment Split-Dollar Life Insurance Agreements. EITF 06-10 provides guidance for determining a liability for the postretirement benefit obligation as well as recognition and measurement of the associated asset on the basis of the terms of the collateral assignment agreement. EITF 06-10 is effective for fiscal years beginning after December 15, 2007. The Company is currently evaluating the impact the adoption of the EITF will have on the Company’s results of operations or financial condition.

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Note 3. Per Share Data

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

Options to purchase 8,276 and 9,002 shares of common stock at the price of $40.29 were outstanding during the three months ended March 31, 2007 and 2006, respectively, but were not included in the computation of diluted earnings per share as they were anti-dilutive due to the strike price being greater than the market price as of March 31, 2007 and 2006, respectively.

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 11 of the Company’s Consolidated Financial Statements included in the Annual Report on Form 10-K for the year ended December 31, 2006.

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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 three months ended March 31, 2007 and 2006, respectively:

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, 2006, that it expected to contribute $500,000 to its defined benefit plan in 2007.  As of March 31, 2007, there were no contributions 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.

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.

Outstanding financial instruments with off balance sheet risk are as follows:

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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

Effective April 26, 2006, the Company implemented 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 three months ended March 31, 2007, there were 672 shares issued under the plan.

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 wishes to caution 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, 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.

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

EARNINGS SUMMARY

Comparison of the Three Months Ended March 31, 2007 and 2006

Summary Results

Net income for the three months ended March 31, 2007 was $2,281,000 compared to $2,455,000 for the same period of 2006.  Basic and diluted earnings per share for the three months ended March 31, 2007 were $0.59 as compared to $0.62 for the three months ended March 31, 2006.  Return on average assets and return on average equity were 1.56% and 12.13% for the three months ended March 31, 2007 as compared to 1.72% and 13.24% for the corresponding period of 2006.  Net income from core operations for the three months ended March 31, 2007 and 2006, excluding after-tax net securities gains of $215,000 and $369,000, respectively, were $2,066,000 and $2,086,000 or $0.53 per share for the periods being compared.  (Management uses the non-GAAP measure of net income from core operations in its analysis of the Company’s performance.  This measure, as used by the Company, adjusts net income by 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 means net income adjusted to exclude after-tax net securities gains.  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.)

Interest Income

Interest income for the three months ended March 31, 2007 increased $657,000 to $8,679,000 as compared to $8,022,000 for the same period of 2006.  The increase in total interest income was primarily the result of growth in average loans of $17,717,000 for the three months ended March 31, 2007 as compared to 2006.  The average loan growth and a 35 basis point (“bp”) increase in loan portfolio yields accounted for $614,000 of the total interest income growth.  Over this time frame, the average balance of investment securities decreased $15,076,000 as the funds were utilized to assist in funding the loan growth.  The decrease in the average investment portfolio was offset by an increase of 34 bp in the investment portfolio yield which resulted in total interest income from the investment portfolio increasing $43,000 to $2,256,000 for the three months ended March 31, 2007.  On a taxable equivalent basis, the interest income from the investment portfolio increased $106,000 as the portfolio was strategically shifted to a more tax-exempt weighting.  The increase in dividends received is the result of an increase in the level of dividends from the Federal Home Loan Bank of Pittsburgh (“FHLB”).

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Interest income composition for the three months ended March 31, 2007 and 2006 were as follows:

Interest Expense

Interest expense for the three months ended March 31, 2007 increased $750,000 to $3,939,000 as compared to $3,189,000 for the same period of 2006.  The increased expense associated with deposits is primarily the result of rate increases for time deposits, which are comprised of various certificates of deposit (“CD”) accounts, from the three months ended March 31, 2006 to the corresponding period of 2007.  Factors that led to the rate increases include, but are not limited to, several period prime rate increases, competitive market pricing pressure, and promotional campaigns run in conjunction with the opening of the Montoursville branch and the one year anniversary celebration of the State College North Atherton Street branch.  The increase in CD interest rates has exceeded the increase for other deposit accounts.  This has led to a shift of a portion of the money market and savings deposit portfolios into higher yielding CDs.

Short-term borrowing costs increased as rates paid increased 84 bp as a direct result of the four prime rate increases since the start of 2006 and a minimal increase in the average balance of $1,131,000.  Long-term FHLB borrowing expense decreased minimally due to a decline in average borrowings of $3,614,000.  The decline was the result of maturities of $11,500,000, with an average rate of 3.77%, during the first three months of 2007 offset by the acquisition of $10,000,000, with an average rate of 4.28%.

Interest expense composition for the three months ended March 31, 2007 and 2006 were as follows:

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Net Interest Margin

The net interest margin (“NIM”) for the three months ended March 31, 2007 was 3.95% as compared to 4.08% for the corresponding period of 2006.  The decrease in the NIM was the result of the yield on earning assets increasing 36 bp to 6.87% for the three months ended March 31, 2007, as compared to 2006; however, interest bearing liabilities increased 59 bp over the same period.  The increase in the yield on earning assets is attributable to growth in the taxable loan portfolio of $17,614,000 in addition to the yield on taxable loans increasing 36 bp coupled with an increase of 53 bp on the taxable investment portfolio.  The average loan growth was predominately comprised of residential and commercial real estate loans.  The yield on total loans increased to 7.27% from 6.92% due to the impact of the Federal Open Market Committee rate increases enacted over the past year offset by competitive factors. The average taxable investment securities portfolio declined by $3,440,000, as the cash flow from the portfolio was utilized to fund the growth in loans. The investment portfolio yield increased to 6.10% from 5.76% primarily from the previously noted shift in the portfolio to a portfolio weighting of tax-exempt investments.  The average interest rate paid on deposit accounts increased to 3.25% as compared to 2.52% for the 2006 period.  This increase was driven by growth in average time deposits of $25,767,000 and an increase in the rate paid on time deposits of 98 bp.  A portion of the increase in deposit volume and the average interest yield paid is due to several CD promotions during the past year to attract new customers while retaining existing customers.  The promotions were designed to gather deposits that would have maturities of two years or less.  In addition, the promotions served as a catalyst to cross sell other deposit products and to implement management’s strategy regarding the CD portfolio allocation among various maturities and therefore, reducing the concentration of time deposit maturities within any single month.

The prime rate increased 100 bp to 8.25% at March 31, 2007 from 7.25% at January 1, 2006, as further evidence of the correlation between the Company’s primary source of borrowed funds, the FHLB, and the primary lending rate indicator used on a national basis.  Based on this increase, short-term borrowings realized an increase of 84 bp in interest rates for the three months ended March 31, 2007 as compared to March 31, 2006.

Following is a schedule of average balances and associated yields for the three month periods ended March 31, 2007 and 2006:

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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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The following table presents the adjustment to convert net interest income to net interest income on a fully taxable equivalent basis for the three month periods ended March 31, 2007 and 2006.

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 month periods ended March 31, 2007 and 2006:

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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.

The allowance is calculated 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 March 31, 2007, 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, employment, 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 $4,185,000 at December 31, 2006 to $4,201,000 at March 31, 2007.  At March 31, 2007, the allowance for loan losses was 1.17% of total loans compared to 1.16% of total loans at December 31, 2006.  Management’s conclusion is that the allowance for loan losses is adequate to provide for possible losses inherent in the loan portfolio as of the balance sheet date.

The provision for loan losses totaled $40,000 for the three months ended March 31, 2007, respectively, as compared to $198,000 for the same period in 2006.  The decrease in the provision was the result of several continuing positive factors, including but not limited to, annualized net charge offs to average loans of 0.03%, nonperforming loans to total loans of 0.28%, and an allowance for losses to nonperforming loans of 412.27%.

Based upon this analysis, as well as the others noted above, senior management has concluded that the allowance for loan losses remains at a level adequate to provide for probable losses inherent in its loan portfolio.

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Non-interest Income

Total non-interest income for the three months ended March 31, 2007 compared to the same period in 2006 decreased $363,000 to $1,974,000.  Excluding net security gains, non-interest income would have decreased $130,000.  Deposit service charges declined $49,000 as overdraft protection fees declined and customers migrated to new checking accounts having reduced or no service charges.  Other income increased due primarily to revenue generated from increased debit card transactions and commissions generated by The M Group for securities transactions.

Insurance commissions for the three months ended March 31, 2007 decreased $122,000 as compared to the same period in 2006 due to a shift in product mix.  Management of The M Group continues to pursue new and build upon current relationships.  The sales call program continues to expand to other financial institutions, which typically results in additional revenue for The M Group.

Non-interest income composition for the three months ended March 31, 2007 and 2006 were as follows:

Non-interest Expense

Total non-interest expense increased $177,000 from the three months ended March 31, 2006 compared to the same period of 2007.  The increase in salaries and employee benefits was attributable to several items including: standard cost of living wage adjustments for employees, new additions to our staff, and increased benefit cost.  Occupancy expense increased due to the new branch in Montoursville, which opened in the third quarter of 2006, and increased cost of maintenance and property taxes.  Other expenses increased primarily due to normal anticipated inflationary adjustments to ongoing business operating costs and the amortization related to two low income housing partnerships that began operation during the first and fourth quarters of 2006, respectively.

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Non-interest expense composition for the three months ended March 31, 2007 and 2006 was as follows:

Provision for Income Taxes

Income taxes decreased $301,000 for the three month period ended March 31, 2007 compared to the same periods of 2006.  The effective tax rates for the three months ended March 31, 2007 and 2006 were 10.4% and 18.7%, respectively.  The decline in the effective tax rate is consistent with management’s repositioning of the investment portfolio from taxable investment securities to tax-exempt investment securities and tax credits related to investments in low income housing projects.

ASSET/LIABILITY MANAGEMENT

Cash and Cash Equivalents

Cash and cash equivalents decreased $2,118,000 from $15,373,000 at December 31, 2006, primarily as a result of the following activities during the three months ended March  31, 2007:

Operating Activities

The significant components of operating activities are net income and the origination and proceeds of loans held for sale.  Activity regarding loans held for sale resulted in sale proceeds, less $138,000 in realized gains, exceeding loan origination disbursements by $720,000 for the period.

Loans

Gross loans decreased $2,810,000 since December 31, 2006 due to the early payoff of  a large commercial loan coupled with increased competition for commercial loans.

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The allocation of the loan portfolio, by category, as of March 31, 2007 and December 31, 2006 is presented below:

The recorded investment in loans for which impairment has been recognized in accordance with Statement of Financial Accounting Standards No. 114, Accounting by Creditors for Impairment of a Loan, amounted to $1,209,000 at March 31, 2007, as compared to $574,000 at December 31, 2006.  The valuation allowance related to impaired loans amounted to $73,000 at March 31, 2007 and $42,000 at December 31, 2006.  The increase in impaired loans is primarily from a single commercial relationship that accounted for $523,000 of the increase, while the increase in valuation allowance is the result of a second commercial relationship that had a specific collateral weakness.

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.

Investments

The amortized cost and estimated fair market value of the investment securities portfolio in total has remained constant since December 31, 2006.  Over the first three months of 2007, the amortized cost of equity securities has increased $591,000, while U.S. Government and agency securities decreased $399,000.  The position in state and political securities remained relatively static as the Bank continued its strategy to maintain call protection, maintain taxable equivalent yields, reduce the effective federal income tax rate, and invest in communities across the Commonwealth of Pennsylvania and the country.

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The amortized cost of investment securities and their estimated fair values are as follows: