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)

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.  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, 2008.

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, 2008.

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 April 2009, the FASB issued FASB Staff Position (“FSP”) No. FAS 141(R)-1, Accounting for Assets Acquired and Liabilities Assumed in a Business Combination That Arise from Contingencies (“FAS 141(R)-1”).  This FSP requires companies acquiring contingent assets or assuming contingent liabilities in business combination to either (a) if the assets’ or liabilities’ fair value can be determined, recognize them at fair value, at the acquisition date, or (b) if the assets’ or liabilities’ fair value cannot be determined, but (i) it is probable that an asset existed or that a liability had been incurred at the acquisition date and (ii) the amount of the asset or liability can be reasonably estimated, recognize them at their estimated amount, at the acquisition date.   If the fair value of these contingencies cannot be determined and they are not probable or cannot be reasonably estimated, then companies should not recognize these contingencies as of the acquisition date and instead should account for them in subsequent periods by following other applicable GAAP.  This FSP also eliminates the FAS 141(R)-1 requirement of disclosing in the footnotes to the financial statements the range of expected outcomes for a recognized contingency.  This FSP shall be effective for assets or liabilities arising from contingencies in business combinations for which the acquisition date is on or after the beginning of the first annual reporting period beginning on or after December 15, 2008.  The adoption of this FSP has

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not and is not expected to have a material effect on the Company’s results of operations or financial position.

In April 2009, the FASB issued FSP No. FAS 157-4, Determining Fair Value When the Volume and Level of Activity for the Asset or Liability Have Significantly Decreased and Identifying Transactions That Are Not Orderly (“FAS 157-4”).  This FSP relates to determining fair values when there is no active market or where the price inputs being used represent distressed sales.  It reaffirms the need to use judgment to ascertain if a formerly active market has become inactive and in determining fair values when markets have become inactive. FAS 157-4 is effective for interim and annual periods ending after June 15, 2009, but entities may early adopt this FSP for the interim and annual periods ending after March 15, 2009. The adoption of this FSP is not expected to have a material effect on the Company’s results of operations or financial position.

In April 2009, the FASB issued FSP No. FAS 107-1 and APB 28-1, Interim Disclosures about Fair Value of Financial Instruments (“FAS 107-1 and APB 28-1”), which relates to fair value disclosures for any financial instruments that are not currently reflected on the balance sheet of companies at fair value.  Prior to issuing this FSP, fair values for these assets and liabilities were only disclosed once a year. The FSP now requires these disclosures on a quarterly basis, providing qualitative and quantitative information about fair value estimates for all those financial instruments not measured on the balance sheet at fair value.  FAS 107-1 and APB 28-1 is effective for interim and annual periods ending after June 15, 2009, but entities may early adopt this FSP for the interim and annual periods ending after March 15, 2009.  The adoption of this FSP is not expected to have a material effect on the Company’s results of operations or financial position.

In April 2009, the FASB issued FSP No. FAS 115-2 and FAS 124-2, Recognition and Presentation of Other-Than-Temporary Impairments (“FAS 115-2 and FAS 124-2”), which provides additional guidance designed to create greater clarity and consistency in accounting for and presenting impairment losses on securities.  FAS 115-2 and FAS 124-2 is effective for interim and annual periods ending after June 15, 2009, but entities may early adopt this FSP for the interim and annual periods ending after March 15, 2009.  The adoption of this FSP is not expected to have a material effect on the Company’s results of operations or financial position.

Note 3. Per Share Data

There are no convertible securities which would affect the denominator in calculating basic and dilutive earnings per share; therefore, 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.

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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, 2008, that it expected to contribute a minimum of $325,000 to its defined benefit plan in 2009.  As of March 31, 2009, 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.

Financial instruments whose contract amounts represent credit risk are as follows at March 31, 2009 and December 31, 2008:

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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

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, 2009 and 2008, there were 723 and 718 shares issued under the plan, respectively.

Note 8.  Fair Value Measurements

Effective January 1, 2008, the Company adopted the provisions of FAS No. 157, Fair Value Measurements (“FAS 157”), for financial assets and financial liabilities.  FAS 157 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.  The FASB issued Staff Position No. 157-1, Application of FASB Statement No. 157 to FASB Statement No. 13 and Other Accounting Pronouncements That Address Fair Value Measurements for Purposes of Lease Classification or Measurement under Statement 13, which removed leasing transactions accounted for under FAS 13 and related guidance from the scope of FAS No. 157.  The FASB also issued Staff Position No. 157-2, Partial Deferral of the Effective Date of Statement 157, which deferred the effective date of FAS 157 for all nonfinancial assets and nonfinancial liabilities to fiscal years beginning after November 15, 2008.

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FAS 157 establishes a hierarchal disclosure framework associated with the level of pricing observability utilized in measuring assets and liabilities at fair value. The three broad levels defined by FAS 157 hierarchy are as follows:

The following table presents the assets reported on the balance sheet at their fair value on a recurring basis as of March 31, 2009 and December 31, 2008, by level within the fair value hierarchy. As required by FAS 157, financial assets and liabilities are classified in their entirety based on the lowest level of input that is significant to the fair value measurement.

The following table presents the assets reported on the balance sheet at their fair value on a non-recurring basis as of March 31, 2009 and December 31, 2008, by level within the fair value hierarchy. As required by FAS 157, 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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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, 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 Months Ended March 31, 2009 and 2008

Summary Results

Net income for the three months ended March 31, 2009 was $839,000 compared to $2,131,000 for the same period of 2008 as after-tax securities losses increased $1,589,000 (from a gain of $25,000 to a loss of $1,564,000).  Included within the change in after-tax securities losses was an other than temporary impairment charge relating to certain equity securities held in the investment portfolio of $2,333,000. Basic and diluted earnings per share for the three months ended March 31, 2009 were $0.22 compared to $0.55 for the three months ended March 31, 2008.  Return on average assets and return on average equity were 0.52% and 5.64% for the three months ended March 31, 2009 compared to 1.36% and 12.01% for the corresponding period of 2008.  Net income from core operations (“operating earnings”) increased 14.1% to $2,403,000 for the three months ended March 31, 2009 compared to $2,106,000 for the same period of 2008.  Operating earnings per share for the three months ended March 31, 2009 increased 16.7% to $0.63 basic and dilutive compared to $0.54 basic and dilutive for the three months ended March 31, 2008.

(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 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 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.)

Interest And Dividend Income

Interest and dividend income for the three months ended March 31, 2009 decreased $131,000 to $8,917,000 compared to $9,048,000 for the same period of 2008.  The decrease in interest income was the result of a decline in loan interest of $161,000 offset by an increase in investment securities income of $30,000.  The decline in loan interest is the result of the low interest rate environment that has existed over the past year.  This has caused the interest rate of new loans to be at a lower rate, resulting in a 56 basis point (“bp”) decline in loan portfolio yield.  Dividend income decreased as a direct result of the current status of the economy that has caused many of the equity holdings in our portfolio to decrease their dividend.  In addition, the Federal

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Home Loan Bank of Pittsburgh (“FHLB”) has suspended payment of dividends on shares of its common stock, which has resulted in a decrease of approximately $75,000 in dividend income.  Offsetting the decreased dividend income was an increase in taxable investment securities income of $173,000.  On a taxable equivalent basis, the decline in total interest income was limited to $73,000.  Average loan portfolio growth of $27,202,000 limited the impact of the decline in loan portfolio yield.  In addition, the investment portfolio yield increased 43 bp resulting in increased taxable equivalent income of $41,000.

Interest and dividend income composition for the three months ended March 31, 2009 and 2008 was as follows:

Interest Expense

Interest expense for the three months ended March 31, 2009 decreased $1,087,000 to $3,080,000 compared to $4,167,000 for the same period of 2008.  The decreased expense of $536,000 associated with deposits is primarily the result of a reduction of 138 bp in rate paid on time 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 12 month or shorter maturity CDs resulting in an increased repricing frequency.  Short-term borrowings interest expense decreased $271,000 as the increase in average balance of $10,374,000 was countered by a decrease in the rate paid of 231 bp due to the FOMC rate actions and overall decline in the treasury security market.  Long-term borrowing interest expense decreased $280,000 as the average balance of such borrowings decreased $18,756,000, while the average rate decreased 26 bp to 4.23%.  The change in average balance and rate is reflective of $29,600,000 in long-term borrowing maturities during the first half of 2008 at an average rate of 4.77% offset by the acquisition of $10,000,000 in long-term borrowings at a rate of 3.18% during the third quarter of 2008.

Interest expense composition for the three months ended March 31, 2009 and 2008 was as follows:

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Net Interest Margin

The net interest margin (“NIM”) for the three months ended March 31, 2009 was 4.47% compared to 3.87% for the corresponding period of 2008.  The increase in the NIM was driven by a 105 bp decline in the rate paid on interest bearing liabilities that more than compensated for a 19 bp decline in the yield on earning assets.  The decrease in earning asset yield is due to the impact on the loan portfolio of the current low rate environment offset in part by an increase in yield for the investment portfolio.  The increase in the investment portfolio yield was driven by a strategic initiative to increase tax equivalent net interest income by purchasing tax-exempt and taxable municipal bonds in anticipation of the decreasing rate environment that has continued to date.  The decrease in the cost of interest bearing liabilities to 2.45% from 3.50% was driven primarily by a reduction in the rate paid on time deposits of 138 bp and total borrowings of 121 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 following is a schedule of average balances and associated yields for the three months ended March 31, 2009 and 2008:

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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 $4,356,000 at December 31, 2008 to $4,441,000 at March 31, 2009.  At March 31, 2009 and December 31, 2008, the allowance for loan losses to total loans was 1.15% and 1.14%, respectively.

The provision for loan losses totaled $126,000 for the three months ended March 31, 2009, compared to $60,000 for the same period in 2008.  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 $5,714,000 since December 31, 2008, a ratio of annualized net charge offs to average loans of 0.04% for the three months ended March 31, 2009, a ratio of nonperforming loans to total loans of 0.59%, and a ratio of the allowance for loan losses to nonperforming loans of 195.72% at March 31, 2009.

Non-interest Income

Total non-interest income for the three months ended March 31, 2009 compared to the same period in 2008 decreased $2,690,000 to $(776,000) due to a $2,407,000 decrease in net securities gains and losses realized when comparing the three month periods ended March 31, 2009 and 2008.  Excluding net securities gains and losses, non-interest income for the first quarter of 2009 would have decreased $283,000 as compared to the 2008 period.  Deposit service charges decreased $45,000 as overdraft fee income declined $33,000 in addition to customers migrating to no service charge checking accounts that were introduced as part of a customer acquisition and retention program.  Gain on sale of loans decreased $34,000 due primarily from a change in product mix which has resulted in a greater percentage of the fee collected being categorized as other income.  Other income increased due to increased revenue from electronic card (debit/credit) usage and fees from the sale of loans into the secondary market, which countered losses realized from the sale of other real estate owned.

Insurance commissions for the three months ended March 31, 2009 decreased $226,000 compared to the same period in 2008 due to a softening market and 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 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.

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Non-interest income composition for the three months ended March 31, 2009 and 2008 was as follows:

Non-interest Expense

Total non-interest expense increased $200,000 for the three months ended March 31, 2009 compared to the same period of 2008.  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.  Pennsylvania shares tax increased $66,000 due to the utilization of Pennsylvania Enterprise Zone tax credits from a low income housing partnership during 2008.  Other expenses increased primarily due to normal anticipated inflationary adjustments to ongoing business operating costs.

Non-interest expense composition for the three months ended March 31, 2009 and 2008 was as follows:

Provision for Income Taxes

Income taxes decreased $708,000 for the three months ended March 31, 2009 compared to the same period of 2008.  The decrease, due to net securities losses of $2,369,000, resulted in a tax benefit of $549,000 for the three months ended March 31, 2009.  Excluding the impact of the net securities gains and losses, the effective tax rate for the three months ended March 31, 2009 was 9.63% as compared to 6.48% for the same period of 2008.  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

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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 decreased $3,672,000 from $16,581,000 at December 31, 2008 to $12,909,000 at March 31, 2009 primarily as a result of the following activities during the three months ended March 31, 2009:

Loans Held for Sale

Activity regarding loans held for sale resulted in sale proceeds exceeding loan originations, less $118,000 in realized gains, by $1,108,000 for the three months ended March 31, 2009.

Loans

Gross loans increased $5,714,000 since December 31, 2008 due to the increase of commercial related loans, while non-commercial loans remained relatively constant.

The allocation of the loan portfolio, by category, as of March 31, 2009 and December 31, 2008 is presented below: