Cautionary Statement

We have made forward-looking statements in this document, and in documents that we incorporate by reference, that are subject to risks and uncertainties. Forward-looking statements include information concerning possible or assumed future results of operations of Citizens Financial Services, Inc., First Citizens National Bank, First Citizens Insurance Agency, Inc. or the combined Company. When we use words such as "believes," "expects," "anticipates," or similar expressions, we are making forward-looking statements. For a variety of reasons, actual results could differ materially from those contained in or implied by forward-looking statements. The Company would like to caution readers that the following important factors, among others, may have affected and could in the future affect the Company's actual results and could cause the Company's actual results for subsequent periods to differ materially from those expressed in any forward-looking statement:

· Interest rates could change more rapidly or more significantly than we expect.

· The economy could change significantly in an unexpected way, which would cause the demand for new loans and the ability of borrowers to repay outstanding loans to change in ways that our models do not anticipate.

· The stock and bond markets could suffer a significant disruption, which may have a negative effect on our financial condition and that of our borrowers, and on our ability to raise money by issuing new securities.

· It could take us longer than we anticipate to implement strategic initiatives designed to increase revenues or manage expenses, or we may not be able to implement those initiatives at all.

· Acquisitions and dispositions of assets could affect us in ways that management has not anticipated.

· We may become subject to new legal obligations or the resolution of litigation may have a negative effect on our financial condition.

· We may become subject to new and unanticipated accounting, tax, or regulatory practices, regulations or requirements, including the costs of compliance with such changes.

· We could experience greater loan delinquencies than anticipated, adversely affecting our earnings and financial condition. We could also experience greater losses than expected due to the ever increasing volume of information theft and fraudulent scams impacting our customers and the banking industry.

· We could lose the services of some or all of our key personnel, which would negatively impact our business because of their business development skills, financial expertise, lending experience, technical expertise and market area knowledge.

Additional factors that may affect our results are discussed in the Company's Annual Report on Form 10-K under "Item 1.A/ Risk Factors." Except as required by applicable law and regulation, we assume no obligation to update or revise any forward-looking statements after the date on which they are made.

Introduction

The following is management's discussion and analysis of the significant changes in the results of operations, capital resources and liquidity presented in its accompanying consolidated financial statements for the Company. Our Company's consolidated financial condition and results of operations consist almost entirely of the Bank's financial conditions and results of operations. Management's discussion and analysis should be read in conjunction with the preceding financial statements presented under Part I. The results of operations for the three and nine months ended September 30, 2008 are not necessarily indicative of the results you may expect for the full year.

Our Company currently engages in the general business of banking throughout our service area of Potter, Tioga and Bradford counties in North Central Pennsylvania and Allegany, Steuben, Chemung and Tioga counties in Southern New York. We maintain our central office in Mansfield, Pennsylvania. Presently we operate 16 banking facilities. In Pennsylvania, these offices are located in Mansfield, Blossburg, Ulysses, Genesee, Wellsboro, Troy, Sayre, Canton, Gillett, Millerton, LeRaysville, Towanda, the Wellsboro Weis Market store, and the Mansfield Wal-Mart Super Center. We also expect to complete the acquisition of another Mansfield location in November that we are purchasing from another financial institution (see Footnote 7 to the Consolidated Financial Statements). In New York, we have a branch office in Wellsville, Allegany County.

Risk Management

Risk identification and management are essential elements for the successful management of the Company. In the normal course of business, the Company is subject to various types of risk, including interest rate, credit, liquidity and regulatory risk.

Interest rate risk is the sensitivity of net interest income and the market value of financial instruments to the direction and frequency of changes in interest rates. Interest rate risk results from various re-pricing frequencies and the maturity structure of the financial instruments owned by the Company. The Company uses its asset/liability and funds management policy to control and manage interest rate risk.

Credit risk represents the possibility that a customer may not perform in accordance with contractual terms. Credit risk results from loans with customers and the purchasing of securities. The Company's primary credit risk is in the loan portfolio. The Company manages credit risk by adhering to an established credit policy and through a disciplined evaluation of the adequacy of the allowance for loan losses. Also, the investment policy limits the amount of credit risk that may be taken in the investment portfolio.

Liquidity risk represents the inability to generate or otherwise obtain funds at reasonable rates to satisfy commitments to borrowers and obligations to depositors. The Company has established guidelines within its asset/liability and funds management policy to manage liquidity risk. These guidelines include, among other things, contingent funding alternatives.

Regulatory risk represents the possibility that a change in law, regulations or regulatory policy may have a material effect on the business of the Company and its subsidiary. We can not predict what legislation might be enacted or what regulations might be adopted, or if adopted, the effect thereof on our operations.

Competition

We face strong competition in the communities that we serve from other commercial banks, savings banks, and savings and loan associations, some of which are substantially larger institutions than our subsidiary. In addition, insurance companies, investment-counseling firms, and other business firms and individuals offer personal and corporate trust services. We also compete with credit unions, issuers of money market funds, securities brokerage firms, consumer finance companies, mortgage brokers and insurance companies. These entities are strong competitors for virtually all types of financial services. The financial services industry continues to experience tremendous change to competitive barriers between bank and non-bank institutions. We must compete not only with traditional financial institutions, but also other business corporations that have begun to deliver competing financial services and banking services that are easily accessible through the internet. Competition for banking services is based on price, nature of product, quality of service, and convenience of location.

Trust and Investment Services

Our Investment and Trust Services Department is committed to helping our customers meet their financial goals. The Trust Department offers professional trust administration, investment management services, estate planning and administration, and custody of securities. Assets held by the Company in a fiduciary or agency capacity for its customers are not included in the consolidated financial statements since such items are not assets of the Company. Revenues and fees of the Trust Department are reflected in the Company's financial statements. As of September 30, 2008 and December 31, 2007, the Trust Department had $84.4 and $94.4 million of assets under management, respectively. The $10.0 million decrease is primarily attributable to a decline in market values of trust assets since the end of the year.

Our Investment Representatives offer full service brokerage services and financial planning throughout the Bank's market area. Products such as mutual funds, annuities, health and life insurance are made available through our insurance subsidiary, First Citizens Insurance.

Results of Operations

Overview of the Income Statement

The Company had net income of $3,415,000 for the first nine months of 2008 compared with earnings of $4,894,000 for last year's comparable period, a decrease of $1,479,000 or 30.2%. Earnings per share for the first nine months of 2008 were $1.20, compared to $1.71 last year representing a 29.8% decrease. Annualized return on assets and return on equity for the nine months of 2008 were .76% and 8.93%, respectively, compared with 1.13% and 14.08% for last year's comparable period.

In September, as a result of actions taken by the U.S. Treasury Department and the Federal Housing Financing Agency with respect to the Federal Home Loan Mortgage Corporation ("Freddie Mac") and deteriorating credit and liquidity conditions, we recorded a non-recurring $4.1 million other than temporary impairment charge related to our investments in Freddie Mac preferred stock and a Lehman Brothers corporate bond. The after tax impact for the three months and nine months ended September 30, 2008 was approximately $3.5 million. As a result of EESA being signed into law on October 3, 2008, a provision in the new bill will allow the Freddie Mac preferred stock to be treated as an ordinary loss, allowing a tax benefit of approximately $1,000,000. However, since EESA was not signed until after September 30, accounting rules do not allow us to recognize the $1,000,000 tax benefit until the fourth quarter. It is anticipated that the after-tax impact for 2008 earnings will be approximately $2.5 million, or $.88 per share, after recognition in the fourth quarter of the additional tax benefit.

Net loss for the three months ended September 30, 2008 totaled $1,052,000 compared with net income of $1,754,000 for the comparable period last year, a decrease of $2,806,000. Earnings per share for the three months ended September 30, 2008 and 2007 were -$.37 and $.61 per share, respectively. Annualized return on assets and return on equity for the quarter ended September 30, 2008 was -.69% and -8.01%, respectively, compared with 1.20% and 14.85% for last year's comparable period.

Net Interest Income

Net interest income, the most significant component of earnings, is the amount by which interest income generated from interest-earning assets exceeds interest expense on interest-bearing liabilities.

Net interest income for the first nine months of 2008 was $17,201,000, an increase of $3,203,000 compared to the same period in 2007. For the first nine months of 2008 the provision for loan losses totaled $225,000, the same as 2007. Consequently, net interest income after the provision for loan losses was $16,976,000, an increase of $3,203,000, or 23.3% through the first nine months of 2008.

For the three months ended September 30, 2008, net interest income was $5,963,000 which was $1,078,000 or 22.1% higher than the comparable period in 2007. The provision for loan losses for the third quarter this year was $105,000 compared to $60,000 in 2007. As such, net interest income after the provision for loan losses was $5,858,000 compared to $4,825,000 for the quarters ended September 30, 2008 and 2007, respectively.

The following table sets forth the average balances of, and the interest earned or incurred on, each principal category of assets, liabilities and stockholders' equity, the related rates, net interest income and rate "spread" created for the three months and nine months ended September 30, 2008 and 2007:

                                 Analysis of Average Balances and Interest Rates
                                      (1)

                                                              Three Months Ended
                                         September 30, 2008                       September 30, 2007
                                  Average                    Average        Average                   Average
                                Balance (1)     Interest       Rate       Balance (1)     Interest      Rate
(dollars in thousands)               $             $            %              $              $          %
ASSETS
Short-term investments:
  Interest-bearing deposits             6,173           27         1.74              357           4       4.45
at banks
Total short-term investments            6,173           27         1.74              357           4       4.45
Investment securities:
 Taxable                               96,360        1,162         4.82           99,153       1,228       4.95
 Tax-exempt (3)                        35,324          545         6.17           24,439         366       5.99
 Total investment securities          131,684        1,707         5.19          123,592       1,594       5.16
Loans:
 Residential mortgage loans           211,252        3,939         7.42          210,158       3,938       7.43
 Commercial & farm loans              158,404        3,071         7.71          148,386       3,000       8.02
 Loans to state & political            48,915          768         6.25           45,758         700       6.07
subdivisions
 Other loans                           11,539          266         9.17           12,650         301       9.41
 Loans, net of discount               430,110        8,044         7.44          416,952       7,939       7.55
(2)(3)(4)
Total interest-earning assets         567,967        9,778         6.85          540,901       9,537       6.99
Cash and due from banks                10,423                                      9,674
Bank premises and equipment            12,283                                     12,675
Other assets                           19,653                                     18,937
Total non-interest earning             42,359                                     41,286
assets
Total assets                          610,326                                    582,187
LIABILITIES AND STOCKHOLDERS' EQUITY
Interest-bearing liabilities:
 NOW accounts                         110,434          327         1.18          100,949         571       2.24
 Savings accounts                      42,602           41         0.38           38,774          35       0.36
 Money market accounts                 43,714          186         1.69           50,487         461       3.62
 Certificates of deposit              244,496        2,283         3.71          220,352       2,299       4.14
Total interest-bearing                441,246        2,837         2.56          410,562       3,366       3.25
deposits
Other borrowed funds                   53,221          545         4.07           68,111         928       5.40
Total interest-bearing                494,467        3,382         2.72          478,673       4,294       3.56
liabilities
Demand deposits                        56,715                                     50,373
Other liabilities                       6,566                                      6,990
Total non-interest-bearing             63,281                                     57,363
liabilities
Stockholders' equity                   52,578                                     46,151
Total liabilities &                   610,326                                    582,187
stockholders' equity
Net interest income                                  6,396                                     5,243
Net interest spread (5)                                       4.13%                                    3.44%
Net interest income as a
percentage
 of average interest-earning                                  4.48%                                    3.85%
assets
Ratio of interest-earning
assets
 to interest-bearing                                             1.15                                      1.13
liabilities

(1) Averages are based on
daily averages.
(2) Includes loan origination and commitment
fees.

                                     Analysis of Average Balances and Interest Rates (1)
                                                      Nine Months Ended
                                       September 30, 2008              September 30, 2007
                                Average                 Average   Average              Average
                                Balance    Interest      Rate     Balance   Interest    Rate
                                  (1)                               (1)
(dollars in thousands)             $          $            %         $          $         %
ASSETS
Short-term investments:
  Interest-bearing deposits at     2,543           34        1.79      122           4    4.05
banks
Total short-term investments       2,543           34        1.79      122           4    4.05
Investment securities:
 Taxable                          94,719        3,571        5.03   95,491       3,488    4.87
 Tax-exempt (3)                   34,356        1,588        6.16   23,225       1,046    6.01
 Total investment securities     129,075        5,159        5.33  118,716       4,534    5.09
Loans:
 Residential mortgage loans      212,161       11,798        7.43  211,249      11,675    7.39
 Commercial & farm loans         156,134        8,971        7.67  146,646       8,692    7.92
 Loans to state & political       47,568        2,240        6.29   45,197       2,045    6.05
subdivisions
 Other loans                      11,981          818        9.12   12,308         855    9.29
 Loans, net of discount          427,844       23,827        7.44  415,400      23,267    7.49
(2)(3)(4)
Total interest-earning assets    559,462       29,020        6.93  534,238      27,805    6.96
Cash and due from banks            9,576                             9,368
Bank premises and equipment       12,385                            12,827
Other assets                      19,193                            18,984
Total non-interest earning        41,154                            41,179
assets
Total assets                     600,616                           575,417
LIABILITIES AND STOCKHOLDERS' EQUITY
Interest-bearing liabilities:
 NOW accounts                    104,866        1,037        1.32   93,336       1,495    2.14
 Savings accounts                 40,717          114        0.37   38,446         101    0.35
 Money market accounts            45,350          681        2.01   49,211       1,338    3.64
 Certificates of deposit         231,081        6,676        3.86  228,959       7,172    4.19
Total interest-bearing           422,014        8,508        2.69  409,952      10,106    3.30
deposits
Other borrowed funds              67,786        2,030        4.00   64,494       2,660    5.51
Total interest-bearing           489,800       10,538        2.87  474,446      12,766    3.60
liabilities
Demand deposits                   53,587                            49,103
Other liabilities                  6,233                             6,609
Total non-interest-bearing        59,820                            55,712
liabilities
Stockholders' equity              50,996                            45,259
Total liabilities &              600,616                           575,417
stockholders' equity
Net interest income                            18,482                           15,039
Net interest spread (5)                                  4.06%                          3.36%
Net interest income as a
percentage
 of average interest-earning                             4.41%                          3.76%
assets
Ratio of interest-earning
assets
 to interest-bearing                                       1.14                          1.13
liabilities

(1) Averages are based on daily
averages.
(2) Includes loan origination and
commitment fees.

Tax exempt revenue is shown on a tax-equivalent basis for proper comparison using a statutory, federal income tax rate of 34%. For purposes of the comparison, as well as the discussion that follows, this presentation facilitates performance comparisons between taxable and tax-free assets by increasing the tax-free income by an amount equivalent to the Federal income taxes that would have been paid if this income were taxable at the Company's 34% Federal statutory rate. The following table represents the adjustment to convert net interest income to net interest income on a fully taxable equivalent basis for the periods ending September 30, 2008 and 2007:

                                      For the Three Months         For the Nine Months
(dollars in thousands)                 Ended September 30           Ended September 30
                                       2008         2007             2008        2007
Interest and dividend income
  from investment securities
(non-tax adjusted)                   $    1,552  $     1,464       $    4,637  $   4,153
Tax equivalent adjustment                   182          134              556        385
Interest and dividend income
  from investment securities (tax
equivalent basis)                    $    1,734  $     1,598       $    5,193  $   4,538

Interest and fees on loans (non-tax

adjusted)                            $    7,793  $     7,715       $   23,102  $  22,611
Tax equivalent adjustment                   251          224              725        656
Interest and fees on loans (tax
equivalent basis)                    $    8,044  $     7,939       $   23,827  $  23,267



Total interest income                $    9,345  $     9,179       $   27,739  $  26,764
Total interest expense                    3,382        4,294           10,538     12,766
Net interest income                       5,963        4,885           17,201     13,998
Total tax equivalent adjustment             433          358            1,281      1,041
Net interest income (tax equivalent
basis)                               $    6,396  $     5,243       $   18,482  $  15,039

The following table shows the tax-equivalent effect of changes in volume and rate on interest income and expense.

                          Three months ended September 30, 2008 vs. 2007 (1)     Nine months ended September 30, 2008 vs. 2007 (1)
                            Change in            Change             Total           Change in            Change            Total
 (in thousands)               Volume            in Rate            Change            Volume             in Rate           Change
Interest Income:
Short-term investments:
 Interest-bearing
deposits at banks            $         27      $          (4)     $         23       $         31        $        (1)       $     30
Investment securities:
 Taxable                             (19)                (47)             (66)               (28)                 111             83
 Tax-exempt                           168                  11              179                514                  28            542
Total investments                     149                (36)              113                486                 139            625
Loans:
 Residential mortgage
loans                                  10                 (9)                1                 62                  61            123
 Commercial & farm
loans                                 189               (118)               71                536               (257)            279
 Loans to state &
political subdivisions                 49                  19               68                111                  84            195
 Other loans                         (27)                 (8)             (35)               (22)                (15)           (37)
Total loans, net of
discount                              221               (116)              105                687               (127)            560
Total Interest Income                 397               (156)              241              1,204                  11          1,215
Interest Expense:
Interest-bearing
deposits:
 NOW accounts                          48               (292)            (244)                220               (678)          (458)
 Savings accounts                       4                   2                6                  6                   7             13
 Money Market accounts               (74)               (201)            (275)               (97)               (560)          (657)
 Certificates of
deposit                               232               (248)             (16)                 74               (570)          (496)
Total interest-bearing
deposits                              210               (739)            (529)                203             (1,801)        (1,598)
Other borrowed funds                (616)                 233            (383)                147               (777)          (630)
Total interest expense              (406)               (506)            (912)                350             (2,578)        (2,228)
Net interest income         $         803       $         350     $      1,153       $        854       $       2,589      $   3,443

Tax equivalent net interest income rose from $15,039,000 for the first nine months of 2007 to $18,482,000 for the same period this year, increasing a total of $3,443,000 over last year. Total interest income increased $1,215,000 for the nine months ended September 30, 2008 compared to 2007. Of this, $1,204,000 was due to volume as interest earning assets increased $25.2 million. Tax-exempt investment securities increased $11.1 million since last year due to market opportunities and in an effort to manage our effective tax rate. A $9.5 million increase in commercial and farm loans since 2007 shows our continued efforts and expertise in growing this segment. Only $11,000 of the increase in interest income was due to rate. This is primarily due to the yield on investment securities increasing 24 basis points which offset the slight decrease of 5 basis points in the yield on our loan portfolio.

Total interest expense decreased $2,228,000 for the nine months ended September 30, 2008 compared with last year. Since August 2007, the Federal Reserve has cut the Fed Funds rate by 375 basis points. The Federal Reserve's . . .