PENSECO FINANCIAL SERVICES CORP (Form: 10-Q, Received: 08/09/2012 17:27:05)

Large accelerated filer

Accelerated filer

Non-accelerated filer

¨ (Do not check if a smaller reporting company)

Smaller reporting company

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

FORM 10-Q

x	QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the quarterly period ended June 30, 2012

¨	TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

Commission file number 000-23777

PENSECO FINANCIAL SERVICES CORPORATION

Incorporated pursuant to the laws of Pennsylvania

Internal Revenue Service — Employer Identification No. 23-2939222

150 North Washington Avenue, Scranton, Pennsylvania 18503-1848

(570) 346-7741

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 ¨

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 (Section 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 x No ¨

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 definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act.

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

The total number of shares of the registrant’s Common Stock, $0.01 par value, outstanding on August 1, 2012 was 3,276,079.

PENSECO FINANCIAL SERVICES CORPORATION


	Page
Part I — FINANCIAL INFORMATION

Item 1. Unaudited Financial Statements — Consolidated

Balance Sheets:

June 30, 2012		3

December 31, 2011		3

Statements of Income:

Three Months Ended June 30, 2012		4

Three Months Ended June 30, 2011		4

Six Months Ended June 30, 2012		5

Six Months Ended June 30, 2011		5

Statements of Comprehensive Income:

Three Months Ended June 30, 2012		6

Three Months Ended June 30, 2011		6

Six Months Ended June 30, 2012		6

Six Months Ended June 30, 2011		6

Statements of Changes in Stockholders’ Equity:

Three Months Ended June 30, 2012		7

Three Months Ended June 30, 2011		7

Six Months Ended June 30, 2012		8

Six Months Ended June 30, 2011		8

Statements of Cash Flows:

Six Months Ended June 30, 2012		9

Six Months Ended June 30, 2011		9

Notes to Unaudited Consolidated Financial Statements		10

Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations		34

Item 3. Quantitative and Qualitative Disclosures About Market Risk		56

Item 4. Controls and Procedures		56

Part II — OTHER INFORMATION

Item 1. Legal Proceedings		57

Item 1A. Risk Factors		57

Item 2. Unregistered Sales of Equity Securities and Use of Proceeds		57

Item 3. Defaults Upon Senior Securities		57

Item 4. Mine Safety Disclosures		57

Item 5. Other Information		57

Item 6. Exhibits		57

Signatures		58

PART I. FINANCIAL INFORMATION, Item 1 — Financial Statements

PENSECO FINANCIAL SERVICES CORPORATION

CONSOLIDATED BALANCE SHEETS

(unaudited)

(in thousands, except share and per share amounts)


	June 30, 2012		December 31, 2011 *
ASSETS
Cash and due from banks	$	11,236	$	13,184
Interest bearing balances with banks		8,805		21,296
Federal funds sold		—		—

Cash and Cash Equivalents		20,041		34,480
Investment securities:
Available-for-sale, at fair value		165,277		167,486
Held-to-maturity (fair value of $20,734 and $24,969, respectively)		19,609		23,722

Total Investment Securities		184,886		191,208
Loans, net of unearned income		638,970		631,522
Less: Allowance for loan and lease losses		6,938		6,711

Loans, Net		632,032		624,811
Bank premises and equipment		14,423		13,095
Other real estate owned		726		1,571
Accrued interest receivable		3,093		3,252
Goodwill		26,398		26,398
Bank owned life insurance		17,361		15,870
Federal Home Loan Bank stock		5,268		4,953
Other assets		10,165		9,894

Total Assets	$	914,393	$	925,532

LIABILITIES
Deposits:
Non-interest bearing	$	139,183	$	134,799
Interest bearing		573,217		585,719

Total Deposits		712,400		720,518
Other borrowed funds:
Securities sold under agreements to repurchase		10,488		9,981
Short-term borrowings		—		—
Long-term borrowings		51,792		58,220
Accrued interest payable		756		1,010
Other liabilities		8,590		8,470

Total Liabilities		784,026		798,199

STOCKHOLDERS’ EQUITY
Common stock; $ .01 par value, 15,000,000 shares authorized,
3,276,079 shares issued and outstanding		33		33
Surplus		48,875		48,865
Retained earnings		81,290		78,713
Accumulated other comprehensive income		169		(278	)

Total Stockholders’ Equity		130,367		127,333

Total Liabilities and Stockholders’ Equity	$	914,393	$	925,532

*	as restated see note 18

(See accompanying Notes to Unaudited Consolidated Financial Statements)

PENSECO FINANCIAL SERVICES CORPORATION

CONSOLIDATED STATEMENTS OF INCOME

(unaudited)

(in thousands, except share and per share amounts)


	Three Months Ended June 30, 2012		Three Months Ended June 30, 2011 *
INTEREST INCOME
Interest and fees on loans and leases	$	8,179	$	8,328
Interest and dividends on investments:
U.S. Treasury securities and U.S. Agency obligations		615		745
States & political subdivisions		667		857
Other securities		13		15
Interest on Federal funds sold		—		—
Interest on balances with banks		2		4

Total Interest Income		9,476		9,949

INTEREST EXPENSE
Interest on time deposits of $100,000 or more		300		363
Interest on other deposits		614		955
Interest on other borrowed funds		493		604

Total Interest Expense		1,407		1,922

Net Interest Income		8,069		8,027
Provision for loan and lease losses		114		899

Net Interest Income After Provision for Loan and Lease Losses		7,955		7,128

NON-INTEREST INCOME
Trust department income		341		385
Service charges on deposit accounts		468		519
Merchant transaction income		891		931
Brokerage fee income		84		77
Other fee income		461		431
Bank-owned life insurance income		131		125
Other operating income		181		315
Impairment losses on investment securities		—		—
Realized gains (losses) on securities, net		69		272

Total Non-Interest Income		2,626		3,055

NON-INTEREST EXPENSES
Salaries and employee benefits		3,490		3,313
Expense of premises and equipment, net		715		806
Merchant transaction expenses		596		666
FDIC insurance assessments		120		180
Other operating expenses		2,340		1,971

Total Non-Interest Expenses		7,261		6,936

Income before income taxes		3,320		3,247
Applicable income taxes		721		685

Net Income	$	2,599	$	2,562

Weighted average shares outstanding — Basic		3,276,079		3,276,079
Weighted average shares outstanding — Diluted		3,276,122		3,276,079
Earnings per Common Share — Basic	$	0.79	$	0.78
Earnings per Common Share — Diluted	$	0.79	$	0.78
Cash Dividends Declared Per Common Share	$	0.42	$	0.42

*	as restated see note 18

(See accompanying Notes to Unaudited Consolidated Financial Statements)

PENSECO FINANCIAL SERVICES CORPORATION

CONSOLIDATED STATEMENTS OF INCOME

(unaudited)

(in thousands, except share and per share amounts)


	Six Months Ended June 30, 2012		Six Months Ended June 30, 2011 *
INTEREST INCOME
Interest and fees on loans and leases	$	16,466	$	16,670
Interest and dividends on investments:
U.S. Treasury securities and U.S. Agency obligations		1,254		1,560
States & political subdivisions		1,382		1,724
Other securities		29		29
Interest on Federal funds sold		—		—
Interest on balances with banks		4		6

Total Interest Income		19,135		19,989

INTEREST EXPENSE
Interest on time deposits of $100,000 or more		612		733
Interest on other deposits		1,258		1,847
Interest on other borrowed funds		1,018		1,239

Total Interest Expense		2,888		3,819

Net Interest Income		16,247		16,170
Provision for loan and lease losses		306		1,268

Net Interest Income After Provision for Loan and Lease Losses		15,941		14,902

NON-INTEREST INCOME
Trust department income		703		783
Service charges on deposit accounts		927		991
Merchant transaction income		2,098		2,173
Brokerage fee income		141		133
Other fee income		864		809
Bank-owned life insurance income		249		245
Other operating income		431		945
Impairment losses on investment securities		—		—
Realized gains (losses) on securities, net		116		280

Total Non-Interest Income		5,529		6,359

NON-INTEREST EXPENSES
Salaries and employee benefits		7,204		6,903
Expense of premises and equipment, net		1,552		1,827
Merchant transaction expenses		1,327		1,499
FDIC insurance assessments		230		422
Other operating expenses		4,288		3,800

Total Non-Interest Expenses		14,601		14,451

Income before income taxes		6,869		6,810
Applicable income taxes		1,540		1,522

Net Income	$	5,329	$	5,288

Weighted average shares outstanding — Basic		3,276,079		3,276,079
Weighted average shares outstanding — Diluted		3,276,100		3,276,079
Earnings per Common Share — Basic	$	1.63	$	1.61
Earnings per Common Share — Diluted	$	1.63	$	1.61
Cash Dividends Declared Per Common Share	$	0.84	$	0.84

*	as restated see note 18

(See accompanying Notes to Unaudited Consolidated Financial Statements)

PENSECO FINANCIAL SERVICES CORPORATION

CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME

(unaudited)

(in thousands)


	Three Months Ended June 30, 2012		Three Months Ended June 30, 2011 *
Net Income	$	2,599	$	2,562

Other comprehensive income, net of tax:
Unrealized gains (losses) on securities:
Unrealized holding gains (losses) arising during the period		415		1,617
Less: reclassification adjustment for gains included in net income		40		179

Other comprehensive income (loss)		375		1,438

Comprehensive Income	$	2,974	$	4,000


	Six Months Ended June 30, 2012		Six Months Ended June 30, 2011 *
Net Income	$	5,329	$	5,288

Other comprehensive income, net of tax:
Unrealized gains (losses) on securities:
Unrealized holding gains (losses) arising during the period		518		1,580
Less: reclassification adjustment for gains included in net income		71		182

Other comprehensive income (loss)		447		1,398

Comprehensive Income	$	5,776	$	6,686

*	as restated see note 18

(See accompanying Notes to Unaudited Consolidated Financial Statements)

PENSECO FINANCIAL SERVICES CORPORATION

CONSOLIDATED STATEMENTS OF CHANGES IN STOCKHOLDERS’ EQUITY

THREE MONTHS ENDED JUNE 30, 2012 AND 2011

(unaudited)

(in thousands, except per share amounts)


	Common Stock		Surplus		Retained Earnings			Accumulated Other Comprehensive Income			Total Stockholders’ Equity
Balance, March 31, 2011 *	$	33	$	48,865	$	75,036		$	(2,158	)	$	121,776
Net income *		—		—		2,562			—			2,562
Other comprehensive income (loss)									1,438			1,438
Cash dividends declared ($0.42 per share)		—		—		(1,376	)		—			(1,376	)

Balance, June 30, 2011 *	$	33	$	48,865	$	76,222		$	720		$	124,400

Balance, March 31, 2012 *	$	33	$	48,865	$	80,067		$	206		$	128,759
Stock-based compensation				10								10
Net income		—		—		2,599			—			2,599
Other comprehensive income (loss)									375			375
Cash dividends declared ($0.42 per share)		—		—		(1,376	)		—			(1,376	)

Balance, June 30, 2012	$	33	$	48,875	$	81,290		$	169		$	130,367

*	as restated see note 18

(See accompanying Notes to Unaudited Consolidated Financial Statements)

PENSECO FINANCIAL SERVICES CORPORATION

CONSOLIDATED STATEMENTS OF CHANGES IN STOCKHOLDERS’ EQUITY

SIX MONTHS ENDED JUNE 30, 2012 AND 2011

(unaudited)

(in thousands, except per share amounts)


	Common Stock		Surplus		Retained Earnings			Accumulated Other Comprehensive Income			Total Stockholders’ Equity
Balance, December 31, 2010 *	$	33	$	48,865	$	73,686		$	(2,118	)	$	120,466
Net income *		—		—		5,288			—			5,288
Other comprehensive income									1,398			1,398
Cash dividends declared ($0.84 per share)		—		—		(2,752	)		—			(2,752	)

Balance, June 30, 2011 *	$	33	$	48,865	$	76,222		$	(720	)	$	124,400

Balance, December 31, 2011 *	$	33	$	48,865	$	78,713		$	(278	)	$	127,333
Stock-based compensation				10								10
Net income		—		—		5,329			—			5,329
Other comprehensive income									447			447
Cash dividends declared ($0.84 per share)		—		—		(2,752	)		—			(2,752	)

Balance, June 30, 2012	$	33	$	48,875	$	81,290		$	169		$	130,367

* as restated see Note 18

(See accompanying Notes to Unaudited Consolidated Financial Statements)

PENSECO FINANCIAL SERVICES CORPORATION

CONSOLIDATED STATEMENTS OF CASH FLOWS

(unaudited)

(in thousands)


	Six Months Ended			Six Months Ended
	June 30, 2012			June 30, 2011 *
OPERATING ACTIVITIES
Net Income	$	5,329		$	5,288
Adjustments to reconcile net income to net cash provided by operating activities:
Depreciation		455			543
Provision for loan and lease losses		306			1,268
Stock-based compensation		10			—
Deferred income tax provision (benefit)		72			129
Amortization of securities, (net of accretion)		134			247
Net realized (gains) losses on securities		(116	)		(280	)
(Gain) loss on other real estate		(27	)		(245	)
Decrease (increase) in interest receivable		159			407
(Increase) decrease in bank owned life insurance		(249	)		(245	)
(Increase) decrease in other assets		(343	)		(1,314	)
Increase (decrease) in income taxes payable		1,510			1,567
(Decrease) increase in interest payable		(254	)		(112	)
(Decrease) increase in other liabilities		(1,283	)		(2,927	)

Net cash provided (used) by operating activities		5,703			4,326

INVESTING ACTIVITIES
Purchase of investment securities available-for-sale		(7,343	)		(5,255	)
Purchase of investment securities to be held-to-maturity		—			—
Proceeds from investment securities available-for-sale		7,368			29,985
Proceeds from repayments of investment securities available-for-sale		2,871			1,865
Proceeds from repayments of investment securities held-to-maturity		4,083			8,759
Net loans (originated) repaid		(8,336	)		(4,741	)
Proceeds from other real estate		1,346			864
Investment in premises and equipment		(1,783	)		(420	)
Purchase of bank owned life insurance		(1,242	)		—
Purchase of Federal Home Loan Bank stock		(840	)		—
Proceeds from Federal Home Loan Bank share buyback		525			593

Net cash (used) provided by investing activities		(3,351	)		31,650

FINANCING ACTIVITIES
Net increase (decrease) in demand and savings deposits		9,814			23,993
Net (payments) proceeds on time deposits		(17,932	)		1,830
Increase (decrease) in securities sold under agreements to repurchase		507			2,771
Net (decrease) increase in short-term borrowings		—			(8,281	)
Increase in long-term borrowings		—			—
Payments on long-term borrowings		(6,428	)		(6,268	)
Cash dividends paid		(2,752	)		(2,752	)

Net cash (used) provided by financing activities		(16,791	)		11,293

Net (decrease) increase in cash and cash equivalents		(14,439	)		47,269
Cash and cash equivalents at January 1		34,480			14,219

Cash and cash equivalents at June 30	$	20,041		$	61,488

The Company paid interest and income taxes of $3,142 and $950 and $3,931 and $1,840 during the six months ended June 30, 2012 and 2011, respectively.

*	as restated see note 18

(See accompanying Notes to Unaudited Consolidated Financial Statements)

NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS

For the Three and Six Months Ended June 30, 2012

(unaudited)

These Notes to Unaudited Consolidated Financial Statements reflect events subsequent to December 31, 2011, through the date of this Quarterly Report on Form 10-Q. These Notes to Unaudited Consolidated Financial Statements should be read in conjunction with Parts I and II of this Report and the Company’s Annual Report on Form 10-K for the year ended December 31, 2011, which was filed with the Securities and Exchange Commission (SEC) on March 14, 2012.

NOTE 1 — Principles of Consolidation

Penseco Financial Services Corporation (Company) is a financial holding company incorporated under the laws of Pennsylvania. It is the parent company of Penn Security Bank and Trust Company (Bank), a Pennsylvania state chartered bank.

The Financial Statements of the Company have been consolidated with those of the Bank and its subsidiaries, eliminating all intercompany items and transactions.

The accounting policies of the Company conform with accounting principles generally accepted in the United States of America (GAAP) and with general practices within the banking industry.

NOTE 2 — Basis of Presentation

The unaudited consolidated financial statements have been prepared in accordance with applicable rules and regulations of the Securities and Exchange Commission (SEC), the instructions to SEC Form 10-Q and GAAP for interim financial information. In the opinion of management, all adjustments that are of a normal recurring nature and are considered necessary for a fair presentation have been included. The unaudited consolidated financial statements, as so adjusted, are not, however, necessarily indicative of the results of consolidated operations for a full year or any other period.

All dollar amounts are presented in thousands of dollars, except per share amounts.

For further information, refer to the audited consolidated financial statements and accompanying notes included in the Company’s Annual Report on Form 10-K for the year ended December 31, 2011.

NOTE 3 — Earnings per Share

Basic earnings per share is computed on the weighted average number of common shares outstanding during each reporting period. Diluted earnings per share include restricted stock awards, issuable after a vesting period, calculated on the “Treasury Stock Method”. Restricted stock awards are issued subject to forfeiture during the vesting period.


Three months ended June 30, 2012	Income (Numerator)		Shares (Denominator)		Per-share Amount
Basic EPS
Income available	$	2,599		3,276,079	$	0.79
Shares includable		—		43		—

Diluted EPS	$	2,599		3,276,122	$	0.79


Three months ended June 30, 2011 *	Income (Numerator)		Shares (Denominator)		Per-share Amount
Basic EPS
Income available	$	2,562		3,276,079	$	0.78
Shares includable		—		—		—

Diluted EPS	$	2,562		3,276,079	$	0.78

*	as restated see note 18


Six months ended June 30, 2012	Income (Numerator)		Shares (Denominator)		Per-share Amount
Basic EPS
Income available	$	5,329		3,276,079	$	1.63
Shares includable		—		21		—

Diluted EPS	$	5,329		3,276,100	$	1.63


Six months ended June 30, 2011 *	Income (Numerator)		Shares (Denominator)		Per-share Amount
Basic EPS
Income available	$	5,288		3,276,079	$	1.61
Shares includable		—		—		—

Diluted EPS	$	5,288		3,276,079	$	1.61

*	as restated see note 18

NOTE 4 — Use of Estimates

The preparation of financial statements in conformity with GAAP requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and the disclosure of contingent assets and liabilities at the date of the financial statements, and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates.

Material estimates that are particularly susceptible to significant change relate to the determination of the allowance for loan and lease losses and the valuation of property that is included in “other real estate owned” on our consolidated balance sheet and that was acquired in connection with foreclosures or in satisfaction of loans. In connection with the determination of the allowances for loan and lease losses and valuation of other real estate owned, management obtains independent appraisals for significant properties.

NOTE 5 — Reclassifications

Certain prior year amounts have been reclassified to conform to the current year presentation.

NOTE 6 — Investment Securities

Investments in securities are classified in two categories and accounted for as follows:

Securities Held-to-Maturity – Bonds, notes, debentures and mortgage-backed securities for which the Company has the positive intent and ability to hold to maturity are reported at cost, adjusted for amortization of premiums and accretion of discounts computed on the straight-line basis, which approximates the interest method, over the remaining period to maturity.

Securities Available-for-Sale – Bonds, notes, debentures, mortgage-backed securities not classified as securities to be held to maturity and certain equity securities are classified as available-for-sale and carried at fair value with unrealized holding gains and losses, net of tax, reported as a net amount in a separate component of stockholders’ equity until realized.

The amortization of premiums on mortgage-backed securities is done based on management’s estimate of the lives of the securities, adjusted, when necessary, for advanced prepayments in excess of those estimates.

Realized gains and losses on the sale of securities available-for-sale are determined using the specific identification method and are reported as a separate component of other income in the Statements of Income. Unrealized gains and losses are included as a separate item in computing comprehensive income.

Investment securities are evaluated periodically to determine whether a decline in their value is other than temporary. Management utilizes criteria such as the magnitude and duration of the decline, in addition to the reasons underlying the decline, to determine whether the loss in value is other than temporary. The term “other than temporary” is not intended to indicate that the decline is permanent. It indicates that the prospects for a near term recovery of value are not necessarily favorable, or that there is a lack of evidence to support fair values equal to, or greater than, the carrying value of the security. Once a decline in value is determined to be other than temporary, the value of the security is reduced and a corresponding charge to earnings is recognized.

The amortized cost and fair value of investment securities at June 30, 2012 and December 31, 2011 are as follows:

Available-for-Sale


June 30, 2012	Amortized Cost		Gross Unrealized Gains		Gross Unrealized Losses		Fair Value
U.S. Agency securities	$	77,086	$	781	$	—	$	77,867
Mortgage-backed securities		25,604		998		—		26,602
States & political subdivisions		55,161		4,520		—		59,681
Corporate securities		—		—		—		—

Total Debt Securities		157,851		6,299		—		164,150
Equity securities		800		344		17		1,127

Total Available-for-Sale	$	158,651	$	6,643	$	17	$	165,277

Available-for-Sale


December 31, 2011	Amortized Cost		Gross Unrealized Gains		Gross Unrealized Losses		Fair Value
U.S. Agency securities	$	77,150	$	847	$	12	$	77,985
Mortgage-backed securities		21,270		896		—		22,166
States & political subdivisions		61,405		3,987		4		65,388
Corporate securities		1,002		2		—		1,004

Total Debt Securities		160,827		5,732		16		166,543
Equity securities		709		288		54		943

Total Available-for-Sale	$	161,536	$	6,020	$	70	$	167,486

Held-to-Maturity


June 30, 2012	Amortized Cost		Gross Unrealized Gains		Gross Unrealized Losses		Fair Value
Mortgage-backed securities	$	18,291	$	1,104	$	—	$	19,395
States & political subdivisions		1,318		21		—		1,339

Total Held-to-Maturity	$	19,609	$	1,125	$	—	$	20,734

Held-to-Maturity


December 31, 2011	Amortized Cost		Gross Unrealized Gains		Gross Unrealized Losses		Fair Value
Mortgage-backed securities	$	21,912	$	1,207	$	—	$	23,119
States & political subdivisions		1,810		40		—		1,850

Total Held-to-Maturity	$	23,722	$	1,247	$	—	$	24,969

Equity securities at June 30, 2012 and December 31, 2011 consisted primarily of common stock of companies in the financial services industry.

A summary of transactions involving available-for-sale debt securities for the six months ended June 30, 2012 and 2011 are as follows:


	June 30, 2012		June 30, 2011
Proceeds from sales	$	—	$	15,318
Gross realized gains		—		145
Gross realized losses		—		—

The amortized cost and fair value of debt securities at June 30, 2012 by contractual maturity are shown in the following table. Expected maturities will differ from contractual maturities because borrowers may have the right to call or prepay obligations with or without call or prepayment penalties.


	Available-for-Sale				Held-to-Maturity
June 30, 2012	Amortized Cost		Fair Value		Amortized Cost		Fair Value
Due in one year or less:
U.S. Agency securities	$	20,085	$	20,204	$	—	$	—
After one year through five years:
U.S. Agency securities		57,001		57,663		—		—
States & political subdivisions		169		173		—		—
After five years through ten years:
States & political subdivisions		1,422		1,557		1,318		1,339
After ten years:
States & political subdivisions		53,570		57,951		—		—

Subtotal		132,247		137,548		1,318		1,339
Mortgage-backed securities		25,604		26,602		18,291		19,395

Total Debt Securities	$	157,851	$	164,150	$	19,609	$	20,734

The gross fair value and unrealized losses of the Company’s investments aggregated by investment category and length of time that individual securities have been in a continuous unrealized loss position, at June 30, 2012 and December 31, 2011 are as follows:


	Less than twelve months				Twelve months or more				Totals
June 30, 2012	Fair Value		Unrealized Losses		Fair Value		Unrealized Losses		Fair Value		Unrealized Losses
U.S. Agency securities	$	—	$	—	$	—	$	—	$	—	$	—
States & political subdivisions		—		—		—		—		—		—
Equities		61		5		89		12		150		17

Total	$	61	$	5	$	89	$	12	$	150	$	17


	Less than twelve months				Twelve months or more				Totals
December 31, 2011	Fair Value		Unrealized Losses		Fair Value		Unrealized Losses		Fair Value		Unrealized Losses
U.S. Agency securities	$	13,001	$	12	$	—	$	—	$	13,001	$	12
States & political subdivisions		489		4		—		—		489		4
Equities		136		29		100		25		236		54

Total	$	13,626	$	45	$	100	$	25	$	13,726	$	70

At June 30, 2012, three securities had unrealized losses for less than twelve months and two securities had been in an unrealized loss position for twelve or more months. At December 31, 2011, ten securities had unrealized losses for less than twelve months and five securities had been in an unrealized loss position for twelve or more months.

U.S. Agency Securities

The unrealized losses on the Company’s investments in U.S. Agency securities were caused by interest rate fluctuations and not credit quality. The contractual terms of these investments do not permit the issuer to settle the securities at a price less than the par value of the investment. Because the Company does not intend to sell the investments and it is not more likely than not that the Company will be required to sell the investments before recovery of their amortized cost bases, which may be maturity, the Company does not consider those investments to be other-than-temporarily impaired at June 30, 2012.

Mortgage-backed Securities

The unrealized losses on the Company’s investments in mortgage-backed securities were caused by interest rate fluctuations and not credit quality. The contractual cash flows of these investments are guaranteed by an agency of the U.S. Government. Accordingly, it is expected that these securities would not be settled at a price less than the amortized cost of the Company’s investment. Because the Company does not intend to sell the investments and it is not more likely than not that the Company will be required to sell the investments before recovery of their amortized cost bases, which may be maturity, the Company does not consider those investments to be other-than-temporarily impaired at June 30, 2012.

States and Political Subdivisions

The unrealized losses on the Company’s investments in states and political subdivisions were caused by interest rate fluctuations and not credit quality. The contractual terms of these investments do not permit the issuer to settle the securities at a price less than the par value of the investment. Because the Company does not intend to sell the investments and it is not more likely than not that the Company will be required to sell the investments before recovery of their amortized cost bases, which may be maturity, the Company does not consider those investments to be other-than-temporarily impaired at June 30, 2012.

Marketable Equity Securities

The unrealized losses on the Company’s investments in marketable equity securities were caused by interest rate fluctuations and general market conditions. The Company’s investments in marketable equity securities consist primarily of investments in common stock of companies in the financial services industry. The Company has analyzed its equity portfolio and determined that the market value fluctuation in these equity securities is not a cause for recognition of a current loss. Because the Company does not intend to sell the investments and it is not more likely than not that the Company will be required to sell the investments before recovery of their cost bases, the Company does not consider those investments to be other-than-temporarily impaired at June 30, 2012.

NOTE 7 — Loan Portfolio

Details regarding the Company’s loan portfolio during the periods indicated are as follows:


	June 30,		December 31,
As of:	2012		2011
Loans secured by real estate:
Construction and land development
Residential real estate	$	4,642	$	5,064
Commercial real estate		18,521		20,541
Secured by 1-4 family residential properties:
Revolving, open-end loans		30,241		30,897
Secured by first liens		201,606		214,198
Secured by junior liens		20,468		21,858
Secured by multi-family properties		14,811		9,626
Secured by non-farm, non-residential properties		189,204		188,334
Commercial and industrial loans to U.S. addressees		62,755		55,482
Loans to individuals for household, family and other personal expenditures:
Credit card and related plans		3,051		3,242
Other (installment and student loans, etc.)		48,790		49,574
Obligations of states & political subdivisions		30,857		23,110
All other loans		14,024		9,596

Gross Loans		638,970		631,522
Less: Unearned income on loans		—		—

Loans, net of unearned income	$	638,970	$	631,522

The Company has not engaged in any sub-prime residential mortgage lending. Therefore, the Company is not subject to any credit risks associated with such loans. The Company’s loan portfolio consists primarily of residential and commercial mortgage loans secured by properties located in Northeastern Pennsylvania and subject to what the Company believes are conservative underwriting standards.

Age Analysis of Past Due Loans

As of June 30, 2012


	30-59 Days Past Due		60-89 Days Past Due		Greater Than 90 Days		Total Past Due		Current		Total Loans		Recorded Investment > 90 Days and Accruing
Commercial	$	41	$	73	$	423	$	537	$	107,099	$	107,636	$	—
Commercial real estate:
Commercial real estate — construction		—		—		—		—		18,521		18,521		—
Commercial real estate — other		316		—		145		461		188,743		189,204		—
Consumer:
Consumer — credit card		23		1		12		36		3,015		3,051		12
Consumer — other		2		—		—		2		4,755		4,757		—
Consumer — auto		109		19		32		160		30,399		30,559		1
Student loans — TERI		137		39		28		204		6,394		6,598		—
Student loans — other		139		151		96		386		6,490		6,876		96
Residential:
Residential — prime		543		904		2,832		4,279		267,489		271,768		1,447

Total	$	1,310	$	1,187	$	3,568	$	6,065	$	632,905	$	638,970	$	1,556

Age Analysis of Past Due Loans

As of December 31, 2011


	30-59 Days Past Due		60-89 Days Past Due		Greater Than 90 Days		Total Past Due		Current		Total Loans		Recorded Investment > 90 Days and Accruing
Commercial	$	23	$	—	$	477	$	500	$	87,688	$	88,188	$	—
Commercial real estate:
Commercial real estate construction		—		—		—		—		20,541		20,541		—
Commercial real estate — other		331		—		602		933		187,401		188,334		11
Consumer:
Consumer — credit card		34		11		6		51		3,191		3,242		6
Consumer — other		28		—		10		38		6,825		6,863		—
Consumer — auto		156		5		24		185		29,889		30,074		3
Student loans — TERI		14		62		61		137		6,117		6,254		—
Student loans — other		243		103		113		459		5,924		6,383		113
Residential:
Residential — prime		2,429		1,155		2,647		6,231		275,412		281,643		641

Total	$	3,258	$	1,336	$	3,940	$	8,534	$	622,988	$	631,522	$	774

Credit Quality Indicators. As part of the on-going monitoring of the credit quality of the Bank’s loan portfolio, management tracks certain credit quality indicators, including trends related to loan delinquency, the level of classified commercial loans, net charge-offs, non-performing loans (see details above) and the general economic conditions in the Company’s market area.

The Bank utilizes a risk grading matrix to assign a risk grade to each of its commercial loans. Loans are graded on a scale of 1 to 8. A description of the general characteristics of the 8 risk grades is as follows:

Pass 1 (Minimal Risk)

This classification includes loans which are fully secured by liquid collateral or loans to very high quality borrowers who demonstrate exceptional credit fundamentals, including stable and predictable profit margins and cash flows, strong liquidity, a conservative balance sheet, superior asset quality and good management with an excellent track record.

Pass 2 (Average Risk)

This classification includes loans which have no identifiable risk of collection and conform in all aspects to the Bank’s policies and procedures as well as federal and state regulations. Documentation exceptions are minimal, in the process of correction and not of a type that could subsequently introduce loan loss risk.

Pass 3 (Acceptable Risk)

This classification includes loans to borrowers of acceptable credit quality and risk. Such borrowers are differentiated from Pass 2 in terms of secondary sources of repayment or lesser stature in other key credit metrics in that they may be over-leveraged, undercapitalized, inconsistent in performance or in an industry that is known to have a higher level of risk, volatility, or susceptibility to weaknesses in the economy.

Pass 4 (Watch List)

This classification is intended to be utilized on a temporary basis for pass grade borrowers where a significant risk-modifying action is anticipated in the near term. It is assigned to loans where, for example, the financial condition of the company has taken a negative turn and may be temporarily strained; borrowers may exhibit excessive growth, declining earnings, strained cash flow, increasing leverage and/or weakening market position that indicate above-average risk. Interim losses and/or adverse trends may occur (but not to the level that would affect the Bank’s position) and cash flow may be weak but minimally acceptable.

Criticized 5 (Other Assets Especially Mentioned)

This classification is also intended to be temporary and includes loans to borrowers whose credit quality has clearly deteriorated and are at risk of further decline unless active measures are taken to correct the situation.

Classified 6 (Substandard)

This classification includes loans with well-defined weaknesses that are inadequately protected by current net worth, repayment capacity or pledged collateral of the borrower. Loans are substandard when they have one or more weaknesses that could jeopardize debt repayment and/or liquidation, primarily resulting in the possibility that the Bank may sustain some loss if the deficiencies are not corrected.

Classified 7 (Doubtful)

This classification includes loans that have all weaknesses inherent in the substandard category and where collection or liquidation in full is highly improbable. The possibility of loss is high, but because of certain important and reasonably specific pending factors, its classification as an estimated loss is deferred until its more exact status may be determined.

Classified 8 (Loss)

This classification includes loans considered uncollectible and of such little value that continuance as bankable assets is not warranted and, therefore, should be charged-off. This classification does not mean that the loans have absolutely no recovery or salvage value, but rather it is not practical or desirable to defer writing off these assets even though partial recovery may occur in the future.

Credit Quality Indicators as of June 30, 2012

Commercial Credit Exposure

Credit Risk Profile by Creditworthiness Category


	Commercial		Commercial Real Estate - Construction		Commercial Real Estate - Other
Pass / Watch	$	105,683	$	16,765	$	177,768
Criticized		1,031		1,756		3,024
Substandard		922		—		8,412

Total	$	107,636	$	18,521	$	189,204

Consumer Credit Exposure

Credit Risk Profile by Payment Activity


	Residential Real Estate		Consumer - Credit Card		Consumer - Other		Consumer - Auto		Student Loans - TERI		Student Loans - Other
Performing	$	270,382	$	3,039	$	4,757	$	30,527	$	6,570	$	6,780
Non-performing		1,386		12		—		32		28		96

Total	$	271,768	$	3,051	$	4,757	$	30,559	$	6,598	$	6,876

Non-performing loans are those past due 90 days or more and not accruing.

Credit Quality Indicators as of December 31, 2011

Commercial Credit Exposure

Credit Risk Profile by Creditworthiness Category


	Commercial		Commercial Real Estate - Construction		Commercial Real Estate - Other
Pass / Watch	$	84,431	$	18,036	$	172,072
Criticized		2,790		2,505		7,811
Substandard		967		—		8,451

Total	$	88,188	$	20,541	$	188,334

Consumer Credit Exposure

Credit Risk Profile by Payment Activity


	Residential Real Estate		Consumer - Credit Card		Consumer - Other		Consumer - Auto		Student Loans - TERI		Student Loans - Other
Performing	$	278,996	$	3,236	$	6,853	$	30,050	$	6,193	$	6,270
Non-performing		2,647		6		10		24		61		113

Total	$	281,643	$	3,242	$	6,863	$	30,074	$	6,254	$	6,383

Impaired Loans . Loans are considered impaired when, based on current information and events, it is probable the Company will be unable to collect all amounts due in accordance with the original contractual terms of the loan agreement, including scheduled principal and interest payments. If a loan is impaired, a specific valuation allowance is allocated, if necessary, so that the loan is reported net, at the present value of estimated future cash flows using the loan’s existing rate or at the fair value of collateral if repayment is expected solely from the collateral. Interest payments on impaired loans are typically applied to principal unless collectability of the principal amount is reasonably assured, in which case interest is recognized on a cash basis. Impaired loans, or portions thereof, are charged off when deemed uncollectible.

Impaired Loans

June 30, 2012


	Recorded Investment		Unpaid Principal Balance		Related Allowance		Average Recorded Investment		Interest Income Recognized
With no related allowance recorded:
Commercial real estate	$	145	$	145	$	—	$	145	$	—
Commercial		423		423		—		423		—
Consumer — TERI		28		28		—		30		—
Consumer — other		—		—		—		—		—
Consumer — auto		30		30		—		23		—
Residential real estate		822		822		—		853		—
With an allowance recorded:
Commercial real estate — construction		—		—		—		—		—
Commercial real estate — other		2,576		2,576		600		2,535		73
Commercial		358		358		358		358		11
Residential real estate		564		564		335		566		21

Total:	$	4,946	$	4,946	$	1,293	$	4,933	$	105

Commercial real estate	$	2,721	$	2,721	$	600	$	2,680	$	73
Commercial	$	781	$	781	$	358	$	781	$	11
Consumer	$	58	$	58	$	—	$	53	$	—
Residential real estate	$	1,386	$	1,386	$	335	$	1,419	$	21

Impaired Loans

December 31, 2011


	Recorded Investment		Unpaid Principal Balance		Related Allowance		Average Recorded Investment		Interest Income Recognized
With no related allowance recorded:
Commercial real estate	$	591	$	591	$	—	$	390	$	—
Commercial		—		—		—		—		—
Consumer — TERI		61		61		—		65		—
Consumer — other		10		10		—		10		—
Consumer — auto		21		21		—		32		—
Residential real estate		806		806		—		1,081		—
With an allowance recorded:
Commercial real estate — construction		—		—		—		—		—
Commercial real estate — other		—		—		—		—		—
Commercial		845		845		443		1,000		28
Residential real estate		1,200		1,200		215		1,057		—

Total:	$	3,534	$	3,534	$	658	$	3,635	$	28

Commercial real estate	$	591	$	591	$	—	$	390	$	—
Commercial	$	845	$	845	$	443	$	1,000	$	28
Consumer	$	92	$	92	$	—	$	107	$	—
Residential real estate	$	2,006	$	2,006	$	215	$	2,138	$	—

Non-Accrual and Past Due Loans. Loans are considered past due if the required principal and interest payments have not been received as of the date such payments were due. Loans are placed on non-accrual status when, in management’s opinion, the borrower may be unable to meet payment obligations as they become due, as well as when required by regulatory provisions. Loans may be placed on non-accrual status regardless of whether or not such loans are considered past due. When interest accrual is discontinued, all unpaid accrued interest income is reversed. Interest income is subsequently recognized only to the extent cash payments are received in excess of principal due. Loans are returned to accrual status when all the principal and interest amounts contractually due are brought current and future payments are reasonably assured with the minimum of a six month positive payment history.

Period-end non-accrual loans, segregated by class of loans, were as follows:


	June 30, 2012		December 31, 2011
Commercial	$	423	$	477
Commercial real estate:
Commercial real estate — construction		—		—
Commercial real estate — other		145		591
Consumer:
Student loans — TERI		28		61
Student loans — other		—		—
Consumer — other		—		10
Consumer — auto		30		21
Residential:
Residential real estate		1,386		2,006

Total	$	2,012	$	3,166

The Allowance for Loan and Lease Losses and Recorded Investment in Loans for the six months ended June 30, 2012 is as follows:


	Commercial			Commercial Real Estate			Consumer			Residential		Credit Card			Unallocated		Total
Allowance for Loan and Lease Losses:
Beginning balance 12/31/11	$	793		$	2,294		$	450		$	2,855	$	319		$	—	$	6,711
Charge-offs		(5	)		(33	)		(75	)		—		(18	)		—		(131	)
Recoveries		—			5			46			1		—			—		52
Provision		18			76			173			—		39			—		306

Ending balance 06/30/12	$	806		$	2,342		$	594		$	2,856	$	340		$	—	$	6,938
Ending balance: Individually evaluated for impairment		358			600			—			335		—			—		1,293

Ending balance: Collectively evaluated for impairment	$	448		$	1,742		$	594		$	2,521	$	340		$	—	$	5,645

Ending balance: Loans acquired with deteriorated credit quality	$	—		$	—		$	—		$	—	$	—		$	—	$	—

Loans:
Ending balance	$	107,636		$	207,725		$	48,790		$	271,768	$	3,051		$	—	$	638,970

Ending balance: Individually evaluated for impairment		781			2,721			58			1,386		—			—		4,946

Ending balance: Collectively evaluated for impairment	$	106,855		$	205,004		$	48,732		$	270,382	$	3,051		$	—	$	634,024

Ending balance: Loans acquired with deteriorated credit quality	$	—		$	—		$	—		$	—	$	—		$	—	$	—

The Allowance for Loan and Lease Losses and Recorded Investment in Loans for the year ended December 31, 2011 is as follows:


	Commercial			Commercial Real Estate			Consumer			Residential			Credit Card			Unallocated		Total
Allowance for Loan and Lease Losses:
Beginning balance 12/31/10	$	1,957		$	2,067		$	1,380		$	753		$	343		$	—	$	6,500
Charge-offs		(100	)		(663	)		(153	)		(1,275	)		(109	)		—		(2,300	)
Recoveries		3			18			45			58			6			—		130
Provision		(1,067	)		872			(822	)		3,319			79			—		2,381

Ending balance 12/31/11	$	793		$	2,294		$	450		$	2,855		$	319		$	—	$	6,711
Ending balance: Individually evaluated for impairment		443			—			—			215			—			—		658

Ending balance: Collectively evaluated for impairment	$	350		$	2,294		$	450		$	2,640		$	319		$	—	$	6,053

Ending balance: Loans acquired with deteriorated credit quality	$	—		$	—		$	—		$	—		$	—		$	—	$	—

Loans:
Ending balance	$	88,188		$	208,875		$	49,574		$	281,643		$	3,242		$	—	$	631,522

Ending balance: Individually evaluated for impairment		845			591			92			2,006			—			—		3,534

Ending balance: Collectively evaluated for impairment	$	87,343		$	208,284		$	49,482		$	279,637		$	3,242		$	—	$	627,988

Ending balance: Loans acquired with deteriorated credit quality	$	—		$	—		$	—		$	—		$	—		$	—	$	—

The Company had one commercial loan whose terms had been modified in a troubled debt restructuring as of June 30, 2012 and December 31, 2011; monthly payments were lowered to accommodate the borrower’s financial needs for a period of time.

Modification

June 30, 2012

Pre-Modification

Post-Modification

Number of

Outstanding Recorded

Contracts

Investment

Troubled Debt Restructurings

Commercial

808

358

There were no troubled debt restructurings that subsequently defaulted during the six months ended June 30, 2012.

Modification

December 31, 2011

Pre-Modification

Post-Modification

Number of

Outstanding Recorded

Contracts

Investment

Troubled Debt Restructurings

Commercial

808

368

The loan above, classified as a Troubled Debt Restructuring (TDR), was charged down during 2010 to a balance of $401 and the entire pre-modification balance was split into two notes. The customer is currently paying principal and interest on one note and interest only on the other note. Nonetheless, the loan is fully reserved based on management’s evaluation of both the customer’s ability to maintain its cash flow and the value of the underlying collateral.

NOTE 8 — Loan Servicing

The Company generally retains the right to service mortgage loans sold to third parties. The cost allocated to the mortgage servicing rights retained has been recognized as a separate asset within other assets and is amortized in proportion to and over the period of estimated net servicing income.

Mortgage servicing rights are evaluated for impairment based on the fair value of those rights. Fair values are estimated using discounted cash flows based on current market rates of interest and expected future prepayment rates. For purposes of measuring impairment, the rights must be stratified by one or more predominant risk characteristics of the underlying loans. The Company stratifies its capitalized mortgage servicing rights based on the product type, interest rate and term of the underlying loans. The amount of impairment recognized is the amount, if any, by which the amortized cost of the rights for each stratum exceed the fair value.

NOTE 9 — Goodwill

Goodwill represents the excess of the purchase price over the underlying fair value of merged entities. Goodwill is assessed for impairment at least annually and as triggering events occur. In making this assessment, management considers a number of factors including, but not limited to, operating results, business plans, economic projections, anticipated future cash flows, and current market data. There are inherent uncertainties related to these factors and management’s judgment in applying them to the analysis of goodwill impairment. Changes in economic and operating conditions, as well as other factors, could result in goodwill impairment in future periods.

NOTE 10 — Other Intangible Assets

Intangible assets include the premium assigned to the core deposit relationships acquired in connection with our acquisition of Old Forge Bank in 2009. The core deposit intangible is being amortized over ten years from the date of acquisition on a sum-of-the-years-digits basis. Amortization expense is expected to be as follows:


June 30,
2013	$	248
2014		212
2015		175
2016		138
2017		102
Thereafter		92

Total	$	967

NOTE 11 — Long-Term Debt

The Company has established credit facilities with the Federal Home Loan Bank of Pittsburgh, which are secured by all of the Company’s assets. Additionally, in connection with the credit facilities, the Company has agreed to maintain sufficient qualifying collateral to fully secure the borrowings below.

A summary of long-term debt, including amortizing principal and interest payments, at June 30, 2012 is as follows:


Monthly Installment	Fixed Rate			Maturity Date		Balance
Amortizing loans
$ 29		1.84	%		08/28/12	$	57
90		3.10	%		02/28/13		712
430		3.74	%		03/13/13		3,811
18		2.66	%		08/28/14		450
67		3.44	%		03/02/15		2,048
13		3.48	%		03/31/15		422
10		3.83	%		04/02/18		629
186		4.69	%		03/13/23		18,863

Total amortizing							26,992

Non-amortizing loans
		3.49	%		02/28/13		7,000
		2.89	%		11/28/14		2,000
		2.58	%		05/18/15		6,300
		3.32	%		11/27/15		3,000
		2.36	%		09/22/17		6,500

Total non-amortizing							24,800

Total long-term debt						$	51,792

Aggregate maturities of long-term debt at June 30, 2012 are as follows:


June 30,	Principal
2013	$	14,160
2014		2,686
2015		10,608
2016		4,701
2017		1,781
Thereafter		17,856

Total	$	51,792

NOTE 12 — Employee Benefit Plans

The Company provides an Employee Stock Ownership Plan (ESOP), a Retirement Profit Sharing 401(k) Plan, an Employees’ Pension Plan, an unfunded supplemental executive defined benefit plan (currently frozen) and a defined contribution plan, a Postretirement Life Insurance Plan, a Stock Appreciation Rights Plan (SAR), and a Long-Term Incentive Plan.

The components of the net periodic benefit cost are as follows:


	Pension Benefits						Other Benefits
Six months ended June 30,	2012			2011			2012		2011 *
Service cost	$	—		$	—		$	24	$	22
Interest cost		336			350			70		73
Expected return on plan assets		(404	)		(452	)		—		—
Amortization of prior service cost		—			—			—		4
Amortization of net loss (gain)		68			42			55		52

Net periodic benefit cost	$	—		$	(60	)	$	149	$	151

*	as restated see Note 18

The Company previously disclosed in the financial statements included in its Annual Report on Form 10-K for the year ended December 31, 2011 that it expected to contribute $350 to its pension plan in 2012. As of June 30, 2012, the Company expects to contribute $363 to its pension plan and $20 to its post-retirement plan during 2012 for retirees. Readers should refer to the Company’s Annual Report on Form 10-K for the year ended December 31, 2011 for further details on the Company’s defined benefit pension plan.

The Company sponsors a 401(k) profit sharing plan for all eligible employees. The Company’s profit sharing expense for the six months ended June 30, 2012 and 2011 was $246 and $231, respectively.

The Company granted restricted stock awards during the six months ended June 30, 2012 and 2011 valued at $300 and $56, respectively.

NOTE 13 — Stock Awards

Under the 2008 Long-Term Incentive Plan (the “2008 plan”), the Compensation Committee of the board of directors has broad authority with respect to awards granted under the 2008 plan, including, without limitation, the authority to:

•

Designate the individuals eligible to receive awards under the 2008 plan.

•

Determine the size, type and date of grant for individual awards, provided that awards approved by the Committee are not effective unless and until ratified by the board of directors.

•

Interpret the 2008 plan and award agreements issued with respect to individual participants.

Persons eligible to receive awards under the 2008 Plan include directors, officers, employees, consultants and other service providers of the Company and its subsidiaries, except that incentive stock option may be granted only to individuals who are employees on the date of grant.

The total number of shares of the Company’s common stock available for grant awards under the 2008 plan shall not exceed in the aggregate five percent of the outstanding shares of the Company’s common stock as of February 15, 2008, or 107,400 shares of the Company’s common stock.

The 2008 plan authorizes grants of stock options, stock appreciation rights, dividend equivalents, performance awards, restricted stock and restricted stock units.


	Restricted Stock
Nonvested shares	Number of Shares		Weighted- Average Grant-Date Fair Value
Nonvested, January 1, 2012		—	$	—
Granted		7,731	$	38.80
Vested		—	$	—
Forfeited		—	$	—

Nonvested, June 30, 2012		7,731	$	38.80

Restricted stock granted to officers vest after five years. The weighted average period over which these expenses will be recognized is approximately five years.

In accordance with GAAP, the Company began to expense the fair value of all-share based compensation over the requisite service periods. The fair value of restricted stock is expensed on a straight-line basis. The Company classifies share-based compensation for employees within “salaries and employee benefits” on the Consolidated Statements of Income.

For 2012, the Company recognized $10 of compensation expense for stock awards granted in the six months ended June 30, 2012.

As of June 30, 2012, the following is unrecognized compensation expense:


Restricted stock		$	290

NOTE 14 — Comprehensive Income

Changes in each component of accumulated other comprehensive income for the three months ended June 30, 2012 and 2011 were as follows:


	Unrealized Gains on Investment Securities		Defined Benefit Plans *			Total
Balance, March 31, 2012	$	3,999	$	(4,205	)	$	(206	)
Current period change		375		—			375

Balance, June 30, 2012	$	4,374	$	(4,205	)	$	169

Balance, March 31, 2011	$	1,060	$	(3,218	)	$	(2,158	)
Current period change		1,438		—			1,438

Balance, June 30, 2011	$	2,498	$	(3,218	)	$	(720	)

*	as restated see Note 18

Changes in each component of accumulated other comprehensive income for the six months ended June 30, 2012 and 2011 were as follows:


	Unrealized Gains on Investment Securities		Defined Benefit Plans *			Total
Balance, December 31, 2011	$	3,927	$	(4,205	)	$	(278	)
Current period change		447		—			447

Balance, June 30, 2012	$	4,374	$	(4,205	)	$	169

Balance, December 31, 2010	$	1,100	$	(3,218	)	$	(2,118	)
Current period change		1,398		—			1,398

Balance, June 30, 2011	$	2,498	$	(3,218	)	$	(720	)

*	as restated see Note 18

Other Comprehensive Income

The components of other comprehensive income are reported net of related tax effects in the Consolidated Statements of Comprehensive Income.

A reconciliation of other comprehensive income for the three months ended June 30, 2012 and 2011 is as follows:


Three Months Ended June 30, 2012	Pre-Tax Amount			Tax (Expense) Benefit			Net-of- Tax Amount
Unrealized gains on securities
Unrealized holding gains arising during the period	$	629		$	(214	)	$	415
Reclassification adjustment for gains recognized in net income		(61	)		21			(40	)

Net unrealized gains		568			(193	)		375

Other comprehensive income	$	568		$	(193	)	$	375


Three Months Ended June 30, 2011	Pre-Tax Amount			Tax (Expense) Benefit			Net-of- Tax Amount
Unrealized gains on securities
Unrealized holding gains arising during the period	$	2,450		$	(833	)	$	1,617
Reclassification adjustment for gains recognized in net income		(271	)		92			(179	)

Net unrealized gains		2,179			(741	)		1,438

Other comprehensive income	$	2,179		$	(741	)	$	1,438

A reconciliation of other comprehensive income for the six months ended June 30, 2012 and 2011 is as follows:


Six Months Ended June 30, 2012	Pre-Tax Amount			Tax (Expense) Benefit			Net-of- Tax Amount
Unrealized gains on securities
Unrealized holding gains arising during the period	$	785		$	(267	)	$	518
Reclassification adjustment for gains recognized in net income		(108	)		37			(71	)

Net unrealized gains		677			(230	)		447

Other comprehensive income	$	677		$	(230	)	$	447


Six Months Ended June 30, 2011	Pre-Tax Amount			Tax (Expense) Benefit			Net-of- Tax Amount
Unrealized gains on securities
Unrealized holding gains arising during the period	$	2,394		$	(814	)	$	1,580
Reclassification adjustment for gains recognized in net income		(276	)		94			(182	)

Net unrealized gains		2,118			(720	)		1,398

Other comprehensive income	$	2,118		$	(720	)	$	1,398

NOTE 15 — Regulatory Matters

The Company and the Bank are subject to various regulatory capital requirements administered by the Federal Deposit Insurance Corporation (FDIC) and the Board of Governors of the Federal Reserve System (Federal Reserve Board). Failure to meet minimum capital requirements can initiate certain mandatory–and possibly additional discretionary–actions by regulators that, if undertaken, could have a direct material effect on the Company and the Bank’s Consolidated Financial Statements. Under capital adequacy guidelines and the regulatory framework for prompt corrective action, the Company and the Bank must meet specific capital guidelines that involve quantitative measures of their assets, liabilities, and certain off-balance sheet items as calculated under regulatory accounting practices. The Company and the Bank’s capital amounts and classifications are also subject to qualitative judgments by the regulators about components, risk weightings and other factors.

Quantitative measures established by regulation to ensure capital adequacy require the Company and the Bank to maintain minimum amounts and ratios (set forth in the following Capital Adequacy table) of Tier 1 and Total Capital to risk-weighted assets and of Tier 1 Capital to average assets (Leverage ratio). The table also presents the Company’s actual capital amounts and ratios. Management believes, as of June 30, 2012, that the Company and the Bank meet all capital adequacy requirements to which they are subject.

As of June 30, 2012, the most recent regulatory notifications categorized the Bank as “well capitalized” under the regulatory framework for prompt corrective action. To be categorized as “well capitalized”, the Bank must maintain minimum Tier 1 Capital, Total Capital and Leverage ratios as set forth in the Capital Adequacy table. There are no conditions or events since that notification that management believes have changed the Company’s categorization by the FDIC.

The Company and Bank are also subject to minimum capital levels, which could limit the payment of dividends. As of June 30, 2012, the Company and Bank have capital levels that are in excess of the minimum capital level ratios required.

The Pennsylvania Banking Code restricts capital funds available for payment of dividends to the retained earnings of the Bank. The balances in the capital stock and surplus accounts are unavailable for dividends. Dividends from the Bank are the Company’s primary source of funds.

In addition, the Bank is subject to restrictions imposed by Federal law on certain transactions with the Company’s affiliates. These transactions include extensions of credit, purchases of or investments in stock issued by an affiliate, purchases of assets subject to certain exceptions, acceptance of securities issued by an affiliate as collateral for loans, and the issuance of guarantees, acceptances, and letters of credit on behalf of affiliates. These restrictions prevent the Company’s affiliates from borrowing from the Bank unless the loans are secured by obligations of designated amounts. Further, the aggregate value of such transactions between the Bank and a single affiliate is limited in amount to 10 percent of the Bank’s capital stock and surplus, and the aggregate value of such transactions with all affiliates is limited to 20 percent of the Bank’s capital stock and surplus. The Federal Reserve System has interpreted “capital stock and surplus” to include undivided profits.


Actual						Regulatory Requirements
								For Capital Adequacy Purposes								To Be “Well Capitalized”
As of June 30, 2012	Amount		Ratio					Amount				Ratio				Amount			Ratio
Total Capital (to Risk Weighted Assets)
PFSC (Company)	$	107,585		17.04	%		>	$	50,514		>		8.0	%	>		N/A	>		N/A
PSB (Bank)	$	103,853		16.47	%		>	$	50,456		>		8.0	%	>	$	63,070	>		10.0	%

Tier 1 Capital (to Risk Weighted Assets)
PFSC (Company)	$	100,500		15.92	%		>	$	25,257		>		4.0	%	>		N/A	>		N/A
PSB (Bank)	$	96,915		15.37	%		>	$	25,228		>		4.0	%	>	$	37,842	>		6.0	%

Tier 1 Capital (to Average Assets)
PFSC (Company)	$	100,500		11.23	%		>	$		*	>			*	>		N/A	>		N/A
PSB (Bank)	$	96,915		10.88	%		>	$		*	>			*	>	$	44,535	>		5.0	%

PFSC — *3.0% ($26,852), 4.0% ($35,803) or 5.0% ($44,754) depending on the bank’s CAMELS Rating and other regulatory risk factors.

PSB — *3.0% ($26,721), 4.0% ($35,628) or 5.0% ($44,535) depending on the bank’s CAMELS Rating and other regulatory risk factors.


Actual							Regulatory Requirements
							For Capital Adequacy Purposes								To Be “Well Capitalized”
As of December 31, 2011 *	Amount		Ratio				Amount				Ratio				Amount			Ratio
Total Capital (to Risk Weighted Assets)
PFSC (Company)	$	103,609		16.74	%	>	$	49,503		>		8.0	%	>		N/A	>		N/A
PSB (Bank)	$	99,953		16.17	%	>	$	49,457		>		8.0	%	>	$	61,820	>		10.0	%

Tier 1 Capital (to Risk Weighted Assets)
PFSC (Company)	$	96,793		15.64	%	>	$	24,751		>		4.0	%	>		N/A	>		N/A
PSB (Bank)	$	93,242		15.08	%	>	$	24,728		>		4.0	%	>	$	37,091	>		6.0	%

Tier 1 Capital (to Average Assets)
PFSC (Company)	$	96,793		10.73	%	>	$		*	>			*	>		N/A	>		N/A
PSB (Bank)	$	93,242		10.39	%	>	$		*	>			*	>	$	44,874	>		5.0	%

PFSC — *3.0% ($27,053), 4.0% ($36,071) or 5.0% ($45,089) depending on the bank’s CAMELS Rating and other regulatory risk factors.

PSB — *3.0% ($26,925), 4.0% ($35,899) or 5.0% ($44,874) depending on the bank’s CAMELS Rating and other regulatory risk factors.

*	as restated see Note 18

NOTE 16 — Merger

An Agreement and Plan of Merger (the “Agreement”) by and between the Company, the Bank and Old Forge Bank, was entered into on December 5, 2008. The Agreement provided for, among other things, the Company to acquire 100% of the outstanding common shares of Old Forge Bank through a two-step merger transaction. The Company consummated the acquisition of Old Forge Bank on April 1, 2009, at which time Old Forge Bank was merged with and into the Bank (the “Merger”). Following the Merger, the Bank continues to operate as a banking subsidiary of the Company.

In connection with its acquisition of Old Forge Bank, the Company acquired loans with evidence of credit deterioration that have been accounted for under ASC 310-30. As of June 30, 2012, there were two such loans remaining with a carrying value of $208 and a credit fair value adjustment of $208. As of December 31, 2011, these same loans had a carrying value of $211 and a credit fair value adjustment of $211. As of June 30, 2011, these loans had a carrying value of $228 with a credit fair value adjustment of $228. There is no accretable yield for the specific loans accounted for under Accounting Standard Codification 310-30-30. There were no significant prepayment estimates by management in the determination of contractual cash flows and cash flows expected to be collected.

Changes in the credit fair value adjustment on specific loans purchased are as follows:


Six Months Ended June 30, 2012
				Credit
	Carrying			Fair Value			Net
	Value			Adjustment			Amount
Balance, December 31, 2011
Residential Mortgages	$	—		$	—		$	—
Commercial		211			211			—
Consumer / Other		—			—			—

		211			211			—
Charge-offs
Residential Mortgages		—			—			—
Commercial		—			—			—
Consumer / Other		—			—			—

Total Charge-offs		—			—			—
Loans transferred to other real estate owned
Residential Mortgages		—			—			—
Commercial		—			—			—
Consumer / Other		—			—			—

Total loans transferred to other real estate owned		—			—			—
Payments
Residential Mortgages		—			—			—
Commercial		(3	)		(3	)		—
Consumer / Other		—			—			—

Total Payments		(3	)		(3	)		—

Balance, June 30, 2012	$	208		$	208		$	—


Six Months Ended June 30, 2011
				Credit
	Carrying			Fair Value			Net
	Value			Adjustment			Amount
Balance, December 31, 2010
Residential Mortgages	$	—		$	—		$	—
Commercial		229			229			—
Consumer / Other		—			—			—

		229			229			—
Charge-offs
Residential Mortgages		—			—			—
Commercial		—			—			—
Consumer / Other		—			—			—

Total Charge-offs		—			—			—
Loans transferred to other real estate owned
Residential Mortgages		—			—			—
Commercial		—			—			—
Consumer / Other		—			—			—

Total loans transferred to other real estate owned		—			—			—
Payments
Residential Mortgages		—			—			—
Commercial		(1	)		(1	)		—
Consumer / Other		—			—			—

Total Payments		(1	)		(1	)		—

Balance, June 30, 2011	$	228		$	228		$	—

Note 17 — Fair Value Measurements

The following table sets forth the Company’s financial assets that were accounted for at fair value and are classified in their entirety based on the lowest level of input that is significant to the fair value measurement.

Level I–Quoted prices (unadjusted) in active markets for identical assets or liabilities that the Company has the ability to access at the measurement date.

Level II–Observable inputs other than Level I prices, such as quoted prices for similar assets or liabilities in active markets; quoted prices in markets that are not active for identical or similar assets or liabilities; or other inputs that are observable or can be corroborated by observable market data for substantially the full term of the assets or liabilities.

Level III–Unobservable inputs that are supported by little or no market activity and significant to the fair value of the assets or liabilities that are developed using the reporting entities’ estimates and assumptions, which reflect those that market participants would use.

Assets Measured at Fair Value on a Recurring Basis

A description of the valuation methodologies used for financial assets measured at fair value on a recurring basis, as well as the classification of the assets pursuant to the valuation hierarchy, are as follows:

Securities Available-for-Sale

Securities classified as available-for-sale are reported using Level I, Level II and Level III inputs. Level I instruments generally include equity securities valued in accordance with quoted market prices in active markets. Level II instruments include U.S. government agency obligations, state and municipal bonds, mortgage-backed securities and corporate bonds. For these securities, the Company obtains fair value measurements from an independent pricing service. The fair value measurements consider observable data that may include dealer quotes, market spreads, cash flows, the U.S. Treasury yield curve, live trading levels, trade execution data, market consensus prepayment speeds, credit information and the bond’s terms and conditions, among other things. Level III instruments include certain non-public equity securities and real estate sold under contract. See Note 6 – Investment Securities for additional information.

Assets and liabilities measured at fair value on a recurring basis are summarized as follows:


	June 30, 2012
	Level I		Level II		Level III		Total
Assets:
Securities available-for-sale
U.S. Agency securities	$	—	$	77,867	$	—	$	77,867
Mortgage-backed securities:
Residential		—		26,602		—		26,602
States & political subdivisions:
Bank qualified tax exempt		—		59,681		—		59,681
Corporate securities:
Aaa credit rating		—		—		—		—
Equity securities:
Financial services industry		1,127		—		—		1,127

Total securities available-for-sale	$	1,127	$	164,150	$	—	$	165,277


	December 31, 2011
	Level I		Level II		Level III		Total
Assets:
Securities available-for-sale
U.S. Agency securities	$	—	$	77,985	$	—	$	77,985
Mortgage-backed securities:
Residential		—		22,166		—		22,166
States & political subdivisions:
Bank qualified tax exempt		—		65,388		—		65,388
Corporate securities:
Aaa credit rating		—		1,004		—		1,004
Equity securities:
Financial services industry		943		—		—		943

Total securities available-for-sale	$	943	$	166,543	$	—	$	167,486

Assets Measured at Fair Value on a Nonrecurring Basis

Certain non-financial assets and non-financial liabilities, measured at fair value on a non-recurring basis, include foreclosed and non-performing assets, goodwill and intangible assets.

A description of the valuation methodologies and classification levels used for non-financial assets and non-financial liabilities measured at fair value on a nonrecurring basis are listed as follows:

Goodwill and Other Identifiable Intangibles

The Company employs general industry practices in evaluating the fair value of its goodwill and other identifiable intangibles. The Company calculates the fair value, with the assistance of a third party specialist, using a combination of the following valuation methods: dividend discount analysis under the income approach, which calculates the present value of all excess cash flows plus the present value of a terminal value and market multiples (pricing ratios) under the market approach. Management performed a review of goodwill and other identifiable intangibles as of December 31, 2011. Goodwill and other identifiable intangibles were not evaluated during the six months ended June 30, 2012 as a result of management’s determination that no evidence of impairment was present during the period.

Impaired Loans

At June 30, 2012 certain impaired loans were re-measured and reported at fair value through a specific valuation allowance allocation of the allowance for loan and lease losses based upon the fair value of the underlying collateral and the evaluation of expected future cash flows. Impaired loans with a carrying value of $4,946 were reduced by a specific valuation allowance allocation totaling $1,293, to a total reported fair value of $3,653 based on collateral valuations utilizing Level III valuation inputs.

Federal Home Loan Bank Stock

Federal Home Loan Bank of Pittsburgh (FHLB) stock is a required investment in order for the Company to participate in a FHLB line of credit program. The FHLB stock is stated at par value as it is restricted to purchases and sales with the FHLB.

Other Real Estate Owned

Foreclosed real estate, which is considered to be non-financial assets, has been valued using a market approach. The values were determined using market prices of similar real estate assets, which the Company considered to be Level II inputs.

Certain assets measured at fair value on a non-recurring basis as of June 30, 2012 is as follows:


	Fair Value Measurement Using
	Quoted Prices in		Significant
	Active Markets		Other		Significant		Balance
	for Identical		Observable		Unobservable		June 30,
	Assets/Liabilities		Inputs		Inputs		2012
	Level I		Level II		Level III		Total
Assets
Core deposit intangible	$	—	$	—	$	967	$	967
Goodwill		—		—		26,398		26,398
Impaired loans		—		—		3,653		3,653
Federal Home Loan Bank stock		—		—		5,268		5,268
Other real-estate owned		—		726		—		726

Total non-financial assets	$	—	$	726	$	36,286	$	37,012

Certain assets measured at fair value on a non-recurring basis as of December 31, 2011 is as follows:


	Fair Value Measurement Using
	Quoted Prices in		Significant
	Active Markets		Other		Significant		Balance
	for Identical		Observable		Unobservable		December 31,
	Assets/Liabilities		Inputs		Inputs		2011
	Level I		Level II		Level III		Total
Assets
Core deposit intangible	$	—	$	—	$	1,106	$	1,106
Goodwill		—		—		26,398		26,398
Impaired loans		—		—		2,876		2,876
Federal Home Loan Bank stock		—		—		4,953		4,953
Other real-estate owned		—		1,571		—		1,571

Total non-financial assets	$	—	$	1,571	$	35,333	$	36,904

A reconciliation of items in Level III for the six month period ended June 30, 2012 is as follows:


									Federal
	Core								Home
	deposit					Impaired			Loan Bank
	intangible			Goodwill		Loans			Stock			Total
Balance, December 31, 2011	$	1,106		$	26,398	$	2,876		$	4,953		$	35,333
Amortization of core deposit intangible		(139	)		—		—			—			(139	)
Increase in impaired loans		—			—		2,496			—			2,496
Decrease in impaired loans		—			—		(1,027	)		—			(1,027	)
Purchase of FHLB stock		—			—		—			840			840
Payments received		—			—		(692	)		(525	)		(1,217	)

Balance, June 30, 2012	$	967		$	26,398	$	3,653		$	5,268		$	36,286

A reconciliation of items in Level III for the year ended December 31, 2011 is as follows:


	Core deposit intangible			Goodwill		Impaired Loans			Federal Home Loan Bank Stock			Total
Balance, December 31, 2010	$	1,410		$	26,398	$	3,078		$	6,082		$	36,968
Amortization of core deposit intangible		(304	)		—		—			—			(304	)
Increase in impaired loans		—			—		2,586			—			2,586
Decrease in impaired loans		—			—		(2,178	)		—			(2,178	)
Payments received		—			—		(610	)		(1,129	)		(1,739	)

Balance, December 31, 2011	$	1,106		$	26,398	$	2,876		$	4,953		$	35,333

Disclosures about Fair Value of Financial Instruments

General Accepted Accounting Principles require disclosure of the estimated fair value of an entity’s assets and liabilities considered to be financial instruments. For the Company, as for most financial institutions, the majority of its assets and liabilities are considered financial instruments. However, many such instruments lack an available trading market, as characterized by a willing buyer and seller engaging in an exchange transaction. Also, it is the Company’s general practice and intent to hold its financial instruments to maturity and not to engage in trading or sales activities, except for certain loans and investments. Therefore, the Company had to use significant estimates and present value calculations to prepare this disclosure.

Changes in the assumptions or methodologies used to estimate fair values may materially affect the estimated amounts. Also, management is concerned that there may not be reasonable comparability between institutions due to the wide range of permitted assumptions and methodologies in the absence of active markets. This lack of uniformity gives rise to a high degree of subjectivity in estimating financial instrument fair values.

Estimated fair values have been determined by the Company using the best available data and an estimation methodology suitable for each category of financial instruments. The estimation methodologies used at June 30, 2012 and December 31, 2011 are outlined below. The methodologies for estimating the fair value of financial assets and financial liabilities that are measured at fair value on a recurring or non-recurring basis are discussed in the fair value measurements section above. The estimated fair value approximates carrying value for cash and cash equivalents, accrued interest and the bank owned life insurance policies. The methodologies for other financial assets and financial liabilities are discussed below:

Short-term financial instruments

The carrying value of short-term financial instruments including cash and due from banks, federal funds sold, interest-bearing deposits in banks and other short-term investments and borrowings, approximates the fair value of these instruments. These financial instruments generally expose the Company to limited credit risk and have no stated maturities or have short-term maturities with interest rates that approximate market rates.

Investment securities held-to-maturity

The estimated fair values of investment securities held to maturity are based on quoted market prices provided by independent third parties that specialize in those investment sectors. If quoted market prices are not available, estimated fair values are based on quoted market prices of comparable instruments.

Loans

The loan portfolio, net of unearned income, has been valued by a third party specialist using quoted market prices, if available. When market prices were not available, a credit risk-based discounted cash flow analysis was utilized. The primary assumptions utilized in this analysis are the discount rate based on the LIBOR curve, adjusted for credit risk, and prepayment estimates based on factors such as refinancing incentives, age of the loan and seasonality. These assumptions were applied by loan category and different spreads were applied based upon prevailing market rates by category.

Deposits

The estimated fair values of demand deposits (interest and non-interest bearing checking accounts, savings and money market accounts) are, by definition, equal to the amount payable on demand at the reporting date (their carrying amounts). The fair value for certificates of deposit was calculated by an independent third party by discounting contractual cash flows using current market rates for instruments with similar maturities, using a credit based risk model. The carrying amount of accrued interest receivable and payable approximates fair value.

Long-term borrowings

The amounts assigned to long-term borrowings were based on quoted market prices, when available, or based on discounted cash flow calculations using prevailing market interest rates for debt of similar terms.

The carrying and fair values of certain financial instruments are as follows:


	June 30, 2012						December 31, 2011
	Carrying Amount			Fair Value			Carrying Amount			Fair Value
Cash and cash equivalents	$	20,041		$	20,041		$	34,480		$	34,480
Investment securities held-to-maturity		19,609			20,734			23,722			24,969
Loans, net		632,032			648,366			624,811			637,976
Bank owned life insurance		17,361			17,361			15,870			15,870
Demand deposits		515,604			515,604			505,790			505,790
Time deposits		196,796			199,798			214,728			218,163
Short-term borrowings		10,488			10,488			9,981			9,981
Long-term borrowings		51,792			55,641			58,220			62,125

Standby Letters of Credit	$	(206	)	$	(206	)	$	(191	)	$	(191	)

Note 18 – Restatement

During the quarter ended June 30, 2012, the Company became aware that the actuarially computed value of its postretirement benefit liability was inaccurate. The postretirement benefit plan provides employees with life insurance coverage that continues at various levels after retirement. Due to a change in the assumptions provided by the Company to its actuary as to the cost of future premiums, the actuarially computed unfunded liability was understated.

The restatement resulted in the following changes to numbers previously reported:

As of December 31, 2011, an increase in other liabilities (postretirement liability) of $2,525 and an increase in other assets (deferred taxes) of $858, resulting in a net decrease to Stockholder’s Equity of $1,667, from $129,000 to $127,333.

For the three months ended June 30, 2011, an increase of $67 in salaries and employee benefits expense and a decrease of $23 in applicable income taxes, or a net reduction in net income of $44 from $2,606 to $2,562 or approximately $0.02 per share. Comprehensive income also was reduced by $44, from $4,044 to $4,000.

For the six months ended June 30, 2011, an increase of $132 in salaries and employee benefits expense and a decrease of $45 in applicable income taxes, or a net reduction in net income of $87 from $5,375 to $5,288 or approximately $0.03 per share. Comprehensive income also was reduced by $87, from $6,773 to $6,686.

As of June 30, 2011, an increase in other liabilities of $2,338 and an increase in other assets of $795, resulting in a net decrease to Stockholder’s Equity of $1,543, from $125,943 to $124,400.

As of March 31, 2011, an increase in other liabilities of $2,271 and an increase in other assets of $772, resulting in a net decrease to Stockholder’s Equity of $1,499, from $123,275 to $121,776.

As of March 31, 2012, an increase in other liabilities of $2,589 and an increase in other assets of $880, resulting in a net decrease to Stockholder’s Equity of $1,709, from $130,468 to $128,759.

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

FORWARD LOOKING INFORMATION

This Quarterly Report on Form 10-Q contains forward-looking statements that are based on assumptions and may describe future plans, strategies and expectations of Penseco Financial Services Corporation and its direct and indirect subsidiaries. These forward-looking statements are generally identified by use of the words “believe,” “expect,” “intend,” “anticipate,” “estimate,” “project” or similar expressions. Penseco Financial Services Corporation’s ability to predict results or the actual effect of future plans or strategies is inherently uncertain. Factors which could have a material adverse effect on the operations include, but are not limited to, changes in interest rates, national and regional economic conditions, legislative and regulatory changes, monetary and fiscal policies of the U.S. government, including policies of the U.S. Department of Treasury and the Federal Reserve System, the quality and composition of the loan or investment portfolios, demand for loan products, deposit flows, competition, demand for financial services in Penseco Financial Services Corporation’s market area, changes in the values of real estate and other collateral, particularly in our market area, changes in relevant accounting principles and guidelines and inability of third party service providers to perform.

These risks and uncertainties should be considered in evaluating forward-looking statements and undue reliance should not be placed on such statements. Except as required by applicable law or regulation, Penseco Financial Services Corporation does not undertake, and specifically disclaims any obligation, to release publicly the result of any revisions that may be made to any forward-looking statements to reflect events or circumstances after the date of the statements or to reflect the occurrence of anticipated or unanticipated events.

Unless the context indicates otherwise, all references in this Quarterly Report to “Company,” “we,” “us” and “our” refer to Penseco Financial Services Corporation and its direct and indirect subsidiaries.

The following commentary provides an overview of the financial condition at June 30, 2012, including any significant changes from December 31, 2011, and significant changes in the results of our operations for the three and six month periods ended June 30, 2012 and June 30, 2011.

Critical Accounting Policies

The preparation of financial statements in conformity with generally accepted accounting principles requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates.

Provision and Allowance for loan and lease losses–The provision for loan and lease losses charged to operating expense represents the adjustment that, in management’s judgment, is necessary to maintain the allowance for loan and lease losses at a level that is adequate to absorb probable losses inherent in the Company’s loan portfolio. The allowance for loan and lease losses is determined based on a documented and consistently applied methodology. This methodology considers all significant factors that affect the collectability of the loans within our portfolio, including past loan loss experience, management’s evaluation of the probable loss in the current loan portfolio under current economic conditions and such other factors as, in management’s best judgment, merit recognition in estimating loan and lease losses.

Actuarial assumptions associated with pension, post-retirement and other employee benefit plans–These assumptions include discount rate, rate of future compensation increases and expected return on plan assets.

Income taxes–The calculation of the provision for federal income taxes is complex and requires the use of estimates and judgments. Deferred federal income tax assets or liabilities represent the estimated impact of temporary differences between the recognition of assets and liabilities under GAAP, and how such assets and liabilities are recognized under the federal tax code. The Company uses an estimate of future earnings to support management’s position that the benefit of the deferred tax assets will be realized. If projected income is not recognized, at all or in the amounts predicted, the asset may not be realized and net income will be reduced. Deferred tax assets are described further in Note 18 of the “Notes to Consolidated Financial Statements” in the Company’s most recent Annual Report on Form 10-K.

The Company and its subsidiary file income tax and other returns in the U.S. Federal jurisdiction, Pennsylvania state jurisdiction and certain local jurisdictions.

Management evaluated the Company’s tax positions and concluded that the aggregate liabilities related to taxes are appropriately reflected in the consolidated financial statements. With few exceptions, the Company is no longer subject to income tax examinations by the U.S. Federal, state or local tax authorities for years before 2008.

Fair Value Measurements–Fair values of financial instruments are estimated using relevant market information and other assumptions. Fair value estimates involve uncertainties and matters of significant judgment regarding interest rates, credit risk, prepayment speeds and other factors. Changes in assumptions or in market conditions could significantly affect the estimates. Fair value measurements are classified within one of three levels within a valuation hierarchy based on the transparency of inputs to each valuation as of the fair value measurement date. The three levels are defined as follows:

Level I –quoted prices (unadjusted) for identical assets or liabilities in active markets.

Level II –inputs include quoted prices for similar assets and liabilities in active markets, quoted prices of identical or similar assets or liabilities in markets that are not active, and inputs that are observable for the asset or liability, either directly or indirectly, for substantially the full term of the financial instrument.

Level III– inputs that are unobservable and significant to the fair value measurement. Financial instruments are considered Level III when values are determined using pricing models, discounted cash flow methodologies, or similar techniques, and at least one significant model assumption or input is unobservable.

Other-than-temporary impairment of investments–Investments are evaluated periodically to determine whether a decline in their value is other than temporary. Management utilizes criteria such as the magnitude and duration of the decline, in addition to the reasons underlying the decline, to determine whether the loss in value is other than temporary. The term “other-than-temporary” is not intended to indicate that the decline is permanent. It indicates that the prospects for a near term recovery of value are not necessarily favorable, or that there is a lack of evidence to support fair values equal to, or greater than, the carrying value of the investment. Once a decline in value is determined to be other-than-temporary, the value of the security is reduced and a corresponding charge to earnings is recognized.

Premium amortization–The amortization of premiums on mortgage-backed securities is done based on management’s estimate of the lives of the securities, adjusted, when necessary, for advanced prepayments in excess of those estimates.

Loans purchased–Loans purchased as a result of the Merger were recorded at the acquisition date fair value. Management made three different types of fair value adjustments in order to record the loans at fair value. An interest rate fair value adjustment was made comparing current weighted average rates of the acquired loans to stated market rates of similar loan types. A general credit fair value adjustment was made on similar loan types based on historical loss projections plus a discount for the weak economic environment. A specific credit fair value adjustment was made to loans identified by management as being problematic. The specific loans have been discounted by management based on collateral values and expected cash flows. The interest rate and general credit fair value adjustments are being accreted over an eight year period based on a sum-of-the-years-digits basis. The specific credit fair value adjustment is reduced only when cash flows are received or loans are charged-off or transferred to other real estate owned.

Loan servicing rights–Mortgage servicing rights are evaluated for impairment based on the fair value of those rights. Fair values are estimated using discounted cash flows based on current market rates of interest and expected future prepayment rates. For purposes of measuring impairment, the rights must be stratified by one or more predominant risk characteristics of the underlying loans. The Company stratifies its capitalized mortgage servicing rights based on the product type, interest rate and term of the underlying loans. The amount of impairment recognized is the amount, if any, by which the amortized cost of the rights for each stratum exceed the fair value.

Time deposits–Time deposits acquired through the Merger have been recorded at their acquisition date fair value. The fair value of time deposits represents the present value of the time deposits’ expected contractual payments discounted by market rates for similar deposits. The fair value adjustment is amortized monthly based on a level yield methodology.

Securities sold under agreements to repurchase–The Company also offers securities sold under agreements to repurchase as an alternative to conventional savings deposits for its customers. The securities sold under agreements to repurchase are accounted for as a collateralized borrowing with a one day maturity and are collateralized by U.S. Agency securities.

Core deposit intangible–The fair value assigned to the core deposit intangible asset represents the future economic benefit of the potential cost savings from acquiring core deposits in the Merger compared to the cost of obtaining alternative funding, such as brokered deposits, from market sources. Management utilized an income approach to present value the expected after tax cash flow benefits of the acquired core deposits. The core deposit intangible is being amortized over ten years on a sum-of-the-years-digits basis.

Goodwill–Goodwill is reviewed by management for possible impairment at least annually or more frequently upon the occurrence of an event or when circumstances indicate that its carrying amount exceeds fair value. Management has obtained a professionally prepared qualitative test for goodwill impairment as of December 31, 2011. Market conditions that could negatively impact the value of goodwill in the future are essentially those Risk Factors discussed in Part I, Item 1A of the Company’s Annual Report on Form 10-K for the year ended December 31, 2011, in particular Credit Risk, Interest Rate Risk and Compliance Risk. As a result of such qualitative impairment test, management has determined that goodwill was not impaired at December 31, 2011. Goodwill and other identifiable intangibles were not evaluated during the six months ended June 30, 2012 as a result of management’s determination that no evidence of impairment was present during the period.

Depreciation–Provision for depreciation and amortization, computed principally on the straight-line method, is charged to operating expenses over the estimated useful lives of the assets.

Comparison of Operating Results


	Three Months Ended June 30,						Six Months Ended June 30,
	2012			2011 *			2012			2011 *
Interest Income	$	9,476		$	9,949		$	19,135		$	19,989
Interest Expense		1,407			1,922			2,888			3,819

Net Interest Income		8,069			8,027			16,247			16,170

Provision for loan and lease losses		114			899			306			1,268

Non-Interest Income		2,626			3,055			5,529			6,359

Non-Interest Expenses		7,261			6,936			14,601			14,451

Net Income	$	2,599		$	2,562		$	5,329		$	5,288

Total Revenue (1)	$	12,102		$	13,004		$	24,664		$	26,348

Net Interest Margin (2)		4.14	%		4.04	%		4.17	%		4.10	%
Return on Assets (ROA)		1.13	%		1.11	%		1.15	%		1.15	%
Return on Equity (ROE)		8.01	%		8.33	%		8.24	%		8.36	%

*	as restated see Note 18

(1)	Total revenue is the sum of interest income and non-interest income.

(2)	The net interest margin is equal to tax equivalent net interest income divided by average interest-earning assets.

The Company reported net income for the three months ended June 30, 2012 of $2599, an increase of $37, or 1.4%, to $0.79 per basic and dilutive earnings per share, compared with $2,562, or $0.78 per basic and dilutive earnings per share, from the year ago period. Pre-provision net interest income increased $42, or 0.5%. Net interest income, after provision for loan and lease losses, increased $827, or 11.6%, during the 2012 period, due to a reduction in interest expense of $515, or 26.8%, from lower funding costs and a $785, or 87.3%, decrease in the provision for loan and lease losses, offset by a decrease in interest income of $473, or 4.8%. The decrease in interest income was primarily attributable to investment and loan cash flows being reinvested at historically low yields, including excess reserve deposits held at the Federal Reserve Bank of Philadelphia. Non-interest income decreased $429, or 14.0%, largely due to decreased net realized gains on securities and lower net gains on the sale of other real estate owned property. Non-interest expenses increased $325, or 4.7%, due to higher compensation expenses of $177, Pennsylvania shares tax expenses of $469 and other real estate owned expenses, offset by lower premise and equipment expenses, FDIC insurance expenses and merchant transaction expenses.

The Company reported net income for the six months ended June 30, 2012 of $5,329, an increase of $41, or 0.8%, or $1.63 per basic and dilutive earnings per share, compared with $5,288, or $1.61 per basic and dilutive earnings per share, from the year ago period. Pre-provision net interest income increased $77, or 0.5%. Net interest income, after provision for loan and lease losses, increased $1,039, or 7.0%, during the 2012 period, due to a reduction in interest expense of $931, or 24.4%, from lower funding costs and a $962, or 75.9%, decrease in the provision for loan and lease losses, offset by a decrease in interest income of $854, or 4.3%. The decrease in interest income was primarily attributable to investment and loan cash flows being reinvested at historically low yields, including excess reserve deposits held at the Federal Reserve Bank of Philadelphia. Non-interest income decreased $830, or 13.1%, largely due to income recorded on the reversal of a contingent liability of $500 during the quarter ended March 31, 2011 and decreased net realized gains on securities. Non-interest expenses increased $150, or 1.0%, due to higher compensation expenses, Pennsylvania shares tax expenses and other real estate owned expenses, offset by lower premise and equipment expenses, FDIC insurance expenses and merchant transaction expenses.

We have defined our “core operations” to exclude the reversal, in the three months ended in March 31, 2011, of a contingent liability recorded in connection with the acquisition of Old Forge Bank. Net income from core operations increased $371 or 7.5% for the six months ended June 30, 2012 to $5,329, compared to $4,958 for the same period in 2011. Net income from core operations is a non-GAAP measure of net income. A reconciliation of the net income from core operations and disclosure of the non-GAAP return on assets, return on equity and dividend payout ratio derived from that measure are described in the non-GAAP reconciliation included in this Quarterly Report on Form 10-Q.

The following table reflects net income from accretion and amortization, net of taxes, of acquisition date fair value adjustments relating to the Merger included in the Company’s financial results during the periods indicated.


	Three Months Ended
	June 30,			June 30,
	2012			2011
Homogeneous loan pools (interest income)	$	98		$	128
Time deposits (interest expense)		7			25
Core deposit intangible expense (other operating expense)		(42	)		(49	)

Net income from acquisition fair value adjustment	$	63		$	104


	Six Months Ended
	June 30,			June 30,
	2012			2011
Homogeneous loan pools (interest income)	$	219		$	279
Time deposits (interest expense)		18			55
Core deposit intangible expense (other operating expense)		(91	)		(104	)

Net income from acquisition fair value adjustment	$	146		$	230

Accretion of the loan pools credit fair value adjustment and market rate fair value adjustment is calculated on a sum-of-the-years-digits basis over an eight year period. The fair value market rate adjustment of the time deposits is amortized monthly based on a level yield methodology over five years. The core deposit intangible established in connection with the 2009 acquisition of Old Forge Bank is being amortized over ten years from the date of acquisition on a sum-of-the-years-digits basis.

Net Interest Income and Net Interest Margin

Net interest income, the principal component of the Company’s earnings, is defined as the difference between interest and fees earned on interest-earning assets and interest paid on deposits and other borrowings. Average interest-earning assets are composed primarily of loans and investments while deposits and short-term and long-term borrowings represent interest-bearing liabilities. Variations in the volume and mix of these assets and liabilities, as well as changes in the yields earned and rates paid, are determinants of changes in net interest income.

Net interest income (before the provision for loan and lease losses) increased $42, or 0.5%, to $8,069 for the three months ended June 30, 2012 compared to $8,027 for the three months ended June 30, 2011. The average yield on interest-earning assets decreased 12 basis points, or 2.4%.

The net interest margin represents the Company’s net yield on its average interest-earning assets and is calculated as net interest income divided by average interest-earning assets. For the three months ended June 30, 2012, net interest margin (tax equivalent basis) increased 10 basis points to 4.14% from 4.04% in the same period of 2011.

The most significant impact on net interest income between periods is derived from the interaction of changes in the volume of, and rates earned or paid on, interest-earning assets and interest-bearing liabilities. The volume of earning dollars in loans and investments, compared to the volume of interest-bearing liabilities represented by deposits and borrowings, combined with the spread, produces the changes in net interest income between periods.

Total average interest-earning assets and average interest-bearing liabilities decreased from the three months ended June 30, 2011. Due to historically low interest rates, the Bank is reluctant to portfolio long-term, thirty year, mortgage loans and commit to long-term investment securities and has decided to allow these assets to runoff or refinance out of the Bank’s portfolio. Average interest-earning assets decreased $16.5 million or 1.9%, from $851.6 million for the three months ended June 30, 2011 to $835.1 million for the corresponding period in 2012 and average interest-bearing liabilities decreased $33.9 million, or 5.0%, from $677.0 million to $643.1 million over the same periods. As a percentage of average assets, average interest-earning assets, including bank-owned life insurance (BOLI), decreased for the three months ended June 30, 2012 and 2011, respectively, to 92.4% from 93.7%.

Changes in the mix of both interest-earning assets and funding sources also impacted net interest income in the three months ended June 30, 2012 and 2011. Average loans as a percentage of average interest-earning assets increased from 72.3% for the three months ended June 30, 2011 to 76.5% for the corresponding period in 2012. Average investment securities decreased $16.3 million, or 8.0%, period over period, and as a percentage of interest-earning assets, decreased to 22.5% for the three months ended June 30, 2012 from 24.0% for the three months ended June 30, 2011. Average short-term investments, federal funds sold, FHLB stock and interest-bearing balances with banks, decreased as a percentage of average assets to 0.9% for the three months ended June 30, 2012 from 3.5% for the three months ended June 30, 2011. Average time deposits decreased $46.5 million, or 18.7%, from $248.2 million, or 36.7%, of interest-bearing liabilities for the three months ended June 30, 2011 to $201.7 million, or 31.4%, of interest-bearing liabilities for the corresponding period of 2012. Also, during the three months ended June 30, 2012, average securities sold under agreements to repurchase decreased $11.8 million, or 54.6%, and average long-term borrowings decreased $10.8 million, or 17.0%.

Shifts in the interest rate environment to lower rates and local competition for loans and deposits affected the rates paid for funds as well as the yields earned on assets. The investment securities tax equivalent yield decreased 55 basis points from 4.04% for the three months ended June 30, 2011 to 3.49% for the three months ended June 30, 2012. Also, average loan yields decreased 23 basis points from 5.50% for the three months ended June 30, 2011 to 5.27% for the three months ended June 30, 2012.

The average time deposit costs decreased 26 basis points from 1.60% for the three months ended June 30, 2011 to 1.34% for the three months ended June 30, 2012. In addition, the average cost of money market accounts decreased 13 basis points from 0.47% for the three months ended June 30, 2011 to 0.34% for the three months ended June 30, 2012.

Interest expense for the three months ended June 30, 2012 totaled $1,407, compared to $1,922 in 2011, a decrease of $515 or 26.8%. The average rate paid on interest-bearing liabilities for the three months ended June 30, 2012 decreased to 0.88%, compared to 1.14% in 2011. Average savings deposits increased $6.9, or 5.9%. Average time deposits decreased $46.5, or 18.7%, for the three months ended June 30, 2012 due primarily to the redemption of brokered certificates of deposit. Average demand non-interest bearing deposits increased $18.2, or 15.4%.

The historically low interest rates continue to stress our margin as funding costs have reached a low point and asset yields for the most part continue to price downward. The Dodd-Frank Act, which was enacted in July 2010, and the regulations that have been and will be promulgated under the Act, are reducing our non-interest income, such as overdraft fees, and increasing compliance and regulatory costs.

Distribution of Assets, Liabilities and Stockholders’ Equity / Interest Rates and Interest Differential

The table below presents average balances, interest income on a taxable equivalent basis and interest expense, as well as average rates earned and paid on the Company’s major asset and liability items for the three months ended June 30, 2012 and June 30, 2011.


	June 30, 2012							June 30, 2011 *
	Average Balance		Revenue/ Expense		Yield/ Rate			Average Balance		Revenue/ Expense		Yield/ Rate
ASSETS
Investment Securities
Available-for-sale:
U.S. Agency obligations	$	105,169	$	430		1.64	%	$	98,834	$	483		1.95	%
States & political subdivisions		60,941		650		6.47	%		62,802		720		6.95	%
Other		1,061		12		4.52	%		5,366		15		1.12	%
Held-to-maturity:
U.S. Agency obligations		19,192		185		3.86	%		26,089		262		4.02	%
States & political subdivisions		1,339		17		7.77	%		10,868		137		7.66	%
Loans, net of unearned income:
Real estate mortgages		290,395		3,379		4.65	%		318,282		4,054		5.09	%
Commercial real estate		189,955		2,304		4.85	%		178,131		2,216		4.98	%
Commercial		56,922		765		5.38	%		39,589		555		5.61	%
Consumer and other		101,461		1,731		7.75	%		79,441		1,503		8.24	%
Federal funds sold		—		—		—			1,868		—		—
Federal Home Loan Bank stock		5,356		1		0.07	%		5,578		—		—
Interest on balances with banks		3,334		2		0.24	%		24,717		4		0.06	%

Total Interest-Earning Assets/Total Interest Income		835,125	$	9,476		4.82	%		851,565	$	9,949		4.94	%

Cash and due from banks		18,089							10,393
Bank premises and equipment		14,231							13,356
Accrued interest receivable		3,026							3,350
Goodwill		26,398							26,398
Bank owned life insurance		17,284							15,550
Other assets		16,057							11,844
Less: Allowance for loan and lease losses		6,819							6,667

Total Assets	$	923,391						$	925,789

LIABILITIES AND STOCKHOLDERS’ EQUITY

Deposits:
Demand-Interest bearing	$	93,548	$	57		0.24	%	$	70,125	$	63		0.36	%
Savings		124,783		44		0.14	%		117,894		79		0.27	%
Money markets		159,329		135		0.34	%		155,024		183		0.47	%
Time — Over $100		82,132		300		1.46	%		83,103		363		1.75	%
Time — Other		119,602		378		1.26	%		165,093		630		1.53	%
Federal funds purchased		—		—		—			—		—		—
Securities sold under agreements to repurchase		9,775		8		0.33	%		21,609		23		0.43	%
Short-term borrowings		960		1		0.42	%		519		—		—
Long-term borrowings		52,941		484		3.66	%		63,669		581		3.65	%

Total Interest Bearing Liabilities/Total Interest Expense		643,070	$	1,407		0.88	%		677,036	$	1,922		1.14	%

Demand — Non-interest bearing		136,102							117,868
All other liabilities		14,505							7,906
Stockholders’ equity		129,714							122,979

Total Liabilities and Stockholders’ Equity	$	923,391						$	925,789

Interest Spread						3.94	%						3.80	%

Net Interest Income			$	8,069						$	8,027

FINANCIAL RATIOS

Net interest margin (1)						4.14	%						4.04	%
Return on average assets						1.13	%						1.11	%
Return on average equity						8.01	%						8.33	%
Average equity to average assets						14.05	%						13.28	%
Dividend payout ratio						53.16	%						53.85	%

*	as restated see Note 18

(1)

The net interest margin is equal to tax equivalent net interest income divided by average interest-earning assets. In order to make pre-tax income on tax-exempt investments and loans comparable to taxable investments and loans, a tax equivalent adjustment is made to interest income. This adjustment increased interest income by $579 and $576 for the three months ended June 30, 2012 and 2011, respectively. The Company believes that the tax equivalent presentation is consistent with industry practice. Although the Company believes that these financial measures enhance investors’ understanding of our business and performance, these measures should not be considered an alternative to GAAP.

Net interest income (before the provision for loan and lease losses) increased $77, or 0.5%, to $16,247 for the six months ended June 30, 2012 compared to $16,170 for the six months ended June 30, 2011. The average yield on interest-earning assets decreased 14 basis points, or 2.8%.

For the six months ended June 30, 2012, net interest margin increased 7 basis points to 4.17% from 4.10% in the same period of 2011.

Total average interest-earning assets and average interest-bearing liabilities decreased from the six months ended June 30, 2012. Average interest-earning assets decreased $10.3 million or 1.2%, from $846.1 million for the six months ended June 30, 2011 to $835.8 million for the corresponding period in 2012 and average interest-bearing liabilities decreased $28.0 million, or 4.2%, from $673.2 million to $645.2 million over the same periods. As a percentage of average assets, average interest-earning assets, including bank-owned life insurance (BOLI), decreased for the six months ended June 30, 2012 and 2011, respectively, to 92.2% from 93.6%.

Changes in the mix of both interest-earning assets and funding sources also impacted net interest income in the six months ended June 30, 2012 and 2011. Average loans as a percentage of average interest-earning assets increased from 72.7% for the six months ended June 30, 2011 to 76.3% for the corresponding period in 2012. Average investment securities decreased $18.9 million, or 9.7%, period over period, and as a percentage of interest-earning assets, decreased to 22.7% for the six months ended June 30, 2012 from 24.7% for the six months ended June 30, 2011. Average short-term investments, federal funds sold, FHLB stock and interest-bearing balances with banks, decreased as a percentage of average assets to 0.9% for the six months ended June 30, 2012 from 2.4% for the six months ended June 30, 2011. Average time deposits decreased $42.1 million, or 16.9%, from $248.4 million, or 36.9%, of interest-bearing liabilities for the six months ended June 30, 2011 to $206.3 million, or 32.0%, of interest-bearing liabilities for the corresponding period in 2012. Also, during the six months ended June 30, 2012, average securities sold under agreements to repurchase decreased $10.6 million, or 52.0%, and average long-term borrowings decreased $10.7 million, or 16.4%.

Shifts in the interest rate environment to lower rates and local competition for loans and deposits affected the rates paid for funds as well as the yields earned on assets. The investment securities tax equivalent yield decreased 47 basis points from 4.03% for the six months ended June 30, 2011 to 3.56% for the six months ended June 30, 2012. Also, average loan yields decreased 20 basis points from 5.51% for the six months ended June 30, 2011 to 5.31% for the six months ended June 30, 2012.

The average time deposit costs decreased 23 basis points from 1.55% for the six months ended June 30, 2011 to 1.32% for the six months ended June 30, 2012. In addition, the average cost of money market accounts decreased 14 basis points from 0.49% for the six months ended June 30, 2011 to 0.35% for the six months ended June 30, 2012.

Interest expense for the six months ended June 30, 2012 totaled $2,888, compared to $3,819 in 2011, a decrease of $931 or 24.4%. The average rate paid on interest-bearing liabilities for the six months ended June 30, 2012 decreased to 0.90%, compared to 1.13% in 2011. Average savings deposits increased $6.7, or 5.8%. Average time deposits decreased $42.1, or 16.9%, for the six months ended June 30, 2012 due primarily to the redemption of brokered certificates of deposit. Average demand non-interest bearing deposits increased $21.5, or 18.5%.

Distribution of Assets, Liabilities and Stockholders’ Equity / Interest Rates and Interest Differential


	June 30, 2012							June 30, 2011*
	Average		Revenue/		Yield/			Average		Revenue/		Yield/
	Balance		Expense		Rate			Balance		Expense		Rate
ASSETS
Investment Securities
Available-for-sale:
U.S. Agency obligations	$	104,120	$	855		1.64	%	$	102,118	$	1,016		1.99	%
States & political subdivisions		62,548		1,340		6.49	%		62,720		1,432		6.92	%
Other		1,384		26		3.76	%		5,202		29		1.11	%
Held-to-maturity:
U.S. Agency obligations		20,097		399		3.97	%		26,940		544		4.04	%
States & political subdivisions		1,575		42		8.13	%		11,655		292		7.58	%
Loans, net of unearned income:
Real estate mortgages		293,676		7,231		4.92	%		318,339		8,165		5.13	%
Commercial real estate		187,837		4,427		4.71	%		176,238		4,350		4.94	%
Commercial		55,661		1,486		5.34	%		39,074		1,125		5.76	%
Consumer and other		100,262		3,322		7.54	%		81,813		3,030		8.10	%
Federal funds sold		—		—		—			934		—		—
Federal Home Loan Bank stock		5,278		3		0.11	%		5,767		—		—
Interest on balances with banks		3,364		4		0.24	%		15,304		6		0.08	%

Total Interest-Earning Assets/Total Interest Income		835,802	$	19,135		4.86	%		846,104	$	19,989		5.00	%

Cash and due from banks		21,493							10,387
Bank premises and equipment		13,968							13,397
Accrued interest receivable		3,030							3,372
Goodwill		26,398							26,398
Bank owned life insurance		16,818							15,488
Other assets		14,017							12,124
Less: Allowance for loan and lease losses		6,752							6,573

Total Assets	$	924,774						$	920,697

LIABILITIES AND STOCKHOLDERS’ EQUITY

Deposits:
Demand-Interest bearing	$	90,968	$	122		0.27	%	$	70,140	$	135		0.38	%
Savings		122,959		99		0.16	%		116,310		156		0.27	%
Money markets		159,474		283		0.35	%		151,165		369		0.49	%
Time — Over $100		83,035		612		1.47	%		83,590		733		1.75	%
Time — Other		123,280		754		1.22	%		164,824		1,187		1.44	%
Federal funds purchased		50		—		—			—		—		—
Securities sold under agreements to repurchase		9,775		16		0.33	%		20,418		46		0.45	%
Short-term borrowings		978		2		0.41	%		1,366		3		0.44	%
Long-term borrowings		54,692		1,000		3.66	%		65,385		1,190		3.64	%

Total Interest Bearing Liabilities/Total Interest Expense		645,211	$	2,888		0.90	%		673,198	$	3,819		1.13	%

Demand — Non-interest bearing		137,948							116,370
All other liabilities		12,219							8,560
Stockholders’ equity		129,396							122,569

Total Liabilities and Stockholders’ Equity	$	924,774						$	920,697

Interest Spread						3.96	%						3.87	%

Net Interest Income			$	16,247						$	16,170

FINANCIAL RATIOS

Net interest margin (1)						4.17	%						4.10	%
Return on average assets						1.15	%						1.15	%
Return on average equity						8.24	%						8.63	%
Average equity to average assets						13.99	%						13.31	%
Dividend payout ratio						51.53	%						52.17	%

*	as restated see Note 18

(1)

The net interest margin is equal to tax equivalent net interest income divided by average interest-earning assets. In order to make pre-tax income on tax-exempt investments and loans comparable to taxable investments and loans, a tax equivalent adjustment is made to interest income. This adjustment increased interest income by $1,169 and $1,170 for the six months ended June 30, 2012 and 2011, respectively. The Company believes that the tax equivalent presentation is consistent with industry practice. Although the Company believes that these financial measures enhance investors’ understanding of our business and performance, these measures should not be considered an alternative to GAAP.

Provision for Loan and Lease Losses

The provision for loan and lease losses represents the charge to operating expense necessary to maintain the allowance for loan and lease losses at a level which management determines is adequate to absorb probable losses inherent in the Company’s loan portfolio.

During the three and six months ended June 30, 2012, the local economy continued to struggle. The local housing market remained weak and the unemployment rate in Northeastern Pennsylvania was 8.7% at May 31, 2012. The Company continues to proactively evaluate probable loan and lease losses and address delinquent loans by, among other things, obtaining current appraisals of collateral, increasing communication with clients and placing loans on non-accrual status when collection is in doubt and the loan is moving toward foreclosure.

The Bank’s methodology for determining the allowance for loan and lease losses (ALLL) is based on a documented and consistently applied analysis of its loan portfolio. This analysis considers all significant factors that affect the collectability of the loans within our portfolio and supports the credit losses estimated by this process. Our ALLL methodology includes procedures for a review by a party who is independent of the Bank’s credit approval and ALLL estimation processes.

The Bank applies its allowance methodology in accordance with the Federal Financial Institutions Examination Council (“FFIEC”) Interagency Policy Statements, as amended, and GAAP to assess the adequacy of its allowance for loan and lease losses. Under GAAP, the adequacy of the allowance for loan and lease losses is determined based on the provisions of FASB ASC 310 for loans specifically identified to be individually evaluated for impairment and the requirements of FASB ASC 450 for large groups of smaller balance homogeneous loans to be collectively evaluated for impairment. Loans are identified by the Bank’s rating system, past due reports, watch list and sensitivity to economic factors and are then collectively evaluated for impairment compared to other loans utilizing standard criteria. Consideration is given to current local economic conditions which the Company continues to classify as recessionary.

The Bank’s historical analysis of loss factors, utilizes a rolling twenty quarters, but assigns greater weight to the four quarters of the previous five years that reflected the greatest loan loss allowances calculated by dollar amount. This methodology is designed to better address deterioration in local economic conditions. In addition, and in view of the concentration of the Bank’s loan portfolio in real estate – approximately 80% of the portfolio is secured by real estate mainly in the counties in which the Bank operates – the Bank also took into account the decline in real estate sales and new construction in our market area and drop in real estate values within the market area. The Bank’s provision for loan and lease losses for the quarter ended June 30, 2012 was allocated primarily to commercial real estate and consumer portfolios. Reference should be made to the information about the Company’s provision for loan and lease losses under the heading “General Notes to Financial Statements – Note 7 – Loan Portfolio”.

There were no changes in the methodology of determining the allowance for loan losses during the three and six months ended June 30, 2012. Management continues to focus on trends in real estate delinquencies related to the poor labor and housing markets locally, in determining the allowance for loan losses. Management also continually compares the probable losses estimated in accordance with our allowance for loan loss methodology with actual losses.

Based on this methodology, management made a provision for loan and lease losses of $306 for the six month period ended June 30, 2012, compared to a $1,268 provision for the comparable prior year period, resulting in an allowance for loan and lease losses of $6,938 at June 30, 2012 compared to $6,711 at June 30, 2011. The decrease in the provision for loan and lease losses for the six months ended June 30, 2012 is the result of management’s proactive efforts to resolve credit issues through closer interaction with the affected customers, active collection efforts and foreclosure.

The amount and number of charge-offs and foreclosures during the periods indicated are as follows:


	At and For The			At and For The			At and For The
	Six Months Ended			Twelve Months Ended			Six Months Ended
	June 30,			December 31,			June 30,
At:	2012			2011			2011
Provision for loan and lease losses	$	306		$	2,381		$	1,268
Allowance for loan and lease losses to non-performing loans		344.83	%		211.97	%		116.77	%
Non-performing loans to period end loans		0.31	%		0.50	%		0.93	%
Ratio of charged-off loans to average loans		0.02	%		0.37	%		0.18	%
Ratio of foreclosed loans to average loans		0.11	%		0.38	%		0.01	%
Allowance for loan and lease losses to period end loans		1.09	%		1.06	%		1.08	%


	At and For The				At and For The				At and For The
	Six Months Ended				Twelve Months Ended				Six Months Ended
At:	June 30, 2012				December 31, 2011				June 30, 2011
	Amount		(#)		Amount		(#)		Amount		(#)
Charge-offs	$	131		24	$	2,300		90	$	1,107		41
Foreclosures completed		715		8		2,370		14		80		3
Non-performing loans		2,012		72		3,166		77		5,747		107

The Company had one commercial loan whose terms had been modified in a troubled debt restructuring (TDR) as of June 30, 2012 and December 31, 2011; monthly payments were lowered to accommodate the borrower’s financial needs for a period of time.

The following table presents loans whose terms were modified in a TDR at the dates indicated below:


	June 30, 2012		December 31, 2011
Restructured Loans on Accrual Status and Not Past Due 90 Days or More	$	358	$	368
Restructured Loans Included in Non-Accrual Loans or Accruing Loans Past Due 90 Days or More		—		—

Total Restructured Loans	$	358	$	368

The Company believes that the judgments used in determining the allowance for loan and lease losses are based on reliable information. In assessing the adequacy of the allowance for loan and lease losses, management considers how well prior estimates have related to actual experience. The Company continually monitors the risk elements, historical rates and other data used in determining the allowance on a periodic basis. Based on this ongoing evaluation, a provision for loan and lease losses is made in the amount necessary to maintain an appropriate allowance.

The methodology for determining the adequacy of the allowance is necessarily judgmental and subject to changes in external conditions. Although management uses available information to establish the appropriate level of the allowance for loan and lease losses, future additions or reductions to the allowance may be necessary as a result of changes in economic conditions and other factors. As a result, our allowance for loan and lease losses may not be sufficient to cover actual loan and lease losses, and future provisions for loan and lease losses could materially adversely affect the Company’s operating results. In addition, various regulatory agencies, as an integral part of their examination process, periodically review the Company’s allowance for loan and lease losses. Discussions with these regulatory agencies may result in adjustments to the Company’s allowance based on judgments about information available to the agencies at the time of their examination.

Other than the risks associated with the geographic concentration of our customers, facilities and the collateral securing some of our loans, there are no particular risk elements in the local economy that put a group or category of loans at increased risk. However, the Company has increased its portfolio of commercial loans in recent years, which typically bear a higher risk. These loans are typically secured by real estate to minimize this risk. At June 30, 2012, management believes the allowance for loan and lease losses is adequate to absorb probable loan and lease losses inherent in the loan portfolio.

Non-Interest Income

The following table sets forth information by category of non-interest income for the Company for the three months ended June 30, 2012 and June 30, 2011, respectively:


Three Months Ended:	June 30, 2012		June 30, 2011
Trust department income	$	341	$	385
Service charges on deposit accounts		468		519
Merchant transaction income		891		931
Brokerage fee income		84		77
Other fee income		461		431
Bank-owned life insurance income		131		125
Other operating income		181		315
Realized gains (losses) on securities, net		69		272

Total Non-Interest Income	$	2,626	$	3,055

Total non-interest income decreased $429, or 14.0%, to $2,626 for the three months ended June 30, 2012, compared with $3,055 for the same period in 2011. This decrease was primarily attributable to a decrease of $203 in net realized gains on securities and $134 in other operating income due to a decrease in the gains on the sale of other real estate owned, as well as a $44 decrease in trust department income due to lower estate fees, a $51 decrease in service charges on deposit accounts due to decreased overdraft activity and a $40 decrease in merchant transaction income due to lower volume. These decreases were offset by a $30 increase in other fee income resulting from increased debit card revenue due to an increased number of accounts and, to a lesser extent, increases in brokerage fee income and bank-owned life insurance income.

The following table sets forth information by category of non-interest income for the Company for the six months ended June 30, 2012 and June 30, 2011, respectively:


Six Months Ended:	June 30, 2012		June 30, 2011
Trust department income	$	703	$	783
Service charges on deposit accounts		927		991
Merchant transaction income		2,098		2,173
Brokerage fee income		141		133
Other fee income		864		809
Bank-owned life insurance income		249		245
Other operating income		431		945
Realized gains (losses) on securities, net		116		280

Total Non-Interest Income	$	5,529	$	6,359

Total non-interest income decreased $830, or 13.1%, to $5,529 for the six months ended June 30, 2012, compared with $6,359 for the same period in 2011. This decrease was primarily attributable to a decrease of $514 in other operating income due to income recorded in connection with the reversal of a contingent liability of $500 during the quarter ended March 31, 2011, as well as a $80 decrease in trust department income due to lower estate fees, a $64 decrease in service charges on deposit accounts due to decreased overdraft activity, a $75 decrease in merchant transaction income due to lower volume and a $164 decrease in net realized gains on securities. These decreases were offset by a $55 increase in other fee income resulting from increased debit card revenue due to an increased number of accounts, and, to a lesser extent, increases in brokerage fee income and bank-owned life insurance income.

Non-Interest Expenses

The following table sets forth information by category of non-interest expense for the Company for the three months ended June 30, 2012 and June 30, 2011, respectively:


Three Months Ended:	June 30, 2012		June 30, 2011*
Salaries and employee benefits	$	3,490	$	3,313
Expense of premises and equipment, net		715		806
Merchant transaction expenses		596		666
FDIC insurance assessments		120		180
Other operating expenses		2,340		1,971

Total Non-Interest Expenses	$	7,261	$	6,936

*	as restated see Note 18

Total non-interest expenses increased $325, or 4.7%, to $7,261 for the three months ended June 30, 2012 compared with $6,936 for the same period in 2011. Salaries and employee benefits increased $177, or 5.3%, primarily attributable to merit-based increases, commissions and long-term incentive plan expenses. Other operating expenses increased $369, or 18.7%, resulting from increased Pennsylvania shares tax expense and other real estate owned expenses. These increases in total non-interest expenses were partially offset by a decrease in FDIC insurance assessments of $60, or 33.3%, resulting from new FDIC bank pricing methodology; a decrease in merchant transaction expenses of $70, or 10.5%, due to lower volume and a decrease in premises and fixed asset expenses of $91 or 11.3%, due primarily to lower occupancy and depreciation expense.

The following table sets forth information by category of non-interest expense for the Company for the six months ended June 30, 2012 and June 30, 2011, respectively:


Six Months Ended:	June 30, 2012		June 30, 2011*
Salaries and employee benefits	$	7,204	$	6,903
Expense of premises and equipment, net		1,552		1,827
Merchant transaction expenses		1,327		1,499
FDIC insurance assessments		230		422
Other operating expenses		4,288		3,800

Total Non-Interest Expenses	$	14,601	$	14,451

*	as restated see Note 18

Total non-interest expenses increased $150 or 1.0% to $14,601 for the six months ended June 30, 2012 compared with $14,451 for the same period in 2011. Salaries and employee benefits increased $301, or 4.4%, primarily attributable to merit-based increases, commissions and long-term incentive plan expenses. Other operating expenses increased $488, or 12.8%, resulting from increased Pennsylvania shares tax expense and other real estate owned expenses. These increases in total non-interest expenses were partially offset by a decrease in FDIC insurance assessments of $192, or 45.5%, resulting from new FDIC bank pricing methodology; a decrease in merchant transaction expenses of $172, or 11.5%, due to lower volume and a decrease in premises and fixed asset expenses of $275 or 15.1%, due primarily to lower occupancy and depreciation expense.

Income Taxes

Applicable income taxes increased $36 or 5.3% and $18 or 1.2% primarily due to higher taxable income for the three months and six months ended June 30, 2012, respectively.

Cash Equivalents and Investments

The Company’s investment portfolio has two primary functions: to provide liquidity and to contribute to earnings. To provide liquidity, the Company may invest in short-term securities such as Federal funds sold and interest-bearing deposits with banks, which are classified as cash equivalents, as well as U.S. Treasury securities and U.S. Agency securities with maturities of one year or less. These funds are invested on a short-term basis to ensure the availability of funds to meet customer demand for credit needs.

The Company enhances interest income by securing long-term investments within its investment portfolio by means of U.S. Treasury securities, U.S. Agency securities, municipal securities and mortgage-backed securities, generally with maturities greater than one year. The Company’s mortgage-backed securities portfolio does not contain any sub-prime or Alt-A credits. The Company is considering replacing investment proceeds with loans and the remainder of the excess cash flows being redeployed into AAA-rated securities with a three to four year duration.

The following table presents the carrying value, by security type and by maturity, for the Company’s investment portfolio:


	June 30, 2012		December 31, 2011
U.S. Agency obligations	$	77,867	$	77,985
Mortgage-backed securities		44,893	$	44,078
States & political subdivisions		60,999		67,198
Corporate securities		—		1,004

Total Debt Securities		183,759		190,265
Equity Securities		1,127		943

Total Investment Securities	$	184,886	$	191,208

Loan Portfolio

Details regarding the Company’s loan portfolio are as follows:


As of :	June 30, 2012		December 31, 2011
Construction and land development
Residential real estate	$	4,642	$	5,064
Commercial real estate		18,521		20,541
Residential real estate		267,126		276,579
Commercial secured by real estate		189,204		188,334
Commercial loans		62,755		55,482
Credit card and related plans		3,051		3,242
Installment and other		62,814		59,170
Obligations of states & political subdivisions		30,857		23,110

Loans, net of unearned income		638,970		631,522
Less: Allowance for loan and lease losses		6,938		6,711

Loans, net	$	632,032	$	624,811

There were no purchased loans during the three and six months ended June 30, 2012, other than loan participations with local banks in the Bank’s primary market area. Originations of new loans in 2012 were primarily commercial and municipal loans.

The Company has not engaged in any sub-prime residential mortgage lending. Therefore, the Company is not subject to any credit risks associated with such loans. The Company’s loan portfolio consists primarily of residential and commercial mortgage loans secured by properties located in Northeastern Pennsylvania and subject to what we believe are conservative underwriting standards.

Loans secured by real estate continue to be the largest component of the loan portfolio, representing 75% and 78% of total loans at June 30, 2012 and December 31, 2011, respectively. Economic conditions and recessionary concerns over the past several years have resulted in lower levels of loan demand. The decline ratio on loan applications has remained consistent with our historical experience. As we expect these conditions and concerns to continue for the near term, we expect that loan growth may be slower than historically expected.

Loan Quality

Our lending activities are guided by a comprehensive lending policy approved by our board of directors. Loans must meet certain criteria relating to the character, capacity and capital of the borrower, collateral provided for the loan, and prevailing economic conditions. Our non-performing assets and charge-offs are well below industry levels, which we believe reflects the consistent application of our conservative underwriting standards.

Regardless of credit standards, there is risk of loss inherent in every loan portfolio. The allowance for loan and lease losses is an amount that management believes will be adequate to absorb probable losses on existing loans. The evaluations take into consideration such factors as change in the nature and volume of the loan portfolio, overall portfolio quality, review of specific problem loans, industry experience, collateral value and current economic conditions that may affect the borrower’s ability to pay. Management believes that the allowance for loan and lease losses was adequate at June 30, 2012. Management uses available information to estimate probable losses on loans, however, future additions to the allowance may be necessary based on changes in economic conditions and other factors. In addition, various regulatory agencies, as an integral part of their examination process, periodically review the Company’s allowance for loan and lease losses. Such agencies may require the Company to recognize additions to the allowance, or take other actions that would impact the allowance, based on their judgment of information available to them at the time of their examination.

The allowance for loan and lease losses is increased by periodic charges against earnings as a provision for loan and lease losses, and decreased periodically by charge-offs of loans (or parts of loans) that management has determined to be uncollectible, net of actual recoveries on loans previously charged-off. (See also, “Provision for Loan and Leases Losses.”)

The allowance for loan and lease losses as a percentage of loans was 1.09% at June 30, 2012, compared to 1.06% at December 31, 2011 and 1.08% at June 30, 2011.

Market Area

The Northeastern Pennsylvania economy in which we operate has been affected by the economic decline that has affected the U.S. economy as a whole. The national unemployment rate was 8.2%, the statewide unemployment rate was 7.4% and the Scranton/Wilkes-Barre metropolitan area unemployment rate was 8.7% at May 31, 2012. The region still leads the state’s 14 metro areas with the highest unemployment rate for twenty-six consecutive months, according to the data released recently by the State Department of Labor and Industry. The high unemployment rate can be attributed to a gradual decline in manufacturing in Northeastern Pennsylvania, and much like the rest of the country, a slowdown in construction of residential and commercial property.

High unemployment in Northeastern Pennsylvania will continue to put pressure on the local economy and on our loan portfolio. Average home prices nationally during 2012 were down 2.0% from the first quarter of 2011, according to the latest Case-Shiller House Price Index, which is a leading measure for the U.S. residential housing market. We believe that our focus on identifying borrowers who are facing cash flow problems before they are unable to make their payments will significantly improve our ability to help these borrowers maintain their debt service through difficult times.

Non-Performing Assets

Non-performing assets consist of non-accrual loans and other real estate owned. The following table sets forth information regarding non-performing assets and loans past due 90 days or more and still accruing interest as of the dates indicated:


	June 30,			December 31,			June 30,
As of:	2012			2011			2011
Non-accrual loans
Residential real estate	$	1,386		$	2,006		$	3,207
Commercial real estate		145			591			1,511
Commercial loans		423			477			876
Consumer loans		58			92			153

Total non-performing loans	$	2,012		$	3,166		$	5,747

Other real estate owned		726			1,571			169

Total non-performing assets	$	2,738		$	4,737		$	5,916

Loans past due 90 days or more and accruing:
Residential real estate	$	1,447		$	641		$	608
Commercial real estate		—			11			145
Guaranteed student loans		96			113			169
Credit card loans		12			6			25
Commercial loans		—			—			—
Consumer loans		1			3			10

Total loans past due 90 days or more and accruing	$	1,556		$	774		$	957

Non-performing loans to period end loans		0.31	%		0.50	%		0.93	%
Total loans past due 90 days or more and accruing to period end loans		0.24	%		0.12	%		0.15	%
Non-performing assets to period end assets		0.30	%		0.51	%		0.63	%

Loans are generally placed on non-accrual status when principal or interest is past due 90 days and when payment in full is not anticipated. For commercial loans, an appraisal is obtained if the loan has been downgraded and the appraisal on file is at least one year old. When a loan is placed on non-accrual status, all interest previously accrued but not collected is charged against current income. Loans are returned to accrual status when all the principal and interest amounts contractually due are brought current and future payments are reasonably assured after a minimum of a six month positive payment history.

In 2008, the Company was notified that The Education Resources Institute, Inc. (TERI), a guarantor of a portion of our student loan portfolio, had filed for reorganization under Chapter 11 of the United States Bankruptcy Code. As of June 30, 2012, the Company had $6,598 of TERI-guaranteed loans out of a total student loan portfolio of $13,493. The Company does not anticipate that TERI’s bankruptcy filing will significantly impact the Company’s financial statements. These loans are placed on non-accrual status when they become more than 90 days past due. As of June 30, 2012, $27 of such loans were on non-accrual status.

Loans on which the accrual of interest has been discontinued or reduced amounted to $2,012 and $5,747 at June 30, 2012 and 2011, respectively. We believe that the decrease in non-accrual loans reflects management’s focused efforts to proactively address delinquent accounts. Real estate loans of $1,447 that are past due 90 days or more and still accruing are primarily 1-4 family residential loans with favorable loan-to-value ratios and that are in the process of collection. As of June 30, 2012 several additional loans met this criteria based on an evaluation of each credit.

If interest on non-accrual loans had been accrued, such income would have been $72 and $223 for the six months ended June 30, 2012 and June 30, 2011, respectively. Interest income on non-accrual loans, which is recorded only when received, amounted to $0 for each of the six months ended June 30, 2012 and June 30, 2011, respectively. There are no commitments to lend additional funds to borrowers whose loans are in non-accrual status.

Management’s process for evaluating the adequacy of the allowance for loan and lease losses includes reviewing each month’s loan committee reports which list all loans that do not meet certain internally developed criteria as to collateral adequacy, payment performance and overall credit risk. These reports also address the current status and actions in process on each listed loan. This information is used in our ALLL methodology and resulting adjustments are made to the allowance for loan and lease losses. Such adjustments include both specific loss allocation amounts and general provisions by loan category based on present and past collection experience, nature and volume of the loan portfolio, overall portfolio quality, and current economic conditions that may affect the borrower’s ability to pay.

Estimated “low” and “high” allowances for loan and lease loss amounts are derived by accumulating the loss estimates for specific loans and general pools. The actual allowance for loan and lease losses, situated within the estimated low-to-high range, is approved on a quarterly basis by our board of directors.

As of June 30, 2012, the Company had total impaired loans of $4,946. Of the total allowance for loan and lease losses, $1,293 was specifically related to these impaired loans at June 30, 2012.

Most of the Company’s lending activity is with customers located in the Company’s geographic market area and repayment thereof is affected by economic conditions in this market area.

Loan Loss Experience

The following table presents the Company’s allowance for loan and lease losses during the periods indicated:


	June 30,			June 30,
Three Months Ended:	2012			2011
Balance at beginning of period	$	6,811		$	6,800
Charge-offs:
Residential real estate mortgages		—			664
Commercial real estate		—			258
Commercial loans		—			12
Credit card and related plans		10			32
Installment loans		20			26

Total charge-offs		30			992

Recoveries:
Residential real estate mortgages		—			—
Commercial real estate		—			—
Commercial loans		—			2
Credit card and related plans		—			—
Installment loans		43			2

Total recoveries		43			4

Net charge-offs (recoveries)		(13	)		988

Provision charged to operations		114			899

Balance at End of Period	$	6,938		$	6,711

Ratio of net charge-offs (recoveries) to average loans outstanding		0.00	%		0.16	%


Six Months Ended:	June 30, 2012			June 30, 2011
Balance at beginning of period	$	6,711		$	6,500
Charge-offs:
Residential real estate mortgages		-			725
Commercial real estate		33			258
Commercial loans		5			12
Credit card and related plans		18			52
Installment loans		75			60

Total charge-offs		131			1,107

Recoveries:
Residential real estate mortgages		1			18
Commercial real estate		5			—
Commercial loans		—			3
Credit card and related plans		—			1
Installment loans		46			28

Total recoveries		52			50

Net charge-offs (recoveries)		79			1,057

Provision charged to operations		306			1,268

Balance at End of Period	$	6,938		$	6,711

Ratio of net charge-offs (recoveries) to average loans outstanding		0.01	%		0.17	%

The allowance for loan and lease losses at June 30, 2012 was $6,938 or 1.09% of total loans compared to $6,711 or 1.08% of total loans at June 30, 2011.

The allowance for loan and lease losses was allocated as follows:


As of:	June 30, 2012						December 31, 2011						June 30, 2011
	Amount		%			*	Amount		%			*	Amount		%			*
Residential real estate	$	2,856		42	%		$	2,855		44	%		$	543		48	%
Commercial real estate and all others		3,148		49	%			3,087		47	%			4,389		43	%
Credit card and related plans		340		1	%			319		1	%			352		1	%
Personal installment loans		594		8	%			450		8	%			1,427		8	%

Total	$	6,938		100	%		$	6,711		100	%		$	6,711		100	%

*	Percent of loans in each category to total loans

The entire ALLL is available for losses in any loan category, notwithstanding the allocation above.

Our non-performing loans decreased from $5,747, at June 30, 2011, to $3,166 at December 31, 2011, and to $2,012 at June 30, 2012. As of June 30, 2012, our non-performing loans were comprised of thirty-nine loans of which nine loans were in excess of one hundred thousand dollars in size and the remainder of which were less than one hundred thousand dollars each. The decrease in the non-performing loans can be attributed, to a large extent, to a large land development credit, which was transferred to OREO in the third quarter of 2011 and subsequently sold.

As of June 30, 2012, the total of the allowance for loan and lease losses was $6,938. Through the application of our ALLL methodology, the allowance reflects management’s conservative view of the local economic conditions.

As a result of the local and national weakness in the residential real estate industry, and to evaluate a potential loan loss, the Bank orders a current appraisal of the collateral securing such loan after it is 90 days delinquent to assess the current loan to value ratio. An appraisal is ordered in the case of commercial loans, if a loan has been downgraded and the current appraisal on file is at least one year old. Both residential and commercial appraisals continue to be discounted appropriately for purposes of applying loan to value requirements in the Bank’s loan policy, in view of the weak real estate market.

Other Real Estate Owned

The Bank has eight properties in other real estate owned as of June 30, 2012 with a value of $726 compared to $1,571 at December 31, 2011 and $169 at June 30, 2011. Of the eight properties, one is commercial with a carrying value of $100; the remaining seven properties are residential. The Bank had eight properties in other real estate owned as of December 31, 2011. Of the eight properties, two were commercial with a carrying value of $1,000; the remaining six properties were residential. As of June 30, 2011 the Bank had five properties in other real estate owned, which represented three relationships. One of the properties was commercial and four were residential.

The largest property in other real estate owned at December 31, 2011, with a carrying value of $900, was sold on April 24, 2012 with a total consideration of $900.

Presently, there are sixteen properties in the process of loan foreclosure. Fifteen of these properties are residential with the largest having a balance of $207. The commercial property has a balance of $155.

Deposits

Details regarding the Company’s deposit portfolio at the dates indicated are as follows:


	June 30, 2012		December 31, 2011
Demand — Non-interest bearing	$	139,183	$	134,799
Demand — Interest bearing		89,190		85,111
Savings		125,716		120,269
Money markets		161,515		165,611
Time — Over $100,000		82,932		84,828
Time — Other		113,864		129,900

Total Deposits	$	712,400	$	720,518

The Company largely relies on its core deposit base of checking and savings accounts to fund operations. Management has competitively priced its deposit products in checking, savings, money market and time deposits to provide a stable source of funding.

In general, as interest rates in the economy change, some deposits migrate towards investments with higher anticipated yields. Historically, the Bank’s core deposits have been stable and not significantly impacted by such trends.

As of June 30, 2012, the Company had Certificate of Deposit Account Registry Service (“CDARS”) reciprocal deposits in the amount of $22.8 million. The Bank also currently issues brokered certificates of deposit as an alternative to wholesale funding due to their favorable terms. The balance of this funding as of June 30, 2012 and December 31, 2011 was $16.2 million and $23.2 million, respectively. The brokered certificates of deposit issued were generally a low cost alternative to wholesale funding with the majority offered having a call feature optionality not provided by wholesale funding. As of June 30, 2012, the dollar amount of brokered deposits, exclusive of CDARS reciprocal deposits, was $16.2 million, or 2.3%, of total deposits, compared to $23.2 million, or 3.2%, at December 31, 2011.

Liquidity

The objective of liquidity management is to maintain a balance between sources and uses of funds in such a way that the cash requirements of customers for loans and deposit withdrawals are met in the most economical manner. Management monitors its liquidity position continuously in relation to trends of loans and deposits for short-term as well as long-term requirements. Liquid assets are monitored on a daily basis to assure maximum utilization. Management also manages its liquidity requirements by maintaining readily marketable assets and access to short-term funding sources.

The Company remains in a highly liquid condition both in the short and long term and does not foresee any adverse trends in liquidity. Sources of liquidity include the Company’s U.S. Agency bond portfolios, additional deposits, earnings, overnight loans to and from other companies (Federal Funds) and lines of credit at the Federal Reserve Bank and the Federal Home Loan Bank (FHLB). The Company is not a party to any commitments, guarantees or obligations that could materially affect its liquidity.

The Company offers collateralized securities sold under agreements to repurchase, which have a one day maturity, as an alternative deposit option for its customers. The securities sold under agreements to repurchase are accounted for as a collateralized borrowing with a one day maturity and are collateralized by U.S. Agency securities. The Company also has long-term debt outstanding to the FHLB, which was used to purchase a Freddie Mac pool of residential mortgages. At June 30, 2012, the Company had $195,462 of available borrowing capacity with the FHLB, a Borrower-In-Custody (BIC) line of credit of $34,996 with the Federal Reserve Bank of Philadelphia, available borrowing capacity at the Discount Window of $16,015, an overnight Federal funds line of credit of $19,000 with PNC Bank, an overnight Federal funds line of credit of $5,000 with Wells Fargo and an overnight Federal funds line of credit of $5,000 with Atlantic Central Bankers Bank.

The Company is a separate legal entity from the Bank and must provide for its own liquidity. In addition to its operating expenses, the Company is responsible for paying any dividends declared to its shareholders. The Company’s primary source of funds is dividends received from the Bank. The amount of dividends that the Bank may declare and pay to the Company is generally restricted under Pennsylvania law to the retained earnings of the Bank.

Commitments and Contingent Liabilities

In the normal course of business, there are outstanding commitments and contingent liabilities, created under prevailing terms and collateral requirements such as commitments to extend credit, financial guarantees and letters of credit, which are not reflected in the accompanying Financial Statements. The Company does not anticipate any losses as a result of these transactions. These instruments involve, to varying degrees, elements of credit and interest rate risk in excess of the amount recognized in the Balance Sheets.

The contract or notional amounts of those instruments reflect the extent of involvement the Company has in particular classes of financial instruments.

Commitments to extend credit are agreements to lend to a customer as long as there is no violation of any condition established in the contract. Commitments generally have expiration dates of one year or less or other termination clauses and may require payment of a fee. Since many of the commitments are expected to expire without being drawn upon, the total commitment amounts do not necessarily represent future cash requirements.

Standby letters of credit are conditional commitments issued to guarantee the performance of a customer to a third party. The credit risk involved in issuing letters of credit is essentially the same as that involved in extending loan facilities to customers.

Various actions and proceedings are presently pending to which the Company is a party. Management is of the opinion that the aggregate liabilities, if any, arising from such actions would not have a material adverse effect on the financial position of the Company.

In January 2012, the Bank purchased land in Scranton, Pennsylvania to be used for construction of a new branch facility. The Bank has received regulatory approval for the establishment of this new branch office, which is expected to be operational during the third quarter of 2012. At June 30, 2012 the Bank has entered into contracts for the construction of this new branch office, in the aggregate amount of $1,490, approximately $886 of which had been disbursed as of June 30, 2012.

Capital Resources

A strong capital position is important to the continued profitability of the Company and promotes depositor and investor confidence. The Company’s capital provides a basis for future growth and expansion and also provides additional protection against unexpected losses.

Additional sources of capital are retained earnings from the operations of the Company and proceeds from the sale of additional shares of common stock. Management has no plans to offer additional shares of common stock at this time.

Bank’s Consolidated Financial Statements. Under capital adequacy guidelines and the regulatory framework for prompt corrective action, the Company and the Bank must meet specific capital guidelines that involve quantitative measures of their assets, liabilities, and certain off-balance sheet items as calculated under regulatory accounting practices. The Company and the Bank’s capital amounts and classifications are also subject to qualitative judgments by the regulators about components, risk weightings and other factors.

The Company’s total risk-based capital ratio was 17.04% at June 30, 2012. The Bank’s total risk-based capital ratio was 16.47% at June 30, 2012, which is more than the 10.00% ratio that Federal regulators use as the “well capitalized” threshold under the Federal prompt corrective action regulations. This is the current criteria which the FDIC uses in determining the lowest insurance rate for deposit insurance. The Bank’s risk-based capital ratio is more than double the 8.00% minimum threshold, which determines whether a company is “adequately capitalized”. Under these rules, the Bank could significantly increase its assets and still comply with these capital requirements without the necessity of increasing its equity capital.

Non-GAAP Financial Measures

Core Earnings Calculation

Certain financial measures for the three and six months ended June 30, 2011 reported herein exclude the effect of the reversal of a contingent liability recorded in connection with the 2009 acquisition of Old Forge Bank. Management of the Company believes that investors’ understanding of the Company’s performance is enhanced by disclosing these non-GAAP financial measures as a reasonable basis for comparison of the Company’s ongoing results of operations. These non-GAAP measures should not be considered a substitute for GAAP-basis measures and results. Our non-GAAP measures may not be comparable to non-GAAP measures of other companies.

The following tables present the reconciliation of these non-GAAP financial measures to reported GAAP financial measures:


	Three Months Ended
	June 30,
	2012			2011*			Change
Unadjusted (GAAP)
Net interest income after provision for loan and lease losses	$	7,955		$	7,128		$	827
Non-interest income		2,626			3,055			(429	)
Non-interest expense		(7,261	)		(6,936	)		(325	)
Income tax (provision) benefit		(721	)		(685	)		(36	)

Net income		2,599			2,562			37

Adjustments
Non-interest income
Reversal of a contingent liability recorded in the Merger		—			—			—

Total adjustments pre-tax		—			—			—
Income tax provision (benefit)		—			—			—

After tax adjustments to GAAP		—			—			—

Adjusted “net income from core operations”	$	2,599		$	2,562		$	37

Adjusted Return on Average Assets		1.13	%		1.11	%
Adjusted Return on Average Equity		8.01	%		8.33	%
Adjusted Dividend Payout Ratio		53.16	%		53.85	%

*	as restated see Note 18

Return on average equity (ROE) and return on average assets (ROA) for the three months ended June 30, 2012 was 8.01% and 1.13%, respectively. ROE was 8.33% and ROA was 1.11% for the same period last year. The dividend payout ratio was 53.16% for the three months ended June 30, 2012 and 53.85% for the same period last year.


	Six Months Ended
	June 30,
	2012			2011*			Change
Unadjusted (GAAP)
Net interest income after provision for loan and lease losses	$	15,941		$	14,902		$	1,039
Non-interest income		5,529			6,359			(830	)
Non-interest expense		(14,601	)		(14,451	)		(150	)
Income tax (provision) benefit		(1,540	)		(1,522	)		(18	)

Net income		5,329			5,288			41

Adjustments
Non-interest income
Reversal of a contingent liability recorded in the Merger					(500	)		500

Total adjustments pre-tax		—			(500	)		500
Income tax provision (benefit)		—			170			(170	)

After tax adjustments to GAAP		—			(330	)		330

Adjusted “net income from core operations”	$	5,329		$	4,958		$	371

Adjusted Return on Average Assets		1.15	%		1.08	%
Adjusted Return on Average Equity		8.24	%		8.09	%
Adjusted Dividend Payout Ratio		51.53	%		55.63	%

*	as restated see Note 18

Return on average equity (ROE) and return on average assets (ROA) for the six months ended June 30, 2012 was 8.24% and 1.15%, respectively. ROE was 8.63% (8.09% excluding the reversal of a contingent liability) and ROA was 1.15% (1.08% excluding the reversal of a contingent liability) for the same period last year. The dividend payout ratio was 51.53% for the six months ended June 30, 2012 and 52.17% (55.63% excluding the reversal of a contingent liability) for the same period last year.

Allowance for Loan and Lease Losses and Credit Fair Value Adjustment

Management believes that the following information, as to the Company’s evaluation of probable credit losses and its effect on results of operations and financial condition, is useful to investors. The Company has provided for anticipated loan losses through the allowance for loan and lease losses and a credit fair value adjustment on loans acquired, as shown below:


	June 30,			December 31,			June 30,
	2012			2011			2011
Loans, net of unearned income	$	638,970		$	631,522		$	618,804
Credit fair value adjustment on purchased loans		1,797			2,343			2,928

Total adjusted loans	$	640,767		$	633,865		$	621,732


	June 30,			December 31,			June 30,
	2012			2011			2011
Allowance for loan and lease losses	$	6,938		$	6,711		$	6,711
Credit fair value adjustment on purchased loans		1,797			2,343			2,928

Total adjusted allowance	$	8,735		$	9,054		$	9,639

Total adjusted allowance to adjusted loans		1.36	%		1.43	%		1.55	%

Item 3. Quantitative and Qualitative Disclosure About Market Risk

The Company currently does not enter into derivative financial instruments, which include futures, forwards, interest rate swaps, option contracts and other financial instruments with similar characteristics. However, the Company is party to traditional financial instruments with off-balance sheet risk in the normal course of business to meet the financing needs of its customers. These financial instruments include commitments to extend credit, financial guarantees and letters of credit. These traditional instruments involve to varying degrees, elements of credit and interest rate risk in excess of the amount recognized in the Consolidated Balance Sheets.

Commitments to extend credit are agreements to lend to a customer as long as there is no violation of any condition established in the contract. Commitments generally have fixed expiration dates or other termination clauses and may require payment of a fee. Standby letters of credit are conditional commitments issued to guarantee the performance of a customer to a third party up to a stipulated amount and with specified terms and conditions.

Commitments to extend credit and standby letters of credit are not recorded as an asset or liability by the Company until the instrument is exercised.

The Company’s exposure to market risk is reviewed on a regular basis by the Company’s board of directors. Interest rate risk is the potential of economic losses due to future interest rate changes. These economic losses can be reflected as a loss of future net interest income and/or a loss of current fair market values. The objective is to measure the effect on net interest income and to adjust the balance sheet to minimize the inherent risk while at the same time maximizing income. Management realizes certain risks are inherent and that the goal is to identify and minimize the risks. Tools used by management include the standard GAP report and an interest rate shock simulation report. The Company has no market risk sensitive instruments held for trading purposes. Management believes the Company’s market risk is reasonable at this time.

For a discussion of the Company’s asset and liability management policies, as well as the potential impact of interest rate changes upon the market value of the Company’s financial instruments, see Item 7A in the Company’s Annual Report on Form 10-K for the year ended December 31, 2011. Management, as part of its regular practices, performs periodic reviews of the impact of interest rate changes upon net interest income and market value of the Company’s portfolio equity. Based on, among other factors, such reviews, management believes that there have been no material changes in the market risk of the Company’s asset and liability position since December 31, 2011.

Item 4. Controls and Procedures

Under the supervision and with the participation of the Company’s management, including our Chief Executive Officer (our principal executive officer) and Finance Division Head (our principal financial officer), we conducted an evaluation of our disclosure controls and procedures, as such term is defined under Rule 13a-15(e) under the Securities Exchange Act of 1934. Based upon this evaluation, the Company’s Chief Executive Officer and the Company’s Finance Division Head concluded that our disclosure controls and procedures were effective as of the end of the period covered by this quarterly report.

No changes in our internal control over financial reporting occurred during the quarter ended June 30, 2012 that materially affected, or are reasonably likely to materially affect, our internal control over financial reporting. Subsequent to June 30, 2012, the Company instituted a dual control verification process as to data submitted to its actuary.

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, 2011, which was filed with the Securities and Exchange Commission (SEC) on March 14, 2012. 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

None.

Item 3 — Defaults Up on Senior Securities

None.

Item 4 — Mine Safety Disclosures

None.

Item 5 — Other Information

None.

Item 6 — Ex hibits



10.1 ^*		Employment Agreement by and among Penn Security Bank and Trust Company, Penseco Financial Services Corporation, and Thomas P. Tulaney

10.2 ^*		Supplemental Executive Retirement Plan Agreement by and among Penn Security Bank and Trust Company, Penseco Financial Services Corporation, and Thomas P. Tulaney

31.1		Rule 13a-14(a) / 15-d-4(a) Certifications of the Principal Executive Officer

31.2		Rule 13a-14(a) / 15-d-4(a) Certifications of the Principal Financial Officer

32		Section 1350 Certifications

101.INS		XBRL Instance Document

101.SCH		XBRL Taxonomy Extension Schema

101.CAL		XBRL Taxonomy Extension Calculation Linkbase

101.DEF		XBRL Taxonomy Extension Definition Linkbase

101.LAB		XBRL Taxonomy Extension Label Linkbase

101.PRE		XBRL Taxonomy Extension Presentation Linkbase

*	Denotes a management contract or compensatory plan, contract or arrangement.

SIGNA TURES

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.


PENSECO FINANCIAL SERVICES CORPORATION

By		/s/ CRAIG W. BEST
		Craig W. Best President and CEO (Principal Executive Officer)

Dated: August 9, 2012

By		/s/ PATRICK SCANLON
		Patrick Scanlon Senior Vice President, Finance Division Head (Principal Financial Officer)

Dated: August 9, 2012

Exhibit Index



10.1 ^*		Employment Agreement by and among Penn Security Bank and Trust Company, Penseco Financial Services Corporation, and Thomas P. Tulaney

10.2 ^*		Supplemental Executive Retirement Plan Agreement by and among Penn Security Bank and Trust Company, Penseco Financial Services Corporation, and Thomas P. Tulaney

31.1		Rule 13a-14(a) / 15-d-4(a) Certifications of the Principal Executive Officer

31.2		Rule 13a-14(a) / 15-d-4(a) Certifications of the Principal Financial Officer

32		Section 1350 Certifications

101.INS		XBRL Instance Document

101.SCH		XBRL Taxonomy Extension Schema

101.CAL		XBRL Taxonomy Extension Calculation Linkbase

101.DEF		XBRL Taxonomy Extension Definition Linkbase

101.LAB		XBRL Taxonomy Extension Label Linkbase

101.PRE		XBRL Taxonomy Extension Presentation Linkbase

*	Denotes a management contract or compensatory plan, contract or arrangement.

Exhibit 10.1

EMPLOYMENT AGREEMENT

THIS EMPLOYMENT AGREEMENT (the “ Agreement ”), dated as of May 30, 2012, is made and entered into by and among Penn Security Bank and Trust Company, a Pennsylvania state chartered bank and trust company (the “ Bank ”), Penseco Financial Services Corporation, a Pennsylvania corporation (the “ Parent ”), and Thomas P. Tulaney (the “ Executive ”).

ARTICLE I

RECITALS

WHEREAS , the Executive is currently employed by the Bank, and is qualified by education and experience to serve as the Bank’s Executive Vice President and Chief Lending Officer; and

WHEREAS , the Bank desires to reaffirm and continue the Executive’s employment as Executive Vice President and Chief Lending Officer, pursuant to the terms and conditions set forth in this Agreement; and

WHEREAS , the Executive desires to be so employed by the Bank.

NOW, THEREFORE , in consideration of the foregoing and the mutual covenants and promises contained herein and other good and valuable consideration, the receipt and sufficiency of which are hereby acknowledged, and intending to be legally bound hereby, the parties agree as follows:

ARTICLE II

DEFINITIONS

Section 2.1. “Accrued Obligations” means, as of the Date of Termination, to the extent not theretofore paid, the sum of (i) Executive’s Base Salary through the Date of Termination, (ii) the amount of any bonus or other incentive compensation for any completed bonus period and other vested cash compensation earned by Executive as of the Date of Termination under the terms of any compensation, benefit plans, and deferred compensation plans, policies or arrangements maintained in force by the Company, and (iii) any vacation pay, expense reimbursements and other cash entitlements accrued by the Executive, in accordance with Company policy as of the Date of Termination.

Section 2.2. “Bank Board” means the board of directors of the Bank.

Section 2.3. “Cause” means: (i) conviction of, or the entry of a plea of guilty or no contest to a felony or any other crime of moral turpitude that causes the Bank or any of its subsidiaries or affiliates public disgrace or disrepute, or adversely affects the Bank’s operations, financial performance, or relationship with its customers; (ii) fraud, embezzlement or other misappropriation of funds; (iii) habitual insobriety or illegal use of controlled drugs; (iv) material breach of this Agreement, if not cured within (30) days following Executive’s receipt from the Bank of written notice thereof specifying in reasonable detail the alleged breach; or (v) refusal to perform the lawful and reasonable directives of the Chief Executive Officer of the Bank or the Bank Board, unless such refusal is cured within (30) days following Executive’s receipt from the Bank of written notice thereof, specifying the directives Executive allegedly refused to perform.

Section 2.4. “Change in Control” means the occurrence of any one of the following events: (i) any “person” or “group” (as such terms are used in Sections 13(d) and 14(d)(2) of the Securities Exchange Act of 1934, as amended (the “ Exchange Act ”)), other than any Company employee stock ownership plan or an equivalent retirement plan, becomes the beneficial owner (as such term is used in Section 13(d) of the Exchange Act), directly or indirectly, of securities of Parent representing 50% or more of the combined voting power of Parent’s then outstanding voting securities, (ii) the Parent Board ceases to consist of a majority of Continuing Directors (as defined below), (iii) the consummation of a sale of all or substantially all of the Company’s assets (as measured by the fair value of the assets being sold compared to the fair value of all of the Company’s assets), or (iv) a merger or other combination occurs such that a majority of the equity securities of the resultant entity after the merger or other combination are not owned by those who owned a majority of the equity securities of the Parent prior to the merger or other combination. A “ Continuing Director ” shall mean a member of the Parent Board who either (i) is a member of the Parent Board as of the date of this Agreement or (ii) is nominated or appointed to serve as a member of the Parent Board by a majority of the then Continuing Directors.

Section 2.5. “Change in Control Termination” means the termination of Executive’s employment under this Agreement by the Bank or its successor or assignee without Cause or by Executive for Good Reason, which occurs within 24 months following a Change in Control.

Section 2.6. “COBRA” means the Consolidated Omnibus Budget Reconciliation Act of 1986, as amended.

Section 2.7. “Code” means the Internal Revenue Code of 1986, as amended.

Section 2.8. “Company” means the Parent and its direct and indirect subsidiaries, including, without limitation, the Bank.

Section 2.9. “Date of Termination” has the meaning given to that term in Section 3.6 .

Section 2.10. “Disability” means a condition entitling Executive to benefits under the long term disability plan, policy or arrangement maintained for employees of the Bank. Termination as a result of a Disability will not be construed as a termination by the Bank “without Cause.”

Section 2.11. “Good Reason” means any of the following, without Executive’s prior consent: (i) a material, adverse change in authority, duties or reporting relationships (including the assignment of duties materially inconsistent with the Executive’s position); (ii) a material reduction in Base Salary (except in connection with an across-the-board salary reduction applicable to all of the Bank’s management employees, as described in Section 3.4(a) ) or annual or long term bonus or incentive compensation opportunities described in Article III or employee benefits; (iii) any other material breach of this Agreement by the Bank or the Parent, excluding

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inadvertent action which is remedied by the Bank or the Parent, as applicable, within ten (10) days after its receipt of written notice thereof from the Executive specifying in reasonable detail the alleged breach; or (iv) executive being required to relocate to a principal place of employment more than 50 miles from Scranton, Pennsylvania; provided, that no event or condition described in clauses (i) through (iv) of this Section 2.11 will constitute Good Reason unless: (a) the Executive provides the Bank with written objection to the event or condition within 60 days of the first occurrence of such event or condition, (b) the Bank does not reverse or otherwise cure the event or condition within 30 days of receiving that written objection (the “ Cure Period ”) or the Bank notifies the Executive in writing that it does not intend to cure the event or condition, and (c) the Executive resigns his employment within 30 days following the expiration of that Cure Period. For purposes of this Section 2.11 , the Cure Period shall end on the earlier of the date the Bank notifies Executive in writing that it does not intend to cure the event or condition referenced in the Executive’s written objection, or the 30 ^th day following the Bank’s receipt of such written objection.

Section 2.12. “Parent Board” means the board of directors of Parent.

Section 2.13. “Restricted Period” means the period commencing on the Date of Termination and ending either (i) on date that is 24 months after the Date of Termination, in the event of a Change in Control Termination, or (ii) on date that is 12 months after the Date of Termination, in any other event.

ARTICLE III

EMPLOYMENT AND COMPENSATION

Section 3.1. Employment Term.

(a) The Bank shall continue to employ Executive, and Executive hereby accepts continued employment with the Bank, upon the terms and conditions set forth in this Agreement, effective May 30, 2012 (the “ Effective Date ”) and continuing through May 29, 2016 (the “ Initial Term ”) and thereafter for successive one year periods (each, a “ Renewal Term ”), unless sooner terminated in accordance with this Agreement or written notice is given by one party to the other at least thirty (30) days prior to the expiration of the Initial Term or any Renewal Term, as applicable. The Initial Term and any Renewal Term are herein collectively referred to as the “ Term .”

(b) If Executive dies while employed by the Bank, this Agreement and Executive’s employment by the Bank shall automatically terminate on the date of Executive’s death. The Bank may terminate Executive’s employment and all other positions with the Company upon written notice to Executive at any time (i) due to the Disability of Executive, (ii) for Cause, or (iii) without Cause, for any or no reason. Executive may terminate his employment with the Bank and all other positions with the Company at any time (i) for Good Reason, or (ii) without Good Reason, for any or no reason. Notwithstanding the generality of the preceding sentence, in the event that Executive resigns from his employment pursuant to this Section 3.1(b) without Good Reason, for any or no reason, Executive shall give thirty (30) days written notice to the Bank prior to the proposed effective date of such resignation, and such resignation shall not be effective until the expiration of such notice period, unless such notice is waived by the Bank (in which case such resignation shall be effective as of the date of or indicated in such waiver).

-3-

Section 3.2. Positions and Duties . Executive will serve as Executive Vice President and Chief Lending Officer (“ CLO ”) of the Bank, reporting directly to the Chief Executive Officer (“ CEO ”) of the Bank and will have all duties customarily associated with the position of a CLO, any duties as are set forth in the Bank’s bylaws for such position and all duties as are delegated to Executive from time to time by the CEO or the Bank Board. Executive shall devote his best efforts and substantially all of his business time and services to the Company.

Section 3.3. Other Activities . Executive may be involved in various leadership and non-leadership capacities on a volunteer basis for not-for-profit organizations as a representative of the Company. In addition, nothing contained herein shall preclude the Executive from (i) engaging in charitable and community activities; (ii) participating in industry and trade organization activities; (iii) managing his and his family’s personal investments and affairs; and (iv) delivering lectures, fulfilling speaking engagements or teaching at educational institutions; provided that such activities do not interfere with the regular performance of his duties and responsibilities under this Agreement and do not violate his obligations under Article IV of this Agreement, and provided further that except as disclosed to the Bank prior to the date hereof or with consent of the Bank Board, the Executive shall not serve as a paid director of any organization.

Section 3.4. Compensation . The Bank shall pay or cause to be paid or provided to Executive the following compensation and benefits:

(a) Base Salary . Effective as of the Effective Date, the Executive will receive an initial base salary of $210,000 per annum, paid in accordance with the Bank’s payroll practices. The base salary shall be reviewed on an annual basis by the Compensation and Benefits Committee of the Parent Board (the “ Compensation Committee ”) and may be increased (but not decreased, except in connection with an across-the-board salary reduction applicable to all of the Bank’s management employees) from time to time at the discretion of the Compensation Committee. The initial base salary or such later base salary is hereinafter referred to as Executive’s “ Base Salary .”

(b) Annual Bonus .

(i) For each fiscal year ending during the Term, beginning with the 2012 fiscal year, the Executive will be eligible to earn a cash incentive payment. The target amount of that cash incentive payment will be thirty percent (30%) of the Executive’s Base Salary at the commencement of the applicable fiscal year (the “ Target Bonus ”). The actual cash incentive payment payable with respect to a particular fiscal year (the “ Annual Bonus ”) will be determined by the Compensation Committee based upon the degree of achievement of corporate and/or individual performance objectives established by the Compensation Committee in its sole discretion. The foregoing notwithstanding, with respect to the 2012 fiscal year, the Executive’s Annual Bonus will be no less than $40,000.

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(ii) For purposes of determining any Annual Bonus payable to Executive, the measurement of corporate and individual performance will be performed by the Compensation Committee in good faith. From time to time, the Compensation Committee may, in its sole discretion, make adjustments to corporate or individual performance goals, so that required departures from the Company’s operating budget, changes in accounting principles, acquisitions, dispositions, mergers, consolidations and other corporate transactions, and other factors influencing the achievement or calculation of such goals do not affect the operation of this Section 3.4(b) in a manner inconsistent with its intended purposes.

(iii) Any Annual Bonus payable under this Section 3.4(b) will be paid in the year following the applicable fiscal year in which such bonus is attributable within thirty (30) days following the recommendation of the audit committee of the Parent Board to include the audited financial statements for the applicable fiscal year in Parent’s annual report on Form 10-K, provided that the Executive has not been terminated for Cause before such payment date (the “ Bonus Payment Date ”). No Annual Bonus shall be paid to the Executive if he has been terminated for Cause before any such Annual Bonus would otherwise be paid.

(c) Deferred Compensation Plan . The Executive will be eligible to participate in the supplemental retirement plan substantially in the form attached hereto as Exhibit A .

(d) General Employee Benefits . The Executive will be eligible to participate in the employee benefit plans, policies or arrangements maintained by the Company for employees of the Bank generally, subject to the terms and conditions of such plans, policies or arrangements; provided, however, that this Agreement will not limit the Company’s ability to amend, modify or terminate such plans, policies or arrangements at any time for any reason.

(e) Vacation . In addition to holidays observed by the Bank, Executive shall be entitled to at least 20 working days paid vacation time during each year of employment without reduction in salary or other benefits. Vacation days that remain unused at the end of any year will accrue or expire to the extent provided by the Bank’s vacation policy, as in effect from time to time.

(f) Long-Term Equity Incentives .

(i) Restricted Stock Award . As soon as practicable following the date of this Agreement, subject to the final approval of the Compensation Committee and the terms and conditions of the Penseco Financial Services Corporation 2008 Long Term Incentive Plan (the “ Equity Incentive Plan ”), the Executive will receive an Award (as defined in the Equity Incentive Plan) of that number of shares of Restricted Stock (as defined in the Equity Incentive Plan) equal to the quotient of $300,000 divided by the Fair Market Value (as defined in the Equity Incentive Plan) on the date of grant, rounded down to the nearest whole share (the “ Restricted Stock Award ”). Such Restricted Stock Award shall be granted pursuant to and governed by the terms of (i) the Equity Incentive Plan and (ii) an award agreement to be provided to the Executive at the time of grant in the form, consistent with the Equity Incentive Plan, specified by the Compensation Committee.

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(ii) Annual Performance Based Awards . With respect to the Company’s 2012 fiscal year and each fiscal year thereafter, Executive shall be eligible to receive an Award of Restricted Stock (as such terms are defined in the Equity Incentive Plan) (each, a “ LTI Award ”), with a target value equal to 50% of the Executive’s Base Salary at the commencement of the applicable fiscal year. The actual amount of the LTI Award payable to Executive shall be determined by the Compensation Committee, and shall be based upon the degree of achievement of corporate and/or individual performance objectives established by the Compensation Committee in its sole discretion. The foregoing notwithstanding, the aggregate Fair Market Value (as defined in the Equity Incentive Plan) on the date of grant of the LTI Award with respect to the 2012 fiscal year will be no less than $50,000. Each LTI Award shall be granted on or around each Bonus Payment Date (as defined above). The LTI Awards shall be granted pursuant to and governed by the terms of (i) the Equity Incentive Plan or similar future plan and (ii) an award agreement to be provided to the Executive at the time of grant in the form, consistent with the Equity Incentive Plan (or future plan), specified by the Compensation Committee.

Section 3.5. Reimbursement of Expenses . Executive will be reimbursed by the Bank for all reasonable business expenses incurred by him in accordance with the Bank’s customary expense reimbursement policies as in effect from time to time.

Section 3.6. Severance; Severance Payments . Upon a termination of his employment with the Bank (the effective date of such termination is herein referred to as the “ Date of Termination ”), Executive will be entitled only to such compensation, benefits and rights as described in this Section 3.6 and in any other agreement between Executive and the Bank.

(a) Termination without Cause or for Good Reason . Except as otherwise provided in this Section 3.6 , if Executive’s employment by the Bank is terminated by the Bank without Cause or if Executive terminates his employment for Good Reason, Executive will be entitled to:

(i) Payment of all Accrued Obligations, including but not limited to those earned by Executive under Sections 3.4 and 3.5 above;

(ii) Cash severance payments equal to the sum of (A) one-twelfth of Executive’s Base Salary as of the Date of such Termination plus (B) one-twelfth of Executive’s average Annual Bonus in the three fiscal years ending before the Date of Termination (or, if Executive has not been eligible for an Annual Bonus for three fiscal years, his average Annual Bonus for each fiscal year for which he was eligible to receive an Annual Bonus) (collectively, the “ Monthly Severance Payment ”) for a period of 12 months from and after the Date of Termination, payable in accordance with the Bank’s payroll practices; and

(iii) For a period of 18 months from and after the Date of Termination, Executive will receive monthly payments equal to the monthly “applicable premium,” as that term is defined under COBRA.

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(b) Change in Control Termination . In lieu of any compensation and benefits payable under Section 3.6(a) , in the event that Executive’s employment by the Bank ceases due to a Change in Control Termination, Executive will be entitled to:

(i) Payment of all Accrued Obligations, including but not limited to those earned by Executive under Sections 3.4 and 3.5 above;

(ii) Cash severance payments equal to the Monthly Severance Payment (as determined under Section 3.6(a)(ii) above) for a period of 24 months from and after the Date of Termination, payable in accordance with the Bank’s payroll practices;

(iii) Monthly payments equal to the monthly “applicable premium,” as that term is defined under COBRA, for a period of 24 months from and after the Date of Termination; and

(iv) Executive’s rights under other benefit plans, policies and arrangements maintained for the employees of the Bank generally shall vest or become exercisable, as applicable, to the extent of, and in accordance with the provisions of such benefit plans, policies and arrangements.

(c) Termination Following Expiration of a Term . In the event of a termination by the Bank of Executive’s employment following the expiration of any Initial Term or Renewal Term due to the Bank’s decision not to renew the applicable Term, the Bank shall pay or provide to Executive the amounts, benefits and rights described in Section 3.6(a) .

(d) Except as provided in this Section 3.6 , all compensation and participation in all benefit plans, policies and arrangements will cease at the Date of Termination, subject to the terms of any benefit plans, policies and arrangements then in force and applicable to Executive, and the Company shall have no further liability or obligation by reason of such termination, provided, however , that nothing in this paragraph shall affect or be deemed to affect Executive’s rights to accrued or vested benefits under any benefit plan, policy or arrangement. The payments and benefits described in this Section 3.6 are in lieu of, and not in addition to, any other severance arrangement maintained for the employees of the Bank generally.

Notwithstanding any provision of this Agreement, the payments and benefits described in this Section 3.6 are conditioned on: (a) the Executive’s execution and delivery to the Bank and the expiration of all applicable statutory revocation periods, by the 60th day following the Date of Termination, of a general release of claims against the Company in a form reasonably prescribed by the Bank (the “ Release ”); and (b) the Executive’s continued compliance with the provisions of Article IV of this Agreement. Subject to Section 3.6(f) , below, the benefits described in this Section 3.6 will be paid or provided (or begin to be paid or provided as applicable) as soon as administratively practicable after the Release becomes irrevocable, provided that if the 60-day period described above begins in one taxable year and ends in a second taxable year such payments or benefits shall not commence until the second taxable year. Any payments to be made to Executive and any benefits to be provided to Executive pursuant to this Section 3.6 shall be paid or provided, as applicable, to Executive’s beneficiaries, heirs or estate in the event of Executive’s death.

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(e) Other Terminations . If Executive’s employment with the Bank ceases for any reason other than as described in Sections 3.6(a) , 3.6(b) and 3.6(c) above (including but not limited to termination (a) by the Bank for Cause, (b) as a result of Executive’s death, (c) as a result of Executive’s Disability, or (d) by Executive without Good Reason), then the Bank’s obligation to Executive will be limited solely to the payment of Accrued Obligations. All compensation and participation in benefits will cease at the time of such termination and, except as otherwise provided by COBRA or the terms of such plans, the Company will have no further liability or obligation by reason of such termination. The foregoing will not be construed to limit Executive’s right to payment or reimbursement for claims incurred prior to the Date of Termination under any insurance contract funding an employee benefit plan, policy or arrangement of the Company in accordance with the terms of such insurance contract or Executive’s right to accrued or vested benefits under the terms of any employee benefit plan, policy or arrangement.

(f) Application of Section 409A of the Code .

(i) Notwithstanding anything to the contrary in this Agreement, no portion of the benefits or payments to be made under Section 3.6 hereof will be payable until the Executive has a “separation from service” from the Company within the meaning of Section 409A of the Code. In addition, to the extent compliance with the requirements of Treas. Reg. § 1.409A-3(i)(2) (or any successor provision) is necessary to avoid the application of an additional tax under Section 409A of the Code to payments due to the Executive upon or following his “separation from service,” then notwithstanding any other provision of this Agreement (or any applicable plan, policy, program, agreement or arrangement), any such payments that are otherwise due within six months following the Executive’s “separation from service” (taking into account the preceding sentence of this paragraph) will be deferred without interest and paid to the Executive in a lump sum immediately following that six month period. This paragraph should not be construed to prevent the application of Treas. Reg. § 1.409A-1(b)(9)(iii) (or any successor provision) to amounts payable hereunder. For purposes of the application of Section 409A of the Code, each payment in a series of payments will be deemed a separate payment.

(ii) Any reimbursements and in-kind benefits provided under this Agreement shall be made or provided in accordance with the requirements of Section 409A of the Code, including, where applicable, the requirement that (i) any reimbursement shall be for expenses incurred during the period of time specified in this Agreement, (ii) the amount of expenses eligible for reimbursement, or in-kind benefits provided, during a calendar year may not affect the expenses eligible for reimbursement, or in-kind benefits to be provided, in any other calendar year, (iii) the reimbursement of an eligible expense will be made on or before the last day of the calendar year following the year in which the expense is incurred, and (iv) the right to reimbursement or in-kind benefits is not subject to liquidation or exchange for another benefit.

(g) Limitation on Payments . If any payment or benefit due under this Agreement, together with all other payments and benefits that Executive receives or is entitled to receive from the Bank, the Parent or any of their subsidiaries, affiliates or related entities, would (if paid or provided) constitute an Excess Parachute Payment (as defined below), the amounts

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otherwise payable and benefits otherwise due under this Agreement will be limited to the minimum extent necessary to ensure that no portion thereof will fail to be tax-deductible to the Company by reason of Section 280G of the Code. The determination of whether any payment or benefit would (if paid or provided) constitute an Excess Parachute Payment will be made by the Parent Board, in its good faith discretion. If a reduction to Executive’s payments and benefits is required pursuant to this Section 3.6(g) , such reduction shall occur to the payments and benefits in the order that results in the greatest economic present value of all payments actually made to Executive.

(h) Adjustments Necessary to Comply with Maximum Payment Limit . If, notwithstanding the initial application of Section 3.6(g) , the Internal Revenue Service determines that any amount paid or benefit provided to Executive would constitute an Excess Parachute Payment, Section 3.6(g) will be reapplied based on the Internal Revenue Service’s determination and Executive will be required to repay to the Bank any Overpayment (as defined below) immediately upon receipt of written notice of the applicability of this section.

(i) Recoupment of Certain Incentive-Based Compensation .

(i) Breach of Restrictive Covenants . If the Executive breaches, in any respect, any of the covenants to be performed by the Executive pursuant to Article IV below (regarding non-competition, non-solicitation, confidentiality, or non-disparagement), whether during the Term or the Restricted Period, then the Executive shall repay or return to the Bank the entire amount of any incentive-based compensation received by the Executive during the 12 month period preceding such breach.

(ii) Obligations Not Exclusive . The rights of the Bank and the obligations of the Executive set forth in this Section 3.6(i) are in addition to any other rights and obligations under applicable laws and regulations, the terms and conditions of any plan and award agreement pursuant to which incentive-based compensation is award to the Executive, and the terms and conditions of any claw back, recoupment or similar policy applicable to the executive officers of the Bank, which the Bank or the Company may adopt and maintain from time to time.

(j) Definitions . For purposes of this Agreement:

(i) “ Excess Parachute Payment ” has the same meaning as used in Section 280G(b)(1) of the Code.

(ii) “ Overpayment ” means any amount paid to Executive in excess of the maximum payment limit of Section 3.6(g) of this Agreement.

ARTICLE IV

RESTRICTIVE COVENANTS AND REMEDIES

Section 4.1. Confidential Information . In consideration of the employment by the Bank of Executive and the consideration outlined in Article III of this Agreement, and as an inducement to the Company to continue to entrust Executive with its Trade Secrets (as hereinafter defined), Executive agrees that Executive will not use for himself or disclose to any

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person any Trade Secret of the Company obtained by Executive as a result of his employment by the Bank unless authorized in writing by the Bank to do so. For purposes of this Agreement, “ Trade Secrets ” means any trade secrets and is deemed to include, but not be limited to, all confidential information, including price lists, patents, designs, inventions, copyrighted materials, product lists, marketing strategies, personnel files, customer lists, and all other information or material received by Executive in connection with his employment by the Bank which is not otherwise available to the general public; provided, that the term Trade Secrets shall exclude (i) information that is or subsequently becomes publicly available other than as a result of Executive’s breach of this Agreement; (ii) is acquired from another source not under a duty of confidentiality to the Company and not as a result of a breach of this Agreement; (iii) is independently developed by Executive without use of the Trade Secrets; (iv) is approved for public release by the Company; or (v) is required to be disclosed by court order, subpoena, in connection with a civil or criminal investigative demand, the discovery rules of any court or otherwise by law or legal process. Upon cessation of Executive’s service to the Bank for any reason, all written or electronic materials evidencing Trade Secrets, and all copies thereof, in the possession or control of Executive shall be delivered to the Bank.

Section 4.2. Ownership of Inventions and Ideas . Executive acknowledges that the Bank shall be the sole owner of all the results and proceeds of his service to the Company, including but not limited to, all patents, patent applications, patent rights, formulas, copyrights, inventions, developments, discoveries, other improvements, data, documentation, drawings, charts, and other written, audio and/or visual materials relating to equipment, methods, products, processes or programs in connection with or useful to the business of the Company (collectively, the “ Developments ”) which Executive, by himself or in conjunction with any other person, may conceive, make, acquire, acquire knowledge of, develop or create during Executive’s employment by the Bank, free and clear of any claims by Executive (or any successor or assignee of Executive) of any kind or character whatsoever. Executive acknowledges that all copyrightable Developments shall be considered works made for hire under the Federal Copyright Act. Executive hereby assigns and transfers his right, title and interest in and to all such Developments and agrees that he shall, at the request of the Bank, execute or cooperate with the Company in any patent applications, execute such assignments, certificates or other instruments, and do any and all other acts, as the Bank from time to time reasonably deems necessary or desirable to evidence, establish, maintain, perfect, protect, enforce or defend the Company’s right, title and interest in or to any such Developments.

Section 4.3. Restrictive Covenants . In consideration of the employment by the Bank of Executive and the consideration outlined in Article III of this Agreement, Executive agrees to be bound by this Section 4.3 . Executive will not, directly or indirectly, do any of the following during the Term and the Restricted Period:

(a) engage or participate in any business activity substantially similar to an activity from which the Company derives revenue (or, with respect to the application of this provision during the Restricted Period, engage or participate in any such business activity within 50 miles of Scranton, Pennsylvania) (a “ Competing Business ”);

(b) become interested in (as owner, stockholder, lender, partner, co-venturer, director, officer, employee, agent or consultant) any person, firm, corporation,

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association or other entity engaged in any Competing Business. Notwithstanding the foregoing, Executive may hold up to 4.9% of the outstanding securities of any class of any publicly traded securities of any company;

(c) solicit or call on, either directly or indirectly, for purposes of selling goods or services competitive with goods or services sold by the Company, any customer with whom the Company shall have dealt or any prospective customer that the Company has identified and solicited at any time during Executive’s employment by the Bank;

(d) adversely influence or attempt to adversely influence any supplier, customer or potential customer of the Company to terminate or modify any written or oral agreement or course of dealing with the Company;

(e) adversely influence or attempt to adversely influence any person to terminate or modify any employment, consulting, agency, distributorship or other arrangement with the Company; or

(f) employ or retain, or arrange to have any other person or entity employ or retain, any employee, consultant, agent or distributor of the Company (or with respect to the application of this provision during the Restricted Period, any person or entity who, within the 12 months preceding the Date of Termination, was employed or engaged by the Company as an employee, consultant, agent or distributor).

Executive acknowledges that the restrictions contained in Sections 4.1 , 4.2 and 4.3 are reasonable and necessary to protect the legitimate interests of the Bank and the Parent and that the duration of the Restricted Period, and the provisions of Sections 4.1 , 4.2 and 4.3 , are reasonable given Executive’s position within the Bank and the substantial consideration payable under this Agreement. Executive further acknowledges that Sections 4.1 , 4.2 and 4.3 are included herein in order to induce the Bank and the Parent to enter into this Agreement and that the Bank and the Parent would not have entered into this Agreement in the absence of these provisions.

Section 4.4. Enforcement .

(a) Specific Enforcement . Executive acknowledges that any material breach by him, willfully or otherwise, of this Article IV will cause continuing and irreparable injury to the Bank and the Parent for which monetary damages would not be an adequate remedy. Executive will not, in any action or proceeding to enforce any of the provisions of this Agreement, assert the claim or defense that such an adequate remedy at law exists. In the event of any such material breach by Executive, the Bank and/or the Parent will have the right to enforce this Agreement by seeking injunctive or other relief in any court and this Agreement will not in any way limit remedies of law or in equity otherwise available to the Bank and the Parent.

(b) Restitution . If Executive materially breaches any part of Section 4.1 , 4.2 or 4.3 , the Bank and the Parent will have the right and remedy to require Executive to account for and pay over to the Bank and the Parent all compensation, profits, monies, accruals, increments or other benefits derived or received by Executive as the result of such breach. This right and remedy will be in addition to, and not in lieu of, any other rights and remedies available to the Bank and the Parent under law or in equity.

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(c) Extension of Restricted Period . If Executive breaches Section 4.1 , 4.2 or 4.3 , the Restricted Period will be extended by an amount of time equal to the period that Executive was in breach.

(d) Judicial Modification . If any court determines that Section 4.1 , 4.2 or 4.3 , or this Section 4.4 (or any part thereof) is unenforceable because of its duration or geographic scope, that court will have the power to modify that section and, in its modified form, that section will then be enforceable.

(e) Restrictions Enforceable in All Jurisdictions . If any court holds that Section 4.1 , 4.2 or 4.3 , or this Section 4.4 (or any part thereof) is unenforceable by reason of its breadth or scope or otherwise, it is the intention of the parties hereto that such determination not bar or in any way affect the right of the Bank and the Parent to the relief provided above in the courts of any other jurisdiction within the geographic scope of this section.

(f) Disclosure of Protective Provisions . Executive agrees to disclose the existence and terms of Sections 4.1 , 4.2 and 4.3 to any employer for whom Executive seeks to work during the Restricted Period. Executive also agrees that during the Restricted Period the Executive will provide and the Company may similarly provide a copy of this Section 4 to any business or enterprise (i) which Executive may directly or indirectly own, manage, operate, finance, join, control or of which he may participate in the ownership, management, operation, financing, or control, or (ii) with which Executive may be connected as an officer, director, employee, partner, principal, agent, representative, consultant or otherwise, or in connection with which Executive may use or permit to be used Executive’s name.

ARTICLE V

MISCELLANEOUS

Section 5.1. No Liability of Officers and Directors for Severance Upon Insolvency . Notwithstanding any other provision of the Agreement and intending to be bound by this provision, Executive hereby (a) waives any right to claim payment of amounts owed to him, now or in the future, pursuant to this Agreement from directors or officers of the Company if the Company becomes insolvent, except through their individual or collective acts of malfeasance or misfeasance, and (b) fully and forever releases and discharges the Company’s officers and directors from any and all claims, demands, liens, actions, suits, causes of action or judgments arising out of any present or future claim for such amounts except if such claims, demands, liens, actions, suits, causes of action or judgments are based on their individual or collective acts of malfeasance or misfeasance.

Section 5.2. Ability to Perform . Executive represents and warrants to the Company that there are no restrictions, agreements or understandings whatsoever to which he is a party that would prevent or make unlawful his execution of this Agreement, that would be inconsistent or in conflict with this Agreement or Executive’s obligations hereunder, or that would otherwise prevent, limit or impair the performance by Executive of his duties under this Agreement on and after the Effective Date.

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Section 5.3. Payments Subject to Tax Withholding . All payments and transfers of property described in this Agreement will be made net of any applicable tax withholding.

Section 5.4. Dispute Resolution . Except for disputes arising under Article IV hereof, all disputes involving the interpretation, construction, application or alleged breach of this Agreement and all disputes relating to the termination of Executive’s employment with the Bank shall be submitted to final and binding arbitration in Scranton, Pennsylvania. The arbitrator shall be selected and the arbitration shall be conducted pursuant to the then most recent Employment Dispute Resolution Rules of the American Arbitration Association in Philadelphia, Pennsylvania. The arbitrator shall have authority to rule on any dispositive motions filed by the parties. The decision of the arbitrator shall be final and binding, and any court of competent jurisdiction may enter judgment upon the award. The arbitrator shall have jurisdiction and authority to interpret and apply the provisions of this Agreement and relevant federal, state and local laws, rules and regulations insofar as necessary to the determination of the dispute and to remedy any breaches of the Agreement and/or violations of applicable laws, but shall not have jurisdiction or authority to alter in any way the provisions of this Agreement. The arbitrator shall have the authority to award attorneys’ fees and costs to the prevailing party. The parties hereby agree that this arbitration provision shall be in lieu of any requirement that either party exhaust such party’s administrative remedies under federal, state or local law.

Section 5.5. Successors and Assigns . Each of the Bank and the Parent may assign this Agreement to any affiliate or to any successor to its assets or business by means of liquidation, dissolution, merger, consolidation, sale of assets or otherwise. For avoidance of doubt, a termination of the Executive’s employment by the Bank in connection with a permitted assignment of the Bank’s rights and obligations under this Agreement is not a termination “without Cause” so long as the successor or assignee offers employment to the Executive on the terms herein specified (without regard to whether the Executive accepts employment with the successor or assignee). The duties of the Executive hereunder are personal to Executive and may not be assigned by him.

Section 5.6. Non-Disparagement . Executive agrees that he shall not in any way, orally or in writing, disparage or defame the Company or any of its board members, officers or employees to any third party or commit any libelous or slanderous act against the Company or any of its board members, officers or employees whether in the capacity as his former employer or otherwise.

Section 5.7. Severability . Whenever possible, each provision of this Agreement will be interpreted in such manner as to be effective and valid under applicable law. However, if any provision of this Agreement is held to be invalid, illegal or unenforceable in any respect, such invalidity, illegality or unenforceability will not affect any other provision, and this Agreement will be reformed, construed and enforced as though the invalid, illegal or unenforceable provision had never been herein contained.

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Section 5.8. Survival . This Agreement, including, without limitation, the recoupment provisions set forth in Section 3.6(i) and the restrictive covenants set forth in Article IV , will survive the cessation of the Executive’s employment to the extent necessary to fulfill the purposes and intent of this Agreement.

Section 5.9. Entire Agreement; Amendments . Except as otherwise provided herein, this Agreement contains the entire agreement and understanding of the parties hereto relating to the subject matter hereof. Therefore, this Agreement merges and supersedes all prior and contemporaneous discussions, agreements and understandings of every nature relating to Executive’s employment, compensation, severance, termination or any related matter. This Agreement may not be changed or modified, except by an Agreement in writing signed by the Executive, the Bank and the Parent.

Section 5.10. Notice . Any notice or communication required or permitted under this Agreement will be made in writing and (a) sent by overnight courier, (b) mailed by certified or registered mail, return receipt requested or (c) sent by telecopier, addressed as follows:

If to Executive:

Thomas P. Tulaney

103 Waverly Circle

Clark Summit, PA 18411

If to the Bank or the Parent:

Penn Security Bank and Trust Company

150 North Washington Avenue

Scranton, PA 18503

Attn: Chief Executive Officer

Section 5.11. Governing Law . This Agreement shall be governed by and construed in accordance with the laws of the Commonwealth of Pennsylvania, without regard to the principles of conflicts of laws rules of any state. Any legal proceeding arising out of or relating to this Agreement will be instituted in a state or federal court in the Commonwealth of Pennsylvania, and each of the Executive, the Bank and the Parent hereby consent to the personal and exclusive jurisdiction of such court(s) and hereby waive any objection(s) that they may have to personal jurisdiction, the laying of venue of any such proceeding and any claim or defense of inconvenient forum.

Section 5.12. Counterparts and Facsimiles . This Agreement may be executed, including execution by facsimile signature, in one or more counterparts, each of which will be deemed an original, and all of which together will be deemed to be one an

Section 5.13. Remedies . In the event of any breach of this Agreement by either party, the party injured by such breach shall be entitled to attorneys’ fees, costs and expenses incurred by reason of such breach, if any, together with interest at the maximum rate permitted by law. This paragraph shall not be considered a waiver of or a limitation on the remedies available under this Agreement or at law or in equity for breach of this Agreement.

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[ signature page follows ]

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IN WITNESS WHEREOF , the parties hereto have executed this Agreement on the date first written above.


PENN SECURITY BANK AND TRUST COMPANY

By:	/s/ Craig W. Best	05/30/12
Name:	Craig W. Best	Date
Title:	President & CEO

PENSECO FINANCIAL SERVICES CORPORATION

By:	/s/ Patrick Scanlon	05/30/12
Name:	Patrick Scanlon	Date
Title:	SVP / Controller

EXECUTIVE
/s/ Thomas P. Tulaney		05/30/12
Thomas P. Tulaney		Date

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Exhibit 10.1

EXHIBIT A

[ To be prepared by BOLI provider and attached .]


*Supplemental Executive Retirement Plan*		Plan Year Reporting
Schedule A

Thomas Tulaney

Birth Date: 5/2/1959

Plan Anniversary Date: 1/1/2013

Normal Retirement: 5/2/2024, Age 65

Normal Retirement Payment: Monthly for 20 years


						Early Voluntary Termination Annual Benefit ² Amount Payable at Separation from Service					Early Involuntary Termination Annual Benefit ² Amount Payable at Separation from Service					Disability Annual Benefit ² Amount Payable Upon Disability					Change in Control Annual Benefit ² Amount Payable at Separation from Service					Pre-retire. Death Benefit Annual ² Benefit
Values	Discount Rate	Benefit Level		Accrual Balance		Vesting			Based On Accrual		Vesting			Based On Accrual		Vesting			Based On Accrual		Vesting			Based On Benefit		Based On Benefit
as of	(1)	(2)		(3)		(4)			(5)		(6)			(7)		(8)			(9)		(10)			(11)		(12)
May 2012 ¹			114,600				0	%		0		100	%		0		100	%		0		100	%		71,345		114,600
Dec 2012			114,600		63,102		0	%		0		100	%		4,977		100	%		4,977		100	%		73,235		114,600
Dec 2013			114,600		161,779		0	%		0		100	%		12,759		100	%		12,759		100	%		76,165		114,600
Dec 2014			114,600		265,504		0	%		0		100	%		20,939		100	%		20,939		100	%		79,211		114,600
Dec 2015			114,600		374,537		0	%		0		100	%		29,538		100	%		29,538		100	%		82,380		114,600
Dec 2016			114,600		489,147		0	%		0		100	%		38,577		100	%		38,577		100	%		85,675		114,600
Dec 2017			114,600		609,622		0	%		0		100	%		48,078		100	%		48,078		100	%		89,102		114,600
Dec 2018			114,600		736,260		0	%		0		100	%		58,066		100	%		58,066		100	%		92,666		114,600
Dec 2019			114,600		869,377		0	%		0		100	%		68,564		100	%		68,564		100	%		96,373		114,600
Dec 2020			114,600		1,009,304		0	%		0		100	%		79,600		100	%		79,600		100	%		100,228		114,600
Dec 2021			114,600		1,156,391		100	%		91,200		100	%		91,200		100	%		91,200		100	%		104,237		114,600
Dec 2022			114,600		1,255,293		100	%		99,000		100	%		99,000		100	%		99,000		100	%		108,406		114,600
Dec 2023			114,600		1,354,194		100	%		106,800		100	%		106,800		100	%		106,800		100	%		112,742		114,600
May 2024			114,600		1,453,096		100	%		114,600		100	%		114,600		100	%		114,600		100	%		114,600		114,600

¹	The first line reflects just the initial values as of May 1, 2012.

²	The annual benefit amount will be distributed in 12 equal monthly payments for a total of 240 monthly payments.

Exhibit 10.2

Penn Security Bank and Trust Company

Supplemental Executive Retirement Plan Agreement

Penn Security Bank and Trust Company

Supplemental Executive Retirement Plan Agreement

This Supplemental Executive Retirement Plan Agreement (this “ Agreement ”) is adopted this 31 day of May, 2012, by and among Penn Security Bank and Trust Company, a Pennsylvania state chartered bank and trust company (the “ Bank ”), Penseco Financial Services Corporation, a Pennsylvania corporation (the “ Parent ”), and Thomas P. Tulaney (the “ Executive ”).

The purpose of this Agreement is to provide specified benefits to the Executive, a member of a select group of management or highly compensated employees who contribute materially to the continued growth, development and future business success of the Bank. This Agreement shall be unfunded for tax purposes and for purposes of Title I of the Employee Retirement Income Security Act of 1974, as amended from time to time (“ ERISA ”).

Article 1

Definitions

Whenever used in this Agreement, the following words and phrases shall have the meanings specified:

1.1	“ Beneficiary ” means each designated person or entity, or the estate of the deceased Executive, entitled to any benefits upon the death of the Executive pursuant to Article 4.

1.2	“ Beneficiary Designation Form ” means the form established from time to time by the Plan Administrator that the Executive completes, signs and returns to the Plan Administrator to designate one or more Beneficiaries.

1.3	“ Board ” means the Board of Directors of the Parent as from time to time constituted.

1.4	“ Change in Control ” of the Parent of the Bank shall mean a change in the ownership or effective control applicable to the Parent or the Bank as described in Section 409(a)(2)(A)(v) of the Code (or any successor provision thereto) and the regulations thereunder.

1.5	“ Code ” means the Internal Revenue Code of 1986, as amended, and all regulations and guidance thereunder, including such regulations and guidance as may be promulgated after the Effective Date.

1.6	“ Disability ” shall have the meaning given it in the Employment Agreement.

1.7

“ Early Termination ” means Separation from Service before attainment of Normal Retirement Age but after the Plan Year in which the Executive attains age 62, other than a Separation from Service that occurs within twenty-four (24) months following a Change in Control or due to death, Disability, Termination without Cause or Termination for Cause.

Penn Security Bank and Trust Company

Supplemental Executive Retirement Plan Agreement

1.8	“ Effective Date ” means May 1, 2012.

1.9	“ Employment Agreement ” means the Employment Agreement dated May 30, 2012 by and among the Bank, Parent and the Executive, as may be amended from time to time.

1.10	“ Normal Retirement Age ” means age sixty-five (65).

1.11	“ Normal Retirement Date ” means the later of Normal Retirement Age or Separation from Service.

1.12	“ Plan Administrator ” means the Board or such committee or person as the Board shall appoint.

1.13	“ Plan Year ” means each twelve (12) month period commencing on January 1 and ending on December 31 of each year.

1.14	“ Separation from Service ” means termination of the Executive’s employment with the Bank (and Parent, if applicable) constituting a “separation from service” within its meaning under Treasury Regulations Section 1.409A-1(h).

1.15	“ Schedule A ” means the schedule attached to this Agreement and made a part hereof. Schedule A shall be updated upon a change in any of the benefit amounts under Article 2 or 3.

1.16	“ Specified Employee ” means a “specified employee” as defined in Treasury Regulations Section 1.409A-1(i).

1.17	“ Termination for Cause ” means a Separation from Service in connection with a termination of Executive’s employment by the Bank for Cause (as defined in the Employment Agreement).

1.18	“ Termination without Cause ” means a Separation from Service during or before the Plan Year in which the Executive attains age 62 in connection with a termination of Executive’s employment by the Bank without Cause (as defined in the Employment Agreement).

Article 2

Distributions During Lifetime

2.1	Normal Retirement Benefit . Upon Separation from Service on or after attaining Normal Retirement Age, the Bank shall distribute to the Executive the benefit described in this Section 2.1 in lieu of any other benefit under this Article.

2.1.1

Amount of Benefit . The annual benefit under this Section 2.1 is One Hundred Fourteen Thousand Six Hundred Dollars ($114,600).

Penn Security Bank and Trust Company

Supplemental Executive Retirement Plan Agreement

2.1.2

Distribution of Benefit . The Bank shall distribute the annual benefit to the Executive in twelve (12) equal monthly installments commencing on the first day of the month following Normal Retirement Date. The annual benefit shall be distributed to the Executive for twenty (20) years.

2.2	Early Termination Benefit . If Early Termination occurs, the Bank shall distribute to the Executive the benefit described in this Section 2.2 in lieu of any other benefit under this Article.

2.2.1

Amount of Benefit . The annual benefit under this Section 2.2 is the Early Termination Annual Benefit set forth on Schedule A for the Plan Year ended immediately prior to the Early Termination. Additionally, the annual benefit amount shall be increased by a pro-rated amount relative to the Executive’s service during the partial Plan Year in which Separation from Service takes place. This amount will be added to the Annual Benefit amount at the end of the preceding Plan Year on Schedule A.

2.2.2

Distribution of Benefit . The Bank shall distribute the annual benefit to the Executive in twelve (12) equal monthly installments commencing on the first day of the month following Separation from Service. The annual benefit shall be distributed to the Executive for twenty (20) years.

2.3	Disability Benefit . If the Executive experiences a Disability which results in a Separation from Service prior to Normal Retirement Age, the Bank shall distribute to the Executive the benefit described in this Section 2.3 in lieu of any other benefit under this Article.

2.3.1

Amount of Benefit . The benefit under this Section 2.3 is the Disability Benefit set forth on Schedule A for the Plan Year ended immediately prior to the date in which Separation from Service due to Disability occurs. Additionally, the annual benefit amount shall be increased by a pro-rated amount relative to the Executive’s service during the partial Plan Year in which Separation from Service takes place. This amount will be added to the Annual Benefit amount at the end of the preceding Plan Year on Schedule A.

2.3.2

Distribution of Benefit . The Bank shall distribute the annual benefit to the Executive in twelve (12) equal monthly installments commencing on the first day of the month following Separation from Service. The annual benefit shall be distributed to the Executive for twenty (20) years.

2.4

Change in Control Benefit . If a Change in Control occurs prior to Normal Retirement Age followed by Separation from Service within twenty-four (24) months following the Change in Control, the Bank shall distribute to the Executive the benefit described in this Section 2.4 in lieu of any other benefit under this Article.

Penn Security Bank and Trust Company

Supplemental Executive Retirement Plan Agreement

2.4.1

Amount of Benefit . The annual benefit under this Section 2.4 is the Change in Control benefit set forth on Schedule A for the Plan Year ended immediately prior to the date Separation from Service occurs. Additionally, the annual benefit amount shall be increased by a pro-rated amount relative to the Executive’s service during the partial Plan Year in which Separation from Service takes place. This amount will be added to the Annual Benefit amount at the end of the preceding Plan Year on Schedule A.

2.4.2

Distribution of Benefit . The Bank shall distribute the annual benefit to the Executive in twelve (12) equal monthly installments commencing on the first day of the month following Separation from Service. The annual benefit shall be distributed to the Executive for twenty (20) years.

2.5	Termination without Cause . If the Executive experiences a Termination without Cause, the Bank shall distribute to the Executive the benefit described in this Section 2.5 in lieu of any other benefit under this Article.

2.5.1

Amount of Benefit . The benefit under this Section 2.5 is the Termination without Cause Benefit set forth on Schedule A for the Plan Year ended immediately prior to the date in which the Termination without Cause occurs. Additionally, the annual benefit amount shall be increased by a pro-rated amount relative to the Executive’s service during the partial Plan Year in which such Separation from Service takes place. This amount will be added to the Annual Benefit amount at the end of the preceding Plan Year on Schedule A.

2.5.2

Distribution of Benefit . The Bank shall distribute the annual benefit to the Executive in twelve (12) equal monthly installments commencing on the first day of the month following the Termination without Cause. The annual benefit shall be distributed to the Executive for twenty (20) years.

2.6

Restriction on Commencement of Distributions . Notwithstanding any provision of this Agreement to the contrary, if the Executive is considered a Specified Employee, the provisions of this Section 2.5 shall govern all distributions hereunder. If benefit distributions which would otherwise be made to the Executive due to Separation from Service are limited because the Executive is a Specified Employee, then such distributions shall not be made during the first six (6) months following Separation from Service. Rather, any distribution which would otherwise be paid to the Executive during such period shall be accumulated and paid to the Executive in a lump sum on the first day of the seventh month following Separation from Service. All subsequent distributions shall be paid in the manner specified.

2.7

Distributions Upon Taxation of Amounts Deferred . If, pursuant to Code Section 409A, the Federal Insurance Contributions Act or other state, local or foreign tax, the Executive becomes subject to tax on the amounts deferred hereunder, then the Bank may make a limited distribution to the Executive in a manner that conforms to the requirements of Code Section 409A. Any such distribution will decrease the Executive’s benefits distributable under this Agreement.

Penn Security Bank and Trust Company

Supplemental Executive Retirement Plan Agreement

2.8

Change in Form or Timing of Distributions . For distribution of benefits under this Article 2, the Executive and the Bank may, subject to the terms of Section 8.1, amend this Agreement to delay the timing or change the form of distributions. Any such amendment shall be subject to approval by the Bank in its sole and absolute discretion and:

(a)

may not accelerate the time or schedule of any distribution, except as provided in Code Section 409A;

(b)

except for benefits distributable under Section 2.3, must delay the commencement of distributions for a minimum of five (5) years from the date the distribution was originally scheduled to be made; and

(c)

must take effect not less than twelve (12) months after the amendment is made.

Article 3

Distribution at Death

3.1	Death During Active Service . If the Executive dies prior to Separation from Service, the Bank shall distribute to the Beneficiary the benefit described in this Section 3.1. This benefit shall be distributed in lieu of any benefit under Article 2.

3.1.1

Amount of Benefit . The benefit under this Section 3.1 is the Normal Retirement Benefit as described in Section 2.1.1.

3.1.2

Distribution of Benefit . The Bank shall distribute the annual benefit to the Beneficiary in twelve (12) equal monthly installments commencing within sixty (60) days following the Executive’s death. The annual benefit shall be distributed to the Beneficiary for twenty (20) years. The Beneficiary shall be required to provide to the Bank the Executive’s death certificate.

3.2

Death During Distribution of a Benefit . If the Executive dies after any benefit distributions have commenced under this Agreement but before receiving all such distributions, the Bank shall distribute the remaining benefits to the Beneficiary at the same time and in the same amounts they would have paid to the Executive had the Executive survived. The Beneficiary shall be required to provide to the Bank the Executive’s death certificate.

Article 4

Beneficiaries

4.1

In General . The Executive shall have the right, at any time, to designate a Beneficiary to receive any benefit distributions under this Agreement upon the death of the Executive. The Beneficiary designated under this Agreement may be the same as or different from the beneficiary designated under any other plan of the Bank in which the Executive participates.

Penn Security Bank and Trust Company

Supplemental Executive Retirement Plan Agreement

4.2

Designation . The Executive shall designate a Beneficiary by completing and signing the Beneficiary Designation Form and delivering it to the Plan Administrator or its designated agent. If the Executive names someone other than the Executive’s spouse as a Beneficiary, the Plan Administrator may, in its sole discretion, determine that spousal consent is required to be provided in a form designated by the Plan Administrator, executed by the Executive’s spouse and returned to the Plan Administrator. The Executive’s beneficiary designation shall be deemed automatically revoked if the Beneficiary predeceases the Executive or if the Executive names a spouse as Beneficiary and the marriage is subsequently dissolved. The Executive shall have the right to change a Beneficiary by completing, signing and otherwise complying with the terms of the Beneficiary Designation Form and the Plan Administrator’s rules and procedures. Upon the acceptance by the Plan Administrator of a new Beneficiary Designation Form, all Beneficiary designations previously filed shall be cancelled. The Plan Administrator shall be entitled to rely on the last Beneficiary Designation Form filed by the Executive and accepted by the Plan Administrator prior to the Executive’s death.

4.3	Acknowledgment . No designation or change in designation of a Beneficiary shall be effective until received, accepted and acknowledged in writing by the Plan Administrator or its designated agent.

4.4

No Beneficiary Designation . If the Executive dies without a valid beneficiary designation, or if all designated Beneficiaries predecease the Executive, then the Executive’s spouse shall be the designated Beneficiary. If the Executive has no surviving spouse, any benefit shall be paid to the Executive’s estate.

4.5

Facility of Distribution . If the Plan Administrator determines in its discretion that a benefit is to be distributed to a minor, to a person declared incompetent or to a person incapable of handling the disposition of that person’s property, the Plan Administrator may direct distribution of such benefit to the guardian, legal representative or person having the care or custody of such minor, incompetent person or incapable person. The Plan Administrator may require proof of incompetence, minority or guardianship as it may deem appropriate prior to distribution of the benefit. Any distribution of a benefit shall be a distribution for the account of the Executive and the Beneficiary, as the case may be, and shall completely discharge any liability under this Agreement for such distribution amount.

Article 5

General Limitations

5.1	Termination for Cause . Notwithstanding any provision of this Agreement to the contrary, the Bank shall not distribute any benefit under this Agreement if the Executive’s employment with the Bank is terminated by the Bank due to a Termination for Cause.

5.2

Suicide or Misstatement . No benefit shall be distributed if the Executive commits suicide within two (2) years after the Effective Date, or if an insurance company which issued a life insurance policy covering the Executive and owned by the Bank denies coverage (i) for material misstatements of fact made by the Executive on an application for such life insurance, or (ii) for any other reason.

Penn Security Bank and Trust Company

Supplemental Executive Retirement Plan Agreement

5.3

Removal . Notwithstanding any provision of this Agreement to the contrary, the Bank shall not distribute any benefit under this Agreement if the Executive is subject to a final removal or prohibition order issued by an appropriate federal banking agency pursuant to Section 8(e) of the Federal Deposit Insurance Act.

5.4

Regulatory Restrictions . Notwithstanding anything herein to the contrary, any payments made to the Executive pursuant to this Agreement, or otherwise, shall be subject upon compliance with 12 U.S.C. 1828 and FDIC Regulation 12 CFR Part 359, Golden Parachute Indemnification Payments and any other regulations or guidance promulgated thereunder.

5.5	Competition after Separation from Service . Any unpaid benefits shall be forfeited if the Executive breaches the Employment Agreement, including, without limitation, any restrictive covenant in Article IV thereof.

5.6	Non Applicability. Section 5.5 shall not apply if the Executive has a Separation from Service within twenty-four (24) months of a Change in Control.

Article 6

Administration of Agreement

6.1

Plan Administrator Duties . The Plan Administrator shall administer this Agreement according to its express terms and shall also have the discretion and authority to (i) make, amend, interpret and enforce all appropriate rules and regulations for the administration of this Agreement and (ii) decide or resolve any and all questions, including interpretations of this Agreement, as may arise in connection with this Agreement to the extent the exercise of such discretion and authority does not conflict with Code Section 409A.

6.2

Agents . In the administration of this Agreement, the Plan Administrator may employ agents and delegate to them such administrative duties as the Plan Administrator sees fit, including acting through a duly appointed representative, and may from time to time consult with counsel who may be counsel to the Bank.

6.3

Binding Effect of Decisions . Any decision or action of the Plan Administrator with respect to any question arising out of or in connection with the administration, interpretation or application of this Agreement and the rules and regulations promulgated hereunder shall be final and conclusive and binding upon all persons having any interest in this Agreement.

6.4

Indemnity of Plan Administrator . The Bank shall indemnify and hold harmless the Plan Administrator against any and all claims, losses, damages, expenses or liabilities arising from any action or failure to act with respect to this Agreement, except in the case of willful misconduct by the Plan Administrator.

Penn Security Bank and Trust Company

Supplemental Executive Retirement Plan Agreement

6.5

Bank Information . To enable the Plan Administrator to perform its functions, the Bank shall supply full and timely information to the Plan Administrator on all matters relating to the date and circumstances of the Executive’s death, Disability or Separation from Service, and such other pertinent information as the Plan Administrator may reasonably require.

Article 7

Claims And Review Procedures

7.1	Claims Procedure . An Executive or Beneficiary (“claimant”) who has not received benefits under this Agreement that he or she believes should be distributed shall make a claim for such benefits as follows:

7.1.1

Initiation – Written Claim . The claimant initiates a claim by submitting to the Plan Administrator a written claim for the benefits. If such a claim relates to the contents of a notice received by the claimant, the claim must be made within sixty (60) days after such notice was received by the claimant. All other claims must be made within one hundred eighty (180) days of the date on which the event that caused the claim to arise occurred. The claim must state with particularity the determination desired by the claimant.

7.1.2

Timing of Plan Administrator Response . The Plan Administrator shall respond to such claimant within thirty (30) days after receiving the claim. If the Plan Administrator determines that special circumstances require additional time for processing the claim, the Plan Administrator can extend the response period by an additional thirty (30) days by notifying the claimant in writing, prior to the end of the initial thirty (30) day period, which an additional period is required. The notice of extension must set forth the special circumstances and the date by which the Plan Administrator expects to render its decision.

7.1.3

Notice of Decision . If the Plan Administrator denies part or all of the claim, the Plan Administrator shall notify the claimant in writing of such denial. The Plan Administrator shall write the notification in a manner calculated to be understood by the claimant. The notification shall set forth:

(a)

The specific reasons for the denial;

(b)

A reference to the specific provisions of this Agreement on which the denial is based;

(c)

A description of any additional information or material necessary for the claimant to perfect the claim and an explanation of why it is needed;

(d)

An explanation of this Agreement’s review procedures and the time limits applicable to such procedures; and

Penn Security Bank and Trust Company

Supplemental Executive Retirement Plan Agreement

(e)

A statement of the claimant’s right to bring a civil action under ERISA Section 502(a) following an adverse benefit determination on review.

7.2	Review Procedure . If the Plan Administrator denies part or the entire claim, the claimant shall have the opportunity for a full and fair review by the Plan Administrator of the denial as follows:

7.2.1

Initiation – Written Request . To initiate the review, the claimant, within sixty (60) days after receiving the Plan Administrator’s notice of denial, must file with the Plan Administrator a written request for review.

7.2.2

Additional Submissions – Information Access . The claimant shall then have the opportunity to submit written comments, documents, records and other information relating to the claim. The Plan Administrator shall also provide the claimant, upon request and free of charge, reasonable access to, and copies of, all documents, records and other information relevant (as defined in applicable ERISA regulations) to the claimant’s claim for benefits.

7.2.3

Considerations on Review . In considering the review, the Plan Administrator shall take into account all materials and information the claimant submits relating to the claim, without regard to whether such information was submitted or considered in the initial benefit determination.

7.2.4

Timing of Plan Administrator Response . The Plan Administrator shall respond in writing to such claimant within thirty (30) days after receiving the request for review. If the Plan Administrator determines that special circumstances require additional time for processing the claim, the Plan Administrator can extend the response period by an additional thirty (30) days by notifying the claimant in writing, prior to the end of the initial thirty (30) day period, which an additional period is required. The notice of extension must set forth the special circumstances and the date by which the Plan Administrator expects to render its decision.

7.2.5

Notice of Decision . The Plan Administrator shall notify the claimant in writing of its decision on review. The Plan Administrator shall write the notification in a manner calculated to be understood by the claimant. The notification shall set forth:

(a)

The specific reasons for the denial;

(b)

A reference to the specific provisions of this Agreement on which the denial is based;

(c)

A statement that the claimant is entitled to receive, upon request and free of charge, reasonable access to, and copies of, all documents, records and other information relevant (as defined in applicable ERISA regulations) to the claimant’s claim for benefits; and

Penn Security Bank and Trust Company

Supplemental Executive Retirement Plan Agreement

(d)

A statement of the claimant’s right to bring a civil action under ERISA Section 502(a).

7.3

Arbitration of Claims . All claims or controversies arising out of or in connection with this Agreement shall, subject to the initial review provided for in the foregoing provisions of this Article, be resolved through arbitration. Except as otherwise mutually agreed to by the parties, any arbitration shall be administered under and by the American Arbitration Association (“AAA”), in accordance with the AAA procedures then in effect. The arbitration shall be held in the AAA office nearest to where the Executive is or was last employed by the Bank or at a mutually agreeable location.

Article 8

Amendments and Termination

8.1

Amendments . This Agreement may be amended only by a written agreement signed by the Bank and the Executive. However, the Bank may unilaterally amend this Agreement to conform with written directives to the Bank from its auditors or banking regulators or to comply with legislative changes or tax law, including without limitation Code Section 409A.

8.2

Plan Termination Generally . This Agreement may be terminated only by a written agreement signed by the Bank and the Executive. The benefit shall be the Accrual Balance (as described in Schedule A) as of the date this Agreement is terminated. Except as provided in Section 8.3, the termination of this Agreement shall not cause a distribution of benefits under this Agreement. Rather, upon such termination benefit distributions will be made at the earliest distribution event permitted under Article 2 or Article 3.

8.3

Plan Terminations Under Code Section 409A . Notwithstanding anything to the contrary in Section 8.2, the Bank may terminate this Agreement pursuant to and in accordance with Treasury Regulation Section 1.409A-3(j)(4)(ix) (or any successor provision) and, upon such termination, the Bank may distribute the Accrual Balance (as described in Schedule A), determined as of the date of the termination of this Agreement, to the Executive in a lump sum.

Article 9

Miscellaneous

9.1	Binding Effect . This Agreement shall bind the Executive and the Bank and their beneficiaries, survivors, executors, administrators and transferees.

9.2

No Guarantee of Employment . This Agreement is not a contract for employment. It does not give the Executive the right to remain as an employee of the Bank nor interfere with the Bank’s right to discharge the Executive. It does not require the Executive to remain an employee nor interfere with the Executive’s right to terminate employment at any time.

Penn Security Bank and Trust Company

Supplemental Executive Retirement Plan Agreement

9.3	Non-Transferability . Benefits under this Agreement cannot be sold, transferred, assigned, pledged, attached or encumbered in any manner.

9.4

Tax Withholding and Reporting . The Bank shall withhold any taxes that are required to be withheld, including but not limited to taxes owed under Code Section 409A from the benefits provided under this Agreement. The Executive acknowledges that the Bank’s sole liability regarding taxes is to forward any amounts withheld to the appropriate taxing authorities. The Bank shall satisfy all applicable reporting requirements, including those under Code Section 409A.

9.5	Applicable Law . This Agreement and all rights hereunder shall be governed by the laws of the Commonwealth of Pennsylvania, except to the extent preempted by the laws of the United States of America.

9.6

Unfunded Arrangement . The Executive and the Beneficiary are general unsecured creditors of the Bank for the distribution of benefits under this Agreement. The benefits represent the mere promise by the Bank to distribute such benefits. The rights to benefits are not subject in any manner to anticipation, alienation, sale, transfer, assignment, pledge, encumbrance, attachment or garnishment by creditors. Any insurance on the Executive’s life or other informal funding asset is a general asset of the Bank to which the Executive and Beneficiary have no preferred or secured claim.

9.7	Entire Agreement . This Agreement constitutes the entire agreement between the Bank and the Executive as to the subject matter hereof. No rights are granted to the Executive by virtue of this Agreement other than those specifically set forth herein.

9.8	Interpretation . Wherever the fulfillment of the intent and purpose of this Agreement requires and the context will permit, the use of the masculine gender includes the feminine and use of the singular includes the plural.

9.9

Alternative Action . In the event it shall become impossible for the Bank or the Plan Administrator to perform any act required by this Agreement due to regulatory or other constraints, the Bank or Plan Administrator may perform such alternative act as most nearly carries out the intent and purpose of this Agreement and is in the best interests of the Bank, provided that such alternative act does not violate Code Section 409A.

9.10	Headings . Article and section headings are for convenient reference only and shall not control or affect the meaning or construction of any provision herein.

9.11	Validity . If any provision of this Agreement shall be illegal or invalid for any reason, said illegality or invalidity shall not affect the remaining parts hereof, but this Agreement shall be construed and enforced as if such illegal or invalid provision had never been included herein.

Penn Security Bank and Trust Company

Supplemental Executive Retirement Plan Agreement

9.12	Notice . Any notice or filing required or permitted to be given to the Bank or Plan Administrator under this Agreement shall be sufficient if in writing and hand-delivered or sent by registered or certified mail to the address below:


		Penn Security Bank
		150 north Washington Ave
		Scranton, PA 18504

Such notice shall be deemed given as of the date of delivery or, if delivery is made by mail, as of the date shown on the postmark on the receipt for registration or certification.

Any notice or filing required or permitted to be given to the Executive under this Agreement shall be sufficient if in writing and hand-delivered or sent by mail to the last known address of the Executive.

9.13	Compliance with Section 409A . This Agreement shall be interpreted and administered consistent with Code Section 409A.

IN WITNESS WHEREOF, the Executive and a duly authorized representative of the Bank have signed this Agreement.


EXECUTIVE	BANK Penn Security Bank and Trust Company

/s/ Thomas P. Tulaney	By:	/s/ Patrick Scanlon
Thomas P. Tulaney	Title:	SVP / Controller

	PARENT Penseco Financial Services Corporation

	By:	/s/ Patrick Scanlon

	Title:	SVP / Controller

Penn Security Bank and Trust Company

Supplemental Executive Retirement Plan Agreement



{ }		New Designation

{ }		Change in Designation

I, Thomas P. Tulaney , designate the following as Beneficiary under this Agreement:


Primary:		100%
Margaret E. Tulaney		_____%
		_____%

Contingent: Stephanie Tulaney		25%
Thomas Tulaney II		25%
Tara Tulaney		25%
Marian Tulaney		25%

Notes:

•

Please PRINT CLEARLY or TYPE the names of the beneficiaries.

•

To name a trust as Beneficiary, please provide the name of the trustee(s) and the exact name and date of the trust agreement.

•

To name your estate as Beneficiary, please write “Estate of [your name] ”.

•

Be aware that none of the contingent beneficiaries will receive anything unless ALL of the primary beneficiaries predecease you.

I understand that I may change these beneficiary designations by delivering a new written designation to the Plan Administrator, which shall be effective only upon receipt and acknowledgment by the Plan Administrator prior to my death. I further understand that the designations will be automatically revoked if the Beneficiary predeceases me, or, if I have named my spouse as Beneficiary and our marriage is subsequently dissolved.


By:		Patrick Scanlon

Title:		SVP / Controller

Exhibit 31.1

CERTIFICATION

I, Craig W. Best, certify that:

1. I have reviewed this Form 10-Q of Penseco Financial Services Corporation;

2. Based on my knowledge, this report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this report;

3. Based on my knowledge, the financial statements, and other financial information included in this report, fairly present in all material respects the financial condition, results of operations and cash flows of the registrant as of, and for, the periods presented in this report;

4. The registrant’s other certifying officer and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-15(e) and 15d-15(e)) and internal control over financial reporting (as defined in Exchange Act Rules 13a-15(f) and 15d-15(f)) for the registrant and have:

a) Designed such disclosure controls and procedures, or caused such disclosure controls and procedures to be designed under our supervision, to ensure that material information relating to the registrant, including its consolidated subsidiaries, is made known to us by others within those entities, particularly during the period in which this report is being prepared;

b) Designed such internal control over financial reporting, or caused such internal control over financial reporting to be designed under our supervision, to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles;

c) Evaluated the effectiveness of the registrant’s disclosure controls and procedures and presented in this report our conclusions about the effectiveness of the disclosure controls and procedures, as of the end of the period covered by this report based on such evaluation; and

d) Disclosed in this report any change in the registrant’s internal control over financial reporting that occurred during the registrant’s most recent fiscal quarter that has materially affected, or is reasonably likely to materially affect, the registrant’s internal control over financial reporting; and

5. The registrant’s other certifying officer and I have disclosed, based on our most recent evaluation of internal control over financial reporting, to the registrant’s auditors and the audit committee of the registrant’s board of directors:

a) All significant deficiencies and material weaknesses in the design or operation of internal control over financial reporting which are reasonably likely to adversely affect the registrant’s ability to record, process, summarize and report financial information; and

b) Any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant’s internal control over financial reporting.

Date: August 9, 2012

/s/ CRAIG W. BEST

Craig W. Best

President and CEO

(Principal Executive Officer)

Exhibit 31.2

CERTIFICATION

I, Patrick Scanlon, certify that:

1. I have reviewed this Form 10-Q of Penseco Financial Services Corporation;

b) Any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant’s internal control over financial reporting.

Date: August 9, 2012

/s/ PATRICK SCANLON

Patrick Scanlon

Senior Vice President, Finance Division Head

(Principal Financial Officer)

Exhibit 32

CERTIFICATION PURSUANT TO 18 U.S.C. SECTION 1350, AS ADOPTED PURSUANT TO SECTION

906 OF THE SARBANES-OXLEY ACT OF 2002

In connection with the Quarterly Report of Penseco Financial Services Corporation (the “Company”) on Form 10-Q for the period ending June 30, 2012 as filed with the Securities and Exchange Commission on the date hereof (the “Report”), we, Craig W. Best, President and Chief executive Officer, and Patrick Scanlon, Senior Vice President, Finance Division Head, certify, pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002, that:

(1) The Report fully complies with the requirements of Section 13(a) or 15(d) of the Securities Exchange Act of 1934 (the “Act”); and

(2) The information contained in the Report fairly presents, in all material respects, the financial condition and results of operations of the Company.

/s/ CRAIG W. BEST

Craig W. Best

President and CEO

(Principal Executive Officer)

August 9, 2012

/s/ PATRICK SCANLON

Patrick Scanlon

Senior Vice President, Finance Division Head

(Principal Financial Officer)

August 9, 2012