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 condition 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 months ended March 31, 2009 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 17 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. In November 2008, we completed the acquisition of another Mansfield location from The Elmira Savings Bank, FSB (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 the Bank. 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 primarily based on price, nature of product, quality of service, and convenience of location.

Trust and Investment Services

Our Investment and Trust Services 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 March 31, 2009 and December 31, 2008, the Trust Department had $71.8 and $74.3 million of assets under management, respectively. The $2.5 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. Fee income from the sale of these products is reflected in the Company's financial statements.

Results of Operations

Overview of the Income Statement

The Company had net income of $2,346,000 for the first three months of 2009 compared with earnings of $2,021,000 for last year's comparable period, an increase of $325,000 or 16.1%. Earnings per share for the first three months of 2009 were $0.82, compared to $.71 last year, representing a 15.5% increase. Annualized return on assets and return on equity for the three months of 2009 were 1.41% and 17.59%, respectively, compared with 1.36% and 16.32% for last year's comparable period.

Net Interest Income

Net interest income, the most significant component of the Company's 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 quarter of 2009, was $6,159,000, an increase of $751,000, or 13.9%, compared to the same period in 2008. For the first three months of 2009, the provision for loan losses totaled $150,000, an increase of $30,000 over 2008. Consequently, net interest income after the provision for loan losses was $6,009,000 compared to $5,288,000 during the first three months of 2008.

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:

                                       Analysis of Average Balances and Interest Rates (1)

                                         March 31, 2009                   March 31, 2008
                                 Average                Average   Average               Average
                                 Balance    Interest      Rate    Balance   Interest      Rate
                                   (1)                              (1)
(dollars in thousands)              $           $          %         $          $          %
ASSETS
Short-term investments:
  Interest-bearing deposits at       8,417           2       0.08        1           -       2.01
banks
Total short-term investments         8,417           2       0.08        1           -       2.01
Investment securities:
 Taxable                           130,276       1,648       5.06   94,275       1,218       5.17
 Tax-exempt (3)                     44,783         714       6.38   33,147         510       6.15
 Total investment securities       175,059       2,362       5.40  127,422       1,728       5.42
Loans:
 Residential mortgage loans        206,812       3,747       7.35  213,545       3,947       7.43
 Commercial & farm loans           171,048       2,981       7.07  154,332       2,950       7.69
 Loans to state & political         47,240         734       6.30   45,080         711       6.34
subdivisions
 Other loans                        11,276         251       9.03   12,486         286       9.21
 Loans, net of discount            436,376       7,713       7.17  425,443       7,894       7.46
(2)(3)(4)
Total interest-earning assets      619,852      10,077       6.59  552,866       9,622       7.00
Cash and due from banks              8,929                           8,886
Bank premises and equipment         11,770                          12,497
Other assets                        27,297                          18,694
Total non-interest earning          47,996                          40,077
assets
Total assets                       667,848                         592,943
LIABILITIES AND STOCKHOLDERS' EQUITY
Interest-bearing liabilities:
 NOW accounts                      115,010         248       0.87   98,474         394       1.61
 Savings accounts                   44,899          37       0.33   38,899          36       0.37
 Money market accounts              40,627          99       0.99   46,538         291       2.51
 Certificates of deposit           293,675       2,531       3.50  221,051       2,222       4.04
Total interest-bearing deposits    494,211       2,915       2.39  404,962       2,943       2.92
Other borrowed funds                57,691         523       3.68   82,796         857       4.16
Total interest-bearing             551,902       3,438       2.53  487,758       3,800       3.13
liabilities
Demand deposits                     54,013                          49,568
Other liabilities                    8,567                           6,092
Total non-interest-bearing          62,580                          55,660
liabilities
Stockholders' equity                53,366                          46,525
Total liabilities &                667,848                         589,943
stockholders' equity
Net interest income                              6,639                           5,822
Net interest spread (5)                                  4.06%                           3.87%
Net interest income as a
percentage
 of average interest-earning                             4.34%                           4.24%
assets
Ratio of interest-earning
assets
 to interest-bearing                                       1.12                            1.13
liabilities

(1) Averages are based on daily averages.
(2) Includes loan origination and commitment fees.
(3) Tax exempt interest revenue is shown on a tax equivalent basis for proper comparison using a statutory federal income tax rate of 34%.
(4) Income on non-accrual loans is accounted for on a cash basis, and the loan balances are included in interest-earning assets.
(5) Interest rate spread represents the difference between the average rate earned on interest-earning assets and the average rate paid on interest-bearing liabilities.

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 March 31, 2009 and 2008:

                                                      For the Three Months
                                                         Ended March 31
                                                       2009         2008
Interest and dividend income
  from investment securities (non-tax adjusted)      $    2,120  $     1,544
Tax equivalent adjustment                                   244          184
Interest and dividend income
  from investment securities (tax equivalent basis)  $    2,364  $     1,728



Interest and fees on loans (non-tax adjusted)        $    7,477  $     7,664
Tax equivalent adjustment                                   236          230
Interest and fees on loans (tax equivalent basis)    $    7,713  $     7,894



Total interest income                                $    9,597  $     9,208
Total interest expense                                    3,438        3,800
Net interest income                                       6,159        5,408
Total tax equivalent adjustment                             480          414
Net interest income (tax equivalent basis)           $    6,639  $     5,822

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

                                                    2009 vs. 2008 (1)
                                            Change in     Change      Total
                                              Volume     in Rate      Change
Interest Income:
Short-term investments:
 Interest-bearing deposits at banks          $       2   $       -   $       2
Investment securities:
 Taxable                                           455        (25)         430
 Tax-exempt                                        185          19         204
Total investments                                  640         (6)         634
Loans:
 Residential mortgage loans                      (155)        (45)       (200)
 Commercial & farm loans                           192       (161)          31
 Loans to state & political subdivisions            28         (5)          23
 Other loans                                      (29)         (6)        (35)
Total loans, net of discount                        36       (217)       (181)
Total Interest Income                              678       (223)         455
Interest Expense:
Interest-bearing deposits:
 NOW accounts                                       79       (225)       (146)
 Savings accounts                                    4         (3)           1
 Money Market accounts                            (35)       (157)       (192)
 Certificates of deposit                           539       (230)         309
Total interest-bearing deposits                    587       (615)        (28)
Other borrowed funds                             (243)        (91)       (334)
Total interest expense                             344       (706)       (362)
Net interest income                           $    334    $    483    $    817

(1) The portion of the total change attributable to both volume and rate changes, which can not be separated, has been allocated proportionally to the change due to volume and the change due to rate prior to allocation.

Tax equivalent net interest income rose from $5,822,000 in 2008 to $6,639,000 in 2009, an increase of $817,000 for the three months ended March 31, 2009. The tax equivalent net interest margin improved from 4.24% for the first three months of 2008 to 4.34% in 2009.

Total interest income increased $455,000. Of this, $678,000 was due to volume as the average balance of interest earning assets increased by $67.0 million. There was a decrease of $223,000 due to change in rate, as the yield on interest earning assets decreased 41 basis points from 7.00% to 6.59%. Investment income for the three months ended March 31, 2009 increased $634,000 over the same period last year. Total investment securities increased by $47.6 million since last year due to investment opportunities including higher yields with a minimal impact on the overall duration of our portfolio. Taxable securities increased by $36.0 million while tax-exempt securities increased by $11.6 million, which had the effect of increasing interest income by $455,000 and $185,000, respectively, due to volume. The purchase of tax-exempt securities, along with municipal loans, allows us to manage our effective tax rate as well as the overall yield on our interest earning assets.

Total loan interest income decreased $181,000 for the three months ended March 31, 2009 compared to the same period last year. Interest income on residential mortgage loans decreased $200,000 of which $155,000 was due to volume and $45,000 due to a decrease in rate. The current economic recession, higher unemployment rates and other negative economic factors have resulted in lower loan demand for non-conforming residential mortgages and home equity loans. Loan demand for conforming mortgages, which the Company sells on the secondary market, has increased primarily due to lower interest rates. The average balance of commercial and farm loans increased $16.7 million from a year ago primarily due to our emphasis and ability to grow this segment of the loan portfolio. This had a positive impact of $192,000 on total interest income due to volume. Offsetting this, a decrease of 62 basis points earned on commercial and farm loans had the effect of decreasing interest income by $161,000.

Total interest expense decreased $362,000 for the three months ended March 31, 2009 compared with last year. Of this, a change in rate accounted for a $706,000 decrease in our interest expense. The average interest rate on interest-bearing liabilities decreased 60 basis points, from 3.13% to 2.53%. The actions of the Federal Reserve and current economic downturn had the effect of decreasing our short-term borrowing costs as well as rates on deposit products, including shorter-term certificates of deposit and rate sensitive NOW and money market accounts. Offsetting this, the average balance of interest-bearing liabilities increased $64.1 million resulting in an increase in interest expense of $344,000 (see also "Financial Condition - Deposits"). The average balance of certificates of deposit increased $72.6 million causing an increase in interest expense of $539,000. The average balance of NOW accounts also increased $16.5 million accounting for an increase of $79,000 in interest expense. The average balance of borrowed funds decreased by $25.1 million, which resulted in a decrease in interest expense of $243,000 due to volume.

Provision For Loan Losses

For the three-month period ending March 31, 2009, we recorded $150,000 to the provision as a result of our quarterly review of the allowance for loan losses. The provision was increased by $30,000 over the same time period in 2008. Management's quarterly review of the allowance for loan losses is based on the following information: migration analysis of delinquent and non-accrual loans, impaired loans, estimated future losses on loans, recent review of large problem credits, local and national economic conditions, historical loss experience, OCC qualitative adjustments, actual and expected loan growth and peer comparisons (see also "Financial Condition - Allowance for Loan Losses").

Non-interest Income

Non-interest income for the three months ended March 31, 2009 totaled $1,354,000, an increase of $145,000 when compared to the same period in 2008. Service charge income increased by $36,000 and continues to be the Company's primary source of non-interest income. For the first three months of 2009, account service charges totaled $812,000 compared to $776,000 last year. Approximately $12,000 of the increase is attributable to customers' usage of their debit cards and an additional $11,000 is due to an increase in fees charged to customers for non-sufficient funds.

Brokerage and insurance income increased $56,000 as we continue to increase the principal amounts invested through us by our customers. The hiring of an experienced broker has also had a positive impact on this increase in income. We continue to grow and develop this segment of business with our customers.

During the first quarter of 2009, investment securities gains amounted to $16,000 compared to $0 last year. We sold an agency bond at a gain that was likely to be called later this year. This was offset with a loss on the sale of bank equity shares. Earnings on bank owned life insurance increased by $36,000 compared to last year primarily due to an additional investment in bank owned life insurance of approximately $3.4 million in December 2008 based upon an analysis of new employees and updated future employee benefit costs.

The following table shows the breakdown of non-interest income for the three months ended March 31, 2009 and 2008:

                                      Three months ended
                                           March 31,          Change
(dollars in thousands)                   2009      2008   Amount     %
Service charges                          $   812   $  776  $   36     4.6
Trust                                        163      167     (4)   (2.4)
Brokerage and insurance                      100       44      56   127.3
Investment securities gains, net              16        -      16     n/a
Earnings on bank owned life insurance        121       85      36    42.4
Other                                        142      137       5     3.6
Total                                   $  1,354  $ 1,209  $  145    12.0

Non-interest Expense

Non-interest expenses increased $457,000 or 11.7%, for the first three months of 2009, compared to the same period in 2008. The increase in salaries and employee benefits of $140,000 is due mainly to annual merit increases and increases in incentive pay accruals.

Other expense increased by $383,000 primarily due to an increase in our FDIC deposit insurance assessments. Through the first three months of this year, we have expensed $375,000 for FDIC assessments compared to only $13,000 last year. In 2008 we recognized approximately $209,000 in credits as a result of the Federal Deposit Insurance Reform Act of 2005. Credits related to this legislation were fully utilized by the end of 2008. Due to the recent strain on the FDIC deposit insurance fund, the FDIC has proposed an additional, special assessment of up to 20 basis points on all financial institutions. As such, we anticipate even higher premiums in the second quarter.

Professional fees decreased $50,000 due to non-recurring costs in 2008 surrounding branch expansion activities. The $23,000 decrease in furniture and equipment is due to assets becoming fully depreciated.

The following tables reflect the breakdown of non-interest expense and professional fees as of March 31, 2009 and 2008:

                               Three months ended
                                    March 31,           Change
(in thousands)                    2009      2008    Amount     %
Salaries and employee benefits   $  2,296  $ 2,156   $  140      6.5
Occupancy                             321      314        7      2.2
Furniture and equipment               110      133     (23)   (17.3)
Professional fees                     131      181     (50)   (27.6)
Other                               1,514    1,131      383     33.9
Total                            $  4,372  $ 3,915   $  457     11.7


                               Three months ended
                                    March 31,           Change
(in thousands)                    2009      2008    Amount     %
Other professional fees            $   72   $   99  $  (27)   (27.3)
Legal fees                              8       27     (19)   (70.4)
Examinations and audits                51       55      (4)    (7.3)
Total                             $   131   $  181  $  (50)   (27.6)

Provision For Income Taxes

The provision for income taxes was $645,000 for the three-month period ended March 31, 2009 compared to $561,000 for the same period in 2008. The increase is attributable primarily due to an increase in taxable income of $409,000 for the comparable periods. Through management of our municipal loan and bond . . .